Abstract

The Egyptian economy is marked for its budgetary imbalances. The present paper addresses the important question of whether these noticeable budget deficits have come to bear on the current account component of the Egyptian balance of payments, thus creating imbalances therein as well. We thus examine the familiar so called twin deficit hypothesis. Our findings elucidate the existence of a short and long run relationship linking budgetary deficits to their current account counterparts. Thus a Granger causality test reveals that while budget deficits lead to one lag current account deficits, the latter in turn have arguably been the source of two lags deficits in the government budget, which gives a plausible testimony confirming the reverse hypothesis. Indeed, notwithstanding the strong causal effect whereby budget deficits resulted in four to nine year lagged current account deficits; a remarkably significant counter-effect exists, thus signifying a bi-directional causal relationship between the two types of deficits.

The ECM analysis of our results indicates that a 10 percent increase in the government budget deficit will accentuate itself by a further 7 percent increase in the first lag but will also cause a one lag increase of 8.7 percent in the current account deficit. These findings lend strong support to the twin deficit hypothesis in the Egyptian case. Barring the presence of strong shocks, it can plausibly be claimed that there is a reasonably strong link between government budget deficits in Egypt and the current account deficits in which the labor market situation as well as the business cycles appear to play important roles.

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