Final Project 414

download Final Project 414

of 24

Transcript of Final Project 414

  • 7/26/2019 Final Project 414

    1/24

    The Exchange Rate Regime: A Comparison

    Between Egypt and Venezuela

    ECON !": Economics o# Egypt

    $r% Ahmed El &a#ty

    'ay ()th* +!(,

    Authors:Amira Mostapha

    Dina EidMariam Thabet

    Merna Saad

  • 7/26/2019 Final Project 414

    2/24

    A-stract

    In this research, we compare the exchange rate regimes in Egypt and Venezuela !e

    examine the historical bac"ground #or each country then assess the current economic

    conditions including trade, in#lation, growth, reser$es and so on %ased on our analysis, we

    then recommend the most suitable regimes #or each country &ur conclusions are similar #or

    both nations' mo$e to a more #lexible regime (owe$er, the rationales behind this

    recommendation are di##erent #or each country

  • 7/26/2019 Final Project 414

    3/24

    .istorical Bac/ground

    %e#ore attempting to analyze the current exchange rate regimes, it is critical tounderstand the historical context o# both Egypt and Venezuela !ithin the historical

    bac"ground, we should assess the economic bac"ground as well as the $arious exchange rate

    regimes that both countries ha$e implemented This can #acilitate the process o#recommending suitable exchange rate regimes

    Since the )*+s, Egypt has had a -#ixed ad.ustable peg/ to the 0S dollar coupled with#oreign1exchange controls #ollowed by multiple exchange rates and operating ad.ustments in)*2*, )*3* and )** The multiple exchange rates system was detrimental to in$estments inEgypt 4ollowing the start o# the Economic 5e#orms and Structural Ad.ustment 6rogram7E5SA68 in )**), the Egyptian go$ernment uni#ied the exchange rate system and announcedthat it has adopted a -managed #loating/ regime The multiple exchange rates were simpli#iedinto a dual exchange rate system The #irst1tier rate was reser$ed #or the primary mar"etthrough the 9entral %an" o# Egypt and co$ered all transactions #rom the Suez 9anal, mainexports, o##icial loans and trans#ers and all go$ernment payments The second1tier rate wasdeterminedly #reely and co$ered all #oreign exchange needs not in the primary mar"etincluding public and pri$ate sector demands :e$ertheless, this rate was only de$alued

    between )**) and )**; then "ept #ixed until )+ billion in )**3 It also a##ected the Egyptian economy, as there werecapital out#lows #rom the country, losses #or in$estors and a slow down in the o$erall

    in$estment In )**2, Egypt #aced another crisis, the terrorist attac" in ?uxor where @3 touristswere "illed That led to a decrease o# the tourism re$enues, a ma.or source o# #oreigncurrencies, #or se$eral years ahead and a slowdown in the growth in general %y )**3, the oil

    prices when the price declined #rom 0S >)@+ per barrel to 0S >*2 per barrel That a##ectedthe current account and led to a de#icit o# 0S >; billion In &ctober ;, the second6alestinian inti#ada against the Israeli occupation happened, which led to the re$i$al o#tension in the area It negati$ely a##ected the economy o# the entire region and the Egyptianeconomy particularly as the capital out#low increased and the stoc" exchange per#ormancereached its lowest le$el since )**B

    The go$ernment tried to respond to these shoc"s and the slowdown in the economy ina good way to absorb the bad e##ects In

  • 7/26/2019 Final Project 414

    4/24

    reaching EC6 +)@ per 0SD as it was depending on the supply and demand o# the dollars inthe mar"et This was a trial #rom the go$ernment to resol$e policy inconsistency, originating#rom a combination o# exchange rate rigidity, sa$e and accumulate the international reser$esand an attempt to reduce the interest rate to acti$ate the economy

    Tal"ing about the bad side, there was an study 7will be mentioned be#ore in detail inthe part o# in#lation8 claimed that #loating the exchange rate regime in Egypt led to highin#lation as Egyptian are importing most o# their needs !hile at the same time anotherstudied said that the in#lation will not be that high because Egypt at the time was not thatopen, imports represent only ;F o# the CD6, there was no wage indexation which le#t noroom #or the spiral in#lation, and the #act that the #loating exchange rate came at slowdown inthe economy was good because high prices o# imports will lead to shi#ting to the domestic

    products which will steer the wheel o# the economy In addition, the #loatation was precededby a series o# de$aluations, suggesting that signi#icant #urther de$aluation is not necessary toma"e up #or the delay in exiting the #ixed exchange rate regime A second bad e##ect o# the#loating regime is that the economy did not wor" well because there were some companies

    #rom ban"s at the declared o##icial rates was apparent So, many transactions were still ta"ingplace in the blac" mar"et at rates higher

    &n the other hand, there were $ery positi$e e##ects o# the shi#ting 4irst, this regime issuitable to the emerging countries as Egypt and according to the IM4, the percentage o#de$eloping countries reporting a #lexible exchange rate regime increased #rom )) percent in)*2+ to +; percent in ;) Second thing is by shi#ting to a #lexible exchange rate regime inEgypt that had the ability to boost con#idence and attract capital in#lows, enable the economyto better absorb real external shoc"s, and to stimulate exports A third e##ect was lea$ing the9entral %an" to be the last resort to be in a position to steer the economy in the desireddirection A #ourth bad e##ect was the loses that some importers, #irms with dollar liability andearners o# #ixed income, especially ci$il ser$ants and pensioners while exporters and tourism#irms and were gaining a lot o# money And the e##ect on the go$ernment budget wasambiguous as it depends on the expenditure and the re$enue

