Analysing the fiscal process under a stochastic environment: evidence from Egypt

Abstract

This paper investigates the sustainability of the fiscal budgeting process for Egypt, for both stochastic and non-stochastic environments. Note that persistent deficits and the accumulation of debt do not necessarily imply that the debt is unmanageable, and hence, that fiscal processes are unsustainable. It is possible for a government to change the historical pattern it has been following so that it will not continue to borrow and run a ‘Ponzi’ scheme in the future. This implies that the standard cointegration approach to testing whether a government adheres to its intertemporal budget constraint does not provide sufficient criteria for determining whether the fiscal process is truly sustainable. Consequently, we also use a more encompassing set of criteria under more realistic assumptions for determining whether the fiscal process in Egypt exhibits a sustainable budgeting process. These criteria for sustainability are based on the multicointegration approach. Therefore, both cointegration and multicointegration methodologies were used to evaluate these processes. It was found that the fiscal budgeting process in Egypt is sustainable in neither a stochastic nor a non-stochastic environment. Furthermore, the earlier and recent nationalisation of foreign trade resulted in an increase in deficits-GDP ratio. Adopting an austerity budget in 1967 and paying an additional cost of living allowance to government employees since 1975 were the only two policy regime changes which reduced the deficit per GDP.

Keywords:

• fiscal sustainability
• multicointegration

Notes

Data on debt was taken from Abdel-Khalek (2007).

I(0) and I(1) mean integrated of degree 0 and 1, respectively. In other words, I(0) means a level stationary and I(1) means the variable has a unit root and is non-stationary.

The critical values for the cointegration ADF-test with intercept are given in Haldrup (1998) and with intercept and trends, in Engsted et al. (1997).

Note that in September 2004, the government of Egypt announced a new tariff structure, which removed services fee and import surcharges. This policy change was in effect only in the last four months of the sample period and so we ignored it.

However, while allowing the pound to float, the government has stepped in to limit the decline of the currency. Despite this effort, however, the Egyptian pound has depreciated by about 17% between January 2003 and March 2007.

For the sake of brevity these stationarity test results are not reported, but are available on request.