CAIRO: Fitch Ratings affirmed Egypt’s long-term foreign currency Issuer Default Rating (IDR) at ‘BB’ and long-term local currency IDR at ‘BB+’.
Both ratings have a Negative Outlook and the Rating Watch Negative (RWN) has been removed, according to a statement from the ratings agency carried by Reuters. The agency has also affirmed the Country Ceiling at ‘BB’ and the short-term foreign currency IDR at ‘B’.
"The affirmation and Negative Outlook signifies that although negative rating pressure on Egypt has eased in the short term, political outcomes remain uncertain and could lead to negative rating action in the year ahead if political unrest returns or the government that takes office next year adopts more populist policies, with adverse implications for debt dynamics and reform," said Richard Fox, head of Middle East and Africa Sovereigns at Fitch.
Egypt’s emerging economic picture and recent policy announcements paint a mixed picture, the agency said. The GDP contraction in the first quarter of 2011 (-4.2 percent yaer-on-year) was deeper than expected and official reserves have dropped sharply. However, the current account deficit widened less than expected and tourism, a key growth and external driver, seems to be recovering more rapidly than previously thought likely.
Most recently, the government has announced a lower budget deficit for fiscal year 2011/12 of 8.6 percent of GDP, but one that will make less use of foreign financing than previously budgeted. In particular, the government has decided not to go ahead with a one-year IMF drawing which had been expected to be approved in July.
The lower budget deficit is welcome as it will help stabilize the public debt ratio. Egypt’s high budget deficit and debt ratios, both in absolute terms and compared to peers, are its main rating weakness and the current rating has little tolerance for sustained worsening. The deficit in the fiscal year just ending will approach 10 percent of GDP, mainly due to revenue losses following the political upheavals in January/February. The government’s decision to significantly lower this in the coming fiscal year, at a politically sensitive time and when popular expectations have been raised, sends an important signal about Egypt’s willingness to return to a path of fiscal consolidation as soon as possible.
Nevertheless, the challenges that led the government to originally propose a deficit of 10.9 percent of GDP in 2011/12 have not gone away and will be faced by whatever government emerges from this year’s elections. Measures needed to make major inroads into the deficit — reducing energy subsidies and introducing VAT — will be no easier for the new government than its predecessors. A renewed worsening of debt dynamics is therefore still a longer-term risk, justifying a continued Negative Outlook, until the new government’s policies are clearer.
On the external front, Fitch said, which has long been a key rating strength, the quarter one 2011 current account deficit of $1 billion did not significantly worsen, despite the sharp fall in tourism revenue. The drop in official reserves of almost a quarter by May, was mainly due to outflows of foreign direct and portfolio investment. Net outflows continue but at a much diminished rate and the reserve decline slowed appreciably in May.
Although the decision not to draw from the IMF and some other multilateral lenders increases the risk of continued short-term reserve pressure, pledges from bilateral lenders have begun to crystallize and should help stabilize reserves. However, Egypt’s reserve cushion and net creditor position have been eroded by recent events and with an expected wider current account deficit this year, policies to attract foreign investment will remain at a premium if the erosion is to be stemmed.
Egypt will hold parliamentary elections in September and presidential elections before the end of this year. This is uncharted territory for Egypt and outcomes are uncertain. Renewed political unrest and/or poor policy choices by the incoming government could result in a rating downgrade. By contrast, if the election process is smooth and results in a government committed to fiscal consolidation and reform, and the economy continues to recover, the outlook could revert to Stable.
