Arab Republic of Egypt: Staff Report for the 2005 Article IV Consultation

The Arab Republic of Egypt’s 2005 Article IV Consultation reports that the externally driven recovery has gained steam underpinned by a moderate revival in consumption and improved confidence. The Egyptian pound has appreciated, the stock market has reached record highs, and the current account surplus has increased, enabling banks and the Central Bank of Egypt to strengthen their net foreign asset position. The monetary policy did not contain inflation below double-digit rates, and government borrowing and debt remained high.

Abstract

The Arab Republic of Egypt’s 2005 Article IV Consultation reports that the externally driven recovery has gained steam underpinned by a moderate revival in consumption and improved confidence. The Egyptian pound has appreciated, the stock market has reached record highs, and the current account surplus has increased, enabling banks and the Central Bank of Egypt to strengthen their net foreign asset position. The monetary policy did not contain inflation below double-digit rates, and government borrowing and debt remained high.

I. Overview and Recent Economic Developments

A. Overview

1. Egypt changed the direction of economic policies sharply in 2004 with the appointment in July of a pro-reform cabinet led by Prime Minister Nazif. The new cabinet quickly established its credentials by implementing a number of economic reforms and announcing plans to restructure the financial sector and privatize most state enterprises. Since then, work has continued at a steady pace, although the challenges that lie ahead to build a dynamic, private sector-driven economy are considerable. Output growth remains below the minimum required to absorb labor force growth, the financial sector is weak, and government borrowing remains high, raising concerns about fiscal vulnerability and crowding out. Presidential elections are scheduled for September 2005; the cabinet has to resign prior to the elections and its reappointment will remain at the discretion of the President-elect.1

2. The reform program of the new cabinet covers the areas regarded as critical in recent Article IV consultations. Fund technical assistance has supplemented staff discussions with the authorities in many of those areas, including tax and customs reform, budget classification, the exchange rate system, monetary policy, bank restructuring, and statistics. During 2004, the authorities made substantial progress at reforming the exchange rate system and liberalizing trade. They also started work to modernize the budget, improve the monetary framework, restructure the banking system and improve the quality of statistics, although more remains to be done in all of these areas.

B. Recent Economic Developments

3. The economic recovery gained steam in 2004. Driven by strong growth in exports of goods and services, as well as a moderate revival in consumption, real GDP advanced by 4.8 percent in the first half of 2004/05 (July-December) compared to 4.2 percent in the first half of 2003/04.2 Confidence has rebounded, as reflected in the surge of activity in the stock market following the appointment of the new government.3 Fitch and Standard & Poor’s upgraded Egypt’s credit rating, to stable from negative, in December 2004 and March 2005, respectively.

Figure 1.
Figure 1.

Performance Indicators, 2001/02-04/05

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Sources: Standard & Poor’s; Egyptian authorities; and IMF staff estimates.

4. Egypt made the transition to a unified, flexible exchange rate regime during 2004. The parallel market rate, which had a premium of over 15 percent in late 2003, converged with the banking rate in the second half of 2004 as a result of strong current account inflows and higher interest rates. In December, the government abolished the surrender requirement (introduced in 2003) and formally launched an interbank market by enacting a convention governing foreign exchange trading among all signatory banks. On January 2, 2005, Egypt accepted the obligations of Article VIII, Sections 2-4. In subsequent weeks, activity in the interbank market surged and flexibility in rate-setting was restored. By end-March 2005, the pound had appreciated by over 5 percent.

Figure 2.
Figure 2.

Exchange Rates, June 2002-March 2005

(Egyptian pounds per U.S. dollar; end of period)

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Sources: Central Bank of Egypt; and Reuters.

5. Egypt’s external position strengthened further. All foreign exchange generating activities exhibited robust growth during 2004, which helped offset a sharp rise in non-oil imports to their pre-2001 level. The surplus in the external current account rose to 4.4 percent of GDP in 2003/04, and is expected to be slightly higher in 2004/05. This strength mainly reflects improved competitiveness stemming from the large real depreciation of the pound since 2001, although external factors, such as higher oil prices and higher Suez Canal traffic, also played a role. The official capital account remains in deficit.4 Foreign borrowing has been negligible, foreign direct investment (FDI) remains very low, and resident banks continue accumulating net foreign assets—over US$5 billion in the 18 months to December 2004. Official international reserves remained stable at around $14.5 billion during most of 2004, but began to rise at year-end as the CBE took advantage of market conditions to build up its reserve position. At end-February, official reserves stood at $17.3 billion, equivalent to 7.2 months of imports. Total external debt remained stable at about US$29 billion (31 percent of GDP) at end-2004.

