The external debt‐inflation nexus in Egypt

• Published date: 01 December 2022
• Author: Heba E. Helmy
• Date: 01 December 2022
• DOI: http://doi.org/10.1002/pa.2802

RESEARCH ARTICLE

The external debt-inflation nexus in Egypt

Heba E. Helmy

Department of Economics, Faculty of

Management Sciences, October University for

Modern Sciences and Arts (MSA), 6th of

October City, Egypt

Correspondence

Heba E. Helmy, Department of Economics,

Faculty of Management Sciences, October

University for Modern Sciences and Arts

(MSA), 6th of October City, Egypt.

Email: hebaezzhelmy@yahoo.com;hezz@msa.

edu.eg

Egypt has a long history with external financing dating back to the 19th century.

Nevertheless, Egypt's external debt has been mounting remarkably in the past few

years. This paper examines the impact of Egypt's external debt on its price level, a

topic ignored by researchers. Nonetheless, as inflation is a hydra-headed problem,

this paper develops several models which incorporate fiscal and monetary policies

besides other inflation-inducing internal and external factors using monthly data

extending from 2000M1 to 2020 M1. By employing ARDL cointegration analyses on

monthly time series variables and using Egypt's wholesale price index to account for

inflation, the paper concludes that external debt raises prices both in the short and

long runs. Moreover, money supply and interest rate were also found to increase

prices in the long run long despite decreasing them in the short run. Finally, upsurges

in the international prices of primary products stimulate domestic prices both in the

short and long terms, while depreciation in the local currency aggravates inflation in

the short and long terms as well. As external debt raises inflation and affects many

other inflation-inducing factors indirectly, the paper concludes that reducing Egypt's

external debt may help in curbing Egypt's inflation.

KEYWORDS

ARDL cointegration, Egypt, external debt, fiscal policy, inflation, monetary policy

1|INTRODUCTION

Ever since their independence, many developing countries have reso-

rted to internal or external borrowing in order to finance investments

necessary to achieving their growth targets, and Egypt was no excep-

tion. The main problem associated with debt—and especially external

debt—is that if debt becomes unsustainable it may lead to severe

exchange rate fluctuations, drive foreign capital abroad and debilitate

future foreign direct investment (Hemming et al., 2003). While the link

between a country's external debt and economic growth has been fre-

quently scrutinized, much less has been written on the link between

its external debt and inflation. In fact, external debt can drive inflation

in a country upwards as higher external debt levels are correlated with

substantially higher levels of inflation in emerging markets. Median

inflation doubles as debt ascend from the low range up to the high

range (Reinhart & Rogoff, 2010).

According to the World Bank, Egypt's external debt amounted to

$134 billion in 2020. In fact, Egypt's recent external debt began in the

1970s with the launching of former president Sadat's Open Door pol-

icy in 1975 (Figure 1) although Egypt's historical inception with exter-

nal borrowing dates backs to the 19th century. Not accompanied with

an export-promotion strategy, integrating Egypt's economy with the

world economy in the mid-1970s negatively impacted its weak indus-

trial sector and led to de-industrializing the economy, with the share

of manufacturing decreasing remarkably from 40% in 1967–1973

period to 19% in the years from 1981 to 1991. At the beginning of

former president Mubarak era in the 1980s, the economy had shifted

to a rentier economy depending on external sources of income while

agriculture and manufacturing were disregarded (Farah, 2009). From

1975 to 1980, external debt amplified from $6.3 billion to $19 billion,

rising to almost 90% of its GDP and 207% of its exports of goods and

services in 1981 (Ikram, 2007). Egypt's dependence on volatile and

unsustainable sources of foreign exchange such as the Suez Canal rev-

enue, tourism, oil, and remittances of Egyptians working abroad meant

that any slowdown in the world economy (as that which occurred in

1981) would decrease such resources. Fiscal deficits and mounting

Received: 31 August 2021 Revised: 22 October 2021 Accepted: 1 December 2021

DOI: 10.1002/pa.2802

J Public Affairs. 2022;22(Suppl. 1):e2802. wileyonlinelibrary.com/journal/pa © 2021 John Wiley & Sons Ltd. 1of18

https://doi.org/10.1002/pa.2802

structural imbalances forced Egypt to signing an agreement with the

Paris Club in 1987 to reschedule public debts due June 1988. In

1992, Egypt's external debt amounted to $40 billion at a time when

its GNP amounted to $34.6 billion (World Bank, 1993). A year earlier,

Egypt signed for a loan with the International Monetary Fund (IMF)

