Interest on borrowing to consume almost 50% of public spending in coming fiscal year

Forty-seven percent of expenditure in the coming fiscal year’s budget is set aside for the government to pay interest on borrowing, according to the preliminary budget statement published by the Finance Ministry on Tuesday.  

Expenditure on interest in the budget covers interest payments to which the government is committed on any borrowing it has undertaken to finance the budget deficit — borrowing from international organizations, or through local or international treasury bonds and bills.

The public expenditure in the preliminary budget statement does not disclose allocations for repayment on the principal for existing debt. It should be included in the financial budget statement, which is yet to be discussed in Parliament. 

For the current fiscal year, FY 2023/24, debt service (which includes principal and interest payments) has accounted for 56 percent of total spending. 

Even without accounting for the principal, interest payments represent the largest allocation in the FY 2024/25 budget, as shown in the chart below.

Interest is set to be high for the new fiscal year given a record hike in domestic interest rates. 

The central bank hiked interest rates by 200 basis points in February, and in March, it devalued the Egyptian pound and hiked interest rates by an unprecedented 600 basis points. The step meant that interest rates rose by a full eight percent over Q3 FY 2023/4.

The result has put domestic deposit and lending rates at 27.25 percent and 28.25 percent respectively, making it expensive for the government to borrow from the domestic market.

An average interest rate of 25 percent on treasury bills and bonds is assumed for the coming fiscal year in the government’s preliminary budget statement. The Tuesday statement noted that the estimate hedges against global changes, including an expectation that many countries will be hiking interest rates to counter global inflation.

The government also noted in the statement that the high level of spending on interest in the coming year reflects “a rise in the cost of borrowing,” something it describes as coming in line with “financial burdens stemming from reform packages aimed at tackling the negative effects of global changes on the Egyptian economy.” The government’s decision to raise interest rates in March, alongside currency devaluation, was taken in line with the reforms recommended in its ongoing loan program with the International Monetary Fund.

Economists Salma Hussein and Reem Abdel Halim have criticized the practice of raising interest rates to tackle inflation for failing to curb dollarization in 2023 and mitigate inflation, as inflation in Egypt is primarily linked to the high cost of production, rather than high demand. 

Spending on interest has also increased because of "the decline in the exchange value of the pound after the decision to liberalize the exchange rate,” according to the preliminary budget statement. The pound has fallen by approximately 33 percent since the liberalization of the exchange rate in March.

MP Mohamed Badrawy, a member of the House Planning and Budget Committee, explained to Mada Masr that “interest on external debt fluctuates in value with changes in the exchange rate because it is originally denominated in foreign currency.”

Other trends clear in the data from the preliminary budget statement show that spending is to increase in general over the coming fiscal year. Again, the highest increase in spending is allocated to interest payments, with the allocation for FY 2024/25 63 percent higher than that of FY 2023/24. But for other segments of the budget, the rate of spending increase barely keeps pace with the predicted rate of inflation for FY 24/25.

The IMF expected inflation in Egypt to reach 32 percent in 2024 and decline to 25.7 percent in 2025.

But the new budget estimates are based on an inflation rate of 18.1 percent, with the preliminary statement saying that price rises are “fading.” It attributed price raises over the recent period to “increases in the prices of food, fuel, and intermediate materials, as well as disruptions in supply chains resulting from the war in Europe.”

Apart from interest payments, government investment allocations in the preliminary budget statement are set to witness a sharp decline, contrasting with a significant increase — over 100 percent — from FY 2022/23 to FY 2023/24.

The decline comes as the government commits to a policy of reducing public spending on investments — also an IMF recommendation. 

While governmental investments exclude the economic entities – agencies which have a level of autonomy from the state budget – public investments consist of all spending for entities inside and outside the state's general budget.

Finance Minister Mohamed Maiet said on Wednesday, during the IMF’s and the World Bank’s spring meetings, that his government has set a limit of LE1 trillion on all public investments for the coming year, including those of the military.