Optimal foreign debt for Egypt: A stochastic control approach

This study assesses the foreign debt policy in Egypt and contrasts it versus the optimal policy during the period 1985-2008. It also presents a forecast of the optimal debt during the period 2009-2014. The optimal debt policy was derived using an open economy model for Egypt. The uncertainties in the model stem from the uncertainties in the interest or debt service payments and the uncertainties in the rate of return on investments. The stochastic control approach was used to find the optimal debt policy. It was found that Egypt could borrow externally as long as the trend in the rate of return on investments exceeds the trend in the real interest rate or the trend in the rate of the debt service payments. The analysis finds that Egypt's foreign debt was higher than the optimal level before 1997. After 1997, foreign debt seems to converge to the optimal level. However, Egypt's foreign debt is still below its optimal level which results in an opportunity cost for the economy to grow, otherwise, GDP could have recorded a favorable increase.

► We model an open economy for determining the optimal foreign debt for Egypt. ► We study the impact of interest rate and debt service on the optimal debt level. ► The optimal level of debt is sensitive to uncertainty in the economy. ► It is found that the Egyptian government could borrow more than the current level.