Cablegate: Central Bank of Egypt Releases Core Inflation Index


DE RUEHEG #2082/01 3070914
P 030914Z NOV 09



E.O. 12958: N/A

1.(U) Key Points: -- The Central Bank of Egypt (CBE) released its core inflation index on 25 October. -- Core inflation better reflects underlying inflation and is the statistic that the CBE uses in determining its monetary policy. -- The release of these statistics is a precondition for the CBE adopting a monetary policy of inflation targeting and an increase in trading that will let the market set rates on securities eventually allowing banks and other financial firms to offer long term debt instruments. ----------------------------------------- Core Inflation Index and Detailed Reports -----------------------------------------

2.(U) The Central Bank of Egypt (CBE) released its core Consumer Price Index (CPI) on 25 October. The CBE has looked at core inflation to direct its monetary policy for a few years, but it has now finalized its index and this is the first time the data has been made publicly available. Looking at core inflation instead of headline inflation allows the CBE to use interest rates to target underlying inflationary pressures and avoid overcorrecting for temporary spikes in prices.

3.The index derives from headline inflation but excludes items such as fruits and vegetables, whose prices are highly volatile because of weather conditions and supply disruptions, and goods for which the government regulates prices. By excluding those two categories, core CPI reflects underlying inflation better than headline inflation does.

4.(U) In September, Egypt's headline inflation was 10.8 percent year-on-year (y-o-y), while core inflation was 6.3 percent y-o-y. Core inflation in September was more than 4 percent lower than headline inflation, the largest difference since the beginning of recorded core inflation data in January 2005, according to the CBE,s new inflation report. This is mainly due to high and rising volatility in the prices of fruits and vegetables.

5.(U) The CBE began issuing monthly inflation reports full of detailed statistics and trends at the same time it unveiled its core index. --------------------------------------------- --------------- Insight into Inflation Dynamic and Monetary Policy Decisions --------------------------------------------- ---------------

6.(U) Investors have been asking for the CBE to publicly release its core inflation index for several years because it will help them anticipate CBE monetary policy changes, according to Simon Kitchen, Vice President of EFG-Hermes, a leading regional investment bank. The new index will also allow investors to more accurately forecast inflation trends and factor them into their investment decisions. -------------------- Criticism of Indexes --------------------

7.(U) Some press articles have criticized the new index as meaningless because it excludes almost 30% of commodities whose price increases are felt by most Egyptians. Some investors accuse the CBE of underestimating inflation levels by including the prices of goods kept low by the government in headline inflation in order to make the GOE look good. ---------------------------------- Baby Steps Towards Long-Term Goals ----------------------------------

8.(SBU) Improving inflation statistics is one of the CBE,s prerequisites for eventually adopting inflation targeting as the official monetary policy regime of the CBE. Other requirements include improved GDP growth statistics and reducing the government budget deficit to between 3-4% of GDP, according to Ramez. Ramez also told us that Egypt will need a more mature banking sector before the CBE can adopt an inflation targeting regime. At the moment, credit penetration in Egypt too low for interest rates changes to have significant or immediate effects on economic activity and inflation, according to the IMF.

9.(U) Iman Ismail, Managing Director of the Egyptian Mortgage Refinance Company, told us that this information is necessary for increased trading of fixed income securities. This information will allow investors to anticipate inflation E and interest rate changes and use this information in their investment decisions which might encourage them to trade more and use longer-term instruments. Currently, trading volume of fixed income securities is so low that investors have to rely on issue rates which do not necessarily reflect market conditions. If trading of securities of a variety of maturities increases, the trading will let the market set the securities, rates and ultimately result in a yield curve. This would allow banks and other financial firms to price and therefore widely offer long-term debt instruments, such as mortgages. ------- Comment -------

10.(SBU) The publication of the core inflation index is a welcome improvement in inflation statistics and transparency in monetary policy decisions. This is a good first step towards inflation targeting, but there is still a long way to go. The GOE is unlikely to undertake the unpopular reforms necessary to reduce the budget deficit to 3-4% before the 2011 presidential election. The Egyptian banking sector needs to increase its credit penetration and increase competition to reduce the spread between loan and deposit rates in order to improve the transmission of monetary policy changes to the economy.

11.(SBU) Despite the excitement over the new core inflation index, headline inflation remains the best inflation statistic to help gauge the average Egyptian,s quality of life because it accurately reflects the rising cost of living in Egypt. Scobey

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