Decomposition of the Sources of Real Exchange Rate Misalignment in Egypt: Evidence from the ARDL Model
Articles
Rana Hosni
Cairo University, Egypt
https://orcid.org/0000-0001-5931-4256
Published 2021-12-22
https://doi.org/10.15388/omee.2021.12.58
PDF
HTML

Keywords

exchange rate
misalignment
short-run shocks
fundamental factors
ARDL model
Egyptian pound
undervaluation
overvaluation

How to Cite

Hosni, R. (2021) “Decomposition of the Sources of Real Exchange Rate Misalignment in Egypt: Evidence from the ARDL Model: An Evidence from ARDL Model”, Organizations and Markets in Emerging Economies, 12(2), pp. 305–331. doi:10.15388/omee.2021.12.58.

Abstract

This paper examines the behavior of the real exchange rate in Egypt over the period 1965–2018 by attempting to pursue three interrelated purposes. The first is to investigate the extent of deviations between the actual exchange rate and its equilibrium level and illustrate the magnitude of any currency misalignments. The second is to search for the different phases of over- and undervaluation of the local currency and explain the accompanying economic policies and/or factors leading to them. The third and ultimate purpose is to explore the role of transitory and permanent factors in deviating the actual real exchange rate from its equilibrium level. Understanding these factors should help in the design of economic policies directed to address the misalignment of the local currency. An autoregressive distributed lag (ARDL) bound test approach is used and conducted for both the bilateral and effective real exchange rates to achieve these three purposes during the selected period. To derive the equilibrium exchange rate estimate, the behavioral equilibrium exchange rate (BEER) approach is adopted. The findings reveal that the Egyptian pound was misaligned from its equilibrium value during most of the examined period. The results confirm the relative importance of the terms of trade and degree of openness variables in determining the equilibrium real exchange rate in Egypt followed by investment ratio and government consumption variables. The local currency witnessed a recent phase of overvaluation, which began in 2009, until the free float of the local currency in November 2016, after which, the Egyptian pound was found to have experienced a new phase of undervaluation till the end of the period examined. The findings show a considerable relative impact of fundamental-based factors over a prolonged period spanning from 1986 to 2003 and at the end of the period examined as well. Moreover, the documented results lend general support to the fact that both permanent or fundamental-based factors and short-run shocks prove to be important influential factors impacting currency misalignment in Egypt.

PDF
HTML

References

Adler, K., & Grisse C. (2017). Thousands of BEERs: Take Your Pick. Review of International Economics, 25(5), 1078–1104. https://doi.org/10.1111/roie.12296.

AlShehabi, O., & Ding, S. (2008). Estimating Equilibrium Exchange Rates for Armenia and Georgia. IMF Working Paper No. 110 (Washington: International Monetary Fund).

Aly, H., & Hosni, R. (2018). Examining the Nexus between Exchange Rate Volatility and Export Performance: An Empirical Evidence from the Egyptian Experience. Business and Economic Horizons, 14(3), 542–560. https://doi.org/10.22004/ag.econ.287214.

Asteriou, D., & Hall, S. G. (2007). Applied Econometrics. New York: Palgrave Macmillan.

Central Bank of Egypt (2019/2020). External Position of the Egyptian Economy, Volume No. 20.

Couharde, C., Delatte, A.-L., Grekou, C., Mignon, V., & Morvillier, F. (2017). EQCHANGE: A World Database on Actual and Equilibrium Effective Exchange Rates. CEPR Discussion Paper No. 12190.

Cubeddu, L., Krogstrup, S., Adler, G., Rabanal, P., Chi Dao, M., Hannan, S. A., Juvenal, L., Li, N., Buitron, C. O., Rebillard, C., Garcia-Macia, D., Jones, C., Rodriguez, J., Suk Chang, K., Gautam, D., & Wang, Z. (2019). The External Balance Assessment Methodology: 2018 Update. IMF Working Papers 19/65.

Clark, P. B., & Macdonald, R. (1999). Exchange Rates and Economic Fundamentals: A Methodological Comparison of BEERs and FEERs. In R. Macdonald & J. L. Stein (Eds.), Equilibrium Exchange Rates (pp. 285–322). London, UK: Kluwer Academic Publishers.

Clark, P. B., & MacDonald, R. (2004). Filtering the BEER: A Permanent and Transitory Decomposition. Global Finance Journal, 15(1), 29–56.

Darvas Z. (2012). Real Effective Exchange Rates for 178 Countries: A New Database. Bruegel Working Paper 2012/06.

Edison, H., & Vitek F. (2009). Australia and New Zealand Exchange Rates: A Quantitative Assessment. IMF Working Paper 09/07.