    There was some worry about the out contraction, howe$er, it was noticed that the exportselasticity was low but the de$aluation o# the Egyptian pound made them more competiti$eAnd the external debt o# #irm was less than be#ore which will not cause huge losses to themAnother worry was that people would change their deposits to dollar ones instead o# pounddeposits but had not been signi#icant, despite an interest rate di##erential o# about 3

    percentage points

    A last word about the shi#ting regime was its reuirements Shi#ting to the #loating exchangerate reuires many things one o# them is to gi$e the monetary authority to choose anothernominal anchor such as in#lation targeting Second is to ha$e a strong central ban" withcredibility and the third is to ha$e an understanding o# the transmission mechanisms becausethese mechanisms will ha$e long, changing and uncertain time lags such as change in o##icialinterest rates A##ect such as ban"s and money1mar"et interest rates, expectations o# #uturerates, asset prices 7stoc" mar"et prices8 and the exchange rate, sa$ing and in$estmentdecisions and the supply o# the credit

    This regime was halted in ;@, when a #ixed exchange rate regime was readoptedThis #ixed exchange rate regime persisted #or ) years until ;)@ A#ter ;3 and ;)), there

  • 7/26/2019 Final Project 414

    5/24

    were signi#icant pressures on the exchange rate in Egypt a#ter as an e##ect o# the deterioratingexternal position 4irst a#ter ;37the global #inancial crisis and the increase o# the #ood

    prices8 and a#ter the ;)) re$olution, the reser$es depleted hea$ily and current account de#icitwidened in ;)B) because the tourism collapsed 4ortunately, this imbalance was co$ered

    by support #rom Cul# countries 4or example, @F #all in tourism receipts increased the

    current account balance to @Fo# CD6 7without the grants8, while non1oil exports droppedbelow @F o# CD6 The net #oreign in$estments "ept being #lat due to the political instabilityExternal #inancing gaps were co$ered by some >; billion in Cul# aid 7grants, deposits, andoil shipments %ecause all o# these bad situations that were #ollowing each other, the 9entral%an" o# Egypt 79%E8 supplied large amounts o# #oreign currency trying to stabilize theexchange rate but it led to a huge depletion o# it depleted international reser$es #rom >B@

    billion 7+3 months o# imports8 at end1;) to >)@ billion 7;@ months8 in

  • 7/26/2019 Final Project 414

    6/24

    As oil prices remain relati$ely low, Venezuela #inancing needs are aggra$ated

    7GVenezuela &$er$iewG, ;)+8 %y the end o# ;)@, it had a #iscal de#icit o# about ;F o#CD6 and external #inancing needs ranging #rom 0S>;@ billion to 0S>B@ billion 7GVenezuela&$er$iewG, ;)+8 %ecause o# restrictions on access to external #inancing, the go$ernmenthas had to #inance its public debt by monetizing 7GVenezuela &$er$iewG, ;)+8 Suchmeasures, coupled with price controls and limiting access to #oreign currency ha$e causedin#lation to soar, reaching the world=s highest in#lation rates in ;)@ 7GVenezuela &$er$iewG,;)+8

    6rior to the ;) collapse in oil prices, Venezuela=s exchange rate has su##ered due tothese imbalances To mitigate these pressures on the exchange rate, the go$ernmentimplemented a multiple exchange rate system as well as placed additional controls7GVenezuela &$er$iewG, ;)+8 A#ter #loating the exchange rate #or a #ew years, in ;B, it

    #ixed the exchange rate to the 0S dollar to de#end both its economy and #oreign reser$es aswell as #acilitate paying #or its #oreign debt 7;B8 It gradually introduced a multipleexchange rate system including with the #irst1tier, the strongest rate, being reser$ed #oressential imports, #ollowed by the second1tier, a slightly wea"er rate, used #or ma.ority o# theremaining imports and the wea"est rate, the third1tier, #or the remaining transactions 7%a.pai,;)@8 The rates ha$e gone through multiple de$aluations o$er the years with the #irst1tierreaching +B VE4 per 0SD, the second1tier reaching ); VE4 per 0SD and the third tierreaching @; VE4 per 0SD in ;) 7%a.pai, ;)@8 The go$ernment has introduced manychanges and de$aluations throughout the years To sum up, the table below outlines thegeneral exchange rate regimes #or both Venezuela and Egypt

    Egypt Venezuela

    Time Exchange 5ate 5egime Time Exchange 5ate 5egime

    ("( 9on$entional #ixed peg to%ritish 6ound

    ("(! Cold standard

    (",( 9%E became responsible #ornational currency control

    ("0! Abandoned gold standard

    (",+ 4ixed ad.ustable exchangerate with 0SD

    ("01(")0 9on$entional #ixed peg to the0SD

    (",+1(""( Multiple exchange ratesystems

    (")0 (ea$y currency de$aluations7%lac" 4riday8

    (""( Dual exchange rate system (")01(")" Exchange rate controls75E9ADI8 and multipleexchange rate system

