Macroeconomic policy-making for sustainable development in Egypt

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Chahir Zaki
December 10, 2024

In recent years, economic policy in Egypt has been focused primarily on macroeconomic stabilisation to curb inflation, to reduce the fiscal deficit and the current account deficit, and to increase GDP growth. As this column explains, this has come at the expense of the country’s progress on the Sustainable Development Goals, which is rather modest compared with other economies in the region or at the same income level. Sustainable development needs to be more integrated with the conception and implementation of fiscal and monetary policies.

In a nutshell

While macroeconomic policies have helped Egypt’s economy to stabilise in the short term, sustainable development has not been mainstreamed within the policy mix; spending priorities need to change to focus more productive spending (on health and education).

Exchange rate policy must become more sustainable to reduce the pressure on foreign reserves and boost trade and the competitiveness of the manufacturing sector.

Deep structural reforms are needed to improve the business environment, increase competition, attract foreign direct investment to the manufacturing sector, increase exports and thus increase the availability of foreign currency.

Fiscal policy in Egypt in recent years has mainly been characterised by a high share of current spending (around 80% of total spending with the share of wages declining, interest payments increasing, subsidies decreasing and government consumption almost doubled). In contrast, the share of productive spending (including purchase of non-financial assets and other expenditure) represents around 20%. For government revenues, the lion’s share comes from taxes. To finance the deficit, the government has relied mainly on bank financing with high interest rates. While domestic debt has been declining, external debt has been soaring.

In similar vein, monetary policy in Egypt has been chiefly characterised by high interest rates, high and volatile inflation rates, and an increase in lending to the government by the banking system. The implications of this fiscal dominance is a weakened financial system.

Indeed, access to finance cannot be disconnected from the overall strategy of monetary policy. This is why compared with other economies, Egypt has the lowest share of credit going to the private sector (28%). In other lower-middle-income countries, the share is almost four times higher.

The same result is confirmed by the World Bank Enterprise Surveys, which show that only 11.3% of firms in Egypt use banks to finance investments. This figure is four times higher in Jordan, and three times higher in Morocco and Tunisia. Clearly, this affects Egyptian firms’ expansion, innovation and exports. It is why monetary policy needs to streamline development outcomes to increase the credit going to the private sector and thus boost investment, production, exports and employment.

Despite several currency devaluations, the Egyptian pound has been relatively well managed by the Central Bank of Egypt. But while the official objective of the monetary policy is to ‘achieve price stability by minimizing deviations of inflation from the level considered consistent with price stability (inflation gap) and minimizing volatility of real economic activity with respect to its full capacity utilization (output gap)’, both objectives have been only partly achieved, as growth has been high but not inclusive, and inflation has been increasing and volatile.

The main reason for this is the fact that the overarching objective has been to achieve stable parity between the Egyptian pound and the US dollar at the expense of other macroeconomic aggregates and objectives. In other words, the real sector has been bearing the cost of achieving a stable currency, which ended up being devalued.

Implications for policy

Several stabilisation reforms are needed to reduce the internal and external imbalances. At the level of fiscal policy, growth has been mainly driven by increasing public spending, which has led to a surge in Egypt’s debt. This is why, in the short term, three reforms are necessary:

First, to reduce the pressure on foreign currency and reimburse the external debt, the option of restricting imports that are mainly price-inelastic goods and intermediate inputs might not be a plausible option.

Second, fiscal consolidation is needed to reduce the domestic debt, which will require limiting spending on infrastructure projects.

Third, it is important to revisit spending priorities in order to reduce interest payments and increase spending on education (SDG4) and health (SDG3). In other words, it is crucial to reallocate spending from current to productive spending, which will clearly help people get out of poverty (SDG1) and reduce inequality (SDG10).

At the level of monetary policy, several reforms are needed:

The Central Bank of Egypt must revisit its policy of increasing interest rates, as it does not reduce inflation (which is supply-driven, not demand-driven).

Reducing the fiscal deficit financing is key to increase the availability of liquidity to the private sector and improve access to finance conditions.

At the level of exchange rate policy, the Central Bank of Egypt has kept the Egyptian pound at unrealistic rates and announced several times the adoption of a free-floating exchange rate regime as one of the conditions of the recent loan from the International Monetary Fund (IMF):

This policy must be more credible and more sustainable to avoid managing an overvaluation of the Egyptian pound and to reduce the burden on foreign exchange to keep the currency stable.

While this is necessary to improve the competitiveness of exports (SDG9), some structural reforms are needed to foster and diversify domestic production and remove administrative and unjustified non-tariff measures that affect exports and therefore production.

Finally, a paradigm shift is needed to focus more on structural policies that improve the real sector instead of the focus on stabilisation per se:

Deep structural reforms are needed to improve the business environment, increase competition, attract foreign direct investment to the manufacturing sector, increase exports and thus increase the availability of foreign currency.

Obviously, to achieve all these outcomes, institutional reforms are needed (SDG16). Independence and accountability are important determinants of good institutions.

The Forum ERF

ERF