Developing countries are often obsessed with keeping their currencies strong. They believe that “strong countries have strong currencies,” but this thinking often leads to mistakes.
Recently, Egypt stopped trying to artificially support its currency. Instead, it raised interest rates and allowed the exchange rate to float freely. This move improved its credit rating and secured IMF aid.
Countries that rely heavily on imported goods for production need foreign money, which fuels inflation. This dependence affects everything, from government contracts to tuition fees, all tied to the dollar exchange rate. As the exchange rate rises, so do prices.
This is why attempts by import-dependent countries to devalue their currencies for export competitiveness often fail. When costs go up, so does inflation, bringing them back to square one. This cycle is explained by the “Marshall-Lerner Condition,” a theory about the devaluation-inflation spiral.
The “crawling peg” method
Governments of countries that rely on imported raw materials try to control exchange rates without addressing the policies causing their currency’s depreciation. This approach usually ends poorly, as governments focus on symptoms rather than root causes.