    (""( Announced -managed#loating/ regime

    (")"1("" 4loating exchange rate system

    (""(1(""+ 9urrency de$aluations (""1("", Exchange rate controls7&TA98

    (""+1+!!! 9on$entional #ixed peg to0SD

    ("",1+!!+ Exchange %ands

    +!!(1+!!+ 9rawling peg +!!+1+!!0 4loating Exchange 5ate

    +!!01+!!2 Announced #ree #loating +!!013resent

    Multiple exchange ratesystem, some tiers #ixed and+!!21+!(2 9on$entional #ixed peg

  • 7/26/2019 Final Project 414

    7/24

    others -managed #loating/

  • 7/26/2019 Final Project 414

    8/24

    Current Economic En4ironment

    5% 6$3 and 6rowth

    Figure 1: GDP in real terms (in current US$) 2000-2014 for Eg!t an" #eneuela (Source:

    %orl" &an')

    Egypt, Arab Rep. Venezuela, RB

    %ecause &6E9 is the #ourth largest &6E9 exporter o# oil, it seems uite reasonable#or it to ha$e a higher CD6 in real terms when compared to Egypt as demonstrated in #igure) There#ore, it is more important to compare the economic growth o# both countries

    Figure 2: GDP grot (annual *) 2000-2014 for Eg!t an" #eneuela (Source: %orl" &an')

    Egypt, Arab Rep. Venezuela, RB

  • 7/26/2019 Final Project 414

    9/24

    Cenerally, Venezuela=s CD6 growth witnessed more #luctuations when compared toEgypt %etween ;) and ;B, both Egypt=s and Venezuela=s CD6 growth declined !hileEgypt=s CD6 growth was depressed due to the external shoc"s during the early ;s,Venezuela=s economy shran" %oth economies began to experience growth again #ollowing;B Egypt began to pic" up again as other elements o# the economy began to impro$e in

    ;B, such as the increased tourism, in$estment and so on Egypt=s high CD6 growth wasmaintained until the #inancial crisis o# ;3 resulting in a depressed economic growthVenezuela, howe$er, was already experiencing a sharp decline in its CD6 growth starting in;+, which was #urther aggra$ated by the #inancial crisis, which pushed its economy tocontract in ;* 4ollowing the #inancial crisis, Egypt=s growth was #urther crippled a#ter the;)) re$olution, a#ter which it has experienced a low stunted growth (owe$er, Venezuela=sgrowth began to reco$er again a#ter ;* only to drop a#ter ;);

    Venezuela=s economy is currently in distress As seen can be seen in #igure ;, Since;);, CD6 growth, which was @+F at the time, plummeted to reach 1F in ;) and1@2F in ;)@ despite ha$ing extremely high in#lation 7GVenezuela &$er$iewG, ;)+8 A large

    part o# the contraction in CD6 is embedded in the massi$e decrease in consumption and

    in$estment 7GVenezuela &$er$iewG, ;)+8 In ;), consumption has decreased by BF o#CD6 while in$estment has decreased by a whopping )+*F o# CD6 7;)+8

    55% 5n#lation

    Figure +: ,nflation (annual *) 2000-2014 for Eg!t an" #eneuela (Source: %orl" &an')

    Egypt, Arab Rep. Venezuela, RB World

    Similar to the growth trends, Venezuela=s in#lation has #luctuated a lot more comparedto the Egypt=s in#lation (owe$er, it is important to note that while Venezuela=s in#lationindicators are much worse than those #or Egypt, both are well abo$e the world a$eragein#lation This is critical because high in#lation negati$ely a##ects not only in$estments butalso ma"e them uncompetiti$e trade partners on the global mar"et

    Venezuela in particular su##ers #rom se$ere in#lation, the highest worldwide, reachingan o##icial rate o# )3*F in ;)@, with independent estimates being much higher

    7GVenezuela &$er$iewG, ;)+8 The IM4 predicts that Venezuela=s in#lation will reach 2;F

  • 7/26/2019 Final Project 414

    10/24

    in ;)+ and a staggering ;,;F in ;)2, indicating that Venezuela is on the brin" o#hyperin#lation 7;)+8

    This extreme in#lation places hea$y pressures on the exchange rate !hile the o##icialexchange rates may be #urther aggra$ating this in#lation, they are most li"ely not the rootcause #or it This high in#lation mainly caused by the Venezuelan go$ernment monetizing its

    debt 7GVenezuela &$er$iewG, ;)+8 This type o# #inancing coupled with price controls andlimiting access to #oreign currency to the pri$ate sector, which imports or produces most

    basic goods, ha$e caused in#lation to soar, reaching the world=s highest in#lation rates in ;)@7GVenezuela &$er$iewG, ;)+8

    As #or Egypt, its in#lation le$els were low relati$e the world a$erage be#ore ;B4ollowing ;B, its in#lation le$els rose abo$e the world a$erage and did not decline to its

    pre$ious state again Chada Abdel 5ahman 7;);8 attempts to examine the relationshipbetween the exchange rate regime and in#lation in Egypt, particularly what happened#ollowing the #loating regime introduced in ;B

