DID EGYPT SATISFY PREREQUISITES FOR AN IT REGIME?

The purpose of this study is to answer the question ‘Is Egypt ready to apply an IT regime?’ The study presumed that a country is ready to apply an IT regime once the prerequisites for an IT regime are met. Comparing the current position of Egypt with some emerging market economies, the conclusions of the study are as follows: (i) the CBE is not factually independent. Although the CBE has been granted legal instrument independence, the existence of government representatives as voting members on the MPC and the coercion of the CBE to extend fi nance to the government are two elements suffi cient to undermine the de facto independence of the CBE; (ii) infl ation targets are expected to be missed under the possibility that the behavior of the CBE will be similar to the behavior of the majority of emerging market economies, i.e., adopting an IT regime whereas implicitly targeting FX rates; and (iii) the current level of knowledge about some central issues of designing an IT regime and the quality of the available data are not satisfactory to support the adoption of an IT regime. The study concludes that Egypt is still not ready to apply an IT regime.

DID EGYPT SATISFY PREREQUISITES FOR AN IT REGIME? Ibrahim L. Awad *

Introduction
A recent survey by the IMF assumed that the trend towards the adoption of an Infl ation Targeting (IT) regime by the emerging market economies is continuing. Over one half of the 88 non-industrial countries covered by this survey expressed a desire to move to explicit or implicit quantitative infl ation targets and nearly three quarters of these countries envisaged a shift to full-fl edged infl ation targeting by 2010 (Batini et al., 2006, pp. 7-8).
Egypt, according to the aforementioned survey, is one of the prospective candidates to switch the monetary policy regime to an IT regime in the short term (1-2 years). Also, the Central Bank of Egypt (CBE) has announced on several occasions its intention to adopt an IT regime as a framework for its monetary policy once the fundamental prerequisites are met (IMF, 2007;CBE, 2005). Moreover, the CBE (2007) stated that it is currently applying implicit infl ation targets which will be announced once the CBE completes building up its infl ation targeting framework in coordination with the IMF 1 .
To date, the CBE has not matched its words with deeds. On the one hand, it has not confessed in any degree of detail about which prerequisites are still unfulfi lled. On the other hand, the steps taken by the CBE to apply the IT regime are still unsatisfactory 2 .
The purpose of this study is to answer the question 'Is Egypt ready to adopt/apply an IT regime?' The study presumes that a country is ready to apply an IT regime once the prerequisites for an IT regime are satisfi ed. To explore this presumption in the case of Egypt, the study intends to answer the following questions: (i) what are the prerequisites for an IT regime?; (ii) did emerging market economies satisfy the IT prerequisites in the early days of their adoption of IT regimes?; and (iii) comparing the current position of Egypt to the emerging market economies in the early days of their adoption of IT regimes, has Egypt satisfi ed the prerequisites for an IT regime? Given the willingness to adopt an IT regime, we assume that a country will adopt/apply an IT regime once it becomes ready for it. This paper is organised as follows: Section 2 defines an IT regime. Section 3 reviews the literature regarding the prerequisites for an IT regime. Section 4 subtracts the lessons from the experience of some emerging market economies including the Czech Republic, Poland and Brazil. Section 5 answers the question to what extent Egypt has satisfi ed the prerequisites of the IT regime. Section 6 concludes.

Definition of an IT regime
An IT regime is a framework for monetary policy in which price stability is the primary goal for the monetary policy 3 . Within the IT regime, the central bank (CB) is committed to achieving a publicly announced target for the infl ation rate, typically at a mediumterm horizon of one to three years (Bernanke & Woodford, 2005, p. 1). According to Mishkin (2000), Mishkin and Schmidt-Hebbel (2001), and Schmidt-Hebbel and Tapia (2002), an IT regime encompasses fi ve main elements: (i) a public announcement of medium-term numerical targets for infl ation; (ii) an institutional commitment to price stability as a primary goal of the monetary policy; (iii) an information inclusive strategy in which many variables, not just monetary aggregates or the exchange rate, are used for deciding the setting of policy instruments; (iv) increased transparency of the monetary policy strategy through communication with the public and the markets about plans, objectives, and decisions of the monetary authorities; and (v) increased accountability of the CB for attaining its infl ation targets.

