By Kebour Ghenna
In the late 1970s and early 1980s, the devaluation of African currencies sparked significant debate, particularly between African policymakers and the International Monetary Fund (IMF). The core of the disagreement revolved around whether devaluation should be used as a standard remedy for economic challenges facing the continent. African leaders, like Tanzania’s President Julius Nyerere, were skeptical of this approach, questioning the IMF’s authority to dictate national economic policies.
Today, the debate over exchange rate policy has largely been settled in favor of the IMF and other advocates for liberalizing foreign exchange markets. African countries, often under significant pressure, have accepted the IMF’s recommendations to open up their foreign exchange markets. However, despite these efforts, African nations still struggle with unsustainable balance of payments and overwhelming external debts. Their participation in global trade has continued to shrink, and their reliance on foreign aid has grown, even as global aid flows have declined.
The liberalization of foreign exchange markets, which included removing restrictions on foreign exchange retention, effectively allowed capital outflows before any substantial improvement in export performance could be achieved. Floating exchange rates introduced potential instability in both nominal and real terms, largely due to the inherent volatility of foreign exchange markets.
These markets often rely heavily on unstable sources like commodity markets, remittances, and aid flows, which are contingent on the fulfillment of IMF conditions. While there is an understanding that floating exchange rates can politically relieve governments from the burden of adjusting rates, this approach does not shield governments from public discontent over rising living costs, which can destabilize society. Therefore, a government focused on providing stable incentives for private investment in exports and import substitution would likely avoid allowing exchange rates to fluctuate widely based on external factors.
Pegging the exchange rate to the currency of a developed economy, which operates under different terms of trade, productivity growth, and investment climates, is unlikely to promote growth and structural transformation in Africa. A government aiming for growth and structural transformation would be better served by pursuing an active exchange rate policy. Such a policy would aim to maintain stable incentives for private sector investment in tradable goods. A system based on a crawling peg or band, which takes into account expected changes in terms of trade, aid flows, external debt servicing, and relative productivity growth, is likely more appropriate than either a freely floating or fixed exchange rate system.
In conclusion, managing exchange rates is a critical component of a nation’s economic strategy, particularly in developing economies where stability and growth are paramount. While liberalization and floating exchange rates may seem appealing for their flexibility, they can also expose countries to significant economic volatility, especially when the economy is heavily dependent on unstable sources of foreign income. A more controlled approach, such as a crawling peg or band system, might provide the necessary stability to support long-term growth and structural transformation.
A test for dear readers: Why is Vietnam often considered to be the next emerging economic powerhouse in the global market, says it’s not yet ready for a free-floating exchange rate, while Ethiopia is seen as a country where such a system might be more appropriate? .
Editor’s note : The article appeared first on the personal facebook page of Kebour Ghenna
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