Egypt - Debt and Restructuring

Debt and restructuring

Ironically, in 1990 Egypt found itself heavily indebted as it had been more than a century previously. The practice of external borrowing began with Muhammad Ali, who sought funds to finance, among other things, his ambitious development schemes. Significant debt began to build up only in the second half of the nineteenth century, coinciding with the rise of the export economy. In the 1880s, Egypt was unable to repay its debts, and Britain, the main lender, used this an excuse to occupy Egypt for the next half century. The debt was economically disastrous for Egypt because it consumed all the surpluses accumulated during and after World War I, which could otherwise have been invested in economic development.

Egypt emerged from World II, as from World War I, with substantial reserves resulting from the goods and services it supplied to the Allies and its lower imports because of worldwide shortages. The reserves were kept under British control until the end of the 1940s, when Egypt started to use them to finance imports. They practically disappeared in the late 1950s, and Egypt again began external borrowing. Still, by the late 1960s debt was not substantial.

Only with the increased borrowing under Sadat and Mubarak did debt become the nagging problem it was in 1990. Debt information was incomplete, and estimates of it varied. Variations resulted from the multiplicity of creditors, the private nature of some arrangements, and the exclusion of debt data from official statistics or the showing of lower figures in government budgets. Publicly guaranteed, long-term debt climbed from more than US$3 billion in 1974 to about US$15.8 billion in 1980, or more than five-fold. During the same period, real GDP (at 1980 prices) less than doubled, and exports rose three-fold. If short-term debts were considered, the gap between the growth of debt and that of GDP and exports would be greater.

In 1988 total external debt was expected to reach US$46 billion or about double the amount in 1981. As a result, civilian debt came close to GDP in 1987 and was forecast to surpass it in 1988. Thus, Egypt, like many developing countries, entered the final decade of the twentieth century with burdensome debt.

Most of Egypt's debt was owed to other governments or guaranteed by them, especially when military debt was taken into account. For example, in 1987 debt to private creditors was about 21 percent of the civilian total, and debt to multilateral organizations was about 17 percent of the civilian total. Prior to the peace treaty with Israel in 1979, the largest creditors were Arab countries; since 1979 the Arabs were replaced by OECD members. In 1987 Egypt owed US$10.1 billion to the United States. Of this about US$4.6 billion, or about 23 percent of Egypt's combined debt, was military debt. Within Egypt itself, the largest debtor was the government and the public sector generally. For example, public debt, apart from the military made up about 78 percent of the total; the rest was borne by private enterprises and banks.

As debt increased, Egypt became vulnerable to pressure from creditors who wanted it to repay the debts and restructure the economy. During the 1980s, prolonged, tug-of-war-like negotiations occurred between Egypt and various creditors represented by the IMF and the Paris Club.

Before concluding agreements with other creditors, Egypt had first to win the endorsement of the IMF on the soundness of its financial position. In return for a financial package to ease repayment terms, the IMF policy requires that a government undertake a macroeconomic stabilization program, known as the IMF conditionality, that touches basically on every aspect of the economy. The program consists of two interlinked components, one external and the other internal. The external component applies to the reduction of the trade deficit, in Egypt's case through the devaluation of the Egyptian pound to make exports more competitive. The internal component is far-reaching and aimed at minimizing the role of the state in the economic process. It calls for, among other things, appreciable cuts in the budget deficit, elimination of price controls, and the closing of inefficient public enterprises with the ultimate goal of privatization.

Although there was a growing consensus in Egypt on the need for reform, many interests conflicted and experts differed on the best course. Because of their colonial experience, Egyptians were generally sensitive to having their economic policies dictated by outsiders. As far back as 1966, Nasser rejected on nationalist grounds an IMF "background stabilization program" much more modest than subsequent ones.

The demand for cutting the budget, which would have entailed mainly reducing the subsidies of basic commodities, was officially resisted as politically destabilizing. Within the cabinet itself, there were different voices. For instance, while the minister of agriculture supported dismantling price controls so as to raise the incomes of his constituency, the farmers, the minister of food and supply opposed dismantling them on the ground that lack of such controls would hurt his main constituency, urban consumers.

