Government debt per se creates no immediate threat since relatively little of it is owed in currencies other than Egyptian pounds. But deficit reduction will almost certainly be a condition for much-needed support from the IMF. In any event, permitting the recent surge in deficit spending to continue for much longer would undermine the prospects for a return to rapid growth.
That's because government borrowing is absorbing much of Egypt's relatively meager domestic savings, crowding out private investment. Credit has been increasingly skewed towards support of the government and away from financing private activity.
The other side of the budget ledger matters, too, of course. As the economy recovers, there will be scope for raising revenue by widening the tax base, as well as by fighting corruption and tax evasion. One high-priority target is the revision of export contracts, particularly for natural gas, which would bring in billions in added revenues.
Then there's the issue of price and exchange rate stability. Egypt, like other relatively small open economies, must reconcile conflicting goals here. It needs an exchange rate that makes the country an attractive venue for foreign direct investment and a competitive source of goods and services for global trade. But Egypt is also a big importer of food and fuel, so both domestic inflation and government spending can be quite sensitive to depreciation in the exchange rate.
That explains why the Central Bank of Egypt (CBE) has been spending down its foreign currency reserves in the teeth of declining foreign investment, foreign tourism income, and Suez Canal receipts. But it also explains why the CBE has been of two minds on monetary policy.
Responding to the economic downturn, it cut minimum bank reserves to ease constraints on domestic liquidity in the face of surging government borrowing. However, the CBE has been reluctant to lower interest rates for fear of depressing the Egyptian pound's exchange rate, encouraging capital flight or creating expectations of higher inflation.