Thursday, March 28, 2024 | Ramadan 17, 1445 H
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EDITOR IN CHIEF- ABDULLAH BIN SALIM AL SHUEILI

Depreciation or floating currency, which way to go?

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Lo’ai Batainah -


Lbb_65@yahoo.com -


We have followed recently that the Egyptian government represented by the Central Bank of Egypt and the Ministry of Finance decided to take unprecedented tough economic and financial measures namely the free floating of the Egyptian pound and lifting fuel subsidy. The move comes in a bid to meet the requirements of the IMF to grant Egypt $12 billion worth loan to augment its meagre foreign currency reserves. It also comes as a step in the right direction to attract foreign investments which is a key source for foreign currency.


Floating of the currency is one of the main financial tools used by countries that fix the value their currencies. Floating is thus different from ‘devaluation of currency’ which is decided according to the open market on the basis of supply and demand forces.


The exchange rate for foreign currency is one of the main elements in assessing the macroeconomics of a country. Any change or fluctuation in the exchange rate will affect the income, the production, the employment rates and thus the prosperity levels. It also affects the flow of trade (imports and exports) as well as the demand for financial and real assets of the state.


We are all aware that the value of any currency is decided according to the government policy depending on its gold reserves, debt bonds and foreign currency deposits with foreign banks. The assets are always the cover and the buffer that protects the exchange rate of the local currency.


Contrary to countries like Argentine and Kazakhstan, Egypt is classified as low income country which means that any increase in the foodstuff prices from the floating of the exchange rate will lead to imaginary higher inflation rate. This in turn will have very serious social effects and will lead to more criticism for the government’s economic policies. This social unrest will play a role in hindering the flow of foreign capitals and Foreign Direct Investments (FDI) regardless of the higher interest rates on the local currency.


These steps are very critical for any central bank or government to limit the drain of foreign currency. This drain may lead these governments to buy foreign currency from the black market to finance the purchase of basic goods such as food, medicine and oil derivatives.


During the months that preceded this floating, the Egyptian pound witnessed frequent devaluations almost on daily bases despite the fact that the Central Bank has depreciated the exchange rate and increased the interest rates on deposits in local currency to imaginary levels. These interest rates may be fatal and may push the Egyptian economy to become a dollarized one.


These measures are desired and welcomed by investors especially foreign investors. On the other hand, the measure will alleviate the burden on investors from the weak Egyptian pound and its inability to be resilient before the collapse of the Egyptian economy from the weak oil revenues and Suez Canal fees. Moreover, the financial subsidy and grants provided by the Arab and foreign donors to Egypt have been going backward.


The Egyptian government made steady efforts to activate its economy after what is called “January 2011 Revolution’, still the drain of foreign currency continued. Such situation inevitably led to the measures taken by the Central Bank of Egypt a week ago. The floating of the Egyptian currency will eliminate the need for black market and will augment the investors’ confidence in the ability of the Egyptian pound to recover.


The floating of a currency will lead to having a flexible and active exchange rate that is governed by supply and demand forces. Besides eliminating the need to black market, the move will bring more foreign currency to the local economy and will also help in attracting foreign investments which in turn will boast tourism and export activities.


A number of countries including Egypt and Jordan rely on tourism, agriculture activities and expatriates remittances as major sources for foreign currency. These countries also rely on the subsidies and grants provided by Arab, Gulf and foreign countries including USA, Japan and EU.


The situation has led many countries especially the Arab one to go to international organisations and funds (especially the IMF) to get loans. The weak and low grants pressurized the foreign currency reserves.


The question is will such loans enhance the foreign currency revenues and activate the economic growth at the countries that suffer from the same financial symptoms and problems? I might don’t have the detailed answer about what should be done as many inputs and information are not available like those related to the government plans and programmes, the expenditure, the estimated revenues, the assumptions for assessing such revenues as well as the tax revenues. What I am hundred per cent sure of is that these governments should reduce expenditure especially the capital and non-investment. They need to reduce expenditure on companies that are burden on the state budget.


At the end, the classical theory points out that the depreciation of currency will enhance exports and improve the trade balance due to limiting imports. This applies to Egypt and some Arab countries if their exports are flexible and have the ability to benefit from the competitive edges created by the depreciation or floating of the exchange rate.


Note: A number of financial articles, reports and studies have been used in brief.


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