The Current/Existing Situation
On the 19th of April2018, it was announced by the Egyptian Media that the exchange rate of the US dollar had actually exceeded the 11EGP that was available on the black market. This news led to panic across all the sectors or areas in the Egyptian community. That apart, the Governor of the Central Bank of Egypt, a Mr. Tarek Amer denied any intentions of devaluing the “Egyptian Pound” below the current value existing at the time of 0.11USDand rather laid blame of the US Dollar hike mainly on the informal speculation of markets where the demand emanated from importers who had made attempts that were aimed at Ducking the restrictions of the Central Bank of Egypt which prohibited banks in the country from trading in the US dollars especially in formal markets in order to cover imports of some of the non-essential items or products (Allam et al. 50).
In order to ensure that this problem is resolved CBE recently revised the mechanisms used in the provision of the United States Dollars to majority of the banks in the Egyptian Market. This was due to the fact that initially, the CBE only used the “quote system” in which there was the selling of the fixed volumes of the US dollars at the weekly actions (Breisinger et al. 25). Banks were required through this mechanism to submit requests regarding all the detailed investors to the Central Bank of Egypt after which the CBE created reports regarding the investors and then ultimately ensured that the US Dollars were allocated to the banks.
The allocation of the currency in the products was then only approved by the Central Bank for the relevant imports. CBE beside of using the mechanism also exerted lots of efforts that were aimed at curbing the speculations of the black markets and this was achieved through the devaluation of the currency, closing down of companies that were involved in the allocation of rules on currency exchange, and even eased the restrictions on the dollar deposits especially for figures which ranged from 50,000 to 250,000 USDs for importers of spare parts, machinery, food, medicine, and capital goods while ensuring that the same was maintained for individuals. However, it was quite unfortunate that the actions seemed to have failed since the Egyptian pound continued to depreciate against the United States Dollar (Mahrous et al 352). This eventually led to widespread debates in the Egyptian media regarding the inevitability of devaluation or the floating of the Egyptian Pound.
For an economy which is mainly reliantly mainly on the imports, the devaluation of or the “floating of the Egyptian Pound” was indeed a big NO. This is attributed to the fact that the floating or devaluation was only introduced during the mid-seventies yet the apparent results was actually a dramatic increase in prices of products that led to the burdening of both the middle and the low income earners in Egypt. The first real floating was known to have been executed in the year 1977 by President Sadat and despite the fact that it was the first initial floating, it was implicitly executed in line with other reliable austerity measures which lead in the “1977 Egyptian Bread riots” in which the EGP was known to have lost 50% of the value due to the war spending which occurred as from the year 1967 to 1973 (Elsherif & Marwa 1210). This made the Egyptian government to begin external borrowing so that it covers what was by that time known as the Paris Club Debts.
Floating of the Egyptian pound is known to have been first introduced in the year 2003 when the Egyptian Government that was Chaired by the then Atef Ebied. In the meeting, a decision was made with an aim of floating the Egyptian Pound that ultimately resulted in the depreciation of the Egyptian Pound against the United States dollar by approximately 50%. Initially, the United States Dollar Exchange rate was before the floating of this Egyptian pound 3.40 EGP but however, this rose to 5.50 EGP. The action led to a dramatic increase in the prices of most products. After the occurrence of the Global Financial Crisis that occurred in the year 2008, this situation was further aggravated since Egypt suffered a bad economic setback whose peak was in the year 2011 soon after the revolution that occurred on the 25th of January. This was followed by political instability and unrest that not only led to substantial fall in the tourism rates but also led to the transferring of the foreign exchange, the transfer of the Egyptian experts as well as the revenues in the Suez Canal (Helmy & Essam 42).
Objective and Methodology
The major aim of the paper was to analyze the existing relationship between the rates of exchange and the output of the Egyptian Economy. This study is quite important since it made use of the “Vector Auto-regression Model”. The paper was conducted through the use of the annual data for the country (Egypt) as from the year 1982 to the year 2004.It was indicated that the devaluations had a significant impact on the Output of Egypt. The contractionary impacted lasted for a period of about 4 years in the country before thee expected or desired positive impacts associated with devaluation began to emerge. In addition to that, this study was quite important since it helped in the clarification of the actual exchange rates and the variations which explained a significant part of the actual changes that occurred in Egypt.
Thus this suggested that this could have been too risky and dangerous for an Egyptian government or state to permit the “market forces” to ascertain an actual “value of the Egyptian Pound” especially in contemporary period or times. Intervention thus could have also been required in order to amend any of the undesirable movements which occurred in the rate of exchange (Aly, Heidi & Hosni 550). This could have ultimately continued till the Egyptian economy made full or total transition towards “new flexible” rates of exchange where the “monetary policy” was known to have assumed bigger roles in the stabilization of the Egyptian Economy.
The widely held believe is that the fluctuations in the exchange rate as well as the direct and the indirect impacts play a significant role in the determination of the macro-economic performance of a country like Egypt. The International Monetary Fund or the IMF always recommends the devaluations of currency as being the essence of the “Structural Adjustment Packages” (SAP) especially for nations that are known to suffer from deficits of balance of payments as well as global reserve shortages (Kamar, Bassem & Bakardzhieva 112). Due to that, the devaluations subjects and their related impacts on economic activities have for numerous years attracted lots of attention and debate in the economic literature.
