In recent years, the question of debt sustainability has taken center stage in discussions about fiscal policy, especially in emerging economies like Egypt. Researchers Bohn (1998), Uctum and Wickens (2000), and Brady and Magazzino (2019) laid down foundational arguments emphasizing that current public debt levels must be counterbalanced by future primary budget surpluses for fiscal sustainability to hold in the long term. In this context, a rigorous analysis of Egypt’s fiscal dynamics reveals nuanced short-term and long-term relationships between debt accumulation and fiscal policy responses, shaped decisively by institutional quality.
Using econometric frameworks such as the Autoregressive Distributed Lag (ARDL) and the Error Correction Model (ECM), the evidence suggests a clear structural relationship: in the long run, an elevated debt-to-GDP ratio tends to correspond with higher primary budget surpluses. This is intuitively consistent with the notion that governments, when faced with mounting debt burdens, respond by adjusting fiscal policies to generate surpluses or reduce deficits. Significantly, this adjustment also reflects investment in productive public projects funded through debt, reinforcing the potential for growth that can sustain higher debt levels.
Contrasting sharply with long-term patterns, the short-term effects reveal more complex dynamics. The analysis uncovers a negative association between incremental debt and the primary balance in the short run. This seemingly paradoxical finding stems from the rigid fiscal constraints imposed by austerity measures and the institutional challenges that impede swift fiscal adjustment. Short-term fiscal deterioration, therefore, reflects transitional costs and complexities inherent in stabilizing debt trajectories, underscoring the friction between political economy constraints and economic prudence.
Furthermore, the study probes the relationship between the primary balance and other macroeconomic variables critical to debt sustainability. The output gap—a measure of economic slack—and the real interest rate (RIR) both exhibit positive and significant correlations with Egypt’s primary fiscal balance across all tested models. This indicates that economic performance and the cost of borrowing play pivotal roles in shaping fiscal reactions. However, the exchange rate emerges as statistically insignificant, suggesting that fluctuations in Egypt’s currency regime exert minimal impact on the sustainability of public debt over the study period.
A particularly salient aspect of the analysis focuses on institutional variables, which often constitute the hidden backbone influencing fiscal outcomes. When examined separately, government effectiveness and regulatory quality stand out as robust predictors, each showing a negative association with the fiscal deficit. Improved institutional quality thus correlates with deficit reduction—a powerful testament to governance as a key enabler of fiscal discipline. By contrast, variables such as government corruption, voice and accountability (VA), and political stability (PS) do not show a significant direct effect on primary balance dynamics, highlighting the complexity and specificity of institutional dimensions influencing fiscal policy.
Aggregating these institutional factors into a single standardized index of institutional quality (IQI) strengthens the argument: institutional maturation is not merely desirable but essential for ensuring fiscal sustainability in Egypt. The IQI’s interactions with debt levels reveal further nuances; fiscal responses to debt are moderated by institutional environmental conditions, implying that advanced institutional frameworks empower governments to manage debt risks more effectively through productive investment and enhanced fiscal credibility.
Yet, this institutional advantage is not without its temporal trade-offs. The long-term interaction effect between debt and the IQI is positive, implying that institutional robustness ultimately mitigates debt vulnerabilities. In stark contrast, a negative short-term coefficient manifests, revealing immediate fiscal strain before institutional benefits materialize. Policymakers are thus faced with a delicate balancing act: accepting short-term budgetary constrictions stemming from austerity while accruing long-run sustainability gains facilitated by sound institutions.
Complementing these findings, the speed of fiscal adjustment—as captured by the error correction term (ECT)—appears sluggish. A slow correction rate highlights institutional hurdles and policy rigidities constraining Egypt’s ability to rapidly restore fiscal balance following shock-induced deviations. This prolonged adjustment process amplifies the risk of fiscal stress, emphasizing the urgent need to address impediments to swift policy recalibration in the face of growing debt pressures.
This slow fiscal reaction, compounded by Egypt’s institutional challenges, underscores systemic vulnerabilities threatening long-term debt sustainability. Without proactive reforms and enhanced responsiveness, Egypt could face escalating fiscal stress, risking broader macroeconomic instability. These structural constraints call for judicious policymaking that prioritizes both immediate fiscal consolidation and strategic investments underpinning long-term growth.