    Egypt has experimented with a $ariety o# exchange rate regimes o$er the past ;years In ;B, the #lexible exchange rate regime was simply adopted because o#

    una$ailability o# the #oreign currency at the o##icial prices This has been ongoing be#ore;B and led to the growth o# blac" mar"et transactions Deciding to #loat the exchange ratewas expected to allow #oreign currency to #low bac" into the ban"ing system rather thanremain on the blac" mar"et It was also expected to attract capital in#lows and enable theeconomy to absorb real external shoc"s as well as stimulate exports (owe$er, #ollowing thisexchange rate regime came high monthly in#lation rates in ;, reaching )+@F #rom a lowo# ;F in ;B There#ore, Abdel 5ahman=s 7;);8 paper attempts to in$estigate whether isa relationship between the exchange rate and the in#lation rate since the liberalization o# theEgyptian pound exchange rate

    Figure 4: Eg!ts .ontl inflation rate 200+-2011

    Egypt has witnessed high in#lation rates since the liberalization 7managed #loating8 o#the Egyptian pound in ;B And #rom this period until now, the in#lation rates, based on theconsumer price index, are high and did not witness a decline except only in ;@ when itreached 3F (owe$er, this decline only too" place a#ter the 9%E declared that its adopting

    an in#lation targeting regime :e$ertheless, in#lation returned to rise to *@F in ;2;3and reached )3BF in ;3;* as the result o# supply shoc"s #rom high #ood and energy

  • 7/26/2019 Final Project 414

    11/24

    prices as well as demand pressures, particularly in the construction sector In#lation thendeclined again and reached 7)))F1 ))F8 in 7;);))1;)););8 Such high in#lation

    pressures lead to decrease the real income, in turn a##ecting the ability o# peoples to get theirbasic needs

    A#ter calculating the correlation between the exchange rate 7EC6 against 0SD8 and

    the in#lation rate, results showed a $ery wea", low correlation 7Abdel 5ahman, ;);8:onetheless, it is important to note that in#lation has some e##ect on consumer prices, whetherdirectly or indirectly !hen discussing in#lation=s direct e##ect, it is #ound that imported input

    become more expensi$e which leads to an increase in the production costs, and also theimports o# #inished goods become more expensi$e, all o# which a##ect the 96I As #or theindirect e##ect, #or instance, the domestic demand #or substitutes will increase as substitutegoods and exports become more expensi$e, so the demand #or labor will increase as local

    production increases !ith decreased unemployment and more people who earn moneycompeting to buy goods, prices increase a##ecting the 96I through classical growth1dri$enin#lation This indicates that perhaps the #loating the exchange rate, albeit impro$ing manyelements o# the Egyptian economy, could ha$e been related to the increase in in#lation

    Trade

    Figure /: ,m!orts ( * of GDP) 2000-2014 for Eg!t an" #eneuela (Source: %orl" &an')

    Egypt, Arab Rep. Venezuela, RB

    As seen in #igure @, Egypt imports a larger percentage o# its CD6 compared toVenezuela (owe$er, it is important to note that Venezuela=s CD6 in real terms is much largerthan that o# Egypt=s 4urthermore, Almost all o# Venezuela=s basic needs are imported and sois much more dependent on imports than Egypt

    Figure : E!orts (* of GDP) 2000-2014 for Eg!t an" #eneuela (Source: %orl" &an')

  • 7/26/2019 Final Project 414

    12/24

    Egypt, Arab Rep. Venezuela, RB

    As demonstrated in #igure +, Venezuela generally has a higher exports percent o# CD6than Egypt, accounting #or its hea$y oil trade being an important &6E9 member This hasallowed Venezuela to maintain a steady trade surplus whereas Egypt has generally su##ered#rom a trade de#icit

    Despite ha$ing a positi$e trade balance and being the @)st largest exporting economyin the world, Venezuela=s export pro#ile is extremely unsettling 7&E98 &il production haswitnessed declines since ;3 and coupled with an increase in consumption and smuggling,Venezuela=s exports ha$e critically #allen 7Monaldi, ;)@8 Venezuela=s export di$ersity is

    alarmingly low with o$er *@F o# its exports being petrochemical1related goods 7&E98According to MIT=s the &bser$atory o# Economic 9omplexity 7&E98, Venezuela=s productspace map demonstrates, #igure 3, not only the lac" o# di$ersity in Venezuela=s productionand exports but the low probability o# it e$er ha$ing said di$ersity, especially i# it does notma"e it a priority 7&E98

    Figure : #eneuelas e!orts com!osition (Source: 3E)

    Figure 5: #eneuelas !ro"uct s!ace ma! (Source: 3E)

  • 7/26/2019 Final Project 414

    13/24

    Thus, it is understandable that this &6E9 nation=s economy too" the largest hit#ollowing the collapse in world oil prices mid1;) These exports bring in much needed#oreign exchange into Venezuela=s economy 4ollowing the oil price decreases, e$en the tradesurplus has #allen resulting in a current account de#icit in ;)@ 7-Venezuela &$er$iew/,;)+8

    Figure 6: #eneuelas tra"e !artners for its im!orts (Source: 3E)

    Figure 10: #eneuelas tra"e !artners for its e!orts (Source: 3E)

  • 7/26/2019 Final Project 414

    14/24

    &n the other side, Venezuela relies hea$ily on imports #or most o# its consumption7-Venezuela &$er$iew/, ;)+8 Its top two trade partners are the 0nited States and 9hina7&E98 I# it wants to export non1oil goods, its o##icial exchange rate should be realistic and

    re#lect the relati$e economic conditions %ecause o# the unrealistic o##icial rates set by thego$ernment and the multiple exchange rate systems in place and policy inconsistencies andin#lation, Venezuela=s non1oil exports are extremely not competiti$e in the global mar"et

