1. Introduction
Egypt has been undergoing a major IMF-supported reform program to solve its fiscal structural
problems and move towards fiscal consolidation over the past five years. Those efforts led to
notable fiscal development and overall improvement of the economic climate in Egypt. However,
the COVID-19 pandemic put tremendous pressure on many sectors of the Egyptian economy (e.g.,
tourism and manufacturing), decreasing Egypt’s economic growth rate by two percentage points
compared to the pre-pandemic forecast.
This pandemic led policymakers to adopt an expansionary policy and enact a COVID-19
emergency budget increase of 100 billion Egyptian pounds. In addition, the government passed
tax relief such as halving the dividends tax and the exchange tax relief. The rise in fiscal spending
coupled with reduced revenue constitutes a threat to the Egyptian government's fiscal
consolidation efforts.
We empirically investigate the impact of fiscal stimulus on real economic growth and shed light on
the relationship between these variables. We particularly explore whether fiscal stimulus has a
different effect on real economic activity when a country has low domestic debt versus when it has
high domestic debt as a percentage of GDP. We then empirically quantify a particular threshold
(i.e., a tipping point) at which the effectiveness of fiscal policy changes.
First, we establish the existence of a threshold that splits the data into a low domestic debt regime
and a high domestic debt regime at 81.5% domestic debt-to-GDP ratio. We also test for the
existence of more than one threshold in the data, but we do not find any other threshold. Second,
we establish with statistical significance that fiscal expansion increases real economic growth in
the low-debt regime (≤ 81.5%) and a decrease in real economic growth in the high-debt regime
(>81.5%).
Third, we explore some of the possible theoretical explanations for the existence of the threshold
effect. The first is the “Ricardian equivalence argument” – private investors internalize the
government’s budget constraint and reduce investment spending when debt levels are high, which
leads to lower real economic growth. The second one is that higher fiscal spending increases
interest rates, leading to a crowding out effect on investment. The last potential explanation is the
“precautionary saving hypothesis” (Barro, 1974) – current excessive spending coupled with
existing high levels of accumulated debt causes households to consume less and save more in the
present because of anticipated tax hikes in the future (which has contractionary effects on real
GDP). In the fourth section of this paper, we test empirically whether any of these arguments could
explain why government spending has an adverse effect on growth in the high-debt regime.
To the best of our knowledge, no other empirical papers quantify debt-to-GDP thresholds for Egypt
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or provide policy implications of debt accumulation under different debt regimes. The paper is
divided into five sections. The first section is an introduction that presents the research statement
and the objective of this paper. The second section is a literature review. The third section describes
the data used in the analysis and shows the sources, followed by the empirical methodology used
to test our hypothesis. The fourth section shows the results of the empirical analysis and explores
the theoretical arguments. The fifth section discusses the policy implications of the result. The last
section concludes.
2. Literature Review
Optimal fiscal policy has been extensively studied in the economic literature. For example, authors
have examined fiscal consolidation (Alesina and Ardagna, 2010; von Hagen and Strauch, 2001),
fiscal reaction functions (Bohn, 1995 and 2007), and the optimal level of government expenditures
(Forte and Maggazino, 2016). Several studies have also investigated these topics in developing
economies (Baldacci et al., 2006; Gupta et al., 2005). Others evaluated government expenditures
numerically and tax multipliers ( Blanchard and Perotti, 2002;
Coenen et al., 2012; Ilzetzki et al.,
2013; Ramey, 2019; Romer and Romer, 2010; Woodford, 2011), including in MENA countries
(Al Moneef and Hasanov, 2020; Alnashar, 2017; Cerisola et al., 2015; Espinoza and Senhadji,
2011).
Following the COVID-19 pandemic, fiscal stimulus, and other macroeconomic measures in the
OECD and the US received extensive attention. Yet, as Alon et al. (2020) observes, it quickly
became clear that developing countries could not replicate policies implemented in the advanced
economies. Similarly, the analysis and the policy recommendations in the emerging markets
should naturally follow the patterns intrinsic to developing economies and be based on the local
data. Therefore, in our research, we reference recent work on the pandemic impact in emerging
markets2 and we pay particularly close attention to the papers that examined the fiscal measures
under different debt regimes in developing countries (Burger and Calitz, 2020; Benmelech and
Tzur-Ilan, 2020).
Several aspects of the optimal fiscal policy in Egypt (in particular, the effect of government
spending and tax relief on GDP growth over different time horizons) have not been examined
sufficiently in the recent economic literature. However, two notable works that are exceptions to
this premise exist; both studies provide valuable insights but have some limitations. Alnashar
(2017) evaluates the determinants of the government spending multiplier but does not analyze the
tax change multiplier, and the research covers the pre-pandemic time frame. On the other hand,
El-Khishin (2020) focuses on the economic measures taken by Egypt’s government to alleviate
the impact of the pandemic. However, as a brief policy report, this study provides only the
2 (Addison et al., 2020; Arellano et al., 2020; Loayza and Pennings, 2020)
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descriptive summary of the policy response and lacks the depth of the economic analysis.
The strand of literature that relates closely to our paper examines the empirical relationship
between the level of debt and economic growth. For example, Reinhart and Rogoff (2010) employs
a data set covering 44 countries over 200 years to show that a government debt-to-GDP ratio
exceeding 90% is associated with lower GDP growth. Cecchetti et al. (2011) uses data on
government, corporate, and household debt from 18 OECD countries and find that high debt levels
(>80-90% for government, >90% for corporate, and >85% for household debt) are associated with
lower economic growth while a moderate level of debt can improve welfare. Checherita-Westphal
and Rother (2012) utilizes data from 12 EU countries to show a negative effect of debt-to-GDP at
the high levels of 90-100%. Several papers use threshold regression to study the impact of
government spending on GDP under different debt regimes. Nickel and Vansteenkiste (2008)
employs a panel of 21 developed countries and quantifies a threshold of 85% as the point after
which spending and debt have adverse effects on growth, while Baharumshah et al. (2017) uses
time series data on Malaysia and finds a threshold of 54.71% for domestic debt