How has Egypts exchange rate regime affected its ability to achieve its macroeconomic

goals?
The Egyptian economy has caught news all over the world because of its exchange rate crisis
over the past couple of years. Egypt has been struggling with a major problem in the
devaluation of their currency in the market. Egypt has currently switched from a fixed exchange
rate to a floating exchange rate as an attempt to fix this crisis. This essay will discuss to what
extent a fixed exchange rate is better than a floating exchange rate in relation with the Egyptian
pound.

An exchange rate is the value at which one currency can be sold or exchanged for the currency
of another country. The whole world use to operate with one large exchange rate regime, the
value of currencies were tagged to the value of gold. A demand for a currency is determined by
anybody which would like to buy the currency. The supply of a currency refers to anyone in
possession of the currency and is willing and able to sell it, not just the producers of the
currency or the central bank.

When the value of a currency rises, this is called appreciation. The appreciation of a currency is
caused by increased demand for the currency and that will drive its value up. When the value of
a currency falls it is called depreciation and it is caused when the demand for the currency
decreases.

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As seen in figure 2 there is a shift of the demand curve to the right which shows the increase in
demand for the currency. Subsequently a new equilibrium is reached as 1.44 which shows the
increase in the price of the currency from 1.20 to 1.44. Then on the diagram on the right there is
an increase in

Egypt Context:

Devalued in november 2017

Egypt was having troubles with its exchange rate after the revolutions that they had and the
changes in presidency. The central bank has free floated the egyptian pound on november 3rd
2016 this has caused the value of the egyptian pound to depreciate. The Egyptian pound has
been catching the news as it is severely depreciating once the central bank free floating it.
Egypt is suffering an inflation and the people of the country are severely suffering from the
flotation as all imported goods have become more expensive. The fixed exchange rate that
Egypt had had caused an imbalance as the true value of the egyptian pound was not portrayed
in it’s market value. There was a presence of a black market as the central bank was not
receiving enough dollars as there was a black market for exchanging dollars for the real value of
the egyptian pound. This made the central back have a very low stock of US dollars and foreign
currency, so then the central bank was forced to float the currency. After floating the exchange
rate they have also closed down all the exchange shops in the country so that now whenever
anyone wants to exchange money they will have to go to the bank.

Theory of Fixed Exchange Rate:

A fixed exchange rate is a country’s exchange rate regime, where the central bank or
government pegged the official exchange rate value with another country’s or with the price of
gold. The purpose of having a fixed exchange rate is so that it can keep the country's value
between a certain band and so it can prevent it from fluctuating and creating instability. “Fixed
rates provide greater certainty for exporters and importers, which also helps the government
maintain low inflation, which in the long run will tend to keep interest rates down and stimulate
increased trade and investment.”(Investopedia) Most major industrialized economies such as
the United States and Russia have had floating exchange rate systems since the 1970s yet the
developing countries tend to fix their exchange rate.

Theory of Floating Exchange rate:

A floating exchange rate is a country’s exchange rate regime where it is the exchange rate
between two currencies at any given time. It is set by the forex market which is based off of
supply and demand of the currency. “Floating exchange rates often have a domino effect on a
country’s balance of trade, for instance if a domestic currency devalued compared to other
currencies then it will require more of that currency to pay for imported goods.”(Investopedia)
This makes imports more expensive in the country so then consumers will switch to purchasing
domestic goods as they are cheaper. This procedure reduces the demand for imports which
then changes the country's balance of trade from a deficit to a surplus. A surplus balance of
trade will not only make the country more self sufficient but will also cause the currency to
appreciate in relation to other currencies, thus making imports cheaper. The countries of the
world's major economies allowed their currency to float after the collapse of the Bretton Woods
system in 1971. (See Appendix C)

There are certain factors which affected the exchange rate of the egyptian pound:

Foreign demand for Egypt’s exports:

Demand for Egypt’s exports was gradually decreasing over the years as of their growing
population. “As population grows, the amount of land needed for housing and businesses rises,
and the amount of land for agriculture falls. So Egypt can produce less of its own food, as time
goes on.”(Business Insider) This meant that Egypt couldn’t keep up with the foreign demand so
countries started looking for other providers for fruits and vegetables. A major thing that led to
the decrease in the demand for Egypt’s exports was the Government's decision in ending the
subsidy for cotton growers. This subsidy was the difference between breaking even and making
losses for the cotton growers so then once the government ended the subsidy people
reallocated their land into growing something else that was more profitable. As the market for
cotton is one in perfect competition the market adjusted and firms have exited the market so
now there are fewer firms in the market and they are all making normal profits. This affected
Egypt as there was a high demand by foreign markets for Egyptian cotton which no longer could
be met as there are less farmers growing cotton. The demand for Egypt exports kept going
downhill and in 2015 Saudi Arabia stopped importing from Egypt after they declared that the
vegetables that Egypt exported were “Unsuitable for human consumption”(Arab News) As the
farmers in Egypt were irrigating their vegetables with polluted water and that caused their
vegetables to become inedible. Medhat Nafea an Egyptian economics expert said that “Egypt’s
exports are currently at their worst conditions,” All of these events have caused the value of the
Egyptian pound to depreciate as foreign demand for exports is decreasing means that there are
less countries that are buying goods with the Egyptian pound so this decreases the demand for
it which causes it to depreciate.

Domestic demand for imports:

“Egypt is reported to be the world’s largest importer of wheat. In 2010, the oil minister stated that
Egypt imports 40% of its food, and 60% of its wheat.”(Business Insider) This shows that Egypt is
not self sufficient as they import 40% of their food. This means that they are converting Egyptian
pounds into foreign currency to buy their food so they will be raising the supply more than
proportionately to the demand, subsequently this will cause the value of the Egyptian pound to
depreciate as there is a higher supply the price decreases.