Figure 3.
Figure 3.

External Sector Developments, 2001–04

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Sources: Egyptian authorities; and IMF Information Notice System.
Figure 4.
Figure 4.

Inflation, Interest Rates, and Money Supply, June 2002-February 2005

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Source: Egyptian authorities.1/ See Appendix III, Table 1, Footnote 3.

6. Inflation accelerated during 2004. Annual CPI inflation (12-month rate) was close to 12 percent every month from May to December 2004, while average annual WPI inflation remained at about 17 percent over this period. The higher inflation reflected lagged pass-through pressures from the large nominal depreciation of the pound and lax monetary policy during 2003; for the CPI, the rise also reflected changes in the composition of the index made in early 2004.5 Prices actually fell from end-2004 to February 2005: the WPI and the CPI fell cumulatively by 0.7 percent and 0.2 percent, respectively, bringing 12-month rates of inflation to below 7 percent.

7. Real interest rates remained very low, despite a tightening of monetary conditions in 2004. The CBE allowed interest rates to rise early in the year and moved more aggressively to absorb liquidity mid-year.6 Accordingly, money growth rates stabilized at around 14 percent from June onwards. Long- and short-term interest rates, however, stayed in the 10–13 percent range from April to December 2004, yielding real interest rates of about, or below, zero throughout 2004. Nominal interest rates declined somewhat in early 2005.

8. Government borrowing remained high. Total financing to the general government in 2003/04 was 6.6 percent of GDP, 0.5 percentage points lower than in 2002/03. Borrowing was driven in part by the deficit of the general government as measured by the authorities, which was 2.5 percent of GDP—broadly unchanged from 2002/03. However, as in previous years, most of the borrowing (4.1 percent of GDP) was related to general government operations captured in the official financing data but not in the published measure of the deficit (henceforth referred to as other debt-creating operations). Roughly half of those operations were related to the National Investment Bank (NIB), while payments of investment arrears and suppliers’ credits accounted for the rest.7 The general government continued borrowing exclusively from domestic sources, primarily through the placement of non-indexed bonds with financial institutions (including the CBE).

9. Preliminary data suggest a continuation of recent trends in government borrowing in 2004/05. Staff projects a small increase in the general government deficit, to 3.1 percent of GDP, on account of lower customs and nontax revenues.8 Under the assumption that other debt-creating operations remain broadly at last year’s level, staff envisages that the total financing needs of the government will be about 7 percent of GDP during 2004/05.9

Figure 5.
Figure 5.

Government Borrowing and Public Debt, 2000/01–2004/05

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Sources: Egyptian authorities; and IMF staff estimates and projections.1/ Includes arrears payments, suppliers’ credits, NIB debt-creating operations, and statistical discrepancy.

10. Public debt has continued to rise. Net public debt is now projected to reach LE 350 billion by end-June 2005, up from LE 312 billion at end-June 2004.10 As a percent of GDP, however, net public debt is expected to remain below the peak of 66 percent reached in June 2003, primarily reflecting the large (mostly price-driven) increase in nominal GDP during this period. Gross public debt reached a peak of 112 percent of GDP in June 2004, but government deposits with banks grew at a faster pace, reflecting continued deficiencies in the government’s asset-liability management, reaching 46 percent of GDP by end-2003/04. The cost and maturity structure of government debt, and the implied near- and medium-term vulnerabilities, have not deteriorated, and are expected to remain broadly unchanged during 2004/05 (Box 1).

Public Debt in Egypt, 2000–04

Egypt’s gross public debt rose by 36 percentage points of GDP from 2000 to 2004. The rise was driven mostly by domestic debt, particularly securities; bank loans to the government declined from 10 to 1 percent of GDP. The share of external debt in total debt dropped steadily. Government deposits with banks have grown significantly, especially since 2002. Part of these deposits are repayments of rescheduled external debt kept in “blocked accounts” until they become due. The other deposits come from several sources.

The structure of Egypt’s domestic debt stock sheds light on possible sources of vulnerability:

  • Domestic securities are mostly non-indexed; less than 25 percent are fully tradable and have maturities below one year.

  • Almost half of domestic debt is held by the CBE and just over 25 percent is held by the financial sector (mostly banks). The debt held by households is in the form of saving certificates from the NIB and post offices.

