Bankers and economists are still discussing the implications for the economy of a free-floating pound. Niveen Wahish reports The bombshell was dropped last week by Prime Minister Atef Ebeid when he told an unsuspecting audience of business leaders and government officials that beginning 29 January, "there will be a free market for foreign exchange." The announcement, made in Ebeid's address to the first business roundtable organised in Cairo by The Economist's conference division, came unexpectedly, although not completely out of nowhere. For months the buy and sell price of the dollar against the Egyptian pound has been over LE5.2 on the black market. The official price, meanwhile had remained steady at around LE4.6. The last time the pound was drastically devalued was in early 2001 when a central rate of LE4.5 was set, with a three per cent float margin. Early in 2002, that central rate was changed by only one piastre making it LE4.51. The new system means that the Egyptian government is abandoning the "managed peg system" of the central rate, and is allowing forces of supply and demand to determine exchange rates. Banks will decide the buy and sell rates of foreign currencies on a daily basis, announcing their rates throughout the day and regularly informing the CBE of the size and value of their transactions. Accordingly, the CBE will calculate the weighted average of these rates and announce it. The previous week, the government, in preparation for the floatation, had allowed banks to meet their clients' hard currency demands in exchange for a commission. That commission, which ranged between 12 and 13 per cent, made the cost of the dollar to the pound add up to the market price. Ebeid's announcement was positively received by most bankers. "We could not continue ignoring the fact that the value of the pound has fallen," said Amr Bahaa, treasurer at the Egyptian Commercial Bank. He explained that at the official price, dollars were simply unavailable and banks were having difficulty opening letters of credit. "Clients who wanted to exchange their dollars would sell them on the black market for the market price," Bahaa said. Accordingly, those wanting to open letters of credit were asked to provide foreign exchange from their own resources or purchase from the black market. Bankers hope that the floatation will make black market transactions unnecessary but argue that, at this stage, foreign exchange rates will be unpredictable. One banker, who preferred to remain anonymous, said that the floatation is the first positive sign that the situation with the dollar might improve. She is optimistic that this will allow hard currency to flow back into the banking system rather than the black market. In her opinion, the Central Bank of Egypt (CBE) should have refrained from setting a central rate for the dollar a long time ago. "As long as the CBE cannot meet the foreign currency needs of the market, it should stay out of it," she said. She added that the interest rate on the Egyptian pound should increase slightly to give Egyptians an incentive to hold onto their pounds. Analysing the government's decision Ahmed Galal, executive director of the Egyptian Centre for Economic Studies (ECES) said that, had the managed float system been properly administered, the urgency to move to a floating foreign exchange regime would not have been so urgent. Pointing out the positive aspects of the free-floating system, Galal said that it will unify the rate in the foreign exchange market and will reflect positively on exports, making Egyptian goods cheaper on the international market. It will also promote tourism by making Egypt a cheaper destination. "It will bring transparency to the market and enhance the image, credibility and confidence in Egypt's economy," he said. He stressed however, that what is important now is to make sure that the new regime works as effective as one hopes. Galal is not very concerned that the floatation will cause inflation rates to rise as the inflation rate is currently quite low at around 2.5 per cent, compared to over 20 per cent in the 1980s. Galal is also not worried about the value of the pound depreciating. He expects that any excessive demand for the dollar in the coming few days will not all be real demand and some of it will be speculative. Eventually, the equilibrium nominal price will rule. On the other hand, should an attack on Iraq take place, threatening Egypt's foreign currency earning from tourism, "there could be a transitional impact of significant magnitude." That could be averted if the government plans for such a situation and either borrows to cover any drop in foreign currency earnings or be willing to use the foreign currency reserves. Another area of concern to Galal is the effect of the floatation of the pound on corporations which have liabilities denominated in dollars, but with earnings in Egyptian pounds. He is worried that when companies suffer, banks follow suit. Galal also highlighted that the role of the CBE in managing monetary policy will differ. With a free floating currency, there has to be the institutional capacity to manage that float. "There is no country in the world that has a totally free float," he said, explaining that implicitly, all central banks intervene, but the question is how and to what extent. In fact, following Ebeid's announcement Mahmoud Abul-Oyoun, CBE governor, has been quoted as saying that the CBE will intervene implicitly when it feels there is a need to. But to do that Galal stressed that the CBE must keep a close eye on what goes on in the foreign exchange markets and must set a benchmark for itself. Galal also said that the CBE should now shift its focus to inflation targeting as this is the monetary policy used by countries shifting away from an exchange rate regime. The hike in the value of the dollar during the past couple of years was blamed by many on speculators. But bankers claim that speculation is not solely to blame for the rise in the dollar's value. "It was due to the mismanagement of monetary policy," one banker said. In his opinion, speculators eventually want to collect profit on their transactions which would mean that they need to sell their dollars. This was not happening. "Everyone was hoarding dollars due to a lack of trust in the system," the banker said. Although it is anyone's guess where the value of the pound is heading, experts are worried that the general state of the economy will not support the currency. According to Nasser Fouad, a banking consultant, as long as economic problems persist, the currency will continue to lose ground. "Our industry is not strong enough, our exports are marginal, what's happening in the Gulf is not helping." Moreover, he said that a decrease in the interest rate may lead to increased reliance on the dollar. "Today, nobody will sell any dollars they are holding onto unless in dire need. They will only exchange the exact amount needed."