    Mo$ing to Egypt, it is ha$ing a negati$e trade balance o# >*;% in net imports beingthe B2th largest importer in the world with >3;% in ;), and the +2th largest exporter inthe world with >BB;% in ;) 0nli"e Venezuela, Egypt=s trade pro#ile is more di$ersi#iedAlthough Egypt=s main exports are crude petroleum and re#ined petroleum that accounts #or;@F o# the total exports, Egypt exports pro#ile rely on other goods as well such as metal,gold, #ertilizers, #ruits and $egetables, and others Also, it is important to note that Egypt=seconomic complexity index implies that although Egypt export economy size is not a largeone, Egypt exports ;* products, which means that its share o# the global mar"et larger than

    what it is expected to be gi$en its exports economy size As o# its imports economy, Egyptmainly imports consumption goods such as re#ined petroleum, wheat, cars, and others Andits largest import partners are 9hina, 0S, 5ussia, and 0"raine 7&E98

    Figure 11: Eg!ts e!orts com!osition (Source: 3E)

    Figure 12: Eg!ts !ro"uct s!ace ma! (Source: 3E)

  • 7/26/2019 Final Project 414

    15/24

    Figure 1+: Eg!ts tra"e !artners for its im!orts (Source: 3E)

    Figure 14: Eg!ts tra"e !artners for its e!orts (Source: 3E)

  • 7/26/2019 Final Project 414

    16/24

    7oreign Reser4es

    4or Egypt to co$er its necessities #rom imports, especially that its second largesttrading partner 7within the imports economy8 is the 0S and that its top imports is the

    petroleum along with its hea$ily reliance on imports, it should ha$e enough #oreign reser$esthat co$ers at least B@ months o# its trade needs (owe$er, o$er the past #ew years, especiallya#ter the ;)) re$olution, Egypt=s #oreign reser$es ha$e been #luctuating and decreasing in acontinuous pattern Such a pattern was a result o# not only the political instability that led to#oreign capital out#low and a wea" #oreign direct in$estment 74DI8, but also in ;)B) theEgyptian economy #aced a @F decline within the tourism re$enues along with @F decreaseo# non1oil Egyptian exports Such decline in more than one sector that brings #oreignre$enues led to a huge drop in the Egyptian reser$es, howe$er, such a drop was co$ered at thetime by the Cul# aid that reached >;% Het, as the Cul# countries were #aced with the oilcrisis and the large drop in the oil prices, their support to the Egyptian economy stopped(ence, in order to #ace such an economic de#icit, the 9%E supplied large amounts o# #oreigncurrency to stabilize the exchange rate, which highly a##ects the trade balance and the 4DISuch an action ta"en by the 9%E led to a depletion o# the international reser$es #rom >B@% in;) to >)@% in ;)B, which is only ;@ months o# co$ering the Egyptian imports needs79%E8

    Figure 1/: Eg!ts foreign ecange reser7es

    Such a decrease in the #oreign reser$es along with the unstable exchange rate system,which will be discussed later, negati$ely a##ected the Egyptian trade balance, as Egypt is notonly su##ering #rom low exports annualized rate 7)3F o$er the last @ years8 7&E98, but alsoits imports economy, which mainly #ocuses on the necessities, is highly a##ected by the lac"o# #oreign currencies

    The pro-lem o# shortage o# #oreign currency in the economy:

    Tal"ing about the situation in egypt, The $alue o# the 0S dollar has increased threetimes o$er the past year and continues to inch up, moti$ating the go$ernment to replace the

  • 7/26/2019 Final Project 414

    17/24

    go$ernor o# the 9entral %an" o# Egypt 79%E8 and impose new restrictions on dollartransactions The new mo$es ha$e put #oreign companies operating in Egypt in a dilemma4or example, Ciant cement producer Italcementi said it is considering mo$ing its regionaloperations #rom Egypt due to its pre$ention #rom trans#erring annual re$enues outside thecountry, managing director %runo 9arre told %loomberg on + March In the same wee", Air

    4rance told 5euters they are unable to trans#er their earnings a#ter the 5ussian plane crash inSharm El1Shei"h last &ctober due to the dollar shortage %ritish Airways was also reportedthe same issue In addition, Ceneral Motors announced last month that it would temporarilyclose its #actory i# the crisis surrounding dollar liuidity is not resol$ed, $alidating itsdecisions by stating that ban"s ha$e stopped opening letters o# credit #or the import o#manu#actured cars and the goods reuired #or production As well, customers reported to theDaily :ews that they could not withdraw their dollar sa$ings in local ban"s this wee", e$en i#the account is in #oreign currency %ranches say they do not ha$e 0S dollars so customersend up being unable to access dollars So, the 9%E trying to ease the problem li#ted themonthly cap on dollar deposits and withdrawals #or indi$iduals This compared to 9%E=s

    pre$iously imposed limits on deposits, at >@, per month and >), per day S&, here

    comes the role o# the blac" mar"et, as the main reason behind the dollar shortage in Egyptwere the ?ow in$estment le$els and the sha"y tourism industry and because egypt hea$ilydependent on the imports, that led the blac" mar"et to be stronger There was an inter$iewwith the owner o# a #oreign exchange #irm in 9airo, Mohamed &mran, who told the Daily

