The period started with a crisis and was punctuated by financial difficulties that were only resolved through extensive debt forgiveness and rearrange-ment. These years were also notable for the implementation of a major stabilization program and for a start on some important aspects of struc-tural reform.
Egypt’s debt crisis of 1987 was not caused by a sudden or unexpected shock. There was not the sudden collapse of a fault line; rather, the cumu-lative effects of the heavy external borrowing that the country had engaged in since 1975 began to dominate the economic landscape. The approach of a climacteric had been recognized for some time – a multina-tional bank monitoring the Egyptian economy described the event as “one of the slowest train wrecks in history.” The crisis resulted from a loss of confidence on the part of Egypt’s creditors and the inadequate growth of the country’s foreign exchange earnings. Non-oil exports did not increase sufficiently to compensate for falling oil revenues, and this set in motion a relentless increase in indebtedness and debt service obligations. Foreign creditors lost confidence and cut back new commitments, particularly of supplier credits.
Egypt found itself in a debt trap in which capital inflows were increas-ingly consumed by debt servicing. In 1979, nearly 40 percent of gross dis-bursement of foreign civilian loans and credits was used to finance new investments, while about 60 percent went to service the foreign debt (interest and amortization). With gross disbursements declining and debt service payments increasing sharply, in 1982 virtually all new borrowing was used to finance the debt service. By 1987, the gross inflow of new loans had declined to nearly half its peak five years earlier, and covered less than half the debt service actually paid, which in turn was less than two-thirds of the debt service payments falling due. Large arrears accumu-lated and shut Egypt out of international capital markets.
Under the auspices of the Paris Club, in May 1987 Egypt and the major bilateral donor countries reached a rescheduling agreement. Total arrears of $6.9 billion outstanding at that time were rescheduled, plus all interest and amortization payments (amounting to $4.4 billion) on medium- and
long-term loans falling due until June 30, 1988. These debts were resched-uled over ten years, including a five-year grace period.
The agreement only palliated the problem, rather than resolve it. Even the partial debt service paid amounted to 36 percent of current account receipts – well beyond the ratio of 25 percent after which the World Bank normally becomes concerned about a country’s creditworthiness. Some calculations by the World Bank indicated that even after excluding future financing needs, the debt stock at the end of June 1988 would have required debt service payments of almost $5.6 billion annually in 1989–92.
Including projected financing needs, these payments were likely to rise to
$9 billion, corresponding to nearly 45 percent of Egypt’s projected export earnings in 1995, when the rescheduling period ended.
The main cause of rising external debt was the expansionary policy, exemplified by high budget deficits and a relaxed monetary stance. The consolidated budget deficit of the government, excluding debt and amor-tization, reached 23 percent of GDP in 1986. These deficits were caused primarily by declining revenues, which fell from 40 percent of GDP in 1982 to 24 percent in 1988. About half the decline was directly attribut-able to oil revenues (including tax and transferred profits), which dropped from 7.9 percent of GDP in 1982 to 2.5 percent in 1987.
The authorities tried to limit the deficit by cutting expenditures, particularly on explicit subsidies, which at the end of this period accounted for a little over 5 percent of GDP, compared with more than 13 percent only five years earlier. However, the implicit subsidies, especially the very low retail prices for energy and power in the domestic market and the overvalued exchange rate used to import most basic foodstuffs, must be added to the explicit ones. Both these implicit subsidies represented revenues forgone by the government and together they accounted for nearly 15 percent of GDP.1Thus the total subsidy burden remained large, and during this sub-period the government spent about as much on subsi-dies as on investments. Unfortunately, the bulk of these subsisubsi-dies did not benefit the poorest strata of society. The World Bank estimated that only about 17 percent of the flow of subsidies benefited the poorest 20 percent of the population; in 1988, nearly one-fourth of the subsidies, principally the implicit, went to the richest 20 percent of the population.
