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Book Review
Examining the story behind inflation in Egypt
BY RASHAD MAHMOOD
What Drives Prices in Egypt? An Analysis in Light of International Experience
Edited by Hanaa Kheir-El-Din
AUC Press
What Drives Prices in Egypt? An Analysis in Light of International Experience, edited by Hanaa Kheir-El-Din, is a refreshing reminder of the time when it was possible to read about macroeconomics without the phrase “global economic crisis” or its variants repeatedly appearing in text. Based on research papers presented at a 2007 conference and published in October, the book examines price levels in Egypt from a number of angles. While the book is of most use to policymakers, scholars and professional economists, chapters examining the accuracy of the consumer price index, inflation targeting and wage-price causality may be of wider interest.
Kheir-El-Din’s introduction offers an excellent overview of contemporary thinking on what drives changes in prices and their impact on economic growth. Perhaps the biggest lesson from the book is that moderate inflation at the macroeconomic level is not necessarily a bad thing. According to research by Kheir-El-Din and Hala Abou Ali in Chapter 3, an inflation rate of more than 12 percent imposes costs that begin to hurt economic growth. At lower rates, however, inflation may not have a strong negative or positive impact. Hence, the authors recommend the Central Bank of Egypt (CBE) target an inflation rate of 9-12 percent. Based on further analysis, Kheir-El-Din states that if there is a point at which inflation hurts growth, Egypt has yet to reach it. However, a modest target is important since inflation inflicts costs both on people with fixed incomes and businesses, which are forced to continuously revise prices upward.
Currently, the CBE is in the process of shifting from an exchange rate target to an inflation target. In Chapter 4, Rania Al-Mashat explains: “The exchange rate has been abandoned as the nominal anchor, and price stability has been declared the overriding policy objective.” She assesses Egypt’s preparedness for inflation targeting by comparing it to developing countries that have adopted the policy. Requirements include a strong fiscal position and entrenched macroeconomic stability, a well-developed financial system, central bank independence with a mandate to achieve price stability, an understanding of the channels between policymaking and inflation, a sound methodology for devising inflation forecasts, and transparent policies to build accountability and credibility. It is quite the laundry list – albeit not all-inclusive, as the author points out – and one that Egypt seems unlikely to meet anytime soon.
Yet Egypt is better off than might be expected. Al-Mashat concludes that significant progress has been made since Egypt decided to shift to an inflation-targeting system. Compared to developing countries that have adopted inflation targeting, for example, Egypt has below-average inflation and slightly above-average real gross domestic product (GDP) growth, and it is one of the few countries running a current account surplus. Additionally, the banking law of 2003 granted the CBE more independence and introduced regulations that eventually led to Standard & Poor’s debt rating of Egypt as BBB-, or a medium-class borrower. Al-Mashat argues that the successful floating of the Egyptian pound demonstrates the government’s commitment to an inflation-driven monetary policy. She also praises the development of the CBE’s ability to conduct open market operations, which allow it to buy and sell securities to fine-tune the inflation rate.
Al-Mashat keeps the discussion of Egypt’s fiscal position short, highlighting that it is perhaps the weakest of the pillars of inflation targeting. Compared to other developing countries in the years before they adopted inflation targeting, Egypt is in the worst fiscal position. From 2003 to 2006, Egypt averaged a deficit of 9.1 percent of GDP; the next highest on the list was Brazil, at 7.7 percent, and the average across all the countries was 2.8 percent.
Despite significant reforms in tax collection and attempts to decrease total government spending by reducing subsidies, the government’s fiscal position remains rocky. The government ended the first quarter of FY 2009-10 with over LE 611 billion in debt. In FY 2008-09, it had a deficit-to-GDP ratio of 6.6 percent. However, that was significantly better than the period 2003-06 and includes one-off stimulus spending. Therefore, it appears that Egypt is slowly improving its finances and moving closer to being prepared for inflation targeting.
Al-Mashat sees the lack of transparency in monetary policy and of detailed macroeconomic data as problematic. Regarding transparency, Al-Mashat says, “compared to other IT [inflation targeting] countries, there is a wider scope for improvement in this area for Egypt.” Still, Egypt’s publication of macroeconomic data has increased. The CBE now presents more detailed information than it did in 2007, when the research was conducted. Al-Mashat concludes that “the CBE has taken many important steps to upgrade Egypt’s monetary policy,” but “a number of outstanding issues need to be addressed before Egypt will be ready to adopt a fully fledged inflation targeting framework.”
Another chapter of interest discusses the impact of the budget on inflation. Chapter 4, by Omneia Helmy, focuses on the causal relationship between Egypt’s debt and inflation. Unfortunately for Egypt, she concludes, “targeting macroeconomic stability could be problematic in the context of a weak fiscal position.” The government finances its deficit in two ways: by issuing bonds and treasury bills, or borrowing from the CBE. But when the government borrows from the CBE, it is increasing the money supply and adding inflationary pressure to the pound, while lending securities to banks crowds out lending to the private sector. The government is forced to keep the interest rates on its securities competitive, which leads to shifts in lending from the private to the public sector. Fortunately, not all is doom and gloom. If Egypt continues to slowly address its budget deficit and real GDP growth continues, it will mitigate the effects of government debt.
A topic near and dear to the hearts of business owners is wages. In Chapter 6, “Wage-Price Causality in the Egyptian Economy (1990-2005),” Hala Fares and Alaa Ibrahim examine the ties between increasing wages and changes in inflation. The two most prevalent theories of inflation attribute rising prices either to growing demand along with an increase in the money supply or rising prices of essential commodities.
The authors find that inflation is mostly caused by “factors other than wages, including supply shocks, such as cuts in oil subsidy, or expansionary monetary and fiscal policies, or imported inflation.” One technique that many countries use to deal with inflation is wage indexation, or tying wage growth to some measure of inflation. However, the authors caution that in Egypt, where a majority of workers do not have formal contracts (such as agricultural workers, part-time private sector employees and informal sector labor), if some wages are inflation-adjusted and others are not, income inequality increases. To counter this, the authors call for a minimum wage law and a new legal framework that guarantees workers’ rights. However, they acknowledge that this would lead to inflationary pressures, and advocate a “wise monetary policy” to deal with the problem.
Overall, What Drives Prices in Egypt? is a strong work of scholarship that brings together some of Egypt’s brightest macroeconomic experts. While the logic and rigor of the analysis seems strong, however, the policy conclusions of each section sometimes seem like afterthoughts. Moreover, their implications do not appear fully considered. For example, in Chapter 6 on wage-price causality, the authors neglect to mention that their recommended minimum wage would likely exacerbate unemployment. Likewise, attempts to limit inflation, which many of the authors discuss, can slow economic growth.
It is worth remembering that the questions addressed in the book are genuinely difficult ones. There are no easy answers, but What Drives Prices in Egypt? at least provides a strong background for anyone who wants a better understanding of where Egypt’s economy is coming from and where it is likely going.
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