The investor base and composition of Egypt’s public debt limit the risk of a destabilizing debt spiral. Large bank holdings of public debt, however, create other challenges, including for the valuation of banks’ net work.

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Sources: Egyptian authorities; and IMF staff estimates.

Refers to securities only.

Primarily banks, including state banks.

11. The banking system is still not contributing to the recovery. The credit excesses of the late 1990s continue to weigh heavily on Egypt’s banks. Credit to the private sector continues to decline in real terms, and most of the recent expansion in banks’ domestic claims is to the government. Nonperforming loans (NPLs) rose to over 25 percent of total loans in September 2004, compared to 20 percent in June 2003, and provisioning continued falling. Given the dearth of new credit, the recent behavior of these indicators mostly reflects improved classification of old loans and stricter enforcement of prudential regulations. A scheme outlined by the authorities in early 2004 to restructure the NPLs of public enterprises has not been finalized, but is part of the new financial sector reform program.

Figure 6.
Figure 6.

Sources of Money Growth and Nonperforming Loans

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Sources: Egyptian authorities; and IMF staff estimates.

12. The new cabinet moved aggressively on key structural reforms during its first months in office (Box 2). The authorities see the modernization of government and increased private sector participation as key pillars for attaining sustained economic growth. They have launched ambitious plans to restructure the financial system and privatize most state companies. Work to increase the transparency and efficiency of government operations and strengthen the monetary policy framework also has started. The Fund has intensified its technical assistance to Egypt to support these reforms (see Appendix I).

13. The new authorities have improved the transparency of economic policies. They moved rapidly to resolve the outstanding obstacles to subscription to the Special Data Dissemination Standard (SDDS), to which Egypt officially subscribed in January 2005. The authorities agreed to the issuance of a press release at the conclusion of the 2005 Article IV consultation mission, and submitted their official response to the 2003 Data ROSC in March 2005.11

II. Policy Discussions

A. Exchange Rate and Monetary Policy

14. Staff welcomed the establishment of the interbank market for foreign exchange, a key milestone in Egypt’s transition to a unified flexible exchange rate system. Favorable trends in the balance of payments and increased confidence contributed to the high volume of trading during the initial weeks of the market’s operation, and to the appreciation of the pound in January 2005. Staff supported the CBE’s decision to take advantage of favorable market conditions to strengthen its reserve position.

15. Discussions covered mechanisms to ensure an orderly functioning of the interbank market over the medium term, including well-crafted CBE statements to market participants and opportunistic purchases of foreign exchange. Staff stressed the importance of continuing to refrain from exerting moral suasion and from resisting pressures on the nominal exchange rate in either direction. Noting that the normal operation of the market would give rise to daily and weekly exchange rate fluctuations, staff encouraged the authorities to tolerate those fluctuations and allow the exchange rate to work as a shock absorber. The CBE reaffirmed its commitment to allowing market forces to determine the exchange rate, and agreed with the merits of developing, over time, indicators of “abnormal” conditions that might warrant a policy response.

Economic Reform Initiatives of the Nazif Cabinet: July 2004-March 2005

Exchange rate system

  • Set up interbank market for foreign exchange (September).

  • Formally adopted convention governing interbank foreign exchange trading (December).

  • Abolished surrender requirement on export proceeds (December).

Trade regime

  • Cut average tariff rate (from 14.6 percent to 9.1 percent—weighted), reduced number of tariff bands, and eliminated import fees and surcharges (September).

  • Set up Qualified Industrial Zones allowing products manufactured in the zones tariff-free entry into the United States provided 11.7 percent of components are of Israeli origin (December). These zones are expected to partly offset export losses related to the expiry of the Multi Fibre Agreement.

Public sector

  • Raised prices of subsidized fuel (September) and electricity (December).

  • Modified Income Tax Law—draft submitted to Congress in December—changes include the simplification of the rate structure, cuts in personal and corporate income tax rates, and a higher minimum threshold.

  • Initiated public expenditure management reforms with initial focus on (1) upgrading budget classification and (2) establishing a Treasury Single Account.

  • Currently formulating plans to reform tax administration.

Financial sector

  • Announced comprehensive financial sector restructuring plan (September) with a five-year horizon comprising mergers, sale of stakes in joint venture banks, resolution of NPLs from public and private enterprises, privatization of a state bank, and reform of nonbank financial sector.

  • Imposed deadline of June 2005 for banks to meet LE 500 million in paid up capital.