    :ews Egypt that the 9%E measures are dri$ing importers and companies to resort to theuno##icial mar"et to obtain dollars, rather than ban"s -They come to us and they "now thatthey will ha$e the amount they need with no caps,/ he said &mran said se$eral importers buyhuge amount o# dollars #rom him -e$en at higher prices/ to meet their business needs (eado# the Ceneral Di$ision #or exchange companies at the 4ederation o# Egyptian 9hambers o#9ommerce 74ED9&98, Mohammed Al1Abyad, said in pre$ious statements there iscontinuous communication between exchange #irms and the 9%E so as to aid the latter inregulating the exchange mar"et and alle$iating the current crisis, but the two prices "eep$arying #rom each other As companies are not #inding #oreign currency to do their business,that lead them not to "eep operating in the economy which will lead to a huge rate o#unemployment and a shrin" in the economy and e$en the constraints by the 9%E that statethat only necessities companies will be able to get the #oreign currency while luxuries=companies will not is not good #or the economy because that may lead the economy to shrin"

    because it will lose some o# the operating companies in the #uture

    Mo$ing to Venezuela,Figure 1: #eneuelas foreign ecange reser7es (source: ieconomics)

  • 7/26/2019 Final Project 414

    18/24

    According to the central ban" o# Venezuela, 4oreign Exchange 5eser$es in Venezueladecreased to );,2B) 0SD million in April #rom )B,;B2 0SD million in March o# ;)+ Thea$erage o# the #oreign reser$es #rom )*+; to ;)+ is );,)*+3 0SD million . The reserves

    have reached 42,288 USD million, its highest level in December 2008, and its lowest level of514.5 USD million in Setember 1!"2.

    In Venezuela, the central ban" is the responsible authority on the reser$es and theexchange rate policies Venezuela=s reser$es are made o# gold or a speci#ic currency Theycan also be special drawing rights and mar"etable securities denominated in #oreigncurrencies li"e treasury bills, go$ernment bonds, corporate bonds and euities and #oreigncurrency loans

    Current Exchange Rate Regime

    Egypt has no announced exchange rate regime, but its policies indicate that it is acrawling peg with the 0S dollar as its anchor The current announced exchange rate stands at333 EC6 per 0SD a#ter being de$alued #rom around 23B bac" in March

    Venezuela, on the other hand, has an announced yet a slightly more complexexchange rate regime 4or o$er )B years, the Venezuelan currency has been pegged to the 0Sdollar 7%a.pai, ;)@8 %e#ore 4ebruary o# ;)+, Venezuela had an o##icial three1tieredexchange rate system 7;)+8 The #irst rate was +B VE4 per 0SD and is reser$ed #or #ewcircumstances including imports o# essential goods 7%a.pai, ;)@8 Around 2F o# importsare made using this exchange rate ;F o# the remaining imports are made using the second1tier rate o# ); VE4 per 0SD 7%a.pai, ;)@8 This rate, re#erred to as SI9AD I, is primarily

    used #or priority sectors and while it is supposed to be auction1based, it is generally #ixed7%a.pai, ;)@8 Early in ;)+, Venezuela combines these two rates into a new rate o# ) VE4

    per 0SD, re#erred to as DI56& 7oerner, ;)+8 DI56& will also be maintained by thego$ernment and restricted #or certain uses including essential imports, payments #or $italstate sectors and #or Venezuelan students abroad to pay tuition #ees 7oerner, ;)+8 DI56&,as has been announced by o##icials, will be ad.usted periodically depending on the economicand social en$ironment 7oerner, ;)+8 (ence, indicating that it #alls somewhere between a

    pegged within bands system and a crawling peg The result o# this change was a simpli#ieddual exchange rate system instead o# a three1tiered system

    The third rate was introduced in March ;) and stands at a slightly more realisticrate o# ); VE4 per 0SD relati$e to the +B VE4 o##icial rate and the SI9AD I rate 7%a.pai,;)@8 This rate, re#erred to as SI9AD II, was also controlled by the go$ernment until ;)when it was changed into SIMADI and allowed to lightly #loat 7%a.pai, ;)@J oerner, ;)+84ollowing the exchange rate system changes in ;)+, SIMADI has been allowed to #ree #loat,starting at an o##icial rate o# ;+*; VE4 per 0SD and is now re#erred to as DI9&M7oerner, ;)+8 All transactions that are restricted #rom using DI56& can now bene#it #romthe DI9&M rate 7oerner, ;)+8

    The #ree #loating DI9&M resulted in a massi$e de$aluation compared to the #ormerrate 7oerner, ;)+8 :e$ertheless, the go$ernment hopes to use DI9&M as a tool to bridgethe gap between the blac" mar"et rate and the o##icial rate, slow down its in#lation and

    promote in$estment and production

  • 7/26/2019 Final Project 414

    19/24

    Blac/ 'ar/ets

    &ne o# the ma.or tradable goods in the blac" mar"et is currency It is considered aparallel illegal mar"et o# #oreign exchange The currency blac" mar"et usually #lourishes incountries su##ering #rom high in#lation rate and limited #oreign exchange reser$es Also, strict

    policies that limit the a$ailability o# #oreign currency #or residents ma"es them resort to theblac" mar"et Subseuently, there is signi#icant demand #or #oreign currencies in countrieswith such attributes, as the citizens will aim at preser$ing the $alue o# their cash Het, the

    policies ma"e it di##icult #or people to buy #oreign currency at the o##icial exchange rateThere#ore, blac" mar"ets trade in #oreign currencies at prices that would be at a premium tothe o##icial exchange rate announced by the go$ernment