Prerequisites for an IT regime
There is considerable debate among economists about the prerequisites/preconditions that a country has to meet before adopting an IT regime. This debate refl ects the fact that there is no generally agreed set of preconditions.
Preconditions that are frequently desirable by most economists (Khan 2003, p. 10;Truman, 2003, p. 49;Batini et al., 2006, p. 18;Jonas & Mishkin 2003, p. 6) include the following: (i) a commitment to price stability as the primary goal of the monetary policy; (ii) central bank independence; (iii) macroeconomic stability; (iv) a healthy fi nancial system; (v) transparency of the monetary policy and accountability of the central bank; (vi) absence of fi scal dominance; and (vii) institutional elements, including determining monetary policy transmission mechanisms, infl ation forecasting, and coordination between the monetary and fi scal policies.
Nevertheless, there is no agreement among economists regarding the question whether the prerequisites have to be met prior to the adoption of an IT regime in an emerging market economy? Eichengreen et al. (1999) argue that emerging market 3 Alan Greenspan reportedly once defi nes price stability as a rate of infl ation so low that private sector do not have to take into account in making economic decisions. A strict defi nition of price stability suggests an infl ation rate at or very near zero. Despite the change in the CPI is widely used to measure the infl ation rate the CPI may involve some bias. That is why some economists indicate that targeting the rate of infl ation at zero may create serious problems. These problems refer to the fact that both infl ation and defl ation have negative impact on the economic activity. IT from this perspective is designed for achieving price stability (fi ghting both infl ation and defl ation) through hitting a target of infl ation (Bernanke, Ben S., et al., 1999, pp. 28-30).
economies severely lack the technical capabilities and autonomous central banks. Consequently, these countries will be better off with conventional monetary policy frameworks, e.g., targeting exchange rates or targeting monetary aggregates. But Carare et al. (2002) think that the absence of some of the preconditions should not preclude the adoption of IT, especially when policies are being introduced to establish them in the short or medium-term. Truman (2003) thinks of preconditions as part of "full-fl edged" infl ation targeting that may follow a transitional period. Assessing the role of the "preconditions" for adopting IT, Batini et al. (2006, p. 176) found that no infl ation-targeting central bank had all "preconditions" in place prior to the adoption of IT.
Three basic elements are usually highlighted in the vast majority of the literature as the crucial prerequisites for an IT regime. These elements are as follows.

Factual (de facto) independence of the central bank 4
Central bank independence has to be de facto and not only de jure. Full legal independence of the CB (goal independence and instrument independence) is a controversial issue among economists but factual instrument independence of the CB is an indispensable requirement as a precondition for a successful application of IT. The CB should be free to choose the appropriate tools and change them whenever it is necessary without any pressures from the government. Also, the CB should have the techniques and technicians to achieve its objectives without substantial outside interference. That is, infl ation targets and their tolerance intervals may be formulated by the government and delivered to the CB, which becomes responsible for achieving them. In the course of achieving infl ation targets, the CB should not seek or take instructions from any other body. Therefore, the existence of government representatives on the Monetary Policy Committee (MPC) as voting members should be prohibited. Importantly, with fi scal dominance CB independence is not factual even though the CB enjoys both legal instrument independence and non-existence of government representatives on the MPC. The existence of fi scal dominance will make it risky for any country to adopt an IT regime 5 . The most visible version of fi scal dominance is the formal obligation of the CB to fi nance budget defi cits 6 . Masson et al. (1998), Debelle et al. (1998) and Khan (2003) add another dimension in that the shallowness of a capital market is also a common indication of fi scal 4 Several studies stress this point in relation to the meaning of this paper; see Truman (2003, pp. 49-52), Masson et al. (1998, p. 35), Batini et al. (2006, p. 18), Debelle et al. (1998 pp. 11-13), Fraga et al. (2003, pp. 24-25), and Mishkin and Schmidt-Hebbel (2001, p. 5). 5 Fiscal dominance is a situation in which monetary policy is dominated by the fi nancial needs of the government. The connection between the factual independence of the central bank and fi scal dominance is often presented as follows: if the government does not have suffi cient resources to fi nance its operations in the economy and systematically and signifi cantly requires amounts of fi nance to meet its obligations, then a country's fi scal requirements are likely to dominate and determine the central bank's operations. In such a case, the CB will not be able to achieve its infl ation target or keep it inside a determined path (Khan 2003). 6 In a previous study on the political pressure on CBs in emerging market economies, we evaluated the de facto independence of a CB in terms of the ability of the CB to keep its target of monetary supply despite the government's pressures for higher credit. We found that the Central Bank of Egypt (CBE) could not keep the target of monetary supply, and such a failure refers to fi scal dominance  dominance. On the one hand, a weak fi nancial system may prevent the CB from using interest rates freely to return infl ation forecasts to the intended path. That is because a fragile fi nancial system is likely to be unable to afford an increase of nominal interest rates associated with the CB moping up the liquidity that has been provided at the previous discount window. On the other hand, the fi nancial system is often a by-product of government schemes to extract revenues using various forms of fi nancial repression (interest rate ceiling, high reserve requirements, selective interest rates, and compulsory placement of public debt). In such circumstances, the CB may resist an increase in the market interest rates to correct deviations of forecasted infl ation from the target because of the potential impact on the fi scal position. A related argument is that if the cost of bailing out a weak banking system becomes a large fi scal burden, it may lead to fi scal dominance (Truman, 2003, p. 52). However, with reasonably effective monetary policy instruments, e.g. an overnight interest rate and open-market operations, the CB will be able to follow its target more effi ciently.
To sum up, the factual independence of a CB rests on three basic pillars: (i) legal instrument independence of the CB; (ii) nonexistence of government representatives on the MPC as voting members; and (iii) absence of fi scal dominance including no obligation for the CB to fi nance budget defi cits, while domestic fi nancial markets should have enough depth to absorb placements of public debt such as treasury bills.

