In this week&rsquo;s issue, we shed light on what the government should do to contain the devaluation repercussions and reasons why inflated domestic debt is a matter of concern
<hr>
<h2 dir="ltr">How to Hedge against Devaluation Implications?</h2>
Egypt is <a href="https://www.imf.org/en/Countries/EGY">on the cusp</a> of concluding a new agreement with the IMF, expected to be followed by the fifth currency devaluation in eight years. Economic indicators&mdash;from <a href="https://www.reuters.com/world/africa/egypt-faces-external-debt-reckoning-after-borrowing-spree-2023-06-06/">soaring external debt</a> to declining growth, the <a href="https://aps.aucegypt.edu/en/articles/1354/challenges-exacerbated-by-state-policies-fdi-outflows-and-high-real-estate-prices">dollar shortage</a>, and rampant inflation&mdash;reflect the failure of previous agreements to improve the macroeconomic situation. On the contrary, they made it even harder for Egyptians to meet their daily needs.
<h3 dir="ltr">What went wrong?</h3>
Egypt <a href="https://www.reuters.com/world/africa/egypt-faces-external-debt-reckoning-after-borrowing-spree-2023-06-06/">considered</a> its agreements with the IMF to be a testament to its creditworthiness, so it expanded in foreign <a href="https://www.reuters.com/world/africa/egypt-faces-external-debt-reckoning-after-borrowing-spree-2023-06-06/">borrowing</a>, <a href="https://english.ahram.org.eg/News/510797.aspx">issuing</a> bonds in international markets and chasing Gulf deposits. As a result, the country&rsquo;s foreign debt quadrupled over eight years.
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1707492593imageEd 58_topic 2 - 2-2 EN.png" alt="" width="405" height="179">
In an attempt to shore up the pound, the Central Bank raised interest rates several times, attracting&nbsp; portfolio investments in government debt instruments. The exit of about USD20 billion of these investments from Egypt in 2022 <a href="https://timep.org/2022/12/13/egypts-infinite-economic-crisis/">triggered</a> a dollar crisis.
The interest rate hikes <a href="https://www.imf.org/en/Blogs/Articles/2023/10/10/higher-for-longer-interest-rate-environment-is-squeezing-more-borrowers">made</a> serving domestic government debt more expensive while discouraging corporate borrowing from banks, which contributed to lower growth rates.
At the same time, Egypt&rsquo;s <a href="https://aps.aucegypt.edu/en/articles/1346/stagnation-in-digitalization-and-expats-remittances">initiatives</a> to attract more dollars were not fruitful. Most of the foreign debts were <a href="https://www.alhurra.com/egypt/2020/06/29/%D9%85%D8%B5%D8%B1-%D8%AA%D8%B9%D9%88%D8%AF-%D9%84%D8%B5%D9%86%D8%AF%D9%88%D9%82-%D8%A7%D9%84%D9%86%D9%82%D8%AF-%D8%A7%D9%84%D8%AF%D9%88%D9%84%D9%8A-%D9%85%D8%B1%D8%A9-%D8%A3%D8%AE%D8%B1%D9%89-%D8%B0%D9%87%D8%A8%D8%AA-%D8%A3%D9%85%D9%88%D8%A7%D9%84-%D8%A7%D9%84%D9%82%D8%B1%D9%88%D8%B6%D8%9F#:~:text=%D8%A3%D9%8A%D9%86%20%D8%B0%D9%87%D8%A8%D8%AA%20%D8%A3%D9%85%D9%88%D8%A7%D9%84%20%D8%A7%D9%84%D9%82%D8%B1%D9%88%D8%B6%D8%9F,-%D8%AD%D8%B3%D9%8A%D9%86%20%D9%82%D8%A7%D9%8A%D8%AF%20%2D%20%D8%AF%D8%A8%D9%8A&amp;text=%D8%B9%D8%A7%D8%AF%D8%AA%20%D9%85%D8%B5%D8%B1%20%D8%A5%D9%84%D9%89%20%D8%B5%D9%86%D8%AF%D9%88%D9%82%20%D8%A7%D9%84%D9%86%D9%82%D8%AF,%D9%84%D9%85%D8%B3%D8%A7%D8%B9%D8%AF%D8%AA%D9%87%20%D9%81%D9%8A%20%D9%85%D9%88%D8%A7%D8%AC%D9%87%D8%A9%20%D9%81%D9%8A%D8%B1%D9%88%D8%B3%20%D9%83%D9%88%D8%B1%D9%88%D9%86%D8%A7.">spent</a> on infrastructure projects, so the dollar bleeding continued, creating the need to borrow again from the IMF.
