TCH: Khedives, Canals, Cotton, and Credit

           In the 19th century, control over Egypt fell into the hands of rulers bearing grand ambitions for their country. However, ambitions are expensive and debts mounted as money was poured into new infrastructure projects, most notably the Suez Canal. Egypt was first introduced to the international debt markets while its economy boomed amidst rising prices for locally-produced commodities. However, when that economic tailwind diminished, so too did the country’s ability to repay this debt. Nonetheless, Egypt and its rulers continued to borrow and the episode only ended with the bankruptcy of the country in the 1870s.

Khedives

           After being lost by the Byzantine Empire in the 7th century, Egypt was only once again ruled from Constantinople after an interlude of almost nine centuries. This time under Ottoman control, the country remained outside the West’s frame of view. All this changed in 1798 when the Napoleonic invasion of Egypt began with a French army disembarking in Alexandria. Though officially an Ottoman province, Egypt was governed by the Mamluks, a class of enslaved soldiers, most from other parts of the Ottoman Empire, who often quarreled and rebelled against their own rulers. The Mamluks were unable to defend the country and control over it was briefly in French hands.

           Napoleon’s Egyptian campaign was hardly his most successful though and his army was eventually defeated by an Anglo-Ottoman force two years after Bonaparte himself left for France. Their defeat brought new rulers to Egypt. In the immediate aftermath of the French withdrawal, neither the Mamluks nor the Ottomans managed to regain firm control over the country. Revolt was only avoided when the Ottoman administration yielded to popular local demands that a certain Muhammad Ali be installed as viceroy. In time, he would extinguish the influence the Mamluks had in Egypt and forge a path to de-facto Egyptian independence.

           Muhammad Ali was born in Kavala, an Ottoman city now part of Greece. He was brought to Egypt as the leader of a company of Albanian mercenaries sent to help recover the province from France. During his long tenure as viceroy, Ali was keen on modernizing the country, building out infrastructure and expanding the civilian administration. He also embarked on frequent wars, including against his own Ottoman superiors. The man was easily the most consequential figure in 19th century Egypt and perhaps in the creation of modern Egypt more generally. His many sons went on to rule the country for decades after him. Though they bore the subordinate title of ‘khedive’, it was they who ruled the country on behalf of, and quite independently from, Constantinople.

           The initiatives of Ali and his successors were costly and this cost was met first by implementing higher taxes and then by extensive borrowing. Much of this taxation fell on the peasantry, the fellaheen, who were taxed on purchases of critical necessities like salt. The tax system in Egypt added unnecessary pain; taxes were collected before harvests, when the ability of peasants to pay was at its lowest. It didn’t help matters that Egypt had a primitive system of public finance; there was no separation between the private funds of the khedive and public monies. Thus, it was both the heavy spending on modernization and the private lifestyles of the ruling dynasty that prompted excessive borrowing.

Canal

           Some of the investment in Egypt’s infrastructure was worthwhile but the initiatives overall eventually brought financial ruin. Much of the fiscal breakdown in Egypt occurred concurrently with the construction of the Suez Canal later in the 19th century. The canal project was so monumental that it’s pointless to discuss the state of Egypt’s public finances without also covering the canal.

           Here again, the French invasion was critical. Not only did it trigger regime change in Egypt but the invasion also restored European interest in a canal connecting the Red Sea to the Mediterranean. Napoleon and his entourage of scientists, artists, engineers, and other intellectuals had rediscovered the remnants of an ancient waterway from pharaonic times that connected the Red Sea and the Nile up until its abandonment a millennium earlier. The French occupation also redirected Europe’s attention more broadly to this southeast corner of the Mediterranean world, triggering an orientalist wave in 19th century art and culture.

           That said, the canal would have military and commercial purposes, not cultural ones. For France, it meant a second shot at achieving dominance over trade with Asia. Should a canal be built, and brought under their control, they would have an alternative to the Cape Route around southern Africa that the British, and Dutch before them, had already controlled. With these lofty nationalist ambitions, plans for a canal were drawn up in the early 1840s while Muhammad Ali was still viceroy, but initial progress towards its realization was slow.

