The Legal Implications of Floating the Exchange Rate of the US Dollar
Floating the exchange rate of the US dollar is an economic measure aimed at allowing market forces to determine the value of a currency, rather than pegging it to the dollar or another currency. This step contributes to achieving local and international economic balance by promoting trade, attracting foreign investments, and managing economic crises. Egypt adopted a policy of currency devaluation as part of its economic reform programs between 1991 and 2016.
In early 2016, the Egyptian pound experienced significant and consecutive devaluation over three months, starting in the parallel market (black market). This compelled the Central Bank of Egypt to further devalue the local currency multiple times within weeks to align with market demand and supply forces and to curb speculation on foreign currencies, particularly the dollar.
Definition of Exchange Rate Floating
Floating the exchange rate refers to the process of allowing market forces of supply and demand to determine the value of a currency instead of setting it by the government or central bank. This floating can either be:
- Free-floating: The exchange rate is determined solely by market forces.
- Managed floating: The exchange rate is primarily determined by supply and demand, but the central bank intervenes to steer it in a certain direction by influencing the supply of or demand for foreign currencies.
States resort to exchange rate floating to counter the black market for the dollar by fully floating their currency, thereby unifying the official and parallel exchange rates to curb speculation. This measure can help reduce inflation, which, according to Central Bank data, reached 24.4% in December due to the import of high-priced goods. It also alleviates pressure on foreign currency reserves, which are depleted by speculation-driven demand. Recently, Egypt’s Central Bank managed to regain control of the reserves, supported by revenues from the Suez Canal and Egyptian exports.
Economic and Political Drivers Behind Exchange Rate Floating:
- Addressing balance of payments deficits.
- Attracting foreign direct investments.
- Enhancing economic resilience against international crises.
- Reducing pressure on foreign reserves.
Benefits and Risks of Exchange Rate Floating:
- Benefits: Improved competitiveness, increased investment inflows, and monetary balance.
- Risks: Inflationary pressures, exchange rate volatility, and adverse effects on purchasing power.
The History of Dollar Exchange Rate Floating in Egypt
In November 2016, the Central Bank of Egypt announced the complete floating of the Egyptian pound against the dollar as part of an economic reform program in collaboration with the International Monetary Fund. This measure aimed to eliminate the black market, attract foreign investments, and boost foreign currency reserves. Consequently, the pound experienced a significant depreciation, which directly impacted the cost of living and the prices of goods and services.
An Overview of Exchange Rate Floating in Egypt Since 2016:
In November 2016, Egypt implemented a full exchange rate float as part of its IMF-supported economic reform program.
The Economic Impacts of This Decision
- Positive Impacts: Attracting foreign investments, improving foreign reserves, and reducing the black market.
- Negative Impacts: Rising inflation and diminished purchasing power for citizens.
Impacts of Exchange Rate Floating on the Economy
Positive Impacts:
- Strengthened economic competitiveness.
- Attraction of foreign capital.
- Reduction of balance of payments deficits.
Negative Impacts:
- Increased inflation rates.
- Decline in individuals’ living standards.
- Higher costs of external debt.
The Role of Governments and Central Banks
Governments and central banks play complementary roles in the process of exchange rate floating. While the government establishes policies and addresses social repercussions, the central bank focuses on technical measures to stabilize the market. The success of this process depends on effective coordination between the two parties and readiness to address the economic and social challenges arising from this bold step.
Monetary Policies:
The government and central bank adopt measures to control inflation, such as raising interest rates or supporting productive sectors.
Government Interventions:
Government intervention may occur during severe market fluctuations to maintain financial stability.
Impact on Businesses and Individuals
For Businesses:
- Increased import costs.
- Higher financing costs.
- Enhanced competitiveness for exporting companies.
For Individuals:
- Decreased purchasing power.
- Increased prices of imported goods and services.
Recommendations for Governments
Strategies to Ensure Market Stability Post-Floating:
- Enhance transparency in monetary policies.
- Support productive sectors to reduce reliance on imports.
- Improve the investment climate.
- Provide support programs for low-income families.
Recommendations for Businesses and Individuals:
For Businesses: Diversify revenue sources, improve operational efficiency, and avoid foreign currency debt.
For Individuals: Reduce non-essential expenditures, invest savings in stable assets, and regularly monitor market trends.