Abstract
This Selected Issues paper examines whether Egypt’s current account and exchange rate are in broad equilibrium. The paper analyzes areas of fiscal spending that have the biggest saving potential in a cross-country perspective. An assessment of Egypt’s real exchange rate is presented. The paper uses data envelopment analysis to analyze the efficiency in public spending on health, education, and social protection relative to comparable countries. The results suggest significant scope to improve efficiency in all three social areas, and that room for fiscal savings is particularly apparent in social protection and education.
I. Introduction
1. The Egyptian economy has delivered another year of impressive performance, but the government will need to address several key issues in the future. Sustaining high growth will require domestic and external stability. One issue in this context is to ensure that the level of Egypt’s real exchange rate is appropriate. The still large—if declining—fiscal deficit shows clearly that further fiscal adjustment continues to be crucial for enhancing fiscal sustainability. The Central Bank of Egypt (CBE) intends to adopt inflation targeting as a monetary policy framework as soon as the institutional environment is appropriate.
2. In providing greater in-depth analyses of these challenges, this set of selected issues papers complements the staff report on the 2007 Article IV Consultations. Specifically, the following three issues are covered:
whether Egypt’s current account and exchange rate are in broad equilibrium, thus underpinning external stability;
what areas of fiscal spending have the biggest saving potential in a cross-country perspective; and
to what extent has a crucial component of inflation targeting—a functioning monetary transmission mechanism—developed over the last ten years.
3. An assessment of Egypt’s real exchange rate is made in Chapter II. Egypt’s current account is compared with several benchmarks or norms that arise from various approaches to assess external stability. While the results differ somewhat across empirical approaches, the conclusion is that the exchange rate is broadly in line with fundamentals.
4. Making fiscal spending more efficient should be an integral part of the government’s fiscal adjustment strategy. Chapter III uses data envelopment analysis to analyze the relative efficiency public spending on health, education, and social protection relative to comparable countries. The results suggest significant scope to improve efficiency in all three social areas, and room for fiscal savings is particularly apparent in social protection and education.
5. Except for the exchange rate channel, monetary transmission in Egypt is weak, but recent developments are promising. Based on a forthcoming working paper, Chapter IV discusses empirical evidence on various channels of monetary transmission in Egypt. While most channels are rather weak at present, there is some evidence that recent reforms on the monetary policy framework are contributing to strengthening the transmission of the monetary stance via interest rates to macroeconomic variables such as output and prices.