8 - 14 March 2001
Issue No.524
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Al-Ahram Weekly On-line 8 - 14 March 2001 Issue No.524 |
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Pound off centre
By Niveen WahishRecently two people entered a currency exchange company, one wanting to sell dollars and the other wanting to buy. The one who wanted to buy was refused the entire sum of dollars he requested, and the one who wanted to sell thought the rate was too low. In the end the pair left and completed the transaction between themselves in the street.
This incident epitomises the problems existing in the currency exchange market despite the new system adopted by the government in late January. This new system places full regulation of the exchange market with the Central Bank of Egypt (CBE). The system, dubbed a "managed float," involves fixing a base rate using the weighted average of foreign exchange transactions over three weeks. From that central figure, the exchange rate is allowed to fluctuate within a margin of one per cent in each direction.
While the principles of the new system have been applauded by experts, its application has so far been unsuccessful. In an attempt to explore where the system may have gone wrong, a seminar was recently organised by the Egyptian Centre for Economic Studies (ECES).
According to Ahmed Galal, executive director of the ECES, since the new system has been in place the situation has improved considerably compared to six months ago. In fact, Galal said, the system Egypt has chosen "is the closest to meeting its needs for the time being," although it could do with some improvements. And it should be viewed as a temporary rather than permanent solution.
Galal is not alone in this view. Mahmoud Abdel-Aziz, chairman of the Commercial International Bank (CIB), also believes that the new system needs some modifications. To begin with, Abdel-Aziz asserted, the CBE should have started with a higher base rate than the LE3.85 it specified when it launched the new system because "it is unrealistic." To have chosen a more realistic rate would have enhanced efficacy in implementing the new policy, "And it would have enabled the government to control demand more effectively," he said.
What happened was that when people found that the price of the dollar was cheaper than it had been for some time, many took the opportunity to buy. Thus the system has been ineffective in halting the dollarisation process by which individuals increasingly prefer to convert their savings to the hard currency.
The low base rate is not the only problem; there is also the issue of the margin by which the pound is permitted to fluctuate. Abdel-Aziz, for one, sees this as too narrow. For his part, he sees no harm in letting go of the value of the pound a little. "There is nothing wrong with a little inflation," he said
Galal, too, believes that an inflation rate of up to five per cent is acceptable for Egypt. "It is mainly imports that will become more expensive, thus [a slight increase in inflation] will not affect the products which most people need."
Such shortcomings have meant that the new system has failed to reassure the public and there is still unmet demand for the dollar. To solve this, experts are unanimous in suggesting that the CBE must either pump more dollars into the market or allow the pound to fluctuate within a wider margin.
Trust in the system is a key element for its success. Mahmoud Abul-Oyoun, deputy CBE governor, in addressing members of the German Arab Chamber of Industry and Commerce, had said last week that if the government's monetary policy is to be effective it must have the support of businessmen and the general public. In fact, according to CIB's Abdel-Aziz, 30 per cent of the drop in the value of the pound is attributed to the lack of public confidence.
During the ECES seminar, Galal also offered his view about the reasons Egypt should steer clear of adopting a policy that either fixes or allows the exchange rate to float. Rigidly fixing a currency to the dollar, said Galal, effectively means that the government renounces its control over monetary policy when this can be used as a tool to manoeuvre the economy through a recession or period of high inflation, for example. Such a policy is also unsuitable, said Galal, because it requires public confidence that the government will maintain the policy without wavering. Thus, if the economy's fundamentals do not permit the fixing of the exchange rate for the long term, investors will act on the assumption that sooner or later the government will backtrack on its policy.
The fixed rate system, which was in place until last year, was suitable for Egypt, according to Galal, until 1998, but became too costly to maintain thereafter. To continue such a policy now would require that interest rates return to the levels they were at during the early 1990's -- that is at approximately 20 per cent. Raising interest rates to that level "would destroy everything we have worked for and would halt further investments," Abdel-Aziz said.
A floating exchange rate is also unsuitable for Egypt, said Galal, because it could lead to an "overshooting" of the currency, or an exchange rate that is higher than it actually needs to be. Similarly, it contributes to making the currency highly volatile -- something that is not healthy for investments.
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