Interest rates (both lending and deposit) were kept low and remained mostly negative in real terms for the entire sub-period. Low interest rates discouraged enterprises from self-financing and thus lowered business savings. A World Bank study concluded that a major factor in the financial difficulties experienced by Egyptian public enterprises was the inappropri-ate financial base caused by high debt:equity ratios – a consequence of making debt artificially cheap. Even more harmful were the low deposit rates which depressed domestic savings, especially workers’ remittances. A further drawback to mobilizing resources was the relatively free system of capital transfers, which encouraged Egyptians to hold deposits in foreign
currency. Holders of foreign currency accounts could expect a return equivalent to the international rate of interest plus a margin for the expected depreciation of the Egyptian pound. Given the wide difference between domestic and international interest rates, the incentive to hold foreign currency accounts was very strong.
Low interest rates and high budget deficits contributed to the expan-sionary credit and monetary policies during these years. The large budget deficits also led to the crowding out of credit to the private sector, ham-pering overall economic growth. The method of financing the deficits, with nearly half the amounts being provided by the domestic banking system, fuelled the excessive expansion of liquidity. Between 1982 and 1986 the money supply expanded on average in excess of 22 percent per annum while nominal GDP increased by only 16 percent. Despite exten-sive price controls, which implied fixed prices for staple products and cost-plus pricing for most public manufacturing goods and services, the consumer and wholesale price indexes both rose sharply after 1982;
annual increases in the index of consumer prices for the urban popu-lation consistently remained above 16 percent. Even these figures represented a significant underestimate, both because of the methodology of the index’s construction and of the growing importance in consump-tion of the free market in which prices were substantially higher than in the official.
Developments in the main causal factors determining the behavior of private sector liquidity can be seen from changes in reserve money (cur-rency in circulation and Egyptian pound bank reserves) of the Central Bank and the money multiplier (the multiple between the Egyptian pound component of private sector liquidity and reserve money). The major factor determining reserve money was Central Bank financing of the fiscal deficit. In response to the increasing budget deficits, reserve money increased from about 3 percent of GDP in 1981 to 5.8 percent in 1986, and the money multiplier moved up from about 1.22 in June 1980 to 1.44 in February 1986. The IMF attributed the upward trend in the money multiplier to the decline in the currency:deposit ratio from 1.44 in June 1980 to 0.74 in February 1986, with variations about the trend deter-mined by developments in the ratio of bank reserves to deposits.
Policy adjustment during the earlier part of the period (1987–91) was hesitant and piecemeal. Critics cast doubts on Egypt’s commitment to reform, with Richards (1991: 1727) particularly scathing on Egypt’s nego-tiating tactics with international agencies:
Several tactics supported this strategy [of dilatory reform]. One tactic was to promise much and to deliver little: The GOE constantly pro-claimed “bold new reforms” throughout the economy, it actually did little in comparison with the IMF’s recommendations and even less in comparison with the magnitude of the economic problems facing the
country in the 1990s. Negotiating tactics included “numbers games,”
“smokescreens,” and “musical ministers.” Calculations of inflation rates, the GDP, and government revenues and spending can be dis-torted, concealed, and simply falsified. . . . The government created interministerial committees with overlapping jurisdictions to confuse outsiders – no one knew who was really in charge (if, indeed, anyone was). . . . Finally, World Bank and IMF teams often met with the GOE negotiating team composed of four or five ministers, all of whom dis-agreed with each other; the composition of the team changed from day-to-day, as “important business” took one member away, leading to his temporary replacement with someone else. Such tactics helped to postpone a break with the IMF, buying time for Mr Mubarak to per-suade Mr Bush to call Mr Camdessus [the Managing Director of the IMF].
Richards clearly expected this state of affairs to continue long into the future. He likened Egypt’s acting on economic reform to the final scene from Samuel Beckett’s Waiting for Godot, where the characters must resign themselves to accepting that they face a wait of an unknown, and possibly indefinite, duration.
In view of what happened with later rounds of reforms, this judgment may have been a little hasty. At the time of the 1987 negotiations, the demons of the 1977 bread riots had not yet been exorcized; policymakers were uncertain of the public’s reaction to the reforms proposed by the multilateral agencies, and felt compelled to proceed with caution. This better explains the drawn-out negotiations and the delaying tactics that were bound to frustrate the no doubt well-intentioned urgings of inter-national institutions and to drive to distraction equally well-meaning commentators. Indeed, at the end of a lengthy report on the negotiations, a representative of the international financial institutions wrote that the most suitable encapsulation of their feelings during the process was pro-vided by some lines of Rudyard Kipling in The Naulakha, to the effect that their epitaphs would describe them as fools who tried to hurry the East.