           The task of promoting the canal fell on Ferdinand de Lesseps, a French diplomat turned entrepreneur. De Lesseps’s father was well known to Muhammad Ali; he was made a count under Napoleon and was said to have helped Ali seize power whilst France’s consul-general in Egypt. The family’s friendship with the khedives continued thereafter. Critically, de Lesseps was in the good graces of Muhammad Ali’s French-speaking son, Mohamed Sa'id, who covered the expenses for a study of the canal’s feasibility. Finally, a charter favorable to all parties was granted in 1856 and de Lesseps’s Compagnie universelle du canal maritime de Suez was founded two years later.

The Suez Company

           De Lesseps’s company was capitalized in an initial public offering conducted late in 1858. During the subscription period, 400,000 shares were offered at five hundred francs each, raising a total of 200 million francs. The sum was intended to exceed the estimated cost of the project with the difference used to fund a 5% dividend to be paid even during the canal’s construction. Curiously, the shares were sold directly by de Lesseps and his company. The diplomat-businessman was no banker though, so he had previously spoken to the Rothschilds about organizing the offering but found their hefty charge of 5% of offering proceeds excessive. Without access to the Rothschilds’ connections to Europe’s largest investors, de Lesseps turned his attention to the common man.

           In the end, the offering was sold almost exclusively to small investors. It helped that the offering price of five hundred francs made a single share at least somewhat affordable, especially when considering that not all this money was due at once. Money raised from the subscriptions was payable in installments of fifty francs as the company gradually drew down the committed capital.

           The company raised the 200 million francs it had hoped for, but with mixed success. Shares sold more briskly in France than elsewhere despite de Lesseps’s efforts to promote the project across Europe. Perhaps those in rival nations saw the scheme as too helpful to the French national interest to pass the patriotic investor’s scrutiny. In France though, a total of 21,000 Frenchmen participated, buying an average of just ten shares each. These were mostly ordinary people; indeed, only a single investor bought more than a thousand shares and the vast majority bought under a hundred.

           Outside France, there was one massive investor though, the Egyptian khedive himself. To make sure the project went ahead, Mohamed Sa'id, now ruler, agreed to buy any unsold shares and so he picked up the slack from weak international interest. This was a large sum of money though and had to be partially financed by the personal borrowings of the khedive.

           The aforementioned backstop was not the only support the poor country or its rich rulers provided; Egypt continued to subsidize the project under Isma'il Pasha, Mohamed Sa'id’s successor. There was a reward though; under the 1856 charter, the Egyptian government was to receive 15% of the canal company’s profits. This was in addition to its fraction of whatever was left for shareholders. The state had a strong interest in seeing to it that the canal was built. Nonetheless, the project remained slow-going and was well behind schedule by the mid-1860s.

           Many suspected that the construction would never finish. As a result, a subsequent bond offering by de Lesseps’s Suez company failed to generate much interest, raising just 30 million francs of the 100 million needed, and this despite carrying an over 8% interest rate. The remaining money had to be raised in, of all schemes, a lottery; de Lesseps was truly entrepreneurial. Nonetheless, the negativity surrounding the project was not all harmful. In fact, some attribute the British government’s ambivalence to the canal, which could be regarded as a threat to its own interests, to its skepticism that the project would ever be completed. 

Egyptian Economy and Borrowing

           Whatever the delays with the canal, Egypt’s economy did get a break following the start of the American Civil War. That war, and the consequent blockade of ports in the southern United States, caused a shortage of the cotton vital to Europe’s textile industry. The events caused cotton prices to surge from a mere 10 US cents per pound to over $1.75 by the mid-1860s. This benefited Egypt as it was an alternative source of cotton and it helped the Egyptian state in particular since it controlled much of the trade in the commodity.

           The economic tailwind higher cotton prices provided Egypt was put to use in helping finance the canal. It also encouraged the country to float its first sovereign bonds while investors had their guard down. It was in these fortunate times that Egypt’s inaugural bond offering opened to investors in 1862. It is worth repeating that this was an Egyptian sovereign bond, rather than a personal debt of the khedive or an obligation of the larger Ottoman Empire, then still the titular rulers of Egypt. The offering was underwritten by the London bank Frühling & Goschen and paid 7% interest. However, it priced well below its face value, yielding even more to investors who bought it at this discount.

           This loan was intriguing in that it was specifically backed by revenues generated by the Egyptian provinces in the Nile Delta. It was to be the first of many creative offerings though. New bonds were floated in 1866, 1867, and 1870 and these were secured by the personal property of the khedive, another instance of a gray line between the finances of the state and those of its rulers. Regardless, by this point the fiscal condition of Egypt was on an unsustainable path. Investors knew the risks were increasing and bond yields rose as borrowing grew and cotton prices fell back towards pre-American Civil War levels.