Relative interest rates:

Relative interest rates affect the exchange rate of a currency. An interest rate is a return on
investment by investors, a higher interest rate in foreign country rates will attract investors to
invest their money there. A higher interest rate will cause an appreciation for the currency as the
demand for it has increased.

Relative inflation rates:

Relative interest rates have an affect on the value of a currency as if the inflation rate in the
country is faster than outside then exports will lose competitiveness as foreigners would need
more foreign currency to purchase the same good or service. This means that a higher inflation
rate would result in people selling the currency which would increase the supply which will force
the value of the currency to depreciate.

Investment from overseas in a country’s firms:

Investments across countries is in one of two ways: foreign direct investment or portfolio
investment. Foreign direct investment is the purchase of at least 10%of a business entity by a
foreign firm. Portfolio investment is the purchase of financial capital for example derivatives,
bonds or foreign exchange. When investments from overseas increase this will have a positive
correlation with the demand of the currency. Demand of the currency will rise as the investors
will have to purchase the currency so that they can invest in the country.

Speculation:

Speculation plays a major role in currency values as people have the ability to bet on the future
price of currencies. Traders usually make knowledgeable decisions in the currencies that they
want to invest in and this plays a role in society as if people speculate that the value of a
currency will go down, the demand for it will start to decrease and the supply will increase
rapidly as people will try to sell the currency before it depreciates.

Egypt was having troubles with it exchange rate after the revolutions that they had and the
changes in presidency. The central bank has free floated the egyptian pound on november 3rd
2016 this has caused the value of the egyptian pound to depreciate. The Egyptian pound has
been catching the news as it is severely depreciating once the central bank free floating it.
Egypt is suffering an inflation and the people of the country are severely suffering from the
flotation as all imported goods have become more expensive. The fixed exchange rate that
Egypt had had caused an imbalance as the true value of the egyptian pound was not portrayed
in it’s market value. There was a presence of a black market as the central bank was not
receiving enough dollars as there was a black market for exchanging dollars for the real value of
the egyptian pound. This made the central back have a very low stock of US dollars and foreign
currency, so then the central bank was forced to float the currency. After floating the exchange
rate they have also closed down all the exchange shops in the country so that now whenever
anyone wants to exchange money they will have to go to the bank.

There are pros of this government intervention. When the government floated the exchange rate
this automatically showed the true value of the egyptian pound as now the value was portrayed
through market forces. This also had a positive effect as it has caused the bank to build a great
stock of foreign exchange which they didn’t have before. This move made egypt decrease
importation because of prices, this also caused egyptians to invest more in their country as
investing abroad would be a lot more expensive. This made egypt a lot more self sufficient and
this is slowly growing the economy again.
Although there are pros to floating the exchange rate there are also the cons. A major thing that
this government intervention has caused is that it has caused inflation in the economy as
everything got more expensive over night. This has also triggered a source of disequilibrium
within markets as thanks to speculation producers would put high prices on goods or services
as they thought the value of the egyptian pound will continue to depreciate. As egypt was
already suffering as an economy, floating the exchange rate only made it worse for low income
earners as now they were struggling greatly. The cost of living has increased yet the wages are
still the same so people are taking a change to the worse.

Although egypt currently have a free floating exchange rate they previously did have a fixed
exchange rate. This fixed exchange rate had a lot of pros on the economy, it avoided currency
fluctuations, which then allowed firms to trade easily as they didn’t have to bear the risk of
appreciation or depreciation in the exchange rate which can then affect their overall profit. “By
controlling its domestic currency a country can – and will more often than not – keep its
exchange rate low. This helps to support the competitiveness of its goods as they are sold
abroad.”(Investopedia) By keeping the exchange rate low this allows costs of production to stay
low and when exported this guarantees profits back home. A major pro that comes with fixing
the exchange rate is that it lowers inflation in the economy and this encourages investment in
the country as prices will remain stable.

There are lots of cons though about the fixed exchange rate which caused the egyptian
government to free float it. The fixing of the exchange rate gave the US Dollar a a value that
was less than its real value when compared to the egyptian pound. This started the rise of the
black market which took over in Egypt greatly as people took the real value of the US Dollar and
were trading it in the black market for Egyptian pounds. “Nothing is worth more than somebody
is willing to give for it. Thus, if the black market (for which read free market) value of the
Egyptian pound was £18 to the dollar then that's just what an Egyptian pound was worth. The
government promising to buy and sell them for 8.88 just wasn't going to work. Sure, it could be
done for some time but the longer it went on the more the Egyptian government was going to
lose and the poorer the Egyptian people were going to be. This is always true of price fixing, it
makes people poorer.”(Forbes) This also had an incentive for Egyptian people to quit their job
and buy a large reserve of US Dollars and then sell them after a period of time and make profit
as the value of the Egyptian pound in the black market was decreasing over time yet market
prices in Egypt were still the same. This caused corruption in the economy as lots of people
were quitting their jobs and this was disrupting the economy.
https://www.forbes.com/sites/timworstall/2016/11/03/egypts-extremely-sensible-decision-to-float-
the-pound-greece-should-take-note/#177a88b02f0a

http://www.investopedia.com/articles/forex/08/pegged-vs-floating-currencies.asp

http://www.investopedia.com/terms/f/fixedexchangerate.asp

http://www.dailynewsegypt.com/2017/01/24/reason-behind-rise-egypts-foreign-currency-reserve
s-remain-unknown/
https://history.state.gov/milestones/1969-1976/nixon-shock