Moody’s Investors Service has upgraded Egypt’s issuer and senior unsecured bond ratings to B3 from Caa1, with a stable outlook.
Moody’s has also raised Egypt’s foreign-currency bond ceiling to B2 from B3, the foreign-currency deposit ceiling to Caa1 from Caa2, and the local-currency country risk ceiling to Ba2 from Ba3. The short-term country ceilings for foreign-currency bonds and deposits remain unchanged at Not-Prime (NP). The Aaa rating assigned to Egypt’s senior unsecured bonds backed by the United States government remains unaffected by today’s rating action.
First driver — Improving macroeconomic performance
The first driver of the rating action is the expectation that recent improvements in Egypt’s growth performance and macroeconomic stability will be enduring. Moody’s expects real GDP growth in Egypt to recover to 4.5% year-on-year for the current fiscal year 2015, which ends in June, and then to rise to around 5%-6% over the coming four years. This expected level is based on an assumption that domestic political stability will continue, as will improvements in the business environment, which in Moody’s view will be conducive to higher investment levels.
Second driver — Reduction in external vulnerabilities
Net international reserves have stabilized at $15.5 billion at the end of February 2015, providing ample coverage for external debt payments due in 2015. Since July 2013, the governments of Kuwait, Saudi Arabia, and the United Arab Emirates have remained committed to support Egypt by making large foreign currency deposits in the Central Bank of Egypt.
Moody’s expectation of a recovery in domestic and foreign investment is underscored by the strong donor support in Egypt’s Economic Development Conference, which was held during March 13-15 in Sharm El-Sheikh. The support came predominantly but not exclusively from Gulf Cooperation Council (GCC) member countries, which pledged a total of $12.5 billion in official aid and investments. Together with the approximately $38 billion in reported signed investment deals, the large amount of financial support will help to mitigate external vulnerabilities and reduce balance-of-payments risks.
Third driver — Ongoing commitment to fiscal and economic reform
Finally, Moody’s expects the Egyptian government to carry on with fiscal and economic reforms. Expenditure-side reforms, such as recalibration of subsidies and putting a lid on public sector salary growth, coupled with revenue-enhancing measures such as the likely introduction of a full-fledged value added tax in the coming fiscal year, will help to gradually reduce fiscal deficits. The rating agency expects the general government deficit to decline to around 10% of GDP in fiscal 2015, and edge down further to around 9.3% by 2016.
Moody’s also projects general government debt to decline gradually to less than 90% of GDP during 2015-16. In addition, lower government borrowing costs on the back of declining inflation rates, and maturity lengthening measures, will help to reduce Egypt’s very large government borrowing requirements. Going forward, the government is planning to diversify its sources of financing — which will further help lower the cost of debt — by issuing dollar-denominated bonds as well as tapping into the sukuk market.
RATIONALE FOR THE STABLE OUTLOOK
Moody’s views the downward pressures on the rating as limited. The strong support from the GCC countries and increasingly from other foreign donors also mitigates these pressures. Relations with the IMF have also improved, reflected in the publication of the first Article IV report since 2010 in February 2015.
However, despite the positive developments that Moody’s expects, Egypt still faces marked challenges, and upward pressure on the government bond rating is likely to be limited over the next 12-18 months.
RATIONALE FOR THE B3 RATING
Egypt’s B3 government bond rating remains primarily constrained by the weak level of government finances, marked by still sizeable deficits and elevated debt levels, which both will continue to exceed the median for B3-rated peers.
In addition, while government effectiveness has improved and risks to policy making are diminishing, Moody’s still sees elevated security risks, as reflected in ongoing terrorist attacks — particularly in North Sinai — and due to Egypt’s exposure to regional sectarian violence. In addition, declining yet high unemployment rates create social pressure which translates into ongoing demand for comparatively high levels of recurrent government spending.
Finally, structural impediments to a quick return to high growth rates include Egypt’s weak business environment, as reflected in weak scorings in global surveys, such as the World Bank’s “Doing Business” survey or the World Economic Forum’s Global Competitiveness Report.
FACTORS THAT COULD CAUSE THE RATING TO MOVE UP/DOWN
The stable outlook indicates that rating pressures are balanced.
Nevertheless, Moody’s would consider the following developments as credit positive: (1) an accelerated implementation of measures to lower fiscal deficits and government debt; (2) a faster and sustained growth recovery to pre-revolution levels, combined with a sharper reduction in inflation rates; (3) a faster-than-envisaged build-up of foreign exchange reserve buffers, driven by less reliance on external donor support; and/or (4) further improvement in the domestic security situation.
On the other hand, Moody’s could take a negative rating action in the case of: (1) a renewed intensification of political turmoil and instability; (2) a significant deterioration in the external payments position; (3) a slippage or reversal of fiscal and economic reforms, which leads to a sharp rise in the government’s funding costs; and/or (4) diminution in the banking system’s capacity to fund government deficits.