Commitment to price stability as a primary goal of monetary policy
The CB should not target any other variables, e.g. exchange rate or employment. On the one hand, the monetary policy under the commitment to other targets will be confi ned with those targets and, as a result, the monetary authority is more likely to fail in achieving the announced infl ation target. On the other hand, the public will have no assurance that the monetary authorities will give the infl ation targets a priority. Such a situation is likely to deteriorate individuals' expectations about the future infl ation path because of the uncertainty concerning the credibility of the announced target. Nevertheless, the CB should intervene to prevent undesirable effects of the change in other macroeconomic variables on the future infl ation path (Khan, 2003, p. 10).
The commitment to price stability as a primary goal of monetary policy requires some degree of accountability for the CB concerning implementation of infl ation targets. The lessons from the international experience as indicated by Bernanke et al. (1999, p. 38, p. 296) delivered two forms of accountability: fi rstly, by comparing infl ation outcomes with the targets; and secondly, by the CB's obligation to provide the public with a convincing rationale for the policy choices it makes. Given that infl ation responds to policy after some lags and infl ation targets are rarely hit exactly in the short term, the second form has become the only alternative for maintaining accountability. Practically, many CBs prefer to be more transparent and credible to the public by announcing escape clauses, i.e., exceptions from the obligation to fulfi ll the infl ation target. This explains, on the one hand, why accountability of CBs is less formalized in practice and, on the other hand, why a transparent monetary policy is so important not only as a device to tie down individuals' expectations around an announced infl ation target but also as a means of accountability of CBs to the public.
To sum up, a commitment to price stability requires two basic elements: (i) a CB should not target any other variables than the rate of infl ation; and (ii) a CB should be transparent to the public about the exemptions of its infl ation target. That is, a CB should announce escape clauses for its infl ation target. Such a transparency is a practical device to make a CB accountable to the public in achieving the infl ation target.

Forecasting capabilities
Because of time lags between the change of monetary policy instruments and their associated effects on infl ation, an IT regime has to be pursued in a forward-looking manner where the current adjustment of monetary policy instruments has to be established on a systematic assessment of the future path of infl ation. Consequently, the adoption of an IT regime by announcing some targets for infl ation to be achieved in the future and the way to proceed towards achieving such targets requires (Debelle et al., 1998, pp. 3-4): (i) a model for infl ation forecasting and infl ation projections has to be set up in advance; (ii) the CB has to have a clear idea about its monetary policy transmission mechanisms and the associated lags; and (iii) a high-quality inclusive and updated database of the economic variables has to be available.

Lessons from the experience of some emerging market economies
Appendix 1 outlines the experience of some emerging market economies including the Czech Republic, Poland and Brazil (henceforth, CPB) 7 . It stresses mainly the following dimensions: (i) the factors behind the decision to adopt an IT regime in each country; (ii) the level of legal independence granted to the CB and whether there was a legal obligation for the CB to fi nance budget defi cits; (iii) the commitment to price stability as a primary goal of monetary policy, the price index used to formulate and gauge infl ation targets, and the reaction of the CB to supply shocks; and (iv) the level of knowledge for both infl ation forecasting and monetary policy transmission mechanisms. Different lessons may be subtracted from the experience of these countries under the adoption of IT as a framework for their monetary policy regimes: 4.1 These countries were seriously keen on and willing to achieve the goal of price stability. The real intention to achieve the goal of price stability was the stimulus behind the preparation for the adoption of IT regimes in these countries. As the intention was real, it was swiftly translated into tangible steps on the ground. From the Brazilian experience, when the BCB and the government became convinced of the adoption of IT as a means to achieve the goal of price stability, the preparation and the switching to the IT regime occurred in a very limited period of time: between March and June 1999. Until the beginning of March 1999, the BCB was not granted formal instrument independence, the forecasting capabilities were very limited, and the majority of the BCB staff did not even know what an IT regime was (see Appendix 1).

