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Background No. 28 Updated - February 2012


Bild: monasosh, flickr

Democracy needs debt relief

Background No.28 – Egypt: Democracy needs debt relief Released: 27.04.2011, Updated: 27.02.2012 - Entwicklung braucht Entschuldung Carl-Mosterts-Platz 1 40477 Düsseldorf Tel.: +49 (0) 211 - 46 93 - 196 Fax: +49 (0) 211 - 46 93 – 197 E-Mail: Website: Author: Jürgen Kaiser Editor: Sebastian Bonse, PR Phone: +49 (0) 211 - 46 93 - 211 E-Mail: Pictures: Title: monasosh (flickr), License: Creative Commons, Source:


1. A new situation Since the fall of the iron curtain some twenty years ago, no popular uprising has met with so unanimous global sympathy as that in Egypt at the beginning of 2011. For nearly two months Cairo's Tahrir Square was the focus of Arabian democratization – a process that started with the fall of Tunisia's Ben Ali regime, and continues to shake the region until today. Egyptian President Mubarak was certainly not the most ruthless among Arab dictators. However, he obviously was the one with a great talent for diverting public resources into his private coffers. Estimates of assets stolen by himself and his family reach up to US-$ 70 bn.1 Much faster than usual, financial centres, including Switzerland, froze identified assets of the former president. The amounts discussed in relation to the former dictator's private properties, represent nearly one third of Egypt's annual GNI. Thus, those numbers reveal the economic risks, which are associated with the transformation to democracy, but also the huge potential for an economic take-off, which a "democratisation dividend" may provide to the Egyptian people. Additionally Egypt faces economic risks through democratisation, which are unrelated to the ex-dictator’s private fortunes:


inevitably the weeks of social turmoil have implied disruptions in economic activity, as well as (more limited) destruction through the fighting between demonstrators and the regime's security forces;


disruption to tourism, which is one of the most important hard currency earners in the Egyptian economy.

Politically, the breathtaking changes in Egypt itself were followed by equally fast changes in the behaviour of the traditional donors and creditors of the Mubarak regime: The friendship with the guarantor of a relative stability in the conflictive Middle East disappeared practically over night and gave way to a wide-spread enthusiasm among European leaders for the Egyptian people, who so bravely fought for their freedom. That ultimately raises the question whether this U-turn will also imply that the newly democratising society can also expect a comparable or even enhanced material support from their admirers. Given the huge amounts spent by Mubarak on an exorbitant military and on his personal well-being, there may indeed result a considerable fiscal space for Egypt's development if external support continues to come in and can be spent on more worthwhile purposes. The treatment of Egypt's foreign debt is one important sub-item of this crucial question. 1. Data and Indicators At first sight, it does not look particularly important, however. The most important debt indicators, which the World Bank has made available for end-2009, as the latest year with coherent data, do not look very alarming. The three most common indicators "total external debt to gross national income" (EDT/GNI), "total external debt to annual export earnings" (EDT/XGS) and "total external debt service to annual export earnings" (TDS/XGS) are considerably below commonly applied thresholds for critical debt levels.2 Indicator






1 um+6744.twl 2

Data from World Bank: Global Development Finance 2011. Regarding the logic of threshold indicators applied see: Schuldenreport 2011, S. 6-18








Egypt's total external debt of US-$ 32.1 bn3 consists of


10.8 bn towards multilateral creditors, such as the World Bank, African Development Bank as well as several Arab multilateral institutions;


18.1 bn towards bilateral creditors, largely governments, resulting from either official development aid (ODA) or publicly guaranteed exports (ECA);


3.2 bn towards private creditors, most of it in the form of public bonds; only US-$ 325m are (syndicated) loans owed to private banks.

The most important bilateral creditors are France and Germany. Other European countries like Spain (total claims € 455m) and Britain (€ 110m) follow at a distance. Most interesting is the inverted distribution of total claims among ODA and ECA between France and Germany: € million









2. The need for innovative solutions So, if Egypt's debt indicators are so clearly below critical thresholds, where is the problem? In fact, three major reasons mean that exceptional debt relief is required:

First, Egypt's contractual debt service on existing external debt is projected to rise drastically. The table below shows debt service paid for 2008 and 2009. 2010-2013 shows the contractual debt service on debt existing end-2009 (printed in grey).








annual external debt service (US-$ m)







In 2010 and 2011 debt service is already projected to rise to a level some 20% higher than in the two preceding years. In 2012 contractual debt service will nearly double over debt service paid in 2009. It needs to be considered that the amounts indicated refer only to debt outstanding end-2009. Since then new loans have been taken out and not all loans have a grace period. Interest payments also accrue on those new loans; so the actual debt service in 2011 and 2012 will certainly be even higher than indicated here. As Egypt's debt service ratio was 6.5% in 2009, i.e. less than half of the critical threshold, this rise in debt service could probably be sustained without throwing the country into a debt trap. However, just immediately before the popular uprising the IMF assumed annual growth rates of the Egyptian economy between 5 and 6.5% in 3

Central Bank of Egypt; External Debt Statistics; 4.Q. FY 2010/11


the period 2010 to 2015. At least in 2011 this level will hardly be attainable (if there is any growth at all). Thus, the denominator of the indicator will probably shrink (or grow less than anticipated), so the indicator is bound to rise even further.

