We all slept yesterday on the news that the Exchange market will set a ceiling for buying the USD at 2000 Lira.
What can be the reason for this move? What is a currency PEG and how does it work?
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What can be the reason for this move? What is a currency PEG and how does it work?
Follow me
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1-We all know what a PEG is, for a lot of you, you have never known but the PEG. Since you started dealing with money, you have always used the $ at 1500 Lira.
Any country can either Fix its currency to another currency, let it float in the market, or be somewhere in between.
Any country can either Fix its currency to another currency, let it float in the market, or be somewhere in between.
2-What are the advantages of fixing the Lira?
If Lebanon was a single country on Mars there would be no need for a foreign currency. But to do international trade you need to deal with foreign currencies.
If Lebanon was a single country on Mars there would be no need for a foreign currency. But to do international trade you need to deal with foreign currencies.
3-Pegging the Lira to the USD:
-Increases standard of living, since your currency is strong and foreign goods are “cheap”
-Protects the Lira from high volatility. Your Lira is stable and is not jumping up and down
-Lowers risk on trade and adds confidence to investors
-Increases standard of living, since your currency is strong and foreign goods are “cheap”
-Protects the Lira from high volatility. Your Lira is stable and is not jumping up and down
-Lowers risk on trade and adds confidence to investors
4-What are the disadvantages of fixing the Lira?
-BdL Monetary policy is ineffective
-Shocks affect the real economy rather than the exchange rate
-It is “expensive” to export your goods
Let us look at these points
-BdL Monetary policy is ineffective
-Shocks affect the real economy rather than the exchange rate
-It is “expensive” to export your goods
Let us look at these points
5-Why ineffective Monetary policy?
If BdL attempts to manage money supply? Lira will depeg & BdL would have to intervene using reserves to bring the $ to 1500LL
With a Pegged Lira you cannot have an independent monetary policy to target inflation, trade balance, unemployment…
If BdL attempts to manage money supply? Lira will depeg & BdL would have to intervene using reserves to bring the $ to 1500LL
With a Pegged Lira you cannot have an independent monetary policy to target inflation, trade balance, unemployment…
6-What about shocks?
Let's take an example of an oil shock. Lebanon is a net oil importer. What if oil prices suddenly increase?
Oil is sold in USD, with floating Lira, the real exchange rate will depreciate to absorb that shock.
Let's take an example of an oil shock. Lebanon is a net oil importer. What if oil prices suddenly increase?
Oil is sold in USD, with floating Lira, the real exchange rate will depreciate to absorb that shock.
7-If the currency is pegged that shock cannot be absorbed by the exchange rate and thus will affect other aspects of the economy.
You can think of the exchange rate as a thermometer. If BdL keeps intervening to peg the Lira, that thermometer will always show 37 degrees Celsius.
You can think of the exchange rate as a thermometer. If BdL keeps intervening to peg the Lira, that thermometer will always show 37 degrees Celsius.
8-So why was the Lira pegged in the first place?
As we have seen that volatility in a currency is not desirable but looking at the USD/LBP exchange rate in 1996 and 1997 just prior to the beg shows that there was not much monthly volatility in the exchange rate.
As we have seen that volatility in a currency is not desirable but looking at the USD/LBP exchange rate in 1996 and 1997 just prior to the beg shows that there was not much monthly volatility in the exchange rate.
9-The Rafic Hariri government formed on November 7 1996, few months before the official peg, pledged to stabilize the Lira. Few months later a law was passed in the parliament to borrow in USD.
Why do you think the PEG was established in the first place?
Let me know.
Why do you think the PEG was established in the first place?
Let me know.
10-So how does a currency get fixed?
BdL has to always intervene in the market selling USDs and increasing the supply of USD in the market to keep the Lira from depreciating.
How does he get the dollars to intervene? He has to dip into its foreign currency reserves.
BdL has to always intervene in the market selling USDs and increasing the supply of USD in the market to keep the Lira from depreciating.
How does he get the dollars to intervene? He has to dip into its foreign currency reserves.
