A fixed exchange rate is not a solution, but caution against speculation and inaction

Blog albania, altax, Bank of Albania, current account balance, euro, Euro depreciation, Eurobond, exchange rate, fixed exchange rate, informalitet, informality, lek appreciation, market, speculation 0 Comments

Fixed exchange rates are best for partner countries with similar macroeconomic factors and economic strength, such as the US and the European Union.

If countries still wish to establish a fixed exchange rate[1], they can maintain such a relationship without affecting their interest rates by adopting strict capital controls. They can control the entry of foreign investment into the country and also restrict the transfer of funds abroad. This will help maintain stability in exchange rates.

Below some descriptions according to a summary from several sources, but mainly referring to #thebalancemoney:

+ Establishing a fixed exchange rate with the trading partner will provide currency rate certainty for importers and exporters.

When a small country fixes its currency to a superpower like the European Union, they protect themselves from paying more when importing products from developed countries. This appreciation occurs when the US economy grows, which strengthens the dollar, thus making imports expensive for smaller countries. Therefore, a fixed exchange rate protects them from such risk.

A fixed exchange rate helps ensure the smooth flow of money from one country to another. It helps smaller and less developed countries to attract foreign investment. It also helps smaller countries avoid devaluation of their currency and keep inflation steady.

– In a floating exchange rate, when the trade account deficit increases, the country must borrow more from foreign currency. Thus, the price of the currency increases, which also pushes up the price of foreign goods in the domestic market. It reduces the demand for foreign goods and reduces the trade deficit. However, this rebalancing is not possible in the case of a fixed exchange rate.

Fixed exchange rates will limit the freedom of central banks to adjust interest rates to stimulate the economy.

A floating exchange rate helps the central bank to ensure the stability of the economy, as it is not bound by any rules to maintain the exchange rate. Also, with a variable rate, the money supply can be put to its best use.

In terms of the clarifications on the positive (+) and negative (-) sides, we must say that all legal consultations regarding the pursuit of the monetary regime with a fixed exchange rate must become part of a comprehensive policy and with an implementation effect from the medium term to long term.

However, if we take it for granted that this new regime is already accepted, it is worth noting that when money moves freely between Albania and different countries, the issue with adopting a fixed interest rate is that Albania links the Lek to the Euro/Dollar American etc. should conduct its monetary policy similar to the reference country. This means that interest rates must be similar to maintain the fixed exchange rate. If this does not happen, the country with the low interest rate will push its money supply to the country with the higher interest rate until interest rates become equal again. Such a phenomenon, which is defined as the arbitrage of the capital market, makes this approach very harmful, since the Albanian market has already created the experience with the monetary regime of the free exchange rate, anchoring around this political choice everything related to the financial market. and the fiscal system.

For example, let’s assume that the Bank of Albania (BoA), after changing its object related to market monitoring, decides to link the Lek to the Euro. The main objective of BoA is to maintain the stability of its prices (inflation). If inflation starts to rise in Albania, then BoA would be forced to raise interest rates to control price increases.

Since the Lek is already linked to the Euro, BoA will have to maintain similar interest rates to those of the European Central Bank (ECB). In order to control inflation, BoA may still raise interest rates above those of the ECB. This movement theoretically makes the Lek more attractive and money from different countries should come to Albania.

To meet the demand for Lek, BoA must increase the supply of Lek. However, the increase in money supply will lead to inflation, which contradicts the main objective of BoA.

Therefore, when the movement of money between countries is smooth, it is better either to adopt a floating rate or to fix a rate within the country, but not both.

In fact, in our observation we see another disturbing and harmful phenomenon. In major foreign exchange markets it is happening more and more often that countries manipulate the value of their own currency by selling it to buy foreign currency in order to make their exports cheaper and their imports more expensive.

The concern about the reality of the alleged speculation in Albania is related not to the approach as above but to the opposite of this approach.

Why?

Albania is not selling Lek to buy Euros on a large scale to balance the market entry of Euros and other hard currencies. According to our speculative assumption, we can have a ratio of inflows of different currencies in such ratios, where the Euro dominates the flow of inflows close to 70% of the foreign exchange market, while the US dollar, the British pound, the Swiss franc hold the rest of the foreign exchange market of 30%. Based on an increased flow of hard currencies beyond last year’s value and even more than 2021, in the analysis of purchases by BoA for the addition of its reserves in these two years it appears that 2023 in just the first 6 months has exceeded the annual interventions in the foreign exchange market compared to the previous two years.

This indicates a presence of hard currencies with at least much more than inflows from economic development in 2021 and 2022, along with remittances and net income from tourists including currencies that circulate as informal money in the market.

In the case of Albania, the speculation is already in the direction of increasing the supply of Euros from the addition of debts in Euros (Eurobond) and other debts from donors in Euros, from the auctions carried out in 2021 and much more in 2022[2] and the first 6-months of 2023, withdrawing from circulation for short and medium-term periods[3] a total amount of 1.03 trillion lek with a ratio of the average interest rate paid by bond issuers to the nominal value of the bond of 2.12%.