Edwards, S. (1988). Real and Monetary Determinants of Real Exchange Rate Behaviour: Theory and Evidence from Developing Countries. Journal of Development Economics, 29(3), 311–341. https://doi.org/10.1016/0304-3878(88)90048-X.

Edwards, S. (1989). Real Exchange Rates in the Developing Countries: Concepts and Measurement. Working Paper No. 2950 (Cambridge: National Bureau of Economic Research).

Edwards, S. (1994). Real and Monetary Determinants of Real Exchange Rate Behavior: Theory and Evidence from Developing Countries. In J. Williamson (Ed.), Estimating Equilibrium Exchange Rates (pp. 61–91). (Washington: Institute for International Economics).

Egert, B., Halpern, L. & MacDonald, R. (2005). Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues. Journal of Economic Surveys, 20(2), 257–324. https://doi.org/10.1111/j.0950-0804.2006.00281.x.

Esfahani, H. S. (1990). The Experience of Foreign Investment in Egypt under Infitah. Bureau of Economic and Business Research, Working Paper No. 90-1710, University of Illinois at Urbana-Champaign.

El-Shazly, A. (2011). Designing an Early Warning System for Currency Crises: An Empirical Treatment. Applied Economics, 43(14), 1817–1828. First published on 10 November 2009. https://doi.org/10.1080/00036840802600657.

Feyzioglu, T. (1997). Estimating the Equilibrium Real Exchange Rate: An Application to Finland. IMF Working Paper 97/109.

Giannellis, N., & Koukouritakis, M. (2013). Exchange Rate Misalignment and Inflation Rate Persistence: Evidence from Latin American Countries. International Review of Economics and Finance, 25(C), 202–218. https://doi.org/10.1016/j.iref.2012.07.013.

Giordano, C. (2018). Price and Cost Competitiveness Misalignments of the Euro Area and of its Main Economies According to a Quarterly BEER Model, 1999–2017. Bank of Italy Occasional Papers 444.

Faruqee, H. (1995). Long-Run Determinants of the Real Exchange Rate: A Stock-Flow Perspective. IMF Staff Papers, 42(1), 80–107.

Handy, H. (1998). Egypt: Beyond Stabilization, Toward a Dynamic Market Economy. IMF Occasional Paper No.163 (Washington: International Monetary Fund).

Hamilton, J. D. (1994). Times Series Analysis. Princeton NJ: Princeton University Press.

Holtemöller, O., & Mallick, S. (2013). Exchange Rate Regime, Real Misalignment and Currency Crises. Economic Modelling. 34(C), 5–14. https://doi.org/10.1016/j.econmod.2012.09.017.

IMF (2019). The International Financial Statistics 2019 (IFS) Database.

IMF (2020). Arab Republic of Egypt. IMF Country Report No. 20/271.

Isard, P., & Mussa, M. (1998). A Methodology for Exchange Rate Assessment. In P. Isard & H. Faruqee (Eds.), Exchange Rate Assessments: Extensions of the Macroeconomic Balance Approach (pp. 4–24). International Monetary Fund Occasional Paper, Volume 167.

Kheir-El-Din, H., & El-Shawarby, S. (2000). Trade and Foreign Exchange Regime in Egypt. Working Paper No. 2034, Economic Research Forum.

Khodeir, A. N. (2012). Towards Inflation Targeting in Egypt: The Relationship between Exchange Rate and Inflation. South African Journal of Economic and Management Sciences, 15(3), 325–332. https://doi.org/10.4102/sajems.v15i3.203.

Kemme, D. M., & Roy S. (2006). Real Exchange Rate Misalignment: Prelude to Crisis. Economic Systems, 30(3), 207–230. https://doi.org/10.1016/j.ecosys.2006.02.001.

Kennedy, P. (2008). A Guide to Econometrics. USA: Blackwell Publishing.

Koske, I. (2008). Assessing the Equilibrium Exchange Rate of the Malaysian Ringgit: A Comparison of Alternative Approaches. Asian Economic Journal, 22(2), 179–208. https://doi.org/10.1111/j.1467-8381.2008.00274.x.

MacDonald, R., & Ricci L. (2003). Estimation of the Equilibrium Real Exchange Rates for South Africa. IMF Working Paper (44).

MacDonald, R., & Dias P. (2007). Behavioral Equilibrium Exchange Rate Estimates and Implied Exchange Rate Adjustments for Ten Countries. Working Papers, 2007_12, Business School - Economics, University of Glasgow.

Meese, R., & Rogoff, K. (1983). Empirical Exchange Rate Models of the Seventies: Do they Fit Out of Sample? Journal of International Economics, 14(1-2), 3–24. https://doi.org/10.1016/0022-1996(83)90017-X.