After 1987 the shortfall in resources began to take its toll on the GDP growth rate, which began to slow steadily; by 1991 real growth had dropped to 3.7 percent. The rising budget deficits, the accumulating debt, and the rising debt service were exacerbated by the Gulf crisis of 1990.
Estimates of the direct economic loss to Egypt of that crisis ranged from
$2.5 billion upwards.
The situation was unsustainable. By 1991 the budget deficit had reached 15.3 percent of GDP; the money supply had increased in one year by 27.5 percent, and inflation was running at an annual rate of 14.7 percent. Confidence in the domestic currency was ebbing; the “dollariza-tion ratio” (the share of total liquidity accounted for by foreign currency deposits) increased to nearly 50 percent. The external picture was equally
difficult: balance of payments deficits continued; foreign exchange reserves had dropped to $3.9 billion (providing cover for only 3 months of foreign exchange payments); external debt in that year reached $31.1 billion, or 28 percent of GDP;2more pertinently, the ratio of debt servic-ing to foreign exchange earnservic-ings climbed to nearly 55 percent. This amount could not be paid without substantially cutting imports, with severe consequences for production, investment, and per capita consump-tion. Accumulated debt service not paid in 1991 amounted to $3,855 million, about 10 percent of GDP. With arrears again mounting rapidly, Egypt’s creditworthiness suffered further blows.
At this time the authorities made a determined bid to rectify the situ-ation. Egypt entered into negotiations with the International Monetary Fund and the World Bank. The Egyptian negotiating team (Kemal El Gan-zoury, Atef Ebeid, Mohammed Ahmed El Razaz, Salah Hamed, Youssef Boutros Ghali) was technically strong and politically adept, and had the firm backing of the President and the Prime Minister. The negotiations were prolonged, but it was evident that the government was serious about trying to break the cycle of continuing crises. According to Youssef Boutros-Ghali (who was responsible for much of the technical work on the Egyptian side), the overriding instruction from President Hosni Mubarak to the team was to reach an agreement that would quickly trigger the debt relief arrangements offered by the Paris Club.3 The Bank and the Fund were equally serious about supporting a program that would deal not only with the immediate difficulties, but would also create a basis for sustained growth. Fortuitously, Egypt’s role in the Gulf war had inclined the major donors to look favorably on attempts to resuscitate the economy. They not only seconded the efforts of the international organizations, but also undertook bilateral actions, especially in the form of write-offs and reschedulings of Egypt’s external debt.
The Bank and the Fund were concerned with two overarching aspects of Egypt’s economic problems. The first was the immediate issue of stabi-lizing the economy and bringing into balance the main macroeconomic indicators. Second, structural reforms had to be undertaken that would minimize rigidities and free up the economy. In order to do this, the authorities would have to commit to visible actions demonstrating their determination to move towards a market economy. Only this would dissi-pate the ambiguity engendered by what the 1978–82 Plan had labeled “a socialist society that thinks with a capitalist mind.”
The core of the discussions between the Bank/Fund and the Egyptian authorities comprised four strategic issues.
The first was the sequencing of reforms. A consensus was reached that stabilization would be coupled with a clear signal that the private sector would increasingly be provided a level field on which to compete with the public sector. Therefore, in addition to the usual measures associated with stabilization, a simultaneous move towards privatizing public enterprises,
especially those in the areas of production, distribution, and services would be made. The privatization measures were to exclude the “Eco-nomic Authorities” (such as the Suez Canal, the General Authority for Supply Commodities, etc.) from their ambit. It was hoped that the com-mencement of privatization in a vigorous manner would clearly signal that Egypt was looking to the private sector as the future engine of growth, while the preservation of Economic Authorities in the public sector would reassure the public that the country’s key assets would not be turned into private monopolies.
