Money Supply, Exchange Rate and Inflation

There are dialectical relationships between a country’s money supply, exchange rate and inflation that in turn impact on its central bank interest rate determining, thus bearing on the productive sector (growth rate, employment rate, etc.) and on the general purchasing power.

As we all know any economic policy ought to, whilst avoiding any monetary illusion, synchronize the real and the financial spheres, the economic and social dynamics.  It goes without saying that all petro economies of the MENA region find themselves in similar traumatic convulsions between fiscal shortcomings and rising domestic and international demand for money.

The problem of the Algerian Dinar (DZD) is that all economic agents (enterprises and households) in the prevailing uncertainty, are expecting inflation to likely block productive investment that would need in any case visibility and which can be done only in the medium and long term thus lead the country into an inflationary spiral without limit in the short term.

FOREIGN EXCHANGE RATE

On September 26, 2017, a $ 1 = DZD112 and €1 = DZD133.66 as pe the official bank rate. Anticipating the effect of the non-conventional financing as accentuated by alarmism, the rate on the Port Said unofficial Exchange market of Algiers for the 25/26 September 2017, exceeded the DZD 200 per Euro and could if some officials continue to pour into the gloom and without a strategic vision, possibly reaching DZD 250 a Euro.

This slide down of the Dinar not to say devaluation, because 70% of the households and public and private businesses alike are sourced from overseas will affect the size of the budget deficit of both regular and oil tax.  This slippage of the Dinar, explains the increase in the costs of imported raw materials, equipment and consumer goods.  This will affect the process of imported inflation, mainly through the dominant informal sphere trade, aligning for unsubsidized products, on the parallel market

Foreign exchange reserves tend to hold the rating of the Dinar to around 70%, depending on of course the revenues from hydrocarbons, 97 / 98% directly and indirectly with the derivatives of foreign exchange earnings.

These estimated peaked at $ 190.66 in 2012 before coming in 2016 to $ 114 billion, and even $ 97 billion by end of this year according to the Minister of Finance, or per the latest report of the IMF, $ 92.3 billion.

The World Bank in a comprehensive report for the region MENA of 2016 provided the foreign exchange reserves of Algeria to be of $ 60 billion towards the end of 2018 and if there were no deep reforms to be had, their complete exhaustion by 2019/2020.  Therefore, the natural reflex of any economic agent and the household or private operators would be to rush to the purchase of hard currency, gold or real estate for the obvious reasons of hoarding.

INFLATION

The official inflation rate between 1989 and September 2017 fluctuated from 17.87% in 1989 to 25.88% in 1991 peaking to 31.68% in 1992 eventually coming down to 2.9% in 2015, before climbing back up to 6.7% in 2016 and averaging 6%+ to 2017 per the Office National of Statistics with 6% in September 2017.

With non-conventional financing, combined with a blind restriction of imports, if not capped the advances of the Bank of Algeria to Treasury according to the proposed draft of amendment of article 45 of the law on Money and Credit that does not set no limit for the next five years, the risk in the event of assignment to the deficit of the balance of payments of non-productive activities, the rate of inflation in 2018 could be between 15 and 20% with a greater cumulative effect in 2019.

However, regarding the overall inflation index, it must be regularly updated as need is historically dated, and needs evolve. The official inflation rate is biased, before the burst by products according to the consumption model by social layers (function of the stratification of national income) and furthermore artificially compressed by the grants otherwise it would exceed the 10% .

The family unit, paradoxically, apart from the recurrent housing crisis and all those poorly managed and aimlessly targeted social subsidies that have reached between 2010 and 2016, up to 23 / 27% of GDP play imperfectly and temporarily as a social buffer. What will happen with the breakup of the family unit and in case of a fall in the price of oil that can no longer subsidize, a couple with two children to collect minimum between DZD 45,000 and 60,000 / month for only survival before avoiding a race to the bottom for some suicidal populists reasons ?

We are in a vicious circle: inflation accelerates social demands for wages increase which in turn accelerates inflation especially in case of no productivity. As the deterioration of purchasing power increases or the indebtedness of households accelerates the dishoarding of households including the middle classes increased pauperisation, their savings inflating the money supply in circulation, accelerating the inflationary process furtherr in the case of rigidity of supply,

When the State has reasonably sound financial means, importation of subsidized goods plays as a transitional buffer. Because inflation will also have a negative impact on the bank interest rate that will have to be raised, to avoid the bankruptcy of the banks in the first place. The risk is obstructing productive investment, an inflationary spiral, according to the vicious circle – social demands, increase in wages without correlated with productivity, inflation and social demands.

In short, unlike those speeches of doom and gloom, Algeria isn’t bankrupt but suffers a crisis of governance as recently declared in interviews with the local media. The truth is that any Nation can distribute only what it has previously produced even if left to drift towards political, social and economic nowhere.

Inflation is like a vector of redistribution and concentration of the national income for the benefit of the variable income and penalises fixed income.  A bureaucratic rentier vision is to believe that the solution to problems is by laying laws. However, this is not a matter of laws but to act on the functioning of society by deepening the institutional and microeconomic reforms, assuming a minimum of political and social consensus.

It is not a matter of having a short-term vision by reducing imports of goods and services, $ 60 billion of outflows of currency in 2016 for goods and services.

These measures will artificially stabilize the short term macroeconomic framework, without resolving the fundamental problems. The acceleration of the overall reform would be the sine-qua-non adoption of a productive economy in the context of international values. Algeria can continue to pay wages without productive counterparties, and devote large amount of money to an overstretched welfare system not specially aimed at the poorest.

With precise strategic objectives, a language of truth, the return to confidence and morality, and another local and central governance model, based on the knowledge economy, central and local institutions realizing the symbiosis State – citizens; all admittedly difficult reforms for Algeria that can meet the many challenges.

ademmebtoul@gmail.com

 

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