What not to do when floating a currency: Lessons for Egypt

If Egypt can learn anything from emerging markets that have abandoned control of their currencies, it’s that a half-hearted approach is bound to fail.

The North African country on Thursday became the latest developing nation to announce a free float in the past two years, unleashing a 45 percent slide in the pound to 16 per dollar, according to quotes from six banks including Commercial International Bank Egypt SAE. Whether the move eases the dollar crunch and quashes the black market will depend on how committed the central bank is to staying hands-off when currency swings ensue.

If the experience of countries like Russia, Kazakhstan and Argentina is anything to go by, the initial pain will be worth it in about a year’s time, according to David Hauner, a strategist at Bank of America Corp. A weaker currency not only makes Egypt’s exports more competitive, it also boosts the country’s appeal for tourists and eases pressure on the central bank to drain reserves that have slumped since the Arab Spring.

“Anything that is in-between, in particular any pegs that lack credibility due to a lack of reserves and are far removed from fair value, are a bad option,” Hauner said from London. “This adjustment is never easy. There is clearly a period where things get worse, but when you look at the experience of countries that have moved to a free-float, it has proven to be beneficial.”

For a country like Egypt that’s always managed its exchange rate, the transition will be tough. This is especially the case as soaring import costs will spur inflation and make lives harder for the 92 million citizens whose per-capita income is among the lowest in the Middle East and North Africa.

Yet anything other than a complete break is destined to fail. When policy makers fiddle with the exchange rate, black-market activity inevitably surges, as Nigeria’s experiment with a free-float attests. It can also be costly.  Russia spent about $90 billion defending the ruble against short-sellers in 2014 before ultimately giving up in November that year.

Even in Egypt, attempts to manage the pound rather than unshackle it completely in 2003 and earlier this year led to soaring unofficial trading and prompted individuals and companies to hoard dollars because they lacked confidence in the currency’s stability.

Below is a summary of how five emerging markets fared after they removed currency pegs.


What happened?Russian Central Bank Governor Elvira Nabiullina abandoned currency interventions in November 2014 as the country grappled with sanctions and a slump in the price of oil, its main export. The ruble, which rebounded this year, is still down about 32 percent since then. Was it effective? Two years on, implied three-month ruble volatility has fallen to levels last seen before the free-float, inflation expectations are coming down, net capital outflows have slowed and Nabiullina has been lauded as Europe’s most-orthodox central banker. What’s more, households have lost interest in currency swings and are keeping 60 percent of their savings in rubles, according to a poll released in August.


What happened?Policy makers decided on Aug. 20, 2015, to match devaluations by China and Russia, its neighbors and biggest trading partners. The tenge has since tumbled 42 percent. Was it effective?After the move, the country’s central bank was forced to spend at least $1.7 billion, or 6 percent of reserves, to smooth swings in what became the world’s most volatile currency. A year later, the tenge has stabilized and foreign currency reserves are up about 13 percent this year to $31 billion.


What happened?President Mauricio Macri removed a crawling peg on the peso on Dec. 17, 2015. The move was part of an economic overhaul aimed at luring investment and jump-starting an economy suffering from anaemic growth and a shortage of dollars. Was it effective?While the currency slid 27 percent on its first day of freedom, the depreciation since then has slowed and inflation is showing signs of easing. The peso’s three-month historical volatility has fallen to among the lowest in Latin America. Investors showed their renewed confidence in the country this year by mopping up a record $33 billion of international bond sales, while the use of black-market exchanges by locals, a widespread practice before the free float, has become less common.


What happened?The former-Soviet oil producer moved to a managed free float on Dec. 21 after the central bank used up more than two-thirds of reserves to support the manat. The currency has since fallen 39 percent. Was it effective?The authorities stepped in to prop up the currency in September after it depreciated for three months, forcing banks to either stop or limit their sales of dollars. While the interventions stabilized the currency, the run on the manat reflected Azerbaijan’s failure to restore people’s confidence after the devaluations. Almost 80 percent of savings are now in dollars, according to S&P Global Ratings.


What happened? Policy makers in Africa’s second-biggest oil producer gave in to market pressure to stop fixing the naira’s exchange rate on June 20 in favor of a free-float. It’s fallen 38 percent since then. Was it effective?The move hasn’t done much to lure back investors, who have criticized the central bank for micro-managing the exchange rate such that it has traded in a tight range of around 315 per dollar since the August. As a result, the spread between the black-market and official rates is now back to pre-devaluation levels. Foreign-currency reserves, meanwhile, have continued to dwindle and stand at $23.8 billion, about $4 billion lower than at the beginning of the year.