           Delays in the Suez Canal’s construction no doubt made the problem worse. However, the project was finally completed in 1870, over five years behind schedule. Worse, its completion did not turn out to be a boon to Egypt. Initial traffic volumes came in far under expectations. The new decade marked the beginning of the end for the debt-fueled modernization of the country. As the decade went on, borrowing conditions turned less favorable. Higher yields on the public debt were matched by more conservative loan structures with larger required payments into sinking funds designed to amortize the debt. The country also increasingly relied on a form of internal financing from landowners, called monkabalah, which essentially was an arrangement where landowners pre-paid their future taxes.

           Despite the increasing fiscal strain and higher interest costs, the khedives kept their bankers at the ready. In 1873, a new loan was arranged by a consortium of Ottoman, German, and French banks and it was the most massive of them all. The ￡32 million bond offering paid a 7% interest rate but was sold at a discount of 21% enhancing its yield to almost 9%. The bonds were secured by a patchwork of assets including certain railway and tax revenues. Some of the proceeds were used to refinance old debt by allowing subscribers in the new issue to pay for their investment with old bonds. The balance was used to finance further government spending.

           The 1873 bonds were the last sold to investors until Egypt’s subsequent descent into bankruptcy. The need for money went on unabated though. Two years later, the khedive sold his 45% stake in the Suez Canal to Britain. A little over 177,000 shares changed hands for ￡4 million in the Rothschild-arranged sale. At a price equivalent to about 565 francs a share, Egypt’s immediate return on its investment was minimal. The country retained its right to 15% of canal profits following this sale but even this was given away by the khedive for under ￡1 million soon after.

Consolidation and Coup

           By 1875, Isma'il Pasha had been khedive for a dozen years. With the exception of the 1862 inaugural bond offering, virtually the entirety of Egypt’s debt was accumulated while he governed. By this point, the national debt stood at around ￡100 million. A British member of parliament, Steven Cave, was sent to investigate the state of Egypt’s fiscal health and penned a report in 1875 calling for international control of Egypt’s finances. The next year, an international commission, called the Caisse de la Dette Publique, was established to resolve the country’s debt.

           The commission was run by the governments of France, Britain, Italy, and Austria-Hungary. It arranged a debt restructuring in 1877, a year of drought that brought further economic pain to Egypt. The national debt was consolidated and foreigners were put in charge of managing government revenues and expenses, a Brit in the case of revenues, and a Frenchman in the case of expenses. This ‘dual control’ by Britain and France also introduced a system of mixed courts, which separated the justice system that handled disputes among Europeans from those that handled local cases. Upset by this foreign influence, a revolt broke out that the khedive Isma'il Pasha was slow to put down, perhaps because of his own sympathy with their cause. As a result, Britain and France arranged for his overthrow by pressuring the Sultan in Constantinople to revoke his title. With that, a financially draining era in Egypt’s history came to an end.

Lesson            

           Historical accounts of modern Egypt are rare in the West so the connection between khedives, canals, cotton, and broken debt commitments must have been new to most readers. Nonetheless, there is a more universal lesson here. For the governments of less developed countries, as for individuals and other institutions, the need for debt financing is most unavailable when it is most needed. In the case of Egypt, the government borrowed heavily while a window opened up to international debt markets amidst the high cotton prices of the American Civil War era. When the economy slowed following the decline in commodity prices and the delayed completion of the Suez Canal, the government found its need for borrowing greater than ever before. However, it was by then so encumbered that the khedives and their country were all but bankrupt.

Further Reading

1.      Baer, Werner. “The Promoting and the Financing of the Suez Canal.” Business History Review, vol. 30, no. 4, 1956, pp. 361–381.

2.      Cole, Juan Ricardo. Napoleon's Egypt: Invading the Middle East. St. Martin's Griffing, 2008.

3.      Dawkins, Clinton E. “The Egyptian Public Debt.” The North American Review, vol. 173, no. 539, Oct. 1901, pp. 487–507.

4.      “The Middle East and the Balkans, 1870–1914 .” Sovereign Debt and International Financial Control , by Tunc?er Ali Cos?kun, Palgrave Macmillan, 2015, pp. 29–52.

5.      Rosen, David. The Last Cheetah of Egypt: A Narrative History of Egyptian Royalty from 1805 to 1953. iUniverse Inc, 2015.