Egypt floats it's currency to gain advantage

Egypt has announced that its currency will move from a fixed to a floating exchange rate from Sunday. In anticipation of a decline in the value of the Egyptian Pound it has been devalued in the fixed rate system by 48% (almost certainly to prevent speculative gains).

This is a pretty rare event and hardly ever seen in the opposite direction (floating to fixed), so its probably a permanent move, which is important for our analysis.

The Egyptians hope that the depreciation/devaluation (both are going to occur floating/fixed regimes) will boost their economy. The competitiveness of Egypt as a tourist destination will be greatly improved, and this is their most important industry. Whether this will be enough to persuade tourists to return is another issue as the country has been very unstable recently.

Notice in the article the Egyptians acknowledge that it will take eighteen months 'to see changes' and this is possibly a reference to the 'J-Curve' effect.

Notice how maintaining the fixed exchange rate has caused significant problems for Egypt recently and the examples of how they have tried to maintain the chosen fixed rate.

There is a massive downside to this move. Imported goods will cost more and this is going to impact on the poorest households the most as imported food and fuel rise in price. There will be a significant impact on the distribution of income.

Will this move actually work? Well that will depend in part on the Marshall-Lerner conditions being met. If they are then Egypt will see an improving current account balance and a reduction in the rate they are accumulating foreign debt. However the problem of tourism isn't one of price (or Price Elasticity of Demand), rather the demand curve for Egyptian holidays by foreigners shifted violently to the left due to the political instability the country has experienced.

In the long term, and this must be seen as an irreversible move, the potential gains may only be fleeting. Egypt will gain competitiveness initially, however their high inflation will continue to erode that. Further they will now have to cope with the unpredictability of a floating exchange rate and it might be expected that the Egyptian Pound will be quite unstable in the longer term bringing a large dollop of uncertainty to the already hard pressed businesses of Egypt.

Note that floating the exchange rate is one condition of IMF help to the country. This is another issue, but space dictates it can't be dealt with here.

The NYTimes covers the story here

This story is really for IB students. It has relevance to both International Trade and Development economics and is an excellent modern example of the debate between fixed and floating exchange rates.