IT was adopted to serve as a new nominal anchor for monetary policy.
After fl oating their currencies, the CPB found that an IT regime is the only available alternative in order to achieve the goal of price stability on a forward-looking basis. On the one hand, a monetary policy regime without an explicit nominal anchor was not an appropriate alternative for tying down individuals' expectations about the future path of infl ation where CBs in these countries did not have a track record of credibility. On the other hand, a monetary targeting regime was neither an appropriate alternative especially after the liberalization of the capital fl ows and fi nancial markets, which undermined the relationship between the money supply and the price levels.
Why had the CPB fl oated their currencies? The CPB were, in fact, forced to fl oat their currencies in order not to lose the infl uential part of their foreign reserves on the aftermath of the economic crises. The decision to fl oat came as the aftermath of the speculative attacks on the domestic currencies triggered by both the Asian crisis and external imbalances in their current accounts. The imbalances in the current accounts emerged as a result of pegging foreign exchange rates in conjunction with high domestic infl ation, whereby a depreciation of the domestic currencies occurred.
4.3 IT is problematic in case the pass-through effect is higher; the problematic issue here being that the CB, on the one hand, has to be credible with the announced target of infl ation to make it serve as a nominal anchor for individuals' expectations. On the other hand, however, the CB may encounter a high effect of the exchange rate pass-through which may undermine the ability of the CB to achieve the infl ation target. To be credible, the CB has to determine in advance escape clauses for its targets.
After Brazil was forced to fl oat its currency (the real) in order not to lose an infl uential part of its foreign reserves under the pegging of the foreign exchange rates, the BCB was afraid of a higher level of the pass-through effect in the economy. The BCB estimated the pass-through effect at that time at 30-40 percent based of the estimated share of tradable goods in the economy. Although the pass-through effect was higher, the BCB did not explicitly continue targeting the foreign exchange rates but rather it announced its intention to apply an IT regime. The reason for the IT regime was that a nominal anchor for the monetary policy was essentially needed at that time to mitigate the panic in the economy (Fraga, 2000). In practice, the higher level of the pass-through effect led the BCB to, implicitly, target the exchange rate in an asymmetric way, i.e. by fi ghting devaluation and tolerating revaluation.

Missing infl ation targets were generally referred to as forecast fl aws.
Although the escape clauses were defi ned explicitly in the case of the CNB (Czech Republic) and implicitly in the case of the NBP (Poland) 8 , the CBs in both the countries missed their infl ation targets several times. In its assessment of ten years of IT, the CNB concluded that the forecast fl aws were responsible for missing most of its targets (see Appendix 1). Although the NBP was less transparent regarding the real reasons behind the missing of its targets, it took similar steps as the CNB to improve its forecasting ability by building more accurate and sophisticated models and improving its knowledge about monetary policy transmission mechanisms.

CB independence was factual.
According to the aforementioned criterion of factual independence, the CBs in these countries possess legal instrument independence with an absence of both government representatives on the MPC as voting members and fi scal dominance in the form of formal obligation to the CB to fi nance budget defi cits.
4.6 Factual independence of the CB mostly not granted by the government but assumed by the CB. The CBs, especially in the Czech Republic and Brazil, were the initiators proposing the IT regimes to the governments. Perhaps the CNB did not have to exert so much effort to convince the government of the adoption of an IT regime because the government was mainly motivated by the EU accession, but the BCB played an active role in convincing the government of the adoption of an IT regime.

