Egypt and Lebanon, which have practically anchored their currencies to the U.S. dollar, witnessed sharp increases in their real effective exchange rates. Among the countries that maintain substantial capital controls, Algeria and Syria posted declines in their real effective rates, the former because of an adjustment in the nominal exchange rate, the latter mainly because domestic prices rose more slowly than prices in its trading partners. Morocco and Tunisia have adopted a managed float that, in recent years, has essentially stabilized their real effective exchange rates. All the countries had reserves well in excess of three months of imports. An efficient and sound financial sector is an essential ingredient of capital account convertibility, enabling banks to invest capital inflows prudently and weather shocks.
Efficiency requires market-based monetary instruments and a liberal regulatory framework.
The sector's soundness depends on, among other things, effective banking supervision and observance of prudential ratios. All nine Southern Mediterranean countries have reformed, to varying degrees, their monetary instruments and banking systems. Countries that have already opened their capital account rely more heavily on indirect instruments and on market-based interest rates. In Egypt, Israel, Lebanon, and Turkey, indirect instruments play an important role in determining market interest rates. The treasury bill rate, determined through auctions, and the discount rate have a strong influence on deposit and lending rates.