Successive devaluations of the pound resulted in a spiral increase in inflation rates to reach a record of 38% in September. Accordingly, real incomes declined, as did the value of&nbsp;<a href="https://aps.aucegypt.edu/en/articles/1344/how-are-savings-rates-increasing-amid-inflation">individuals&rsquo; savings</a>, while consumption slowed and pressures on low-income Egyptians mounted.
The adverse impacts of devaluation were thus <a href="https://aps.aucegypt.edu/en/articles/1351/wages-and-food-inflation-are-government-policies-exacerbating-or-mitigating-the-crisis">more evident</a> than its positive outcomes. Theoretically, the currency float, by making Egyptian products cheaper and foreign goods more expensive, should have boosted exports and reduced imports.&nbsp;
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1707493210imageEd 58_topic 2 - 3 EN copy.png" alt="" width="405" height="404">
But this did not happen in the Egyptian case. The official price of the US dollar against the pound increased by 248% from 2016 until the end of 2023, while the value of exports rose by 116% in the same period, and most of this came from oil exports. Egyptian non-oil products are not high value-added and so are unable to compete in global markets and thus spur an export boom. Imports, on the other hand, increased by 23.5% in the same period, and even the marked decline in total imports between 2021/22 and 2022/23 was caused by the shortage of dollars.
<h3 dir="ltr">How did Malaysia succeed despite going counter to IMF directives?</h3>
In the 1990s, Malaysia, along with other East Asian countries, <a href="https://aps.aucegypt.edu/en/articles/965/the-malaysian-experience-with-the-imf-what-lessons-can-egypt-learn">confronted</a> a financial crisis. Unlike Thailand, Indonesia, and South Korea, Malaysia did not sign a deal with the IMF, but instead pursued for one year all the policies that the fund usually prescribes like fully&nbsp; liberalizing the exchange rate, lifting restrictions on financial systems, raising interest rates, and cutting government spending.
Across East Asian states, implementing IMF policies resulted in <a href="https://aps.aucegypt.edu/en/articles/965/the-malaysian-experience-with-the-imf-what-lessons-can-egypt-learn">lower</a> domestic demand, corporate loan defaults, and, in turn, the loss of investor confidence and jobs. As for Malaysia, it opted after the first year to <a href="https://aps.aucegypt.edu/ar/articles/965/the-malaysian-experience-with-the-imf-what-lessons-can-egypt-learn">adopt</a> alternatives to IMF prescriptions, which had served to push its economy into recession in a year.
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1707495281imageEd 58_topic 2 - 3 EN.png" alt="" width="405" height="405">
Malaysia <a href="https://www.imf.org/external/pubs/nft/op/207/index.htm">achieved</a> high growth during the period in which it pursued these policies. It also made its economy more resilient, which allowed it to easily cope with successive shocks and achieve high growth even in recessionary periods, most recently during the Covid-19 pandemic.
<h3 dir="ltr">How to keep the economy afloat following the imminent devaluation?</h3>
<ul>
<li dir="ltr" aria-level="1">
<a href="https://aps.aucegypt.edu/en/articles/935/qanda-on-devaluation">Follow</a> the Malaysian example by pursuing long-term development plans to improve economic performance, and rejecting&nbsp; IMF <a href="https://aps.aucegypt.edu/en/articles/965/the-malaysian-experience-with-the-imf-what-lessons-can-egypt-learn">demands</a> for more austerity, especially that the IMF <a href="https://aps.aucegypt.edu/en/events/92/public-talk-development-in-a-time-of-crisis-with-the-renowned-economist-alfredo-saad-filho">policies</a> do not usually meet the aspirations of the people and may reduce the popularity of governments.
</li>
<li dir="ltr" aria-level="1">