To what extent has Egypt satisfied prerequisites for an IT regime?
This section explores whether Egypt has satisfi ed the aforementioned prerequisites for an IT regime in such a way that it makes the adoption of an IT regime in Egypt feasible to anchor individuals' expectations around the potential infl ation targets. In this context I will exploit the experience of the CPB by comparing their positions in the early days of their adoption of IT regimes with the current position of Egypt. Such a comparison may enable us to assess whether Egypt is able to apply an IT regime or not.
The economic circumstances in Egypt in the 1990s were very similar to the comparison countries. The application of the economic reform program with the advent of the 1990s and the pegging of foreign exchange rates for long periods of time are the two common aspects between Egypt and the comparison countries. The main deference, however, was the reaction of the CBE to the economic crises that occurred in the second half of the 1990s. While the comparison countries reacted to the economic crises by fl oating their domestic currencies and adopting IT regimes, the CBE did not (see Appendix 3) 9 .
The first prerequisite: factual independence of the CB As mentioned above, the factual independence of a CB rests on three basic pillars: (i) legal instrument independence of the CB; (ii) nonexistence of government representatives on the MPC as voting members; and (iii) absence of fi scal dominance including no obligation for the CB to fi nance budget defi cits, while domestic fi nancial markets should have enough depth to absorb placements of public debt such as treasury bills.
We may explore these elements for the CBE in light of Act no. 88 of the year 2003, amended by Act no. 162 of the year 2004 and Act no. 93 of the year 2005, known as the new laws on the CB, the banking sector, and the money (henceforth, the new legislation) 10 . 9 Appendix 3 includes details about the reasons that forced Egypt to fl oat the FX rate. It is available upon request. 10 Available at: http://www.cbe.org.eg/public/Banking%20Laws/Law%2088,%20amendments,%2013-7-2005.pdf.
(i) The legal independence of the CBE. Similar to the CPB, the new legislation determined the primary objective of the monetary policy to be the achievement of the goal of price stability and banking system soundness within the context of the general economic policy of the state. In agreement with the government, the CBE sets the objectives of its monetary policy through a coordinating council formed by a Decree of the President of the Republic 11 .
The Governor of the CBE is appointed by a Decree of the President, upon his/her nomination by the Prime Minister, for a renewable term of four years, and is treated the same as a Minister in terms of his/her pension. The resignation of the Governor is accepted by a Decree of the President. The Governor has two Deputies appointed by a Decree of the President, upon their nomination by the Governor, for a renewable term of four years.
Like the CPB, the CBE possesses instrument independence, where the board of directors (BoD), or MPC, of the CBE is the authority responsible for realizing the objectives of the monetary policy through implementing monetary, credit, and banking policies. The MPC also determines the instruments required to achieve the objectives; particularly, the instruments of monetary policy to be followed, the structure of credit and discount rates, the regulatory and supervisory standards to guarantee the soundness of the fi nancial position of banks, and the regulation of auctions and tenders.
(ii) The government representatives in the MPC. Unlike the CPB, the MPC of the CBE includes government representatives as voting members. It consists of fourteen members, including two Deputy Governors, the chairman of the capital market authority, three members representing the Ministries of Finance, Planning and Foreign Trade, and eight experts in monetary, fi nancial, banking, legal, and economic affairs designated by the President of the Republic for a renewable term of four years.
(iii) The obligation of the CBE to fi nance budget defi cits. The CBE acts as a fi nancial advisor and agent for the Government. Consequently, the CBE executes banking transactions pertaining to the Government and public legal persons, as well as internal and external fi nance with banks according to the conditions set by the MPC.
Unlike the other CBs of the CPB, the CBE has to extend fi nance to the Government, upon its request, to cover the seasonal defi cit of the general budget, with an amount not in excess of 10% of the average revenues of the general budget in the three previous years. The term of such fi nance is three months renewable for other similar periods, with a maximum of twelve months. The conditions concerning such fi nance are determined upon agreement between the Ministry of Finance and the CBE. Also, the CBE has to guarantee the fi nance and credit facilities obtained by public legal persons from banks, fi nancial institutions, and foreign or international institutions.
Moreover mparison between Egypt and the CPB in the early days of their adoption of IT regimes may shed some light on the position of Egypt relative to these countries, and highlight both the downsides and the benefi ts of the economic policy applied in Egypt. Table 1 exhibits some indicators of macroeconomic stability for both Egypt and the CPB. Both the infl ation rate and the output growth rate in Egypt during the periods of 1995-1998 and 2005-2007 were better than those of the CPB during the period of 1995-1998. Also, the coeffi cient of variation (v) for both the infl ation and the growth in Egypt during the period of 2005-2007 was better than that of the CPB during the period of 1995-1998.