The economic theory is founded on the basis that the devaluation of the currency for a particular country ultimately triggers a mechanism of expenditure switching. In essence, devaluation is responsible for increases in foreign goods that are relative to the domestic products or goods. That apart, it is also important to note that the rising in prices of “foreign output” also directs the “domestic demand” from the imports as well as directs it to the domestic outputs. This thus leads to the stimulation of the “import substitution” production.
A decline in price’s of a given country’s products especially in terms of its foreign currencies leads to an improvement in its global “competitiveness thus boosting” its exports. This leads to enhancement in the nation’s “trade balance” thus acting as a remedy or solution for any of the shortages that may occur on the global reserves (Scope 15). On the other hand, the “expansionary effect” that is associated with the “devaluation on aggregate demand” is highly believed to not only lead to an increase in the output but also a reduction in the unemployment rates.
As opposed to the conventional aspects, substantial research that has been supported through empirical evidence has indeed depicted that devaluation can lead in “contractionary impacts” on the outputs. Even though there may exist numerous reasons on why the issue of devaluation can lead to a decrease in the output growth of a country, the major one is that the rising in the prices of imported and intermediate products due to devaluation also leads to an adverse impact on the country’s production. Devaluations can also result in the increase in the overall price levels thus leading to the lowering of the global competitiveness, a reduction in the aggregate demand, and also a reduction in the real income (Ecker, Olivier, et al. 35).
Devaluation in a country like Egypt is known to lead in the production of the “income redistribution effects” which are usually in favour of groups that have low marginal propensities of consuming like the firm owners and exporters whose profits go on the increase and away from other groups that have high marginal propensities of consuming like workers or employees actual wages decline. This ultimately leads in both a decrease in the “aggregate expenditure” as well as the confidence of foreign investors in the economy. In addition to that, the counter inflationary “macro-economic policies” that are used in the control of inflationary impacts of devaluation reduces output and aggregate demand.
Based on empirical evidence, it was ascertained that there are numerous situations where devaluations resulted in the deterioration of the trade balance. For instance, in the year 1972, the United States “trade balance” went on a decline due to a “dollar devaluation” that happened in the year 1971. The phenomenon was known as the J-Curve and it lead to the stimulation of “additional research” regarding the “impact of devaluation” on both “trade balances” and even on the “balances of payments” (Ratha, Dilip, et al. 70). It is noted that “the time path” of present account soon after the “devaluation process” was indeed similar to letter J. This was attributed to the fact that the present “account of the balance of payments” tended to reduce or decline instantly soon after the “occurrence of devaluation” especially in a time frames that was less than a year. It was maintained and noted that initially, the trade balance deteriorated since in the short run, it mainly included the transactions of the goods that were under contract and in transit. However, as time went by, the “relative price changes” that occurred due to devaluation started to enhance the trade balance through affecting both the import and the export volumes.
The Pass-Through analysis is an idea that indicated that even though there was an absence in the settlement of the contracts in firms, the “degree of pass-through” is usually low in times that instantly followed the devaluation process (Zaki et al. 28). The “exchange rate pass through” refers to a percentage in which the rise in the import prices occurs upon the depreciation of the home currency just by only one percent. It is also prudent to note that the “limited exchange pass rate through” leads to a reduction in the impact of the nominal exchanges on the actual rate of exchange. This means that the quantities of the imports and exports responded to the price changes (Noureldin 70). Developing countries are usually affected by the “contractionary effect of devaluation” and this was evident because such countries not only have low export and import demand elasticises in respect to the changes in the actual rate of exchange which led in slow adjustments in their present accounts. This was also due to the fact that developing countries highly relied on the imports of capital and intermediate goods thus ultimately leading to a rise in the production costs after devaluations in such countries (Massoud, Ali & Horvath 28).
Despite the fact that there has been wide interest regarding the question as to whether the devaluations impact can have a contradictionary or an expansionary impact on the output, it was ascertained that majority of the empirical studies that was done on the developing nations were mostly concerned with the South East Asian and Latin American nations in the 1990s. It was also ascertained that empirical research regarding the topic mainly focussed or placed emphasis on the African and Middle Eastern nations and it was quite limited (Ahmed & Akl 123). The results indeed revealed that “devaluation” had a “positive impact on the current account” due to a reduction or decrease in the imports.
Based on the above information, it is quite evident that the decision of the Egyptian government to switch towards the “floating-exchange” rate regime was an indicator that Egyptian pounds’ “exchange rate” shall ultimately be “freely determined” or ascertained through market forces. Thus this will thus probably “render fluctuations” to become pronounced as opposed to when they could have been “before the float”. An investigation on the relationship that exists between the exchange rates changes as well as the contractionary or expansionary impacts on the economy is indeed quite essential for a country like Egypt. The application of the “Vector Auto-regression” technique or VAR was the most effective methodology to be used in ascertaining the effect or impact of “devaluation on the output” of this Egyptian economy. The technique or method is the most appropriate since it was presented as means of overcoming the numerous limitations that were linked with the traditional or conventional structural approach especially in the modeling of the macro-economic variables. The VAR model is the best because it is a “non-structural approach”.
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