  • Established a Bank Restructuring Unit staffed by professional bankers at CBE; identified Bank of Alexandria as the state bank to be sold by end-2005; two small banks were absorbed by larger banks; the state’s share in one bank and one securities trading firm were sold for a total of LE 536 million.

Privatization

  • Announced plans to privatize most state-owned firms, including in sectors previously off-limits.

  • Between July 2004 and March 2005, 17 nonfinancial companies were privatized, generating proceeds of LE 2.35 billion.

Transparency

  • Outstanding issues for subscription to SDDS resolved (December); subscribed in January 2005.

  • Sent official response to 2003 Data ROSC (March).

16. The CBE has made progress at improving the focus of monetary policy and strengthening its technical capacities. In addition to adding reverse repurchase operations to its toolkit, the CBE is formulating plans, with the assistance of MFD, to increase the efficiency of monetary operations, including through the creation of a standing facility to reduce the volatility of interbank rates. Work to examine the channels of transmission and the lags of monetary policy is also underway. Staff encouraged further improvements in this direction.

17. However, developing a cohesive monetary policy framework will take some time. Considerable work is needed to make monetary operations effective, increase interest rate flexibility, and effectively anchor inflation expectations under a flexible exchange rate. All modifications to monetary policy should be closely linked to the CBE’s medium-term framework; piecemeal changes that could send confusing signals should be avoided. The CBE should also give priority to upgrading the technical skills of its staff, including through increased interactions with visiting experts. Staff regretted the delays in producing a reliable price series, stressing that improvements in monetary policy will only be partial as long as the inflation measure remains imperfect.

18. The monetary policy strategy in the near term needs to be defined more clearly. Staff argued that the monetary regime had been without a clear anchor for inflation expectations for some time. In addition, as of December 2004, real interest rates were negative, the slowdown in broad money growth had ceased, asset prices had surged, and the available measures of inflation did not show a declining trend. Staff underscored the risk that high inflation expectations could become entrenched. To bolster the credibility of the CBE’s commitment to low inflation, staff argued for a tightening of liquidity conditions. The authorities did not agree, noting that higher interest rates would have adverse effects on output growth.

19. Clear communication about the general direction of monetary policy should be a critical component of the near-term strategy. Periodical announcements by the CBE will provide guidance to the market and help anchor inflation expectations while the main pillars of the monetary policy framework are being developed. The authorities agreed that monetary policy announcements would be valuable, and were considering moving rapidly on this front.

B. Fiscal Policy and Public Debt

20. Staff welcomed the decisive fiscal actions taken in the areas of tariff reform, income tax reform, and subsidies since September 2004 (Box 2). The authorities highlighted the importance they attach to fiscal reform in their overall agenda. Staff noted that reforming Egypt’s public sector would be a demanding and complex task, and agreed with the authorities on the importance of assessing carefully the sequencing of reforms and securing continued political support.

21. Plans to reform subsidies and tax administration are being developed. The authorities intend to move gradually all implicit subsidies onto the budget to increase the transparency of public spending.12 Staff welcomed these plans, and recommended replacing across-the-board subsidies with better targeted social programs. The authorities regard the modernization of Egypt’s tax system as a priority, and are studying the recommendations of a December 2004 FAD mission on tax administration.

22. The official measure of the fiscal deficit underestimates the borrowing needs of the government. Official estimates of the general government deficit (and its financing) explain a relatively small part of the annual changes in Egypt’s net indebtedness. Staff presented an augmented fiscal deficit equal to the sum of the official deficit and other debt creating operations obtained from the consolidation of financing data.13 This measure accounts for the bulk of the rise in public debt recorded in recent years; staff regards this as the best available indicator of Egypt’s fiscal stance, and recommended that it be the key focus of fiscal policy.

23. Ongoing efforts to modernize Egypt’s budget and improve treasury cash management will not necessarily reduce government borrowing. Although the 2005/06 budget had not been finalized at the time of the consultation and was not discussed in detail, the authorities noted that it was being prepared in accordance with the modified GFSM-2001 classification suggested by FAD. The authorities also intend to follow FAD recommendations for the establishment of a Treasury Single Account (TSA). Staff agreed that the new budget classification would improve the transparency of the fiscal accounts, and that a TSA would help prevent a continued accumulation of government bank deposits. However, while these reforms are necessary conditions for an efficient control of government expenditure, they will not result in lower levels of spending, nor affect the fiscal stance in 2005/06, unless supplemented with concrete expenditure-reducing measures.