Mohieldin, M., & Kouchouk A. (2003). On Exchange Rate Policy: The Case of Egypt 1970–2001. Working Paper No. 0312, Economic Research Forum.

Mongardini, J. (1998). Estimating Egypt’s Equilibrium Real Exchange Rate. IMF Working Paper No. 5 (Washington: International Monetary Fund).

Nkoro, E., & Uko, A. K. (2016). Autoregressive Distributed Lag (ARDL) Cointegration Technique: Application and Interpretation. Journal of Statistical and Econometric Methods, 5(4), 63–91.

Nuryadin, D. (2006). Real Effective Exchange Rate Determination in Indonesia: A Behavioral Equilibrium Exchange Rate Approach. Economic Journal of Emerging Markets, 11(2), 147–158.

Lebdaoui, H. (2013). The Real Exchange Rate Misalignment: Application of Behavioral Equilibrium Exchange Rate BEER to Morocco1980Q1–2012Q4. International Journal of Economics and Finance, 5(10), 36–50. https://doi.org/10.5539/ijef.v5n10p36.

Lee, J., Maria, G., Ostry, J. D., Prati, A., Ricci, L. A., & Milesi-Ferretti, G. M. (2008). Exchange Rate Assessments: CGER Methodologies. IMF Occasional Paper No. 261 (Washington: International Monetary Fund).

Obstfeld, M., & Kenneth, R. (2001). The Six Major Puzzles in International Macroeconomics: Is there a Common Cause? NBER Macroeconomics Annual, 15, Cambridge Mass: MIT Press.

Helmy, O., Fayed, M., & Hussien, K. (2018). Exchange rate pass-through to inflation in Egypt: A structural VAR approach. Review of Economics and Political Science, 3(2), 2–19. https://doi.org/10.1108/REPS-07-2018-001.

Panday, A. (2014). Exchange Rate Misalignment in Nepal. Journal of South Asian Development. 9(1), 1–25. https://doi.org/10.1177/0973174113520581.

Panizza, U. (2001). Macroeconomic Policies in Egypt: An Interpretation of the Past and Options for the Future. ECES Working Paper No. 61.

Pesaran, M. H., & Shin, Y. (1999). An Autoregressive Distributed Lag Modelling Approach to Cointegration Analysis. In S. Strom (Ed.), Econometrics and Economic Theory in 20th Century: The Ragnar Frisch Centennial Symposium. Cambridge University Press.

Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds Testing Approaches to the Analysis of Level Relationships. Journal of Applied Econometrics, 16(3), 289–326. https://doi.org/10.1002/jae.616.

Rajan, R. S., Sen, R., & Siregar, R. (2004). Misalignment of the Baht and its Trade Balance Consequences for Thailand in the 1980s and 1990s. The World Economy, 27(7), 985–1012. https://doi.org/10.1111/j.1467-9701.2004.00638.x.

Siregar, R. Y. (2011). The Concepts of Equilibrium Exchange Rate: A Survey of Literature. The South East Asian Central Banks Research and Training Centre, Staff Paper No. 81.

Tang, X., & Zhou, J. (2013). Nonlinear Relationship between the Real Exchange Rate and Economic Fundamentals: Evidence from China and Korea. Journal of International Money and Finance, 32, 304–323. https://doi.org/10.1016/j.jimonfin.2012.04.010.

Tödter, K. H. (2002). Exponential Smoothing as an Alternative to the Hodrick-Prescott Filter?. In I. Klein & S. Mittnik (Eds.), Contributions to Modern Econometrics. (Dynamic Modeling and Econometrics in Economics and Finance, vol 4.). Boston, MA: Springer. https://doi.org/10.1007/978-1-4757-3602-1_15.

Williamson, J. (1993). Exchange Rate Management. The Economic Journal, 103(416), 188–197. https://doi.org/10.2307/2234345.

Williamson, J. (1994). Estimates of FEERs. In J. Williamson (Ed.), Estimating Equilibrium Exchange Rates (pp. 177–244). Washington: Peterson Institute for International Economics.

World Bank (2019). The World Development Indicators 2019 (WDI) Database.

World Bank (2021). The World Bank World Integrated Trade Solution Database.

Yajie, W., Xiaofeng, H., & Soofi, A. S. (2007). Estimating Renminbi Equilibrium Exchange Rate. Journal of Policy Modelling, 29(3), 417–29. https://doi.org/10.1016/j.jpolmod.2006.12.003.

Youssef, H., & Zaki, C. (2019). From Currency Depreciation to Trade Reform: How to Take Egyptian Exports to New Levels? World Bank Policy Research Working Paper No. 8809.

Most read articles in this journal

1 2 3 4 5 > >>