The fear of political instability was not the only reason for resistance to restructuring. Politically significant Egyptian groups, including public-sector employees, some leading intellectuals, and ruling party functionaries, viewed with suspicion attempts to weaken drastically the role of government and the public sector. Egypt, they said, had a weak state for more than a century and free trade for an even longer period, yet the country remained underdeveloped. They pointed to the wasteful economic behavior of the private sector during the infitah and the way this policy widened the income gap between rich and poor. Finally, they referred to the successes of Japan, the Republic of Korea (South Korea), and Taiwan, where strong partnerships between the state and the private sector propelled economic growth.

Private-sector entrepreneurs themselves were little interested in certain aspects of reform. They considered state intervention necessary in such areas as tariff protection against foreign competition, stabilization of input prices, increased savings, and investment in infrastructure. Although they wanted to see less red tape and the simplification of investment procedures, they were able to turn market restrictions to their advantage through manipulation. Their relationship to the public sector was often more symbiotic than adversarial. For example, in the mid-1980s the poultry industry--which had grown astronomically since the mid- 1970s as a result of private investment by entrepreneurs, government officials, and military officers--wanted the government to ban egg imports and to limit new farms and emergency low- interest loans to offset what it saw as market saturation. Poultry farm owners resorted to a massive slaughter of 4 to 5 million chickens to dramatize their demand.

In spite of these constraints and because of the economic difficulties and mounting debt and deficit, the government since the mid-1980s had no alternative but to come to terms with the IMF and its creditors. In the negotiations, disputes often centered on the pace and scope of restructuring, not on the need for it. Finally, after intense bargaining and pressure on the IMF by the United States, which was concerned about the impact of the Cairo security police riots in February 1986, an agreement was signed in May 1987. The agreement was considered lenient by IMF standards, although not by the Egyptians. For example, it involved Egypt's agreement to lower its budget deficit to 10 percent of GDP, a ceiling that the government found arbitrary. The IMF allowed Egypt to keep the official rate of ŁE1 = US$1.43 for pricing oil, cotton exports, and rice but stressed the need for eventually eliminating the multiple exchange-rate system.

In return, the government was to obtain SDR250 million, or about US$327 million, much less than the US$1.5 billion standby credit Egypt had applied for in 1986. More important, the agreement paved the way for an arrangement with Paris Club creditors to alleviate Egypt's debt. Toward the end of May, the Paris Club approved a ten-year rescheduling, with a five-year grace period. The arrangement also covered arrears outstanding at the end of 1986, in addition to interest and principal repayments due between the beginning of 1987 and June 1988 on all guaranteed debts contracted before the end of October 1987.

The government subsequently implemented many changes, including raising energy and food prices, setting higher and market- determined prices for farm production with the exception of cotton, and trimming budget and trade deficits. The IMF and Paris Club members, however, were not satisfied with the pace of reform and expressed their concern that Egypt was delivering much less than it had promised. Egypt wanted to extend the period of arrears and payments on publicly guaranteed loans to the end of 1989 instead of June 1988 as was stipulated in the 1987 agreement with the Paris Club. A new round of negotiations began, and an accord with the IMF was anticipated in July 1989. The deadline passed inconclusively, and the marathon bargaining was continuing in early 1990.

Irrespective of the conclusion of these negotiations, Egypt entered the closing decade of the twentieth century facing an enormous economic challenge. Economic growth was unable to keep up with that of population, and inflation was eating into the modest income of many Egyptians. The government introduced uneven reforms in pricing and other policies, but more effective reform was needed, especially in the stagnant and outmoded industrial field and the notoriously inefficient bureaucracy. Although Egyptian agricultural yields were respectable, they could be enhanced substantially. Revenues from oil, the Suez Canal, workers' remittances, and tourism--the main sources of foreign currency-- were expected to grow, if at all, at low rates. Egypt had to propel its agriculture and industry forward if it were to achieve a self- sustaining growth and feed and create jobs for a rapidly growing population.

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