24. The overriding goal of Egypt’s public sector reform should be to achieve fiscal consolidation in order to lower government borrowing and place government debt on a firmly declining path. The levels of government borrowing and public debt recorded in recent years are inimical to growth and hinder private investment through many channels, including by crowding out bank credit and fueling expectations of future tax increases. A multi-year fiscal consolidation would reduce the risks associated with maintaining government borrowing and debt at current levels, and would create room for a sustained resumption of private investment. The lion’s share of the consolidation should fall on government expenditures (including those financed with the other debt-creating operations), although there is also scope to strengthen the revenue side. Staff argued that bringing the investment budget under the full control of the Ministry of Finance (with its attendant consequences for the NIB) was critical for the success of this strategy, and encouraged the authorities to make the integration of Egypt’s current and capital expenditure budgets a priority.

25. The impending fiscal costs of financial sector reform strengthen the case for fiscal consolidation. Staff stressed the importance of producing realistic estimates of the size and expected timing of the net additions to government debt associated with the future recapitalization of public banks.14 Those additions will be inevitable and have to be well timed to minimize their adverse effects on market perceptions of Egypt’s fiscal solvency. Staff encouraged the authorities to revise and update the estimates periodically, including their distribution over time, and evaluate the effects they may have on public debt dynamics.

26. Staff projections show that Egypt’s public debt-to-GDP ratio will not fall unless the government reduces its total borrowing. The medium-term fiscal scenarios presented to the authorities linked explicitly the augmented fiscal deficit to changes in net public debt under the current policy stance, and under various paths of fiscal consolidation. Egypt’s high levels of public debt and government borrowing were assumed to impede sustained increases in private investment and restrain output growth below its long-run average of 5.2 percent under all scenarios (Box 3). Figure 7 and Tables 56 summarize the results from two scenarios: the first (baseline) scenario assumes that government borrowing remains between 6 ½-7 percent of GDP until 2009/10, while the second assumes that government borrowing falls by about 1 percent of GDP per annum.15 Two results are noteworthy. First, keeping government borrowing at the levels of recent years would not reduce the public debt-to-GDP ratio, and could lead to a ratio of 80 percent by 2009/10 if growth slowed suddenly. Second, a decline in government borrowing of 1 percent of GDP per annum for five years would lower the public debt ratio by about 8 percentage points of GDP; staff regards this as the minimum adjustment needed to place public debt on a firmly declining path, thereby creating room to absorb shocks and contingent liabilities, particularly related to bank restructuring.16

Figure 7.
Figure 7.

Government Borrowing and Public Debt Scenarios

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 177; 10.5089/9781451811841.002.A001

Sources: Egyptian authorities; and IMF staff estimates and projections.
Table 1.

Egypt: Selected Macroeconomic Indicators, 2001/02–2005/06 1/

(Quota: SDR 943.7 million)

Population (2003): 69.2 million; Per capita GDP (2003): $1,172

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Sources: Egyptian authorities; and IMF staff estimates.

Egyptian fiscal year ends June 30.

For 2004/05, last observation is February 2005.

Table 2.

Egypt: Monetary Survey, 2001/02–2005/06

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Sources: Central Bank of Egypt; and IMF staff estimates.

Excludes reverse repos and deposit auctions; see Appendix III, Table 1, Footnote 3 for CBE definition.

Excludes reserve requirements on foreign currency deposits.

Including blocked accounts.

Ratio of broad money to reserve money.

Broad money less foreign currency deposits.

Table 3.

Egypt: Summary of General Government Operations, 2001/02–2005/06 1/

(In percent of GDP)

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Sources: Egyptian authorities; and IMF staff estimates.

The General Government comprises the budget sector, the NIB, GASC, and the Social Insurance Funds.

Includes a US$1 billion (1 percent of GDP) capital transfer from EGPC in 2005/06.

Includes social security contributions.

Includes wages, and goods and services; excludes grant-financed expenditures.

Includes transfers to social insurance funds.

As recorded above the line (official estimate of overall balance of the general government).

Information on the stock of suppliers’ credits and arrears is not available.

Includes assumption of debt and statistical discrepancy, adjusted for privatization proceeds.

Table 4.

Egypt: Summary of Budget Sector Operations, 2001/02–2005/06 1/

(In percent of GDP)

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Sources: Egyptian authorities; and IMF staff estimates.

The budget sector comprises central and local government agencies (administrative authorities and local authorities).

Includes a US$1 billion (1 percent of GDP) capital transfer from EGPC in 2005/06.

Includes social security contributions.

Includes wages, and goods and services; excludes grant-financed expenditures.