M = Mean, S = Standard deviation, V = Coeffi cient of variation (S/M).
Source: The author: 1 Appendix 1, 2 Calculated from Appendix 2, Although the average rates of infl ation in Egypt during both the periods of 1995-1998 and 2005-2007 were very similar, the rate of infl ation during the latter period was ascendent and hit two-digit fi gures in mid-2007 according to the formal statistics (Appendix 2, Table 2.3). Theoretically, the higher of the rate of infl ation and the lower of the rate of growth are more likely correlated with the adoption of an IT regime (Hu, Yifan, 2003). The high level of infl ation rate in the CPB during the period of 1995-1998 and the reaction of their CBs by tightening their monetary policies explain the relatively high value of the coeffi cient of variation (V) of the real interest rate in these countries compared with Egypt, where the rate of infl ation was going down during the same period. Table 2 deliver nother piece of information pertaining fi nancial depth and symptoms of fi scal dominance. Williamson and Mahar (1998) suggest that fi nancial depth, measured by M2/GDP, is a helpful indicator to determine a fi nancial system's effi ciency in mobilizing funds. According to this indicator, as shown in Table 2, Egypt exhibited better shape than the CPB even during the period of 1995-1998. Also, the claims on the government (annual growth as % of M2) seem reasonable, comparable with Poland and much better than Brazil.
Currently, the main shortcoming and the downside of the macroeconomic policy in Egypt is the performance of the general budget. Although the budget defi cit (% of GDP) in Egypt was reasonable, comparable with the CPB during the period of 1995-1998, it has been exacerbated during the successive periods after 2002 (see Table 3).
The higher ratio of the budget defi cit in conjunction with both the existence of government representatives on the MPC and the legal obligation of the CBE to fi nance budget defi cits represented the greatest danger for both the CBE's independence and the macroeconomic stability in Egypt.   Table 3 mirrors the interaction among these factors. The high ratio of both the budget defi cit and the public debt, averaging at 9.1% and 63% respectively for the period of To sum up, although the new legislation determined the primary objective of the monetary policy to be the achievement of the goal of price stability, and granted the CBE legal instrument independence, the existence of government representatives as voting members on the MPC and the coercion of the CBE to extend fi nance to the government are two elements suffi cient to underpin any meaning of the de facto independence of the CBE. Consequently, the legal instrument independence granted to the CBE is sketchy and does not go beyond the de jure independence 13 . Moreover, although the comparison between Egypt and the Czech Republic, Poland, and Brazil came in favor of Egypt in many areas, the main shortcoming of the macroeconomic policy in Egypt is the performance of the general budget, including the high ratio of both budget defi cit and public debt with a high contribution of the banking system and the CBE to fi nancing it.