    The currency blac" mar"et in Egypt has been pro$ed to ha$e a great e##ect on theEconomy and the recent dollar issues in particular The history o# currency1blac" mar"et inEgypt extends to long ages ago, but used to be a low1pro#it business until ;B, when thecentral ban" adopted the policy o# #loating currency exchange, based on a mini researchcarried out by the Daily :ews Egypt That made the business extremely pro#itable #or blac"mar"et $endors, until ;) in which the prices were decided by the central ban" again,#orcing the blac" mar"et to depend more on companies o# currency exchange

    (owe$er, by the re$olution o#

  • 7/26/2019 Final Project 414

    20/24

    go$ernment #or its imports and other #oreign transactions It is also o$er 2F abo$e the-#loating/ SIMADI rate that people can access !ith the thri$ing corruption, many-in#luencers/ are able to ta"e ad$antage o# the arbitrage opportunity by getting #oreigncurrency at the legal rates and selling them in the blac" mar"et #or lo#ty pro#its, which #urtherworsens the currency crisis

    Despite the pro$en drawbac"s o# blac" mar"ets, as business is not regulated by thego$ernment, nor the #low o# money can be traced, lea$ing the economy worse o## anyways,some people thin" blac" mar"ets may ha$e a positi$e impact on countries, since they pro$idelegal necessities in which there is shortage There#ore, go$ernments can con$ert blac"mar"ets into use#ul tools to co$er peopleKs legal needs, but to a$oid their negati$e impact,strict laws should be implemented on whoe$er get in$ol$ed in any illegal transactions withthe traders To conclude, currency blac" mar"et will exist as long as negati$e economic and

    political circumstances remain (owe$er, its impact diminishes as the countryKs #oreignexchange reser$es increases and more policies towards open economy are adopted

    Exchange Rate 3olicies

    As what was mentioned abo$e, the Egyptian exchange rate system was #aced withperiods o# signi#icant pressures and instability o$er the past #ew years, especially a#ter the;)) re$olution In order to co$er the high economic de#icits and instabilities that hit theEgyptian economy a#ter ;)) and resulted in capital out#low, decrease in the 4DI, and currentaccount de#icit, which was pre$iously discussed, the 9%E supplied large amounts o# #oreigncurrencies into the mar"et to stabilize the exchange rate and protect the Egyptian pound(owe$er, such an action led to a huge decline within the Egyptian #oreign reser$es Also,with #ixing the exchange rate, the o##icial $alue o# the Egyptian pound to the 0SD was

    unrealistic, which led to the increase o# the blac" mar"et operations (owe$er, by the end o#;) the real exchange rate appreciated by )3F, which was a result o# #ixing the exchangerate to an unrealistic $alue while the 0SD was appreciating against other ma.or currenciesalong with the high in#lation di##erentials with Egypt=s trading partners

    Another action the 9%E too" to de#end the Egyptian pound was reuiring the ban"s to-pro$ide the #inancing to their strategic customers, against deposits held #or the ban"s at the9%E/, howe$er, such a policy led to a huge decrease in the :et #oreign assets o# the ban"sreaching a net negati$e balance o# ?E B+% by the end o# ;)@

    A #inal action that was ta"en by the 9%E in an attempt to support the exchange ratesystem and restore the circulation o# the #oreign currency was de$aluing the exchange rate by)@F, which is 33@ per 0SD, in ;)+ 7Alshari#, ?in, and Ehab source )8, howe$er, such an

    action did not help in sol$ing the monetary mar"et problems, neither the decrease $alue o# theEgyptian pound nor the decreasing amounts o# #oreign reser$es

    As the Egyptian exchange rate system was "ept #ixed, although announced to beheading towards a more #lexible system, the pressures on the monetary mar"et continuedalong with the increase in the blac" mar"et=s operations and in its premium that reached morethan )@F The 9%E has to consider adopting a more #lexible exchange rate system, whichshould be applied in real li#e and not only stated policies As what was stated by MohamedAbu %asha, a 9airo1based economist at in$estment house E4C (ermes, in his inter$iew withal1Ahram, with the current depleted #oreign reser$es, Egypt will not be able to peg theEgyptian pound against the 0SD, and hence, the 9%E should see" the implementation o# amore #lexible exchange rate system Abu %asha, also, highlighted the possibility that the 9%Ewould choose going bac" to managed #loat system, which was used between ; and ;))

  • 7/26/2019 Final Project 414

    21/24

    0nder such a system, the Egyptian pound would be lin"ed, not to the 0SD, but to a bas"et o#currencies 7Abaza source ))8

    &ummary Ta-le

    Egypt Venezuela

    Exchange Rate

    Regime

    4lexible peg to 0SD 7crawling peg8 Dual exchange rate') 6egged to 0SD; -#loating/

    Blac/ mar/et L;F premium L))F premium on pegged rateL2F premium on #loating rate

    6rowth Slow, stunted growth 7less than @F8 Shrin"ing economy 7negati$egrowth rates8