11-Foreign currency reserves are assets of BdL, mostly in USD, formed of net reserves, deposits of local banks (reserve requirement), deposits of international banks, and selling certificate of deposits.
12-The reason why BdL holds foreign reserves:
-To target exchange rate, in our case a full PEG
-Higher reserves mean better sovereign rating and lower borrowing cost
-To intervene during a financial crisis
-To target exchange rate, in our case a full PEG
-Higher reserves mean better sovereign rating and lower borrowing cost
-To intervene during a financial crisis
13-Following the latest financial crisis, the peg is no longer and the USD has been trading above 2000LL on the parallel market.
14-Fast forward to last week when BdL governor met the association of exchange rate offices and yesterday when it was announced that Exchange offices set a ceiling for buying USD at 2000LL.
15-What might be the reason behind that decision?
-Create a sense that a new government will bring things back to normal.
-This might tap in to some of the hoarded dollars, estimated at $5 Billion, from people who rush to exchange.
-Create a sense that a new government will bring things back to normal.
-This might tap in to some of the hoarded dollars, estimated at $5 Billion, from people who rush to exchange.
16-
-Psychologically create a new peg at 2000LL that BdL can readjust to.
-Create 2 parallel pegged markets where arbitrage can be done between banks, Exchange offices, and BdL. This would be a direct haircut on depositors.
-Psychologically create a new peg at 2000LL that BdL can readjust to.
-Create 2 parallel pegged markets where arbitrage can be done between banks, Exchange offices, and BdL. This would be a direct haircut on depositors.
17-How could this play out?
-In the short term depositors might believe that the Lira is appreciating after the formation of the government.
-They will rush to sell their Dollars.
-This will increase Dollar supply at Exchange offices.
-In the short term depositors might believe that the Lira is appreciating after the formation of the government.
-They will rush to sell their Dollars.
-This will increase Dollar supply at Exchange offices.
18-
-The Exchange offices are not selling dollars, so it means a shortage of dollars in the market.
-This will force the creation of a black market where dollars are exchanged at a higher rate.
-The Exchange offices are not selling dollars, so it means a shortage of dollars in the market.
-This will force the creation of a black market where dollars are exchanged at a higher rate.
19-
-The only way to curb the creation of a 3rd market is for Exchange offices to sell dollars.
-If the demand for dollars increases the exchange offices have to make sure the dollar supply keeps up.
-The only way to curb the creation of a 3rd market is for Exchange offices to sell dollars.
-If the demand for dollars increases the exchange offices have to make sure the dollar supply keeps up.
20-
-This is only possible if BdL promised the exchange offices Fresh supply of Dollars.
-This will tap in to the foreign reserves of BdL.
-Those reserves are already being depleted by Fuel, Medicine, and Wheat subsidies & to a limited extent International transfers and imports
-This is only possible if BdL promised the exchange offices Fresh supply of Dollars.
-This will tap in to the foreign reserves of BdL.
-Those reserves are already being depleted by Fuel, Medicine, and Wheat subsidies & to a limited extent International transfers and imports
21-What is Salamé Thinking?
He has proved to always be two steps ahead of the curve.
Only time will tell how this unfolds. But for sure this can turn out into a Pandora’s box.
He has proved to always be two steps ahead of the curve.
Only time will tell how this unfolds. But for sure this can turn out into a Pandora’s box.
NERD @Mohdfaour89 I believe is writing something about the new rate. @lebfinance Predicted this a month ago ?. @HuseinNourdin Hussein has written about this in Arabic.
@EHSANI22 Has extensively written about the lifestyle that the PEG created.
@EHSANI22 Has extensively written about the lifestyle that the PEG created.
Follow @OmarTamo19 @sugargrizzly and @masss11 to find out about exchange rate and money supply.
Follow these nerds @AndyKhalil1 @nafezouk @AdibChristian @dgheim for some excellent perspective on the crisis.
Follow these nerds @AndyKhalil1 @nafezouk @AdibChristian @dgheim for some excellent perspective on the crisis.
All the threads can be found on the blog finance4lebanon.com
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