Egypt's Debt Spiral: A Warning for Western Nations?

This week, Egypt announced its fourth currency devaluation since the onset of 2022. This signals a deepening debt crisis fuelled by half a decade of reckless fiscal management and excessive money printing.

This drastic measure has led to the Egyptian pound plummeting approximately 26.5% to a new low of 42 pounds to the dollar, immediately following a significant and unexpected interest rate hike by the central bank, which also declared its decision to let the currency float freely.

In a move to tackle the crisis, Egypt’s central bank has escalated the base interest rate to an unprecedented 27.25%. This decision comes in response to a significant shortage of more stable currencies, essential for maintaining the Egyptian pound’s exchange rate.

The rapid depreciation of the currency, coupled with soaring inflation rates, is a direct consequence of years of poor economic strategies. This raises pressing questions: How did Egypt find itself in this dire situation? Moreover, does this scenario foretell a similar destiny for Western nations grappling with alarmingly high debt levels?

Years of Irresponsible Spending

For eight years in a row, Egypt has rapidly increased the volume of its foreign loans

It has mainly been borrowed to build a new administrative capital and infrastructure, to buy weapons and to support an overvalued domestic currency.

As foreign currency reserves have dried up, it is increasingly difficult to repay foreign debts. Massive amounts of money have been printed to finance the large budget deficit, which has sent the pound’s purchasing power into freefall. The country has been hit by the biggest economic crisis in recent decades.

By June 2023, Egypt’s public debt rose to 96 percent of its Gross Domestic Product (GDP), marking a 6 percentage point rise from the year before. This level of indebtedness ranks Egypt as having the second highest debt ratio in Africa, trailing only behind Sudan. Sudan, embroiled in its own profound economic turmoil due to internal conflict, sees its national debt spiralling to 250 percent of GDP.

You can read where Egypt’s debt level is compared to other countries in the article comparing the debt burdens of the world’s countries published at the end of last year .

If you look at the level of Egypt’s public debt compared to GDP over the last 10 years, we do not see a very drastic increase there. So the problem is primarily that the interest paid on the high level of debt has grown rapidly and put the government budget under severe pressure. The budget deficit is already 6-7 percent of GDP.

Interest Payments Account for 60% of Government Expenditure

The increase in interest rates has resulted from both the monetary policy of the Central Bank of Egypt and the fact that investors no longer want to direct their money to Egypt. Over the past year (12 months), there has been a huge sell-off in Egypt’s government bond market, driving up short term interest rates. Because of this, the state has to pay higher and higher raising interest rates on the new debt.

While in 2015, interest payments accounted for about 15-25 percent of government good and services expenditures, in the first quarter of the 2023/24 fiscal year (July to September last year), payments already reached 60 percent of government expenditures. This means that 60 percent of the costs are interest payments, which does not even include the repayment of the principal amount of the loan.

Interest creditors are demanding from Egypt on 10-year bonds, which has risen to 28 percent by early March this year. As a comparison, it can be pointed out that the corresponding interest rates of the United States and European countries reach 4-7 percent.

Debt Spiral

The situation has led to a debt spiral in Egypt, exerting intense pressure on the nation’s economy, diminishing the value of its currency, and adversely affecting the livelihoods of its people.

By May 2023, there was a 32 percent increase in the amount of Egyptian pounds in circulation compared to the previous year. The central bank has reached a point where it no longer possesses sufficient resources to stabilise the pound’s exchange rate, resulting in the currency being devalued four times in recent years. Despite these measures, the supply of money continues to expand, as there seems to be no alternative means to fulfil debt obligations and monthly payments.

Inflation in Egypt reached a peak last summer, hitting 38 percent, underscoring the severity of the economic challenges the country faces.

Read more on What is The Federal Reserve here.

Learn more about the relationship between The Consumer Price Index (CPI) and Gold

Could the Same Fate Await the Western Countries?

The debt levels in Western nations are not any lower than those of Egypt

In fact, the average debt-to-GDP ratio in Eurozone countries exceeds 90 percent, while the US national debt stands significantly higher at 124 percent of GDP.

Despite these high levels of indebtedness, major issues have yet to emerge, largely because the variable rate of interest on US and European government bonds have been on a downward trend for decades. This has allowed these countries to increase their debt levels substantially without immediate repercussions. However, in recent years, this trend has shifted, and the interest rates on these debts have begun to climb once more, signalling potential challenges ahead and struggles in economic growth.

You can read more about the US debt spiral here.

Should the US and European governments persist in escalating their debt levels and engaging in reckless spending practices (characterised by substantial budget deficits), they risk encountering a crisis akin to that of Egypt.

Operating within a debt-reliant system makes alternative approaches challenging. Nonetheless, investors currently maintain confidence that such a scenario is unlikely to unfold in Western countries.

This confidence is underpinned by the fact that the dollar and the euro serve as the world’s primary reserve currencies. These currencies benefit from investor trust and are backed by the robust economies of developed nations.