    5n#lation ?ow double digits 7);1)BF in

    ;)@8

    :earing hyperin#lation expected to

    be 2;F ;)+ and ;;"F in ;)2Reser4es In.ect reser$es to protect exchange

    rateIn.ect reser$es to protect exchangerate

    Trade partners Asia and Europe 0S and 9hina

    Economic

    $i4ersity

    5elati$ely economic di$erse 5elati$ely no economic di$ersity7*+F o# exports are oil products8

    Recommendations

    Egypt: 'ore 7lexi-le Regime

    %ased on our research, we recommend that Egypt mo$e to a more #lexible exchangerate regime %ased on its trade, it has no reason to peg its currency to the 0SD 4urthermore,

    pegging at such an unrealistic rate pushes it to dedicate its monetary policy to maintain thisexchange rate 7because o# the impossible trinity8 This not only restricts the monetary policy#rom amending the economic conditions in Egypt but also depletes Egypt=s #oreign reser$esas it continues to in.ect them into the mar"et to bac" this unrealistic rate !ith the stuntedgrowth that Egypt is currently experiencing and high in#lation, the 9%E has to #ree itsmonetary policy to target these issues and the only way to do so is to gradually mo$e to amore #lexible regime

    Moreo$er, a more #lexible regime can bring in many bene#its #or Egypt As theexchange rate de$alues based on supply and demand, imports would decrease and exports areli"ely to increase It will also attract #oreign direct in$estment All o# these changes wouldstimulate the economy as well as maintain Egypt=s reser$es It would also allow the monetary

    policy to target in#lation The "ey is to begin implementing this change in regimes graduallybut steadily

    Venezuela: 'ore 7lexi-le Regime

    !e also recommend that Venezuela mo$e to a more #lexible exchange rate regime but#or slightly di##erent reasons 0nli"e in Egypt=s case, a de$aluation in Venezuela=s boli$ar ismuch more detrimental to its economy than a de$aluation in the Egyptian pound This is

    because Venezuela=s main exports 7*+F8 are oil products, all o# which are $alued in 0SD In

  • 7/26/2019 Final Project 414

    22/24

    addition, its main trade partners are the 0S and 9hina, both o# which deal in 0SD Theeconomy is not di$ersi#ied at all meaning that de$aluation is not li"ely to stir non1oil exportsVenezuela is also much more dependent on imports #or basic goods so a de$aluation would#urther aggra$ate the already poor li$ing conditions in Venezuela

  • 7/26/2019 Final Project 414

    23/24

    Het, the main ad$antage #rom a more #lexible regime is that the Venezuela=s monetarypolicy will be #reed up to deal with the eminent hyperin#lation (ad Venezuela beenexperiencing moderate in#lation, we would ha$e recommended dollarization (owe$er, withthe triple digit in#lation it is experiencing and the threat o# hyperin#lation creeping in, anindependent monetary policy that targets in#lation is criticalRe#erences

    Abaza, D 7;)+, March )8 Economists welcome Egyptian 6ound de$aluation, #lexibleexchange rate 5etrie$ed May )+, ;)+, #romhttp'englishahramorgeg:ews9ontentB);)**3@%usinessEconomyEconomists1welcome1Egyptian16ound1de$aluation,1#leaspx

    Abdel 5ahman, C 7;);8 Exchange rate pass1through and in#lation in Egypt 8P.8S5etrie$ed May )3, ;)+

    Alshari#, A, :oueihed, ?, 4arou", E 7;)+, March )8 Egypt de$alues pound, announcesmore #lexible exchange rate policy 5etrie$ed May )+, ;)+, #romhttp'wwwreuterscomarticleus1egypt1currency1id0S9:!C)N2

    %a.pai, 6 7;)@, 4ebruary ;8 The Impact VenezuelaKs %oli$ar Exchange 5ates OIn$estopedia 5etrie$ed May )2, ;)+, #rom

    http'wwwin$estopediacomarticles#orex;;)@impact1$enezuelas1boli$ar1exchange1ratesasp

    %assiouny, A 7;)+, March *8 Dollar $s Egyptian 6ound' Surging %lac" Mar"et Exchange5ate PInter$iewQ 5etrie$ed May ), ;)+, #romhttp'wwwaucegyptedunewsstoriesdollar1$s1egyptian1pound1surging1blac"1mar"et1exchange1rateRiploginnocacheFA;F+yF)BFA%F+FDBF%*

    4arid, D 7;)+, March *8 0n#lagging EC6 Decline Threatens EgyptKs EconomicCrowthDail 9es Eg!t (Eg!t) 5etrie$ed May )2, ;)+, #romhttp'wwwhighbeamcomdoc)C)1@+B@;;htmlRre#ideasyh#

    CD6 growth 7annual F8 7nd8 5etrie$ed May )2, ;)+, #romhttp'dataworldban"orgindicator:HCD6MT6DUCcountriesVERdisplaygraph

    IM4 7;)@8 2014 8;,

  • 7/26/2019 Final Project 414

    24/24

    #eneuela 37er7ie 7;)+8 %orl"Can'Borg 5etrie$ed )2 May ;)+, #romhttp'wwwworldban"orgencountry$enezuelao$er$iewW)

    Venezuela 6egs %oli$ar To Dollar 7;B, 4ebruary +8 ;e Guar"ian 5etrie$ed May )2,;)+