More than monetary policy

Gamal Wagdy
Tuesday 12 Dec 2023

Getting a grip on the exchange rate goes beyond the realm of conventional monetary policy, writes Gamal Wagdy


Recent media reports have sparked speculation about a potential agreement between Egypt and the International Monetary Fund (IMF) in early 2024 to peg the pound to a basket of international currencies and gold.

While these reports have been met with official denials, the Central Bank of Egypt’s (CBE) acting governor has nevertheless revealed ongoing efforts to establish an index doing precisely this. Whether this materialises as a basket peg or as an indicator, these endeavours underscore the urgent need to address the depreciation of the pound. In order to fully understand the situation, it is crucial to correctly define the current crisis as a prerequisite to exploring potential solutions.

Pegging a currency to a basket of other currencies and using a basket of other currencies as an indicator of a currency’s exchange rate are related concepts, but they involve different approaches to managing and determining exchange rates. Both approaches aim to achieve a level of stability and diversification compared to pegging to a single currency. However, the degrees of flexibility they provide are different.

A currency can be pegged to a basket of other currencies rather than being tied to a single one, an approach known as a “currency basket peg” or a “basket peg” where the value of the currency is linked to the weighted average of several major currencies. The composition of the basket is determined by the monetary authorities of the country concerned, and the weights assigned to each currency in the basket are usually based on the country’s trading relationships or other economic considerations.

This approach is aimed at providing more stability and reducing vulnerability to fluctuations in any single currency within the basket. It allows the pegged currency to move in tandem with the combined movements of the currencies in the basket. The authorities may periodically adjust the weightings or the currencies included in the basket in order to reflect changes in trade patterns or economic conditions.

One notable example of a currency pegged to a basket of currencies is the IMF’s Special Drawing Right (SDR). The SDR is an international reserve asset created by the IMF and based on a basket of major currencies, including the dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling. While the SDR is not a currency used for everyday transactions, it serves as a unit of account for the IMF and is used in international financial transactions.

Some countries have adopted basket pegs for their currencies. The Kuwaiti dinar, the Saudi riyal, the Chinese renminbi, and Singapore’s dollar are all examples of currencies that are pegged in this way. It is important to note that the exact details of the currency basket, including the currencies included and their weightings, are often not publicly disclosed by the relevant central banks or monetary authorities.

On the other hand, using a basket of currencies as an indicator of a currency’s exchange rate refers to a policy where the exchange rate is managed or determined based on the value of a specified basket of currencies. In this case, the currency is not directly pegged to the basket, but its value is influenced or guided by its movements. A country’s central bank can monitor the basket and adjust the exchange rate in response to changes in the basket’s value. This approach allows for more flexibility than a strict peg to a specific set of currencies.

While both approaches are designed to mitigate the impact of adverse movements in a single currency and provide a more diversified and stable exchange rate, they are far from being a cure-all for exchange-rate challenges.

Instead, they can be considered as complementary measures within a broader framework rather than a fundamental solution for local currency depreciation. While they offer certain advantages in managing exchange-rate stability and mitigating risks, they are typically part of a comprehensive strategy rather than a standalone remedy. Neither of them alone can address the root causes of insufficient foreign-currency resources.


EGYPTIAN POUND: In Egypt’s case, the problem of the pound’s exchange rate is not short-term variations or movements in the value of the pound relative to other currencies, but the pound’s continuous depreciation against all convertible currencies, signalling deeper economic issues.

Distinguishing between short-term fluctuations and persistent depreciation is crucial. Although both fluctuations in exchange rates and persistent depreciation involve changes in currency values, they are different in many other ways, mainly in duration, causes, impact on the economy, policy responses, and market perceptions. Persistent depreciation implies a more prolonged and consistent decline in the value of the currency over an extended period, which indicates deeper economic issues that require more comprehensive and sustained policy measures to address.

Several determinants contribute to the depreciation of the pound’s exchange rate. The trade deficit, indicating that Egypt consistently imports more than it exports, creates demand for foreign currencies, putting pressure on the pound. Concurrently, the current-account deficit, encompassing the balance of trade and net income from abroad, further contributes to the pound’s depreciation.

Higher inflation rates in Egypt compared to its trading partners make its goods relatively more expensive, reducing exports and increasing demand for foreign goods. Speculative activities in the foreign-exchange market, driven by expectations of future currency depreciation, also play a role in the pound’s decline.

Perceptions about political and economic instability, whether valid or not, also erode confidence in the pound, prompting individuals to seek safer assets, including foreign currencies. Additionally, a high government debt or budget deficit raises concerns about fiscal health, further pressuring the currency. Central bank policies, such as excessive money supply growth, also contribute to inflation and depreciation. It is important to note that these factors often interact, and multiple influences can be at play simultaneously.

In order to stabilise the pound and address the underlying causes of its depreciation, a comprehensive and multifaceted approach is imperative. This solution transcends the purview of the CBE and necessitates a coordinated effort at the national level across various dimensions. A combination of monetary, fiscal, and exchange-rate policies is essential to tackle the interconnected factors influencing the exchange rate.

Addressing the trade and current-account balances is a pivotal component of this strategy. Initiating and implementing measures to reduce imports, boost exports, and advocating for policies that foster a surplus in the current account are vital steps towards creating a more stable economic environment. Equally crucial is addressing the inflation problem by adopting and enforcing policies aimed at curtailing inflation and instituting structural reforms designed to effectively counter it.

Speculation and market confidence issues must also be given due attention. Tougher measures against the black market to eradicate speculative activities that adversely impact the exchange rate are crucial. Implementing policies that foster both political and economic stability is equally important to restore confidence in the pound among market participants.

Enforcing prudent fiscal policies aimed at reducing budget deficits and promoting fiscal responsibility is imperative for maintaining fiscal health. Managing public debt requires the development of strategic approaches to alleviate concerns about the sustainability of the country’s fiscal position.

The CBE can play a pivotal role in this comprehensive strategy. It should adopt responsible monetary policies to control the growth of the money supply, mitigate inflationary pressures, and use interest rates and other monetary tools judiciously to stabilise the local currency. Additionally, a comprehensive strategy for managing external debt is crucial, considering its impact on the overall economic outlook. Addressing apprehensions about the country’s ability to service its external debt is vital for instilling confidence in both domestic and international investors.

Egypt finds itself confronted with the formidable task of mitigating the depreciation of the pound. It is abundantly clear that overcoming this challenge requires a holistic and all-encompassing approach that transcends the traditional bounds of central bank interventions. While contemplating the idea of pegging the pound to a basket of currencies or utilising it as an indicator demonstrates a commitment to seeking viable solutions, it is essential to recognise the limitations of these measures in addressing the root causes of the currency depreciation.

In order to effectively handle this complex problem, Egypt must embark on a comprehensive national endeavour that extends far beyond the realm of conventional monetary policies. A concerted effort involving a harmonised blend of monetary, fiscal, and exchange-rate policies, coupled with structural reforms, is not merely advisable, it is imperative.


The writer is a banking consultant.

* A version of this article appears in print in the 14 December, 2023 edition of Al-Ahram Weekly

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