Encourage investment and support the role of the private sector operating in export-oriented industries to boost dollar revenues.
</li>
<li dir="ltr" aria-level="1">
Develop a plan to increase exports that comports with the facts of the Egyptian market and existing factories, especially those producing value-added <a href="https://meae.journals.ekb.eg/article_207031_e8cdf03b35c0e94af887b71900f069a8.pdf">products</a>, while diversifying exports away from oil.
</li>
<li dir="ltr" aria-level="1">
Set spending priorities and channel most dollar resources to sectors that generate returns in dollars, such as industry and tourism.
</li>
<li dir="ltr" aria-level="1">
Introducing pre-emptive social protection packages, taking into account changes in inflation rates and the value of the pound.
</li>
</ul>
<hr>
<h2 dir="ltr">Stepping Willingly into the Domestic Debt Trap</h2>
The Ministry of Finance <a href="https://cnnbusinessarabic.com/economy/47924/%D9%85%D8%B5%D8%B1-%D8%AA%D8%B9%D8%AA%D8%B2%D9%85-%D8%B2%D9%8A%D8%A7%D8%AF%D8%A9-%D8%A5%D8%B5%D8%AF%D8%A7%D8%B1%D8%A7%D8%AA%D9%87%D8%A7-%D9%85%D9%86-%D8%A3%D8%AF%D9%88%D8%A7%D8%AA-%D8%A7%D9%84%D8%AF%D9%8A%D9%86-%D8%A7%D9%84%D9%85%D8%AD%D9%84%D9%8A%D8%A9-30-%D8%AE%D9%84%D8%A7%D9%84-3-%D8%A3%D8%B4%D9%87%D8%B1">intends</a> to increase its issuance of local debt by 30 % during the current quarter (January&ndash;March) compared to the previous one to reach EGP1.646 trillion. This brings the total value of treasury bills and bonds issued locally during the first nine months (July&ndash;December) of the fiscal year 2023/-2024, to EGP4.1 trillion, according to Adasa&rsquo;s calculations. This amount is nearly double&nbsp; Egypt&rsquo;s financing <a href="https://www.asharqbusiness.com/article/50010/%D9%85%D8%B5%D8%B1-%D8%AA%D8%B1%D9%81%D8%B9-%D8%A7%D8%AD%D8%AA%D9%8A%D8%A7%D8%AC%D8%A7%D8%AA%D9%87%D8%A7-%D8%A7%D9%84%D8%AA%D9%85%D9%88%D9%8A%D9%84%D9%8A%D8%A9-%D8%A8%D8%A7%D9%84%D9%85%D9%8A%D8%B2%D8%A7%D9%86%D9%8A%D8%A9-%D8%A7%D9%84%D8%AC%D8%AF%D9%8A%D8%AF%D8%A9-27/">needs</a> for the entire fiscal year projected in the <a href="https://mof.gov.eg/ar/posts/stateGeneralBudget/65911fe582bd240008c29151/%D9%85%D9%88%D8%A7%D8%B2%D9%86%D8%A9%20%D8%B9%D8%A7%D9%85%D8%A9%202024%2025">&nbsp;</a>general <a href="https://mof.gov.eg/ar/posts/stateGeneralBudget/65911fe582bd240008c29151/%D9%85%D9%88%D8%A7%D8%B2%D9%86%D8%A9%20%D8%B9%D8%A7%D9%85%D8%A9%202024%2025">budget</a> at about EGP2.1 trillion.
The rise in the value of domestic borrowing this year is <a href="https://www.asharqbusiness.com/article/59414/%D9%85%D8%B5%D8%B1-%D8%AA%D9%83%D8%AB%D9%81-%D8%A7%D9%84%D8%A7%D8%B3%D8%AA%D8%AF%D8%A7%D9%86%D8%A9-%D9%85%D8%AD%D9%84%D9%8A%D8%A7%D9%8B-%D8%A8%D8%A7%D9%86%D8%AA%D8%B8%D8%A7%D8%B1-%D8%A7%D9%86%D9%81%D8%B1%D8%A7%D8%AC%D8%A9-%D8%B5%D9%86%D8%AF%D9%88%D9%82-%D8%A7%D9%84%D9%86%D9%82%D8%AF/">due</a> to the increase in government spending, interest rate hikes which inflated debt service payments and the jumps in inflation rates in conjunction with the decline in growth rates.The current structure of debt is worrying as most of it matures in the short term.
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1707495661imageEd 58_2 EN.png" alt="" width="405" height="405">
The reasons behind the expansion in domestic debt are the same ones that create fears of inability to repay.
<h3 dir="ltr">Why should we worry about domestic debt?</h3>
The government uses the revenues of new treasury bills and bond offerings to meet installments and interest payments on old debt. In other words, these instruments are used to cover the budget deficit and not to increase the GDP growth rate or public revenues sufficiently to cover the cost of borrowing. GDP growth rate <a href="https://www.zawya.com/ar/%D8%A7%D9%82%D8%AA%D8%B5%D8%A7%D8%AF/%D9%85%D8%B5%D8%B1/2023-2024-uvhut72b">fell</a> to 2.6% during the first quarter of the current fiscal year, down from 4.4% in the same quarter of the previous fiscal year.