after agreeing to launch an Economic Reform and Structural Adjust-

ment Program (ERSAP) along the Fund's conditions. Accordingly,

Egypt's rescue from its financial impasse at that time came through

the generous bailout plan of the IMF ($20 billion reduction of debt)

and as a result of its contribution in the Gulf War in 1990 ($7 billion

reduction of US military debt). Instead of investing the new money in

productive sources, the government invested in infrastructure mega-

projects such as the New Valley and the Toshka project. The share of

exports in general and manufacturing exports in particular as percent-

ages of GDP fell and the balance of trade remained in deficit, although

the balance of payments was in some years rescued by the old tradi-

tional volatile sources of revenues such as the Suez Canal, tourism

and workers' remittances (Richards et al., 2013). As with all IMF pro-

grams, inflation and structural imbalances were mitigated (for a short

period) but economic growth and employment based on productive

sectors were not achieved. Consequently, the economy's structural

imbalances remained. The period 2000–2010 witnessed the falling

back of the economy in the debt trap as a series of external political

and economic shocks negatively impacted the traditional vulnerable

sources of foreign exchange leading to successive devaluations of the

pound. The government's fiscal deficit recurred and, resorting to for-

eign financing again, the country's external debt amounted $36 billion

by the end of the Mubarak era in 2010 (Figure 1), an amount close to

the pre-IMF-agreement debt levels.

The post-Mubarak era 2011 onwards witnessed a series of politi-

cal developments that culminated finally in the reemergence of similar

economic challenges as those faced by the country in the early-

1990s; and which were addressed with more or less similar policies

through investments in new mega-projects. To bridge the financing

gap, the government signed a new agreement with the IMF in 2016

whereby the latter lent Egypt $12 billion over three phases. Addition-

ally, Egypt accessed funding from COVID-19-related facilities

amounting to $8 billion from the IMF—$2.8 billion from the coronavi-

rus rapid financing initiative and $5.2 billion in a one-year stand-by

arrangement—besides other loans from the African Development

Bank, the World Bank and the international capital market (African

Development Bank, 2021). Egypt's external debt alone rose from

$36.8 billion in 2010 to $134.8 billion in 2020, representing 37.1% of

Egypt's nominal GDP of $363.1 billion, but an alarmingly 285% of

Egypt's exports of $47.8 billion, according to the World Bank, (2020)

figures.

Although external debt has been increasing in Egypt this has not

led to macroeconomic stability as inflation has been witnessing fre-

quent upsurges, while the exchange rate has continued to depreciate

systematically. As the case with external debt, Egypt's long history

with double-digit inflation began also in the 1970s with the increase

in its Consumer price Index (CPI) ranging around the 10% figure, but

soaring to nearly 21% in 1980 and 24% in 1986 (Figure 2). Inflation

figures slowed down gradually but escalated again reaching 18% in

2008 (World Bank). As per the Central Bank of Egypt (CBE), Egypt's

monetary policy regime could be described as a “regime with implicit

nominal anchor”as CBE does not assign an inflation target in advance.

Starting 2005, CBE moved from its former “quantitative operational

target”(excess reserves) to an “interest rate target”(overnight inter-

bank rate) (Central Bank of Egypt, 2016, p. 3). Under the previous sys-

tem of monetary targeting, broad money used to serve as an

intermediate target providing information on the expected path of

inflation. The monetary target regime was abandoned in 2005 as men-

tioned earlier for a variety of reasons mainly its inability to stabilize

prices, and CBE launched its interbank rate which functions through

the corridor system. Under that system, CBE assigns two interest

rates, one for deposits and the other for lending, creating a corridor in

which the interbank rate should fluctuate. The corridor system facili-

tated the control of the interbank rate volatility via open market oper-

ations. Nevertheless, inflation kept on rising in the post-Mubarak era,

and by the end of 2012 and the beginning of 2013, a positive money

gap has been taking place in Egypt; that is, the rate of growth of

money has been exceeding the rate of growth of output, mainly as a

result of the government borrowing from the banking system.

According to the CBE official website, inflation reached 32.9% in July

2017 on a year-to-year basis (although the figure was later updated in

the World Bank database to 29%). The rate fell again gradually to

reach 5% in 2020 (Figure 2) (World Bank, n.d.-a). Despite the falling

FIGURE 1 Egypt's external debt 1970–

2020. Source: World Bank, World

Development Indicators as cited in

Macrotrends (n.d.)

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