The Budget Deficit Financing Impact on the Real Exchange Rate in Egypt (1975-2020)

The Purpose of this paper is to examines empirically The causal impact of budget deficit financing methods on real exchange rate in Egypt during the period from 1975 to 2020.The main question of the paper whether there is a causal relationship between the large fluctuations in the real exchange rate and budget deficit/GDP proportion, governed by specific predictable factors, in particular the method of financing the budget deficit. Using structure vector autoregressive (SVAR) framework with variable lag structure, our empirical results provide evidence of the contribution of the money supply ratio to the GDP in the fluctuations of the real exchange rate in the short and medium terms, while the contribution of non-bank financing expressed in the real interest rate contributed to a lesser degree in these fluctuations, which gives an indication of the expansion in the use of local bank financing to finance the budget deficit during the study period. Moreover, the results showed that the government’s dependence on local sources in financing the budget deficit was large, especially the local bank financing. It was also found that the non-banking domestic sources of funding have less influence on the fluctuations of the real exchange rate and therefore the value of the Egyptian pound relative to the US dollar. furthermore, also found out that the periods in which the real exchange rate index decreased and the value of the pound improved, are the periods in which the reliance on non-banking domestic financing was greater than on domestic banking financing, namely the periods from 1993-1997, and from 2005-2010. This paper aims to contribute to filling the gap in the applied literature that examined the relationship between the budget deficit and external imbalance by focusing on the role of the means of financing the budget deficit.