Is there a chance the Central Bank of Egypt could begin cutting interest rates when its monetary policy committee meets tomorrow? Possible, but unlikely, says Simon Williams, HSBC’s chief economist for Central and Eastern Europe, the Middle East, and Africa, arguing that a cut at this point “would be premature … given the stress placed on restoring monetary policy credibility in the March IMF program and the importance of anchoring the new FX regime.”

Headline inflation came in at 32.5% last month compared to April 2023 — and was up just 1.1% month-on-month. A second month of muted m-o-m inflation “gives comfort that the pass through from FX weakness (in the parallel FX market in the first weeks of the year and then in the official rate in March) is now complete and that price expectations have started to stabilize,” Williams wrote in a note to clients. “These signs of stability suggest the CBE may soon consider starting to reverse the 800bps of hikes delivered in the first quarter of the year. But if this cycle is going to be different to those that went before, it’s critical they don’t move too soon.”

The business community needs to see rates come down — and so does the state treasury. High rates have ballooned the government’s debt-service burden (it now accounts for north of 60% of revenues) and have caused corporate borrowing to almost entirely dry up.

We caught up with Williams ahead of his visit to Cairo this week to talk rate cuts, what his clients are asking about Egypt, and how he sees things unfolding from here. Below are edited excerpts from our conversation:

ENTERPRISE- How do you feel about Egypt right now?

SIMON WILLIAMS- The acute stress has passed. That's a reflection in large part of the scale of the bilateral and multilateral funding that came through, but also of the policy measures taken by Egyptian officials. You can see that relief in financial markets and in the financial flows. That said, I'm also very conscious that we're still in the early stages of the adjustment process — and that we have to go through a rebalancing before we can start talking about recovery. That’s going to take time, given the substantial remaining structural challenges, particularly in public finances.

We’re seeing signs that price stability is being established and we could see inflation dip below 20% by 1Q 2025. But it’s going to take some time for the new FX regime to bed-in — for onshore and offshore businesses and investors to be comfortable. But this much is clear: Initial policy steps have been positive, and there is now a path forward. Still this is a long process, and we’re very much at the beginning.

E- How long does it take?

SW- It takes a while. If you look at our forecasts, we've got growth starting to pick up next calendar year — though maybe it comes through a little bit earlier. Inflation should fall to the mid-teens level in annual terms once the base effect hits in 1Q. But there's still a lot of work to do to rebalance the economy, and that rebalancing is important to confidence domestically and abroad. This rebalancing of the economy and the broader structural environment are key — it’s not just about the pace of growth that Egypt can generate, but the quality.

E- How do you feel about the FX regime right now?

SW- It’s moving in the right direction. The EGP seems to have found its level somewhere between 45 and 50 to the USD. But we need to see that this new regime has legs — we need to see what a flexible FX regime means in an Egyptian context, and how the currency responds the next time it's stressed.

E- Are you concerned we’ve just re-pegged?

SW- I don’t think so, no. But we need to see how it plays out, and the answer is being closely watched onshore and offshore. Investors need to see that the EGP moves in both directions and to adapt to the notion that the EGP can weaken or strengthen over time in reaction to macro and other developments.

E- What are you watching for now?

SW- Remittances, certainly. They’re much more important to the long-term health of the balance of payments than portfolio flows. Pressure on Suez earnings is clearly going to last and I need a better sense of how far the energy balance may deteriorate.

E- Let’s move to public finances. The Madbouly government has promised to bring all government spending onto the budget over a period of five years. And that’s key — we think there could be more state spending going out (and more revenues flowing into the treasury) off the budget than there is in the budget as it stands. It will be interesting to see what they bring into the budget and when. And what the exceptions might be.

SW- A key part of the IMF program is to consolidate public finances into a single budget, and we look forward like everyone else to seeing what that number looks like.

But clearly the big pressure on public finances is debt service. Compared to 20 or so emerging markets I cover across the Middle East, Africa and Europe the cost of servicing Egypt’s debt right now is exceptionally high. A rising primary surplus and recovering growth should see the debt stock fall, but those large interest payments will slow the pace of adjustment, keep the headline deficit high and leave Egypt vulnerable to any developments that impair access to funding.

E- How closely are you watching the privatization process?

SW- We should see more asset sales over the rest of this year and into 2025. But privatization was supposed to be a tool for driving structural change rather than just generating revenue, and here there has clearly been a shift in emphasis toward controlling off-budget capital spending. I really like this change in focus, but it’s going to be tough to deliver.

Restoring stability, re-establishing confidence in the currency, and renewing policy credibility are pre-requisites for recovery. But these steps have to be coupled with measures that persuade the private sector at home and overseas that there is an environment emerging where they can invest on equal terms with other actors. Start to get that right, and the potential is clear, not just for strong growth, but growth that is FX generative, whether from much higher exports of goods and services, or stronger levels of FDI in everything from oil and gas, to tourism, renewables, manufacturing, and industry.

The bottom line: That needs to take place in an environment in which macro balances are healthy, where we understand how the currency works, in which we understand how public finances work, and where we can have confidence in price stability. That allows an environment in which private capital sees scope for returns and has confidence that they can compete on equal terms. We’ve seen a big drop-off in private-sector capital formation since 2011.

E- What do you make of the price control initiatives officials have been pushing since the float?

SW- I think the market sets prices. Regulation could have an impact in the short term, but it’s about the market, about supply and demand.

E- You’ve talked about merchandise and service exports as being key to high-quality growth. What sectors do you have your eye on?

SW- It’s clear that Egypt has so much room to do more — it has all the competitive advantages. The geographical position, the natural resources, the trade agreements. There are new cost advantages to operating out of Egypt. While I’ve been very happy to see strong tourism numbers, I also think there’s plenty of room to broaden the base of industrial manufacturing.

E- Last we spoke, you said clients had significant interest in Egypt. How is that holding up?

SW- Interest is certainly very strong. I’ve seen a lot of institutional investors in Europe and Asia since the IMF agreement was signed, and just got back from a week in the US. There are a lot of questions, but confidence in the near-term outlook is good and there is conviction that the returns compensate them for the risks they are running. But doubts over the longer-term outlook are still high; investors argue that recent experience means it’s incumbent on Egypt to show things have really changed. No one is taking it on trust.

Foreign investors are perhaps more accustomed to FX volatility than are domestic companies — if you invest in Turkey or South Africa, you’re accustomed to it. But what no foreign investor can risk is the imposition of capital controls.

Obviously, there’s a lot of talk right now about interest rates with portfolio investors looking at local-currency debt assets, but the conversations with corporates and equity investors are at an earlier stage.

E- So what do you see happening next?

SW- We’ve had the relief phase, which has been made possible by large scale financial support and movement on key policy issues, particularly FX. But to turn that into lasting recovery is many ways more challenging and requires long term focus on the imbalances that left Egypt so vulnerable in recent years. That’s partly about addressing the imbalances in the external accounts, in price stability, and on fiscal stability. But it's also about establishing confidence in how policy works and in creating room for the private sector. It’s going to take policy commitment, it's going to take time.

Get it right, and Egypt becomes one of the most compelling emerging market stories out there.