What Not to Do When Floating a Currency: Lessons Egypt Can Learn – Bloomberg

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.

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