* Dinar drops vs euro and dollar, ending period of stability
* Central bank permitting controlled depreciation
* In line with IMF's policy advice
* Politically risky but may have big economic benefits
* Other North African countries could follow suit
By Tarek Amara and Andrew Torchia
TUNIS/DUBAI, Aug 4 Weakness of Tunisia's dinar
is undermining the purchasing power of its citizens and evoking
memories of the country's economic crisis after its 2011
revolution. But this time, the dinar's depreciation may point to
a stronger financial future.
For the past four months, the central bank has permitted a
slide of the dinar against both the euro and the U.S. dollar,
ending a period of several months in which the bank intervened
to keep the currency steady or even rising.
The depreciation carries economic and political risks as the
country gears up for parliamentary elections in October and
presidential polls in November - votes which it hopes will
complete a sometimes violent transition to democracy.
But a cheaper currency could in the long run have big
benefits for Tunisia, creating jobs by stimulating export
industries, and making it more economical for foreign investors
to put money into the country.
Slim Feriani, executive chairman at London-based Advance
Emerging Capital, said the central bank seemed to have become
more willing in recent months to let the dinar drop in response
to Tunisia's trade deficit and low foreign exchange reserves.
He said the depreciation was moderate and controlled, and
should be seen in the context of pragmatic economic policies
being pushed by a technocratic cabinet appointed in January,
such as cuts in petrol and food subsides.
"There is light at the end of the tunnel" for the economy,
said Feriani, a Tunisian whose company invests in emerging and
frontier markets around the world.
Many North African central banks have been reluctant to let
their currencies depreciate since the Arab Spring revolts of
2011, fearing capital flight and inflation that could worsen
social tensions. If Tunisia's controlled depreciation succeeds
in boosting its economy, other countries could follow its lead.
Tunisia's central bank intervened heavily to support the
dinar in the wake of the revolution by selling hard currency,
though it was only able to slow the drop, not halt it.
The intervention drained the country's foreign currency
reserves, which sank to just 10.39 billion dinars ($6.08 billion
at current exchange rates) or 93 days of import cover in late
April, down from 102 days a year earlier. Central bank governor
Chadli Ayari described the drop in reserves as "dangerous".
The drop appears to have triggered the decision to reduce
intervention and allow a controlled fall of the dinar. The
process began in early April, taking the dinar down from 2.17
against the euro to its current 2.30. Against the
dollar, the dinar fell to 1.71 from around 1.57.
Central bank officials declined to comment publicly on
exchange rate policy, citing the sensitivity of the issue.
But the depreciation coincides with reforms to the foreign
exchange market that were discussed with the International
Monetary Fund, which agreed in June 2013 to lend Tunisia $1.74
billion under a two-year programme.
In March, authorities introduced an electronic trading
platform and created a system of market-making banks as ways to
permit exchange rates to move more flexibly in response to
supply and demand, rather than being dominated by central bank
In a letter to the IMF in late April, the central bank
pledged to take another step towards a more flexible market
before the end of this year by introducing weekly auctions of
It said its intervention now accounted for only about 30
percent of trade in the foreign exchange market, compared to 50
percent just two months earlier.
In place of intervention, the central bank appears to be
relying much more on interest rate levels to prevent any
excessive dinar depreciation; in June it raised its key rate to
4.75 percent from 4.5 percent, the second hike in six months.
The shift in currency policy has won public approval from
the IMF, which in July issued a statement urging Tunisian
authorities "to continue rebuilding foreign exchange reserves,
including through further exchange rate flexibility".
It is not clear how far the dinar's slide will extend. In
its late April statement, the central bank said it thought the
dinar was overvalued by around 7 percent; that implies it should
stabilise at roughly 2.39 against the euro.
On the other hand, it may be difficult for the currency to
find a floor as long as Tunisia continues running a big deficit
in trade in goods and services, which the IMF projects at $3.1
billion or 6.7 percent of gross domestic product this year.
For many ordinary Tunisians, the depreciation is unwelcome,
cutting the hard currency value of their savings and fuelling
inflation, which edged up to 5.7 percent in June.
"Citizens are paying the price for the drop of the Tunisian
dinar. The dinar has no value now with the high prices," said
Wassila ben Saleh, a 40-year-old employee of a transport company
in Tunis. She added that some types of perfume had disappeared
from shops as currency depreciation raised import costs.
Moez Abidi, an economist and former board member of the
central bank, said the dinar's slide was potentially
"catastrophic" and that authorities needed to do more to support
the currency by reducing imports of luxuries such as cars, and
by acting against smuggling.
However, there are signs that the depreciation is already
helping to rebuild Tunisia's foreign currency reserves, which
had rebounded to 12.09 billion dinars or 108 days of imports by
the end of July, according to the central bank's website.
At least part of the recovery is due to foreign aid -
Algeria deposited $100 million with the Tunisian central bank in
May - but some private money may also be returning to the
country. The stock market is up 5 percent since the
end of April.
Tunisia may be well placed to benefit from a newly
competitive exchange rate if a gradual economic recovery in
Europe gathers pace and creates demand for its exports.
Tunisia's policy shift is likely to be closely watched by
other North African states which are also struggling with big
external deficits and need to attract more foreign investment,
but have so far not dared to let their currencies depreciate.
Egypt, for example, has largely kept its pound steady
over the past year, spending billions of dollars of foreign aid
to do so. Morocco has blocked significant depreciation of its
dirham, though the IMF has been urging it to free up its
Jason Tuvey, Middle East economist at Capital Economics in
London, said Tunisia's depreciation of the dinar could in some
ways be seen as a sign of confidence rather than economic
failure, as the country was addressing a key policy issue.
"Other countries in the region such as Egypt could
eventually make the same decision," he said, adding that
Egyptian authorities might move on the currency after
parliamentary elections that are expected at the end of 2014.
(Reporting by Andrew Torchia; Editing by Toby Chopra)