In light of these complexities, the research suggests a multi-pronged policy approach aimed at fostering fiscal resilience. Key recommendations include sustaining economic growth rates above the real interest rate to minimize the debt burden ratio naturally. Simultaneously, Egypt must target reductions in wasteful government expenditures and broaden its tax base through progressive tax system enhancements, thereby equipping its fiscal architecture with robust revenue streams.
Institutional reforms take center stage in this roadmap. Enhancing government effectiveness—particularly by modernizing tax collection systems through digitalization—and streamlining regulatory frameworks by simplifying business licensing procedures promise immediate fiscal and economic dividends. Such improvements stand to reduce bureaucratic inefficiencies and foster a business climate conducive to investment and growth.
Moreover, the elevation of institutional quality entails reinforcing the rule of law, bolstering governance structures, and embedding transparency and accountability throughout public administration. Proposals for establishing an independent fiscal council with citizen oversight and legally mandated participatory budgets aim to institutionalize these principles, fostering societal trust and inclusiveness while tightening fiscal discipline.
Fiscal prudence also mandates capping public debt levels to contain risks effectively. The study proposes maintaining debt below a threshold of 80% of GDP to avoid triggering costly short-run austerity episodes, ensuring that borrowing is channeled predominantly toward productive public investments. Targeted spending in critical development sectors such as education, healthcare, innovation, and infrastructure aligns fiscal management with broader national development objectives, generating synergies that underpin sustainable growth.
Adequate resource allocation and strategic investment decisions also contribute to enhancing fiscal credibility. Transparent and well-informed policymaking reassures stakeholders, attracts investment, and reduces borrowing costs, creating virtuous cycles conducive to fiscal sustainability. By linking debt management with broader development goals, Egypt can navigate its fiscal challenges while advancing economic modernization.
Notwithstanding the valuable insights yielded by this comprehensive study, the authors recognize the potential benefits of extending the analysis to encompass nonlinear fiscal reaction dynamics. Future research employing threshold ARDL models could elucidate whether institutional impacts intensify during specific stress events, such as currency crises or when debt surpasses high thresholds like 90% of GDP. Such nonlinear perspectives might capture asymmetric fiscal responses, enriching understanding of fiscal resilience under pressure.
In addition, expanding the time series to include more recent data would enhance the granularity of short-term adjustment estimations, potentially revealing evolving fiscal behaviors shaped by changing economic and political landscapes. Incorporating broader arrays of control variables, like business environment indicators and regulatory ease, could refine models by accounting for factors influencing fiscal policy decisions.
Elaborating the nexus between debt-to-GDP ratios and economic development by treating the primary budget balance as a mediating variable offers further research avenues. Such analyses can illuminate how fiscal outcomes interplay with growth trajectories and development goals set by Egypt’s government, offering evidence-based pathways to balanced progress.
Understanding Egypt’s fiscal dynamics within this layered institutional context yields lessons applicable to other emerging economies grappling with debt sustainability amid institutional constraints. The intricate interplay of macroeconomic variables, institutional quality, and policy responsiveness demands nuanced approaches that transcend mechanical fiscal rules, embracing reform, innovation, and governance as pillars of lasting fiscal health.
Egypt’s fiscal future, as revealed by this research, is a story of potential and peril. While entrenched challenges and slow fiscal adjustments paint a cautious picture, targeted policy reforms grounded in institutional strengthening and strategic investment hold the promise of reversing adverse trends. The balance of short-term sacrifices against long-term sustainability gains is delicate but navigable, contingent on political will and effective governance.
Ultimately, this study underscores that fiscal sustainability is not merely a function of debt ratios but a multidimensional construct shaped by economic realities, institutional capacity, and policy choices. Egypt’s journey towards sustainable debt management serves as a compelling case study, reflecting broader global debates on the intricate dance between fiscal prudence, institutional quality, and economic development.
Subject of Research: The role of institutional quality in shaping fiscal reaction functions and debt sustainability in Egypt.
Article Title: Do institutions matter in the fiscal reaction function? The case of Egypt.
Article References:
Ezzat, A., Emira, M. Do institutions matter in the fiscal reaction function? The case of Egypt.
Humanit Soc Sci Commun 12, 1464 (2025). https://doi.org/10.1057/s41599-025-05876-8
Image Credits: AI Generated