The second prerequisite: commitment to price stability as a primary goal of monetary policy
As mentioned above, a commitment to price stability requires two basic elements: (i) a CB should not target any other variables than the rate of infl ation; and (ii) a CB should be transparent to the public about the exemptions of its infl ation target, i.e., a CB should announce escape clauses for its infl ation target. We explore these elements in the case of Egypt as follows.
(i) The CB should not target any other variables. The rationale behind this condition, as mentioned, is that targeting any other variables beside infl ation is more likely to make the CB unable to achieve the infl ation target either because of goals confl icting in the short run or because of the infl ationary expectations induced by the uncertainty steaming from the lack of credibility of the CB in achieving the infl ation targets.
As a threshold for switching from their monetary policy regimes to IT regimes, emerging market economies announced fl oating foreign exchange (FX) rates, although practically they applied a managed fl oating regime. Under the managed fl oating regime, a CB has an unannounced/implicit target for FX rates in the form of ranges within which the FX fl uctuates. The CB intervenes on the FX market from time to time to return the FX rate back to the target. The reason that emerging market economies applied a managed and not a completely free fl oating regime may refer to the long history of FX turbulences in these countries, the volatility of international fi nancial fl ows, and their vulnerability to FX rate shocks 14 . Therefore, managed fl oating FX rates are intended to avoid the undesirable effects of FX rate volatility on both the real economy and the price level.
Why target FX rates implicitly not explicitly? In the experience of the CPB, these countries were actually pegging foreign exchange rates but were forced to abandon that on the aftermath of the economic crises in order not to lose infl uential parts of their foreign reserves. After abandoning the pegging of the foreign exchange rates and fl oating domestic currencies, IT appeared to be the only available alternative to anchor individual expectations especially when it became clear that the association between money supply and prices had broken down. That is why many countries switched from their monetary policy regimes to IT regimes after fl oating the foreign exchange rates.
However, adopting an IT regime under the implicit targeting of FX rates may cause two problematic situations for the CB: The fi rst is the case in which the domestic currency depreciates, especially when the pass-through effect is higher. In such a case the CB may increase the short-term nominal interest rate to return the FX rates back to the target. The increase in the short-term nominal interest rate may not lead to missing the infl ation target if the forecasted level of infl ation was higher than the targeted level. However, the CB may miss the infl ation target if the forecasted level of infl ation was lower than the targeted level. In this case, increasing the nominal interest rate to fi x the depreciation of the domestic currency will cause undershooting the infl ation target. The second problematic situation is the case in which the domestic currency appreciates. With the preliminary success of the CB in achieving the infl ation target, the domestic infl ation is turning down but, unfortunately, the domestic currency appreciates as well. One reason for such appreciation of the domestic currency is the convergence of both domestic and foreign infl ation which lead the real exchange rates to increase (Holub, 2004). In such a case, the intervention of the CB by cutting the nominal interest rate to return the nominal exchange rates back to the target may not lead to missing the infl ation target if the forecasted level of infl ation was lower than the targeted level. However, the CB may miss the infl ation target if the forecasted level of infl ation was higher than the targeted level. In this case, cutting the nominal interest rate to fi x the appreciation of the domestic currency will cause overshooting the infl ation target.
Regarding Egypt, the question is: may the aforementioned scenario repeat in the case of Egypt, i.e., adopting an IT regime whereas implicitly targeting FX rates? Three reasons support the possibility that the behavior of the CBE will be similar to that of the majority of emerging market economies after the fl oatation of their currencies.
The fi rst reason: The relationship between money and prices in Egypt has broken down. Consequently, after the decision to fl oat FX rates the CBE is more likely to adopt an IT regime as an anchor for its monetary policy 15 .
The second reason: The FX rate regime in Egypt is not completely fl oating. After long periods of pegging FX rates and the insistence to maintain them despite 15 In a previous study, we assessed the effi ciency of the currently applied monetary targeting regime in Egypt by measuring whether there is a relationship between money and prices, the stability of the velocity of circulation, and the stability of the demand for the money function. The results of the econometric study indicated that the relationship between money and prices in the Egyptian economy is loosened either in the short run or in the long run, the velocity of circulation is found nonstationary, there is no cointegration relationship between the money supply and the nominal GDP, and the long-term demand for the money function is not stable .
the economic crises that occurred in the second half of the 1990s, the CBE was forced to fl oat the FX rates after substantial losses of its foreign reserves (see Appendix 3).
Although the foreign exchange rates are now unifi ed and reasonably fl exible, they are still dominating monetary policy decision-making in the CBE. Figure 1 clearly indicates that the change in the short-term nominal interest rates in the last periods (2006)(2007) was oriented to adjusting the changes in the FX rates. The third reason: The pass-through effect in Egypt is high. Rabanal, 2005 (p. 4, p. 8) estimated the exchange rate pass-through effect in Egypt on both the wholesale price index (WPI) and the consumer price index (CPI) during the period of the exit from the pegging to the fl oatation of the FX rates, i.e., the period of 2000-2004. While the pass-through effect was higher on the WPI (from 30% to 60%) and statistically signifi cant, it was lower and not statistically signifi cant for the CPI. The weak relationship between the exchange rate shocks and the changes in the CPI is referred to the relatively large share of goods with administrated prices included in the CPI series that was used until July 2003 (roughly one third to one half of the CPI items).
In total, the above reasons support the possibility that the behavior of the CBE, in the case of the adoption of an IT regime, will be similar to the behavior of the majority of emerging market economies, i.e., adopting an IT regime whereas implicitly targeting FX rates. Under this possibility, infl ation targets are expected to be missed especially in the fi rst stages of the application of the IT regime.
(ii) The CB should announce escape clauses for its infl ation target. In the experience of the CPB, not all of the CBs announced escape clauses for their infl ation targets. While the BCB did not announce any escape clauses, the CNB preferred to be more transparent to the public by explicitly announcing the escape clauses, whereas the NBP did not explicitly announce any escape clauses but rather defi ned its stance from a shock depending on the scale and the duration of such a shock.
Although the BCB did not announce escape clauses, perhaps it pertained credibility for some reason; it used a relatively wide range: 2 percentage point tolerance interval around the central infl ation target. Neither did the CNB announce escape clauses for its infl ation targets in the early days of adopting an IT regime because during that period the CNB was targeting the so-called net infl ation, which covers 80% from the CPI. The CNB announced the escape clauses immediately after abstaining from targeting the net infl ation and the announcement in April 2001 of its intention to target the headline infl ation measured by the CPI.
However, different alternatives are available to the CBE when it comes to the decision to adopt an IT regime: (i) explicitly announcing escape clauses, like in the case of the Czech Republic; (ii) defi ning shocks and determining the scale and the duration of a shock which will make the CB respond, like in the case of Poland; (iii) using a wide range for its infl ation targets without announcing any escape clauses, like in the case of Brazil.

