Sunday, 13 September 2015

Does currency devaluation help Egyptian exports?

There is little evidence supporting the case for devaluing the currency in order to promote exports in Egypt.

Talks intensified last week about the possibility of devaluing the Egyptian pound. The Investment Minister, Ashraf Salman, told a conference in Cairo that depreciation may no longer be a choice. His colleague, the Minister of Industry and Trade, blamed a strong pound for the recent dismal performance of exports. The latter’s logic suggests that some devaluation of the currency could help Egyptian exports and preserve the dwindling reserves. But is this true? Does currency devaluation actually boost Egyptian exports?

Two considerations are important in answering this question:

1. When it comes to boosting exports, inflation matters as much as the exchange rate. In theory, currency devaluation supports exports by making them cheaper when expressed in a foreign currency. But the gains from the exchange rate devaluation could be wiped out if the cost of exports increases due to high inflation. This suggests using a measure of the exchange rate that also takes into account changes in prices. This measure is called the “real exchange rate”.

2. It is important to look at broader measures of the exchange rate beyond the value of the Egyptian pound against the US dollar. Nearly a quarter of Egypt’s trade was with the Euro Area in 2014 compared to only 7% with the US. This means that movement of the Egyptian pound against the euro is almost four times more important than its movement against the dollar. To account for this, a broad measure of the exchange rate against a basket of currencies can be constructed, with each currency weighted by Egypt’s trade exposure to that country. This measure is called the “effective exchange rate”.

The two considerations suggest we should look at the “real effective exchange rate” (REER) when we want to evaluate the impact on exports. Now, back to the original question: is there a relationship between REER and export growth in Egypt?

The chart above displays the change in Egypt’s REER (on an inverted scale, positive values mean the pound is appreciating) against the change in real net exports. If exchange rate depreciation (red line moving up) drives export growth (blue line moving up), then the two lines should move together. As the chart shows, there is a very weak link between changes in REER and Egyptian exports growth. In fact, over the period 2007 to 2011, the two lines were moving in opposite directions!

The Egyptian authorities are very much aware of this fact. In a statement earlier this year, Hazem Beblawi, the former prime minister, wrote:

The authorities consider imports and exports relatively inelastic to the exchange rate as exports are constrained by non price factors and given the large share of wheat and intermediate inputs in imports. Indeed, the large depreciations of the REER in 2003 were not followed by a strong response in net exports.

This is what the authorities believed then. Have they changed their mind now?