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Macroeconomic shocks and banking sector developments in Egypt

Author

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  • Herrera, Santiago
  • Youssef, Hoda

Abstract

From 2008 to 2011, Egypt was hit by significant shocks, both global and country-specific. This paper assesses the impact of the resulting macroeconomic instability on the banking sector, and examines its role as a shock absorber. The Central Bank of Egypt accommodated the shocks by supplying liquidity to the market. The paper verifies a change in the fiscal regime from one in which the primary fiscal balance was used an instrument to stabilize the public debt ratio to one in which the policy instrument stopped playing that role and affected investors'assessment of the risk of holding public debt. This pattern suggests that fiscal conditions influenced exchange rate and price expectations originating a fiscal dominance situation in which the Central Bank could not control inflation. Hence, the Central Bank lacked functional independence in spite of its de jure independence, which underscores the importance of strengthening institutions that facilitate policy coordination and allow policy to be more predictable. The government also funds itself through non-market mechanisms, in a typical financial repression scheme. The paper estimates the revenue from financial repression at about 2.5 percent of gross domestic product in 2011, which together with the revenues from seignoriage add up to close to 50 percent of the budgeted tax revenues, indicating the need for an in-depth review of the governance of the public banks and the funding of public sector activities. Finally, the paper estimates the impact of shocks to macroeconomic variables on loan portfolio quality and bank capital.

Suggested Citation

  • Herrera, Santiago & Youssef, Hoda, 2013. "Macroeconomic shocks and banking sector developments in Egypt," Policy Research Working Paper Series 6314, The World Bank.
  • Handle: RePEc:wbk:wbrwps:6314
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    Keywords

    Debt Markets; Banks&Banking Reform; Access to Finance; Economic Theory&Research; Currencies and Exchange Rates;

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