The third prerequisite: forecasting capabilities
In the experience of the CPB, infl ation targets were missed several times (see Appendix 1). Upon the explanation of the CNB regarding the decisive element behind the undershooting of the infl ation targets, the non-fulfi llment of infl ation forecasts, owing to a combination of supply shocks and imperfections in the forecasting system, was the main element behind such undershooting.
As mentioned above, forecasting capabilities require three basic elements: (i) a model for infl ation forecasting and infl ation projections has to be in place; (ii) the CB has to have a clear idea about monetary policy transmission mechanisms and their associated lags; and (iii) inclusive, updated, and high-quality data have to be available.
To what extent are these elements currently available in Egypt? Regarding the fi rst and second elements: Al-Mashat, 2008 (pp. 25-26) reported information about the status of infl ation modeling and forecasting inside the CBE as shown in Table 4. Since this information is not available to any scholar in a normal way, then it raises a question regarding the degree of disclosure in the CBE, which is a cornerstone of a successful IT regime.
Moreover, the construction of the CPI core infl ation by the CBE may serve as a useful tool for the MPC to follow up and evaluate the infl ation behavior, but it will be risky if the CBE is planning to use it for the purpose of IT. As the CBE does not have a track record of credibility, the CPI core infl ation or any other price index planned to be used for the purpose of IT has to be calculated by an independent entity, i.e., the CAPMAS in the case of Egypt.
However, even under the assumption that the information reported in Table 4 is corroborated, this information does not, in fact, refl ect a satisfactory level of knowledge about some central issues that have to be tackled before the adoption of an IT regime. Such issues include the relationship between money supply and prices, the stability of the demand for the money function, the exchange rate pass-through effect, the level of the real exchange rate, the relative importance of monetary policy transmission channels and the associated time lags, the rate of infl ation which should be targeted without causing an eruption of public debt, infl ation forecasting, and infl ation projections under different scenarios for supply and demand shocks. The CBE should have different models under different methodologies for each individual issue to compare and subtract accurate information.

Details
The CBE construct its own core infl ation measures, excluding regulated items and volatile food items. To date these measures have been for internal circulation, not for publication. Going forward, there are plans to publish these measures.
The CPI basket has been split into sub-groups, food, non-food and service.
The degree of pass-through from the exchange rate to the CPI and WPI infl ation rates was quantifi ed in an empirical study, utilizing a 5-variable VAR model. The responses of CPI and WPI to exchange rate shocks have been obtained.
VAR analysis has been conducted.The relationship between the variables and the response have been obtained.
The CBE carries out near-term forecasts for one quarter ahead. In addition, there are medium-term forecasts.
Developing these types of models is underway in the CBE.
Developing these types of models is underway in the CBE.
The ECES puts out a business barometr, which surveys business confi dence. However, more needs to be accomplished in this area. Table 4 Status of forecasting and modeling in the CBE

Source: Central Bank of Egypt (CBE) 16
Regarding the third element: Using the Data Quality Assessment Framework (DQAF), the IMF (2005) assessed the quality of data in Egypt. Their assessment included the national accounts, the price indices, the government fi nance, the money, and the balance of payment statistics. Despite several shortcomings in many areas, the most defects in the Egyptian data were found in the accuracy and reliability, the serviceability, and the accessibility. The accuracy and reliability issue was mainly related to the national accounts and the price indices prepared by the Ministry of Planning (MOP) and the CAPMAS successively. The data serviceability issue included the fact that the dissemination of macroeconomic statistics does not in all cases fully meet the users' needs and there is no general oversight regarding the development and coordination of macroeconomic statistics. The data accessibility issue included the diffi culties of the availability of data among all interested parties equally and simultaneously.

Conclusion
The purpose of this study was to answer the question 'Is Egypt ready to apply an IT regime?' The study presumed that a country is ready to apply an IT regime once the prerequisites for an IT regime are met. The presumption of the study has been explored in the case of Egypt by answering the following questions: (i) what are prerequisites for an IT regime?; (ii) did emerging market economies satisfy the prerequisites for IT in the early days of their adoption of IT regimes?; and (iii) comparing the current position of Egypt to the emerging market economies in the early days of their adoption of IT regimes, has Egypt satisfi ed the prerequisites for an IT regime?
The conclusions of the study are as follows: (i) the CBE is not factually independent. Although the new legislation determined the primary objective of monetary policy to be the achievement of the goal of price stability and granted the CBE legal instrument independence, the existence of government representatives as voting members on the MPC and the coercion of the CBE to extend fi nance to the government are two elements suffi cient to underpin any meaning of the de facto independence of the CBE. Moreover, the comparison between Egypt and the Czech Republic, Poland, and Brazil indicated that the main shortcoming of the macroeconomic policy in Egypt is the current performance of the general budget; (ii) there are many reasons in support of the possibility that the behavior of the CBE, in the event of the adoption of an IT regime, will be similar to the behavior of the majority of emerging market economies, i.e., adopting an IT regime whereas implicitly targeting FX rates. Under the possibility of this scenario, infl ation targets are more likely to be missed especially in the fi rst stages of the application of the IT regime; and (iii) the current level of knowledge of the CBE about some critical issues that have to be tackled before the adoption of an IT regime is not satisfactory and the quality of the currently available data is not likely to support the adoption of an IT regime.
In the light of these results, the study concludes that the fulfi llment of prerequisites for an IT regime in Egypt is still unsatisfactory. Consequently, Egypt is still not ready to apply an IT regime.