## QUANTIFYING LIBYA’S EXCHANGE MARKET PRESSURE

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**Canonical URL:** [QUANTIFYING LIBYA’S EXCHANGE MARKET PRESSURE](https://www.imf.org/-/media/files/publications/cr/2024/english/1lbyea2024002-print-pdf.pdf)

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### Introduction
- Libya uses a fixed exchange rate linked to IMF Special Drawing Rights (SDR) as the key nominal anchor.
- Libya’s economy is largely dependent on oil and gas production; fluctuations in international energy prices—denominated in US dollars—put pressure on the exchange rate in both the official and parallel markets.
- The official exchange rate functions as the nominal anchor and is supported by substantial foreign exchange reserves as long as fiscal policy remains broadly consistent with the authorities’ macroeconomic stance.
- After several years of depreciation pressures following the 2015 oil price collapse, the official exchange rate of the Libyan Dinar (LYD) was devalued in January 2021.
- Since January 2021, the official rate has been SDR 0.1555 per LYD 1.
- The paper uses an exchange market pressure (EMP) index to identify and quantify exchange market pressures for the period 2016–2024.

### Overview of the Literature
- EMP indices measure both appreciation and depreciation pressure on a country’s exchange rate and are used to assess financial outflow pressures and policy responses including use of foreign exchange reserves, interest rate policy, and capital flow measures.
- EMP indices have been applied to cases of appreciation pressure (e.g., large capital inflows in Eastern Europe and Switzerland) and depreciation pressure.
- Common methodologies for EMP component weights include structural macroeconomic models (Girton and Roper (1977), Weymark (1995), Goldberg and Krogstrup (2023)), empirically-derived weights (Patnaik and others (2017)), and relative volatility weights (inverse of standard deviations) as in WEO (2007).
- This paper weights EMP components by the inverse of their standard deviations over the entire 2016–2024 sample period.

### Exchange market pressure in Libya
- EMP index adapted for Libya where there is no policy interest rate and foreign exchange reserves are used to absorb exchange market pressures.
- EMP index specification (as applied) aggregates weighted changes in:
  - the exchange rate (e),
  - official foreign exchange reserves (R),
  - and the difference between the official and parallel exchange rates (proxy for capital flow measures, CFM).
- Definitions and measurement details:
  - e is the LYDUSD bilateral exchange rate, defined as number of US dollar per one Libyan dinar.
  - R is international reserves (measured in US dollars).
  - (∆(e/pe)_t)/(e)_t is a proxy for the capital flow measures (CFM) equal to the difference between the official and parallel market exchange rates.
  - w is the standard deviation of each variable over the 2016–2024 sample period.
  - Δ is the first difference operator.
- Interpretation:
  - Appreciation pressure is associated with a positive EMP: strengthening exchange rate and reserves, and/or a decrease in the gap between the official and parallel exchange rates.
  - Depreciation pressure is associated with a negative EMP: weakening exchange rate and reserves, and/or an increase in the gap between official and parallel rates.
  - In Libya, foreign reserve accumulation is a policy target and the increase in official reserves has a depreciating effect on the LYD since there are limited private inflows.
- Empirical findings (monthly data, January 2016–March 2024):
  - Point-in-time EMP indicates depreciation pressure generally prevailed prior to the devaluation in early 2021; the EMP index was mainly negative during 2016–2020.
  - Faced with sustained depreciation pressure, the CBL devalued the dinar in January 2021.
  - Years 2021–22 saw appreciation pressures: after the 2021 devaluation, the EMP index turned positive; in 2022 higher oil prices led to current account surpluses and further appreciation pressure on the LYD.
  - In late-2022, global increases in inflation led to higher interest rates worldwide, bringing back depreciation pressure on the LYD and the EMP index turned negative.
  - The cumulative EMP index for 2016–2024 is negative, suggesting that tighter policies were warranted during 2016–24.
  - The paper notes the starting date of the index affects cumulative EMP calculation and that the index underestimates exchange rate pressure faced during 2011–15 due to lack of reliable data before 2016.
- Policy-relevant observation:
  - The Libyan authorities’ toolkit is limited: they maintain high reserves and an exchange rate peg without conventional monetary policy instruments or consistent use of fiscal policy, which constrains their response options and has led to reliance on capital flow measures at times.

### Conclusions and Policy Recommendations
- Main conclusion: Libya faced substantial cumulative depreciation pressure over 2016–2024 despite alternating appreciation and depreciation episodes; foreign exchange reserves remained relatively stable.
- Policy recommendations:
  - Develop conventional monetary policy tools (introduce and operationalize a policy rate and related instruments).
  - Ensure fiscal policy is consistent with the overall macroeconomic objectives of maintaining high foreign reserves, a pegged official exchange rate, and a narrow gap between parallel and official exchange rates.
  - Use additional monetary tools and fiscal policy to help contain the parallel market premium and avoid the use of capital flow measures.

*International Monetary Fund. Libya: Selected Issues. IMF Country Report No. 24/207. Completed May 30, 2024.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1lbyea2024002-print-pdf.pdf_