Second, in order to win political stability, Egypt needs a democracy dividend – and it needs it now rather than in any distant future. The popular uprising was driven by a middle class, which expressed its discontent with the lack of political freedom, but it won much of its clout by mobilising the poor masses, who saw themselves constantly marginalised and deprived of any chance for a better future. The history of modern revolutions shows that failure to improve the lives of the poor, at least marginally and with a perspective for a brighter future can very quickly lead to a counter-revolution, either by the ancien regime or by forces which strive again for another form of an authoritarian state. Two out of five Egyptians are presently living below the official national poverty line.4 It should be recalled here that Egypt is one of only two countries, which received an extraordinary debt cancellation twenty years ago for political reasons. In a move, which was beyond anything the Paris Club was prepared to provide to anybody in terms of debt relief at that time, Club members awarded Egypt's good-behaviour in the 1991 second Gulf war with a 50% reduction of their claims on the country. Shouldn't the democratisation, which the same Western governments so tirelessly praise, not be comparably "rewarded"?

Third, the Egyptian people have so far gone without any information on the borrowing of its governments - a liability, which the people are ultimately expected to honour. All over the world irresponsible governments have been taking out loans for financing the state apparatus, including its "security" forces, or for enlarging their personal fortunes. International law has coined such liabilities as "illegitimate debt."5 Eliminating such debt is not only a moral imperative. More importantly, it would provide a credible disincentive against continuing that same ruthless complicity among undemocratic governments and their financiers in the future. Only if unscrupulous lenders can not rely any longer that their dodgy deals will never come to light, they will have an incentive to think twice, before propping up any future dictator. Of course, even the Mubarak regime is to enjoy the presumption of innocence, before any concrete misbehaviour has been proven before an independent competent body. This is why transparency with regard to public finances is the key element. Therefore the last paragraph will describe how it can be brought about in practice.

3. Possible next steps A strategy to halt the resource drain from Egypt to its rich creditors can be developed around a few key elements:


The government should immediately cease all payments – at least to all bilateral creditors, in order to win time for a serious assessment of the sustainability and the legitimacy of the country's external debt. By paying the current debt service into a fiduciary account rather than to the creditors, it can make sure that this process is taken seriously by its creditors and they cooperate in shedding light onto past deals. The fiduciary account approach also makes sure that the process is not misunderstood as a unilateral repudiation or a state bankruptcy, which would both be "punished" by a deterioration of the country's access to capital markets.


For an introduction into the concept of illegitimate debt and the "odious debt" doctrine see: Mader,M, A. Rothenbühler (eds): How to challenge illegitimate debt. Theory and legal case studies. Aktion Finanzplatz Schweiz 2009.


The government should launch an independent audit into the background and circumstances of existing debt obligations. As such audits have not been provided by competent national institutions in the past, a separate independent commission should be created for the purpose. In Ecuador such an independent commission has audited the country's debt stock and made proposals to the President regarding the treatment of claims it considered questionable. Subsequently, Ecuador managed to enforce a very favourable debt exchange with holders of its renegotiated Brady bonds. The operations eliminated about US-$ 2 bn of Ecuador's external obligations. Such a commission should be staffed with experts who are independent of the Egyptian government as well as its creditors. Independence is a pre-requisite for any credible and legally solid debt relief proposal.

The German government has committed to work towards a fair and transparent debt workout mechanism in its coalition treaty. Such a debt workout needs to be impartial and treat all claims on the indebted sovereign in one single process, in order to provide a speedy and efficient solution to an actual or a looming over-indebtedness.6 Egypt is presently not under any threat of insolvency. However, we have seen that debt sustainability may face several challenges in the near future, each of which requires a tailor-made solution. Neither the Paris Club, which acts along its predefined "terms", nor the International Financial Institutions, World Bank and IMF, can bring about such a solution, as the latter are themselves creditors, or represent them. A first step towards a sustainable solution, would thus be an independent analysis, which re-considers existing contractual obligations in the light of the country's challenges regarding the fulfilment of the Millennium Development Goals and poverty reduction a large.7

• In the past Egypt had already qualified for debt conversion under the German debt swap program. Some € 150m in re-flows on ODA loans have already been converted or offered for conversion by the German governments since 2002. Germany allows for up to € 150m to be converted each year. However, the number of possibly qualifying countries is very small, and the development ministry has not always been able to use the full amount in the past years. As of this writing no assignment of resources to individual beneficiaries has taken place at the ministry in Berlin. Egypt could indeed obtain an immediate debt service relief, if current debt service can be converted into development finance in the country. Such an operation would of course not provide a solution to a debt problem, however, it could combine partial relief with well-targeted development financing in key sectors. Between the production of the German version of this text and its translation, the German development ministry has indicated its intention to offer Egypt indeed a substantial debt conversion under the program in the range of up to € 100m. As the process requires the consent of the German treasury as well as the parliamentary budget committee, it remains to be seen whether any relief could still become effective in 2011.


Regarding the Concept of a Fair and transparent Debt Workout Mechanism, see: Kaiser,J. Resolving Sovereign Debt Crises; FES Dialogue on Globalization; Sept. 2010


Through such an independent analysis Indonesia managed to obtain a substantial reduction of its debt service obligations in 1969. For a brief summary of the case see: Kaiser,J. Resolving Sovereign Debt Crises; FES Dialogue on Globalization; Sept. 2010; p. 24/5

6 Background Paper - Egypt: Democracy needs debt relief