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Cablegate: Inflation Rises Again

VZCZCXYZ0003
RR RUEHWEB

DE RUEHEG #0282/01 0441610
ZNR UUUUU ZZH
R 131610Z FEB 08
FM AMEMBASSY CAIRO
TO RUEHC/SECSTATE WASHDC 8155
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC 0379

UNCLAS CAIRO 000282

SIPDIS

SIPDIS

STATE FOR NEA/ELA, NEA/RA AND EEB/IDF
USAID FOR ANE/MEA MCCLOUD AND DUNN
TREASURY FOR MATHIASON AND CONNOLLY
COMMERCE FOR 4520/ITA/ANESA/OBERG

E.O. 12958: N/A
TAGS: ECON EFIN EG
SUBJECT: INFLATION RISES AGAIN

REF: A. Cairo 0150 B. Cairo 0152

-------
Summary
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1. (U) Inflation increased to 10.5% year-on-year (y-o-y) in
January, up from 6.9% y-o-y in December. The Central Bank responded
by raising interest rates 25 basis points (bp) on February 7,
defying expectations that rates would remain unchanged in order not
to slow economic growth. The Central Bank cited food inflation as
the main concern prompting the hike. Food inflation caused large
public demonstrations in January (ref A). On a visit to local
markets, staple prices, excluding cooking oil, had not increased
since our last visit (ref B), but vendors expected to raise prices
in the coming week, as wholesale prices increased. Vendors also
lamented a drop in sales of fruits and vegetables. Bakers
complained about the black market for government subsidized flour,
and buyers complained about long lines, short supplies, and smaller
pieces of bread. Given the weak monetary transmission mechanisms in
Egypt, some local economists believe the Central Bank should allow
greater exchange rate fluctuation to control prices, rather than
counting on interest rate hikes to do the job.

---------------------------
Inflation surges in January
---------------------------

2. (U) Inflation rates surged in January according to a report
released February 11 by the Central Agency for Public Mobilization
and Statistics (CAPMAS), the GOE inflation monitoring agency.
Overall inflation increased to 10.5% year-on-year (y-o-y) in
January, up from 6.9% y-o-y in December. The month-on-month
increase of nearly 4% from December to January is the largest since
January 1995. Food inflation jumped to 13.5% y-o-y in urban areas
in January, up from 8.8% y-o-y in December. In rural areas, food
inflation increased to 18.9% y-o-y, up from 12.3% y-o-y in December.
According to the CAPMAS report, the main factor in the increase was
high global food prices, though heating oil increases also
contributed to the higher rate of inflation.

-------------------------
Central Bank Raises Rates
-------------------------

3. (U) The Central Bank's Monetary Policy Committee raised interest
rates at its February 7 meeting by 25 bp, from 8.75% (deposits) and
10.75% (lending) to 9.0% and 11.0% respectively. This is the first
rate change since December 2006. The move surprised financial
analysts, who believed the Central Bank would keep rates unchanged
in order not to slow economic growth. Egypt's economy grew at an
annualized rate of 8.1% in the fourth quarter of 2007, the highest
level since the early 1990s. In raising interest rates, the Central
Bank cited food inflation as the major concern. Rising food prices
spurred demonstrations in a number of Egyptian cities in January
(ref A). For most analysts, including the IMF Resident Rep, the 25
bp increase is merely symbolic, as banks are unlikely to change
their lending behavior due to higher Central Bank rates. However,
Goldman Sachs is projecting more rate hikes later this year.

--------------------
At the Local Markets
--------------------

4. (U) At Shoubra Al Kheima market, in one of Cairo's poorest
neighborhoods, prices of staples such as rice, pasta and beans had
not gone up since our last visit two weeks ago (ref B), but vendors
told us they planned to raise prices next week, as wholesalers had
just increased prices. Cooking oil, on the other hand, had
increased from LE 7 ($1.27) - LE 7.5 ($1.36) two weeks ago to LE 8
($1.45) this week. At Al Tawfikia market in a lower middle class
part of Cairo, vendors told us that buyers have stopped purchasing
fruit and all but the most basic vegetables, complaining that prices
are too high. A private bakery owner echoed stories we heard from
Minister of Social Solidarity Ali Al Moselhi (ref B) about the black
market for subsidized flour. Public bakeries buy 100 kilo bags of
flour for LE 90 ($16) from the government. While using part of the
flour to produce low cost bread, they sell most of it on the black
market for LE 110-120 ($20-22)/bag (Note: This is lower than the
price Al Moselhi quoted us, which was LE 210, or $38).

5. (U) We visited a public bakery in Al Tawfikia, where
approximately 35 people were waiting to buy bread in two lines
segregated by gender. Buyers told us that the bakery allowed people
to cut the line if they were willing to pay more than the official
price of 5 piasters ($.01)/piece of bread. Lamenting the long wait,
buyers said the bakery often runs out of bread before everyone has a
chance to buy. Once public bakeries close, buyers' only recourse is
to purchase bread at private bakeries, where it averages 25 piasters
($.05)/piece. Buyers also claimed that public bakeries were making
pieces of bread smaller than normal, to stretch the small quantity
of subsidized flour the bakeries retain after selling the rest on
the black market. An newspaper article on February 13 claimed that
the Ministry of Social Solidarity (MSS) would raise the price of
subsidized bread to 10 piasters ($.10)/piece in July, but would also
require that each piece weigh 130 grams (Note: This may be a "trial
balloon" by the MSS to gauge public reaction to reduction of bread
subsidies).

-------
Comment
-------

6. (U) The interest rate hike signals GOE awareness of public
concern about high prices, and underlines the Central Bank's policy
focus on fighting inflation. It also demonstrates how Egypt has
weathered the financial problems facing other economies, which are
reducing rates and promoting fiscal stimuli, despite the
inflation-causing effects of those policies. Global prices are
likely to remain high, and abundant liquidity in Egypt's banking
sector has kept domestic credit growth strong. Local economists
point out that to control inflation, the Central Bank would be
better off allowing greater appreciation of the Egyptian pound
against the U.S. dollar, to dampen high import prices. The Central
Bank has carefully managed the exchange rate since late 2004,
allowing only minor fluctuations in a narrow band between LE 5.45/$1
and LE 5.6/$1. Some economist predict the GOE, which is loath to
allow the pound to appreciate, may try to control prices by imposing
more trade-distorting export fees to increase domestic supply, as it
did with rice (ref B).
RICCIARDONE

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