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1707495766imageEd 58_EN 1-2.png" alt="" width="405" height="173">
Also, the high interest rates on public debt instruments, currently exceeding 24%, have raised the cost of debt service and, in turn, the budget deficit, making additional financing necessary. The value of domestic debt service saw a year-on-year increase of <a href="https://www.alborsaanews.com/2024/01/20/1758023">144%</a> during the first half of the current fiscal year, reaching EGP959.4 billion. This figure approaches the <a href="https://mof.gov.eg/ar/posts/stateGeneralBudget/65911fe582bd240008c29151/%D9%85%D9%88%D8%A7%D8%B2%D9%86%D8%A9%20%D8%B9%D8%A7%D9%85%D8%A9%202024%2025">EGP1.12 trillion</a> projected in the budget for the entire fiscal year.
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1707495808imageEd 58_3 EN.png" alt="" width="405" height="405">
The banks are the biggest government lenders as they heavily buy local debt issuances with different maturity dates using the deposits.&nbsp; According to the Central Bank, the banking sector held bonds and treasury bills valued at EGP4.3 trillion in June 2020. This is equivalent to 91.5% of the banking sector&rsquo;s total deposits, in both local and foreign currencies, according to Adasa&rsquo;s calculations. This puts <a href="https://www.imf.org/en/Blogs/Articles/2022/04/18/blog041822-gfsr-ch2-emerging-market-banks-government-debt-holdings-pose-financial-stability-risks">pressure</a> on banks, crowds out other investments, and raises the cost of loans they extend because government debt instruments are a less risky alternative.
This debt repayment scenario is a matter of concern. Given the flagging economic growth rates, there are only a handful of ways to repay local debt: <a href="https://manassa.news/stories/12275">print money</a> absent a corresponding increase in production, which will push up already high inflation rates, or reduce the gap between revenues and expenditures, either by <a href="https://www.skynewsarabia.com/business/1689749-%D9%85%D8%B5%D8%B1-%D8%AE%D8%B7%D8%A9-%D9%84%D9%80%D8%AA%D8%B1%D8%B4%D9%8A%D8%AF-%D8%A7%D9%84%D8%A7%D9%95%D9%86%D9%81%D8%A7%D9%82-%D8%B8%D9%84-%D8%A7%D9%84%D8%A7%D9%94%D8%B2%D9%85%D8%A9-%D8%A7%D9%84%D8%A7%D9%82%D8%AA%D8%B5%D8%A7%D8%AF%D9%8A%D8%A9-%D8%A7%D9%84%D8%AD%D8%A7%D9%84%D9%8A%D8%A9">cutting public spending</a> or increasing revenues 75 % of which comes from taxes, and so any increase may further overburden the citizenry.
<h3 dir="ltr">What is the way out?</h3>
The only possible option is to initiate a genuine development policy to increase the contribution of <a href="https://mjle.journals.ekb.eg/article_260443_05fe90bcbb00b5126039676c19866123.pdf">productive sectors</a> like industry and agriculture. This would bring in greater public revenue and increase the public and private capital turnover, which would in turn reduce the deficit and end the cycle of borrowing to pay off debt.
<hr>
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<div style="text-align: justify;">"Adasa" is a weekly policy digest by Alternative Policy Solutions. "Adasa" provides an analysis of a select number of policy developments and their effect on inclusive development and socioeconomic change.</div>

عدسة

Adasa

السياسة النقدية

Monetary Policy

السياسات الاقتصادية

Economic Policies

الفقر

Poverty

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Why are Further Devaluations and Increased Domestic Debt Daunting?

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