Includes transfers to social insurance funds.

As recorded above the line (official estimate of the budget sector balance).

Table 5.

Egypt: Medium-Term Scenarios, 2001/02–2009/10

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Sources: Egyptian authorities; and IMF staff estimates and projections.

The baseline scenario assumes that the general government deficit declines slightly, while other debt creating operations remain at the 2003/04 level. The steady adjustment scenario assumes that total financing needs decline by 1 percent of GDP per year starting in 2005/06.

As recorded above the line (official estimate of the general government deficit).

Includes arrears payments, assumption of debt, suppliers’ credits, other NIB debt-creating operations, and statistical discrepancy.

Projections do not include any estimate for the costs of bank restructuring or privatization receipts.

Net of government deposits with banks. Deposits include the “blocked accounts” on rescheduled Paris Club debt held at the CBE. Deposits with banks are projected to remain constant in nominal terms; blocked accounts are projected to decrease according to the repayment schedule.

Includes government guaranteed debt, but excludes the contigent pension liabilities of the government’s social insurance funds.

Table 6.

Egypt. Public Sector Debt Sustainability Framework, 2001/02–09/10

(In percent of GDP, unless otherwise indicated

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Sources: Egyptian authorities; and IMF staff estimates.

General government debt minus deposits with banks. Deposits include the “blocked accounts” on rescheduled Paris Club debt held at the CBE.

Deposits with banks are projected to remain constant in nominal terms, while blocked accounts are projected to decrease according to the repayment schedule.

Includes government guaranteed external debt, but excludes contigent pension liabilities of the government’s social insurance funds.

Based on official presentation. Is not a meaningful measure of the “primary deficit” because it omits outlays that are captured in the financing data.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; α = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 5/ r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 5/ as αε(1+r).

Includes suppliers’ credits, NIB debt-creating operations, and statistical discrepancy as reported by MoF.

For projections, this line includes exchange rate changes.

Derived as nominal interest expenditure divided by previous period gross debt stock.

Accounting for Growth in Egypt, 1960–2004

Economic growth in Egypt slowed from 6 percent (annual average) during the 1960s and 70s, to 4.8 percent during the 1980s and 90s, and further to 3.5 percent from 2001–04. Physical capital accumulation was the biggest contributor to growth in output per worker from 1961–2000, but its contribution fell sharply after 2000.

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Staff estimates suggest that investment growth would need to recover strongly, and/or be compensated by sustained increases in productivity, for output growth to rise to its historical average. For example, assuming TFP growth at its long-run average (0.9 percent), real gross fixed investment would need to increase by 12.4 percent per year on average in order for output growth to rise to 4.8 percent, the rate prevailing from 1981-2000.

27. The authorities stated their commitment to reducing the fiscal deficit, but were not prepared to endorse staff’s recommendation of adopting a multi-year fiscal consolidation strategy. They noted that the ongoing modernization of the budget, supported by a tightening of intra-government financial linkages, would reduce the other debt-creating operations and contribute to lower public debt. The authorities also stressed that progress in lengthening the maturity of domestic debt will continue.

C. External Sector

28. The medium-term outlook for Egypt’s balance of payments remains favorable. The strong export performance since end-2002 has been broad based and is underpinned by favorable global and regional conditions. Continued development of its tourism potential and vast gas resources will strengthen further Egypt’s supply of foreign exchange. Staff’s medium-term projections show that a marked slowdown in the pace of current account inflows could accommodate non-oil import growth of about 7 percent per annum and still leave the current account (and the overall balance of payments) in surplus over the medium term (Table 7). The projections also suggest that there is scope for some real appreciation of the pound over the medium term. In the staff’s view, only the joint occurrence of several adverse shocks (i.e., to oil/gas prices, Suez Canal traffic, or tourism) would weaken significantly Egypt’s external outlook. As in the last Article IV consultation, Egypt’s external debt sustainability analysis reveals no major vulnerability; the external debt-to-GDP ratio and the external debt service ratio are projected to decline steadily over the medium term, even in the face of adverse shocks (Table 8).

Table 7.

Egypt: Medium-Term Balance of Payments, 2001/02–2009/10

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Sources: Central Bank of Egypt; and IMF staff estimates.

Includes multilateral and bilateral public sector borrowing and private borrowing.

Table 8.

Egypt: External Debt Sustainability Framework, 1999/2000–2009/10

(In percent of GDP, unless otherwise indicated)

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Sources: Egyptian authorities; and IMF staff estimates.

Derived as [r - g -ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.