The second issue was the speed of the transition, sometimes expressed as a “big bang” versus gradualism. Several voices in the Bank and the Fund argued for shock therapy on the grounds that this was more likely to commit Egypt to a durable acquiescence in the new strategy. However, given the previous experience with the country, this was surely an unrealis-tic expectation; “make haste slowly” was the best that could be expected.
The only area in which a big bang, in the sense of an abrupt and drastic change, might have been felt was budgetary expenditure on government investment, which in fact imploded from about 11.5 percent of GDP to 5.4 percent in the space of four years. But perhaps this should more properly be called a “big whimper.”
The third issue concerned the reform of the banking and financial sector. The outcome of this particular discussion remained muddled. The Bank and the Fund pushed for the early privatization of at least one of the public sector banks, and provided the authorities with some very detailed analyses of the financial sector to justify their concerns and to facilitate the formulation of the authorities’ policies. In the event, the government moved to gradually privatize only the joint venture banks. It was con-sidered too sensitive to act on the major commercial banks, which even in 2000 remained wholly in the public domain.
The fourth major issue that had to be tackled was a realistic alignment of the exchange rate. For at least a decade and a half the authorities had resisted a meaningful devaluation of the exchange rate. The authorities offered various objections to devaluation, prime among which were the following:
• Devaluation would be inflationary. Devaluation would increase the cost of imported food, and thus require further budgetary allocations for subsidies (which had already reached 19 percent of total current expenditure in 1991). Moreover, public enterprise pricing was not on a cost-plus basis, so increases in the domestic prices of imported raw materials would decrease profits or increase losses. Devaluation would also require the government to generate more local currency to service the external debt. The foregoing outcomes would all increase the budget deficit. Egypt was already mobilizing a high level of resources through taxation; thus the increased budget deficits
might have to be financed through increased seigniorage and the inflation tax.
• Devaluation would lower future growth by increasing the price of investment, and would thus make it more difficult to meet the social and political targets for employment.
• The structure of Egypt’s production was dominated by items for which world demand was not growing, while the country’s consumption pattern was heavily weighted by necessities. Thus the elasticity of foreign demand for Egypt’s exports, and Egypt’s demand for imports were both low; hence, devaluation would neither increase exports nor reduce imports sufficiently to materially improve the balance of payments.
• A variant of the foregoing “elasticity pessimism” argument was that devaluation would not work because the pervasive system of controls and institutional impediments would weaken the supply response.
According to this argument, devaluation was likely to succeed only if it formed part of a comprehensive package that liberalized large parts of the economy simultaneously with the exchange rate depreciation. But such a package was likely to require draconian measures and to carry too many politically unpalatable side-effects to be acceptable.
The foregoing points dominated the technical exchanges between Egypt and the international agencies. However, behind the technical façade, there lingered a memory from 1977 of the political consequences of pushing reform at too rapid a pace.
Egypt’s experience under the program of stabilization and structural reform will now be examined in more detail.
The stabilization program
The Egyptian authorities concluded a standby agreement with the IMF in May 1991 and a program with the World Bank in November 1991. This arrangement, the Economic Reform and Structural Adjustment Program (ERSAP), aimed at stabilizing the economy and starting structural reform.
The program aimed at both the external accounts and the budgetary deficit, focusing especially on the links between the two. It sought to stabi-lize the external accounts by correcting and unifying the exchange rate.
This, in turn, would help the budget by valuing imports at higher prices in terms of Egyptian currency and consequently increasing the revenues from import duties; in a like manner the measure increased the contribu-tion of earnings from the Suez Canal. Again, cutting government expendi-tures would not only reduce the budget deficit, but would also reduce the demand for imports and thus move the external position closer into balance. The debt relief package would similarly ameliorate both external
This, in turn, would help the budget by valuing imports at higher prices in terms of Egyptian currency and consequently increasing the revenues from import duties; in a like manner the measure increased the contribu-tion of earnings from the Suez Canal. Again, cutting government expendi-tures would not only reduce the budget deficit, but would also reduce the demand for imports and thus move the external position closer into balance. The debt relief package would similarly ameliorate both external