Al-Ahram Weekly On-line 23 - 29 November 2000 Issue No.509
Published in Cairo by AL-AHRAM established in 1875

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To float or not to float

By Niveen Wahish

The CBE has a tough job at hand photo: Sherif Sonbol

Over 100 economists and monetary and financial experts gathered this week in Cairo for a conference organised by the Egyptian Centre for Economic Studies (ECES) on "Monetary and exchange rate policies: options for Egypt." As the organisers of the conference put it, the findings of the conference are not the ultimate solution.

But looking into the pros and cons of the various forms of exchange rate regimes may provide guidance to the government before making a decision.

One thing which participants were unanimous about was, as Taher Helmi, ECES chairman, said, "It is not easy to make a decision on exchange rate policy. There is no universally appropriate option for all countries at all times."

Mohamed El-Erian, managing director of Pacific Investment Management Company, said, "There simply is no answer" for what the optimal exchange rate regime may be.

Commenting on the current economic situation in Egypt Helmi said that Egypt is "suffering growing pains" through which every emerging economy passes.

On a similar note, John Williamson, senior fellow of the Institute for International Economics, stressed that "Egypt is not an economy on the brink of crisis," but it is not an economy "that is fully exploiting its potential" either.

But investors who will pump in the funds and propel growth, need a coherent framework for monetary and exchange rate policy. And as Taher Helmi put it, what is needed is an exchange rate regime that is "clear, consistent and transparent."

So far, as Ahmed Galal, Director of the ECES, pointed out, it is not clear which way the government is heading with the exchange rate regime. The government has let the value of the pound slide from LE3.4, which it had maintained for around eight years, to LE3.9. But it is not giving any signal on how it will proceed in the future.

Howard Handy of the Institute of International Finance, described the Egyptian government's intervention as "continuing to rely on non-market-based solutions to the problem and there is little response to market pressure through market-based instruments." This, according to him, brings out the need for a more flexible market with a responsive monetary and exchange rate policy. To this end, Handy suggests enhancing the instruments of monetary policy available to the Central Bank (CBE). To achieve this he said in his paper to the conference that the interest rate should be allowed greater flexibility and "decisions to enter the market for purposes of monetary management should rest with the CBE, rather than the Finance Ministry." Handy also called for decentralising and privatising the financial system as a means of modernising it. He lamented the fact that "bank privatisation has been put on the shelf." Handy also said that there is a need for enhancing transparency while improving the regulatory system.

The difficulty of choosing an exchange rate regime and the costs of a wrong decision were a focal point made by the speakers. Several options were laid out. Mohamed El-Erian, managing director of PIMCO and Mahmoud El-Gamal, professor of Islamic economics, presented a paper to the conference wherein they compared between the application of a fixed exchange rate which they term as a nominal anchor, and a flexible exchange rate wherein a target inflation rate is the focus, in five Arab economies. They say that although a nominal anchor is desirable to stabilise inflation it has its shortcomings because it reduces policy freedom, uses up reserves as a shock absorber, and is vulnerable to speculative attacks. The inflation targeting flexible exchange rate policy provides a commitment for long-term price stability. It involves public announcements of the inflation target, needs CBE autonomy, appropriate accountability and transparency procedures, a better regulated and supervised domestic financial market as well as greater information dissemination.

El-Gamal and El-Erian caution that Arab countries should not wait for a crisis situation to make a hasty decision of transition from one regime to another, because, according to them, a crisis would undermine the confidence they wish to establish in the new regime.

As El-Erian pointed out, domestic and international challenges are increasing and becoming more complicated. He suggests that the experience of other emerging markets suggests that Arab economies have to choose greater exchange rate flexibility.

Andres Velasco, of Kennedy School of Government, Harvard University, presented a similar point of view. In his paper to the conference he points out that over the past two decades an increasing number of developing countries have been moving towards an exchange rate regime that entails flexibility. He cited the recent crises which "left many economies with no alternative but to float."

But not everyone is an advocate of the fixed or the flexible regimes. John Williamson of the Institute for International Economics is in favour of an intermediate regime. He said in his paper to the conference that such a regime "allows policy to be directed to limiting misalignments, which is something that cannot be claimed by either of the corners." He explained that fixed rates allow currencies to become overvalued or undervalued, while the floating rates lead to sharper misalignments.

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