The constant search for a practical exchange rate policy can be attributed to various goals that policy makers have attempted to attain through time. These goals differ based on the core objectives of the policy, in relation to the country’s economic growth and inflation, the model of the economy to the minds of the policy makers, or both. Other factors such as world economic conditions, the domestic business cycle, imperfections in the performance of internal markets like widespread price inflexibility, aspects in political economy and academic fads, are also considered by policy makers.
In a number of Middle Eastern and North American (MENA) countries, exchange rate policies in emerging markets have been discussed, more so in the occurrence of the economic crisis in Asia. Several MENA countries have progressed economically through free trade, opened financial systems and implementation of market-based monetary policy mechanisms. Included in these MENA countries are Iran and Egypt.
Iran, for instance had implemented a managed float with a monetary aggregate as the de facto nominal anchor following the unification in March 2002 of officially recognized multiple exchange rates. By intervening in the foreign exchange market, its central bank operates the managed float as the country has practically money markets and the financial rates of return are governmentally controlled. In Iran’s case, oil revenues seems to be the primary cause of fluctuations in the rial’s real effective exchange rate (REER). Hence, an oil stabilization fund was recently created so as to assist the government in resolving the impact of oil price fluctuations. The agreement on the implementation of managed float appears to be appropriate considering the country’s vulnerability to terms of trade shocks, labor market rigidities, ongoing trade reforms, plans of gradual price liberalization and prospects of large capital inflows.
Egypt on the other hand, linked its currency to the U.S. dollar in 1991. However, in mid-2000, the country had abandoned its fixed peg, resulting to a decline in its external accounts. This eventually led to weakened tourism due to terrorism concerns and currency overvaluation on account of the strengthening of the U.S. dollar against other currencies in the late 1990s. Initially, the authorities resolved the market pressure through intervention and tighter credit policies. After a period of managed floating, an adjustable currency band was adopted in January 2001, wherein currency trades were required to be within a specified band. In the following two years, the band was depreciated on five instances and widened twice ensuing to a 27% cumulative depreciation. In response to the inflexibility of the band regime, the exchange rate was floated by the end of January 2003. As of mid-2003, the exchange rate quoted by banks had not moved to a market-clearing level.
The experiences and effects on both countries’ move towards a more flexible exchange rate policy vary. Iran commenced the exchange rate policy from a position of strength, gaining from high oil prices, renewed reform efforts and a few years of experience with a market-determined exchange rate. Moreover, Iran chose a managed floating system wherein most transactions are carried out through the established interbank foreign exchange market. Also, the country was able to limit the pass-through to prices of the depreciation of the official exchange rate, depending on resources previously accumulated in the Oil Standardization Fund and high oil revenue.
Contrastingly, Egypt shifted to greater exchange rate flexibility since 2000 under market pressures and against a background of a series of negative exogenous shocks. This in turn resulted to substantial currency depreciation. Thus, the integrity of the exchange rate policy has yet been fully stabilized, and a parallel exchange market continues to operate.
While it seems for both Egypt and Iran to move to a more flexible exchange rate arrangement, the challenge is to ensure its adequacy. Both countries need to build up a sustaining institutional framework for monetary and economic policies.
References:
Jbili, A. & Kramarenko, V. (2003). Choosing Exchange Regimes in the Middle East and North Africa, International Monetary Fund. Retrieved June 28, 2004, from http://www.imf.org.
Morande, F.G. (2001). Exchange Rate Policy in Chile: Recent Experience, International Monetary Fund. Retrieved June 28, 2004, at http://www.imf.org.
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