All this means that on average the market has more than usual oversaturation in the Euro accompanied by a lack of supply in the Lek, which are two factors that go in the same direction, when they should be in opposite directions or in neutral ratios at least.

Despite the fact that the government has borrowed from citizens, businesses and commercial banks this large amount of Lek, this has not been put into circulation in a short time, since there was anyway non-realization of public expenditure items on time, non-realization of public investments on time, as well as they were paid by buying Euros from the market in the payment periods of the Eurobond, but not necessarily from the foreign exchange market.

So, to some extent, the government itself has speculated with the exchange market, withdrawing an amount of lek several times more than the Eurobond for non-immediate needs, which in fact exceed the needs of the expenses of a budget year[4].

In fact, although clarification of the cash flow of government spending is needed, it must be said that a neutral logic in this perspective is the suspicion of speculative action not to weaken the Lek, but to strengthen the Euro in the country, aiming to reduce the cost of debt service public, the growth of foreign reserves and government assets and the presentation of official statistics. The influence of an electoral approach to the budget and the orientation of politics towards a truncated transparency and lack of accountability and dialogue with experts has influenced the mindset of this approach explained above.

In this case, the good desire of the government to present Albania as a country that has increased per capita income and has also increased the indicators related to export, which is measured through the Euro, despite the fact that the main costs are in Leka, has probably achieved prevail over the necessary financial analysis.

In this analysis, we have also considered the indirect impact of an external factor that comes from Chinese capital investments in Albania and neighboring countries. The strengthening of the presence of Chinese investments in the economy falls with that part of the indirect influence of the Chinese currency (Chinese yuan), which, given that it is currently stronger than the Euro but not against the US dollar[5] gives an indirect influence on the devaluation theirs to Lek.

The reason for the indirect impact is through imports of goods and equipment[6] from China and exports of energy products mainly to the EU countries have effects on the market. If the investments from China will increase in the future, this will also have its share of influence on the Albanian economy, thus also on the foreign exchange market, just as it happened in Serbia and Montenegro[7].

It has already reached a moment that needs a due diligence[8] of the policy approach to the market and in particular to production and exporters.

Meanwhile, consumer frustration that won’t consume as much as they should is probably partially offset by the flow of consumption from tourists and investments, with the 2022 spec for real estate and cryptocurrency purchases being added mainly by offshore areas and high-income individuals. from unjustified sources.

Continuing towards exhausting the argument that the opposite of all the following criteria is happening in Albania, which according to Bergsten and Gagnon, a country must meet to be considered as a manipulator of its own currency in a given calendar year, we can to be listed:

The current account surplus exceeds 3 percent of GDP[9];

Based on data from the Bank of Albania, the current account has a current deficit, which shows that according to this key indicator, there is no speculation in the direction of the devaluation of the lek.

Net purchases of official assets in foreign currency (net official flows) exceed 2 percent of GDP[10];

According to data from the banking system, it does not appear that this level has been reached.

Foreign exchange reserves and other official net assets exceed three months of imports of goods and services (5.54 billion Euros) [11];

According to the Bank of Albania and INSTAT, foreign exchange reserves do not exceed the level of imports for three months.

Foreign exchange reserves and other official net assets exceed 100 percent of short-term external debt, public and private[12];

From the available statistical data, it can be seen that the foreign exchange reserves exceed the short-term external debt.

Official net flows exceed 65 percent of energy exports minus the cost of production[13];

If we look at the data of energy exports and compared to the official net flows, they seem to exceed them.

The country is classified as a high-income or upper-middle-income country by the World Bank[14].

In a summary of the comparative findings according to the criteria above, it seems that even though three of them are fulfilled, we are not in the case of a speculation in favor of the weakening of the lek.

Through this analysis of the position, which has room for comments and interventions, we think that the way it has been operated so far by the government has influenced the foreign exchange market by strengthening the lek, but also helped by the lack of timely action of government institutions whose main task is to fight informality and the limitation of fiscal evasion together with interventions in the market according to the reports that should have declared the suspicious activities for money laundering.

[1]https://www.bankofalbania.org/rc/doc/Buletini_ekonomik_Vellimi_3_Nr_4_Regjimet_e_politikes_monetare_dhe_prirja_e_Bankes_se_Shqiperise_1728_1_6290.pdf
[2] https://financa.gov.al/kalendari-i-emetimeve/
[3] https://financa.gov.al/rezultatet-e-ankandeve/
[4] in 2022, a total of 651 billion Lek was spent from the budget
[5] https://www.reuters.com/markets/currencies/chinas-measures-slow-yuan-depreciation-2023-08-01/
[6] https://www.instat.gov.al/media/11888/tregtia-e-jashtme-qershor-2023.pdf
[7] https://www.europarl.europa.eu/RegData/etudes/BRIE/2022/733558/EPRS_BRI(2022)733558_EN.pdf
[8] exercising prudence by carefully assessing the associated costs and risks before completing transactions
[9] https://www.bankofalbania.org/?crd=0,8,1,1,0,17830&uni=20230804191918162158210212299441&ln=1&mode=alone