Fitch Ratings has downgraded Egypt’s Long-term foreign and local currency Issuer Default Ratings (IDRs) to ‘B’ from ‘B+’. The Outlooks are Negative. The Country Ceiling has also been downgraded to ‘B’ from ‘B+’. The Short-term IDR is affirmed at ‘B’.
RATING RATIONALE
The downgrade of Egypt’s sovereign ratings reflects the following key rating factors:- – The fiscal position has worsened. The general government deficit widened to 10.7% of GDP in FY12 (year ending June) and data for the first five months of FY13 show a further deterioration.
Spending on subsidies, interest payments and the public-sector wage bill are rising and a weak economy is hitting revenues. Fitch forecasts the deficit to rise to 11.2% in FY13 and general government debt to reach 84% of GDP at end-FY13, double the ‘B’ median. – A shortage of foreign exchange has prompted the authorities to tighten capital controls and introduce foreign exchange auctions.
Substantial ad hoc inflows from some bilateral creditors have kept reserves around three months of current account payments cover, but in the absence of funding associated with an IMF program there is potential for on-going depreciation and reserve decline, which would generate inflation in an import-dependent economy and lift the subsidy bill. – The political transition, while making significant progress, has at times been mishandled and serious divisions have opened within society, contributing to sporadic outbursts of violence. Parliamentary elections, likely in April, are a potential flashpoint.
Political conditions are complicating economic policymaking, as evidenced by the backtracking on IMF fiscal prior actions in December. An IMF programme could be delayed until after the elections. – Political instability has caused economic growth to deteriorate. Real GDP growth is forecast to average 3.3% over FY13 and FY14, well below the pace necessary to generate sufficient job opportunities for the 700,000 new entrants to the labour force each year.
Egypt’s ‘B’ rating reflects a balance between short-term reserve pressure, political upheaval, a weak and deteriorating fiscal position and capital flight against our assumption that an IMF program will be in place after the election. An external debt position far stronger than the ‘B’ median supports the rating.
RATING SENSITIVITIES
The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade of the ratings:- – A prolonged delay to the implementation of an IMF program (i.e. beyond Q213), leading to unsustainable fiscal and external positions. Agreement of an IMF program seems likely to be delayed until after upcoming parliamentary elections, the date for which is not yet decided. Program implementation could encounter political push back, as in December. – An abrupt depletion of reserves and a disorderly devaluation of the currency, which could result from strain on external finances stemming from a delay to the IMF program.
As the rating Outlook is Negative, Fitch’s sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. However, future developments that may, individually or collectively, lead to a stabilisation of the Outlook include:- – Sustained implementation of an IMF reform program, paving the way for macroeconomic stability, faster growth and a stronger balance of payments and fiscal position. – Improved confidence in, and acceptance of, the political process, likely involving broad participation in parliamentary elections, leading to greater political stability and reduced violence.
KEY ASSUMPTIONS AND SENSITIVITIES
The ratings and Outlooks are sensitive to a number of assumptions. – Fitch’s economic and fiscal projections are based on the assumption that an IMF program will be in place in the second quarter of 2013 and that performance against the program’s targets remains broadly on track. We further assume that formal agreement of the program would trigger bilateral funding of a similar proportion to that committed alongside the November deal.
Failure to secure a program within this period, particularly if accompanied by capital flight, falling reserves and major currency depreciation, could trigger a downgrade. – Fitch assumes that the parliamentary elections will proceed in an orderly fashion and political instability will subsequently ease.
An inconclusive or contentious election process would extend political uncertainty. There is some tolerance at Egypt’s rating level for such political risk, albeit not unlimited. Continued instability would have detrimental effects on economic performance and policymaking. – Egypt’s imports and subsidy spending are sensitive to global food prices. In the event of a severe and sustained upward price shock, the import and subsidy bill would jump, with potential pass through into the domestic supply chain lifting inflation and potentially adding to social instability.
The reverse would be the case should there be a severe and sustained downward price shock. Progress with fuel subsidy reform is required to reduce the vulnerability to a sustained period of higher oil prices. – An escalation in regional instability is possible. The Morsi administration has won plaudits for its foreign policy and the rating is tolerant to the uncertain regional situation. A significant change in foreign policy that led to a rupture with key donors would be ratings negative. – Fitch assumes there will be no terrorist attacks at any tourist sites. Any attack would hurt current account receipts at a time of an already strained external position.
