Egypt’s current economic troubles and reform efforts have been the main topic of discussion in a slew of articles recently, many of which pin the blame on the country’s ruling regime, such as Bloomberg’s “Egypt’s Failing Economy is Sisi’s Fault”. The government, however, is not only battling against the challenges of the present, but also attempting to deal with 30 years’ worth of problems inherited from the regimes.
While the layman may read sources that only serve to confirm their own opinion, investors may opt for a more encompassing outlook on government policies and reform, which will lay the foundation for the discussions set to take place in Cairo on 19-20 September during the Euromoney conference. Fitch, Moody’s, and Standard and Poor’s (S&P) – also known as the Big Three – are the world’s largest credit rating agencies, and offer exactly that. Their research coverage extends to every economy on the globe, offering detailed insights into the short-, medium, and long-term outlook for each country.
The Big Three assessing Egypt
Fitch affirmed Egypt’s Long-Term Foreign- and Local-Currency Issuer Default Ratings at B, with a “stable” outlook. Egypt’s senior unsecured foreign- and local-currency bonds, as well as the Country Ceiling and Short-Term Foreign-Currency IDR have also received B ratings.
Likewise, Moody’s has affirmed Egypt’s long-term and senior unsecured bond rating at a stable B3 and maintained Egypt’s position at B2/Not Prime (NP) for the foreign-currency bond ceiling, Caa1/NP for the foreign-currency deposit ceiling, and Ba2/NP for the local-currency country risk ceilings.
S&P’s research concluded with a revision of the agency’s outlook on Egypt from a positive to a negative, with a B-/B sovereign credit rating for long- and short-term foreign and local currency deposits.
The Big Three typically use the B rating for speculative, long-term credit risks. Their assessment has a profound impact on countries’ dealings with international banks, who at times, for example, could decide to offer euro bonds only to countries with a minimum investment grade rating of BBB-/Baa3. This is an important step for Egypt, since the country issues $3-5bn bonds.
The importance of these credit ratings also lies in their ability to influence investor decisions, and at times even affect the Central Bank of Egypt’s (CBE) policies. They grant countries access to global markets and attract investment funds to the domestic market, injecting it with much-needed liquidity. Additionally, credit ratings facilitate loans and increase their cost effectiveness, preventing investors from repatriating funds and reducing borrowing costs based on Egypt’s enhanced ability to fulfill its obligations. Currently, Egypt’s borrowing costs have fallen to their lowest point in a year.
Egypt’s current plight
Each credit rating agency has highlighted different risks associated with their outlook on the future in Egypt. While those risks have differed in certain instances, Fitch, Moody’s, and S&P have all agreed on a few of them. Those include Egypt’s wide fiscal deficit; the ratio of government debt to Gross Domestic Product (GDP); low foreign currency reserves that impede import activities; and volatile political conditions. Fitch has stated that the budget deficit is primarily caused by the state’s failure to implement the value-added tax (VAT) and the continuing devaluation of the local currency, both of which have driven increases in interest rates.
In 2015, Egypt’s major sources of foreign currency received one blow after another, with a 5% drop in Suez Canal revenues, a 15% drop in the tourism industry, a 4% drop in remittances, and a 20% deduction in exports compared to 2014.
S&P said that the collapse in tourism has created a major bottleneck that is now encumbering business growth and adding major pressure on reserves. S&P also cites monetary weakness as a major source of concern, stating that the currency has depreciated against the US dollar by about 25% since the beginning of 2015.
Moody’s pointed out that foreign reserves are still on a downward trend due to a “persistently high trade deficit, the negative impact on tourism from recent security incidents, and weaker Suez Canal revenues,” which are expected to increase the current account deficit to more than 5% of GDP.
While the Big Three also share views on the positive aspects of Egypt’s current economic state, specifically the country’s relatively low external debt (which helped lower the its risk profile), views diverge when judging the government’s progress and commitment to economic reform.
Fitch, for instance, has commended the Egyptian government on its efforts so far and was of the view that Egypt will continue on its path of gradual progress in the implementation of economic and fiscal reforms.
On the other hand, S&P said that the pace of reform has been much slower than originally anticipated, citing social fragility as the main reason. The agency also highlighted positive developments, such as lower energy subsidies and “revenue raising measures” like higher corporate and property taxes and increased dues on dividends. The agency takes a long-term view on the resolution of the budget deficit and believes it can only be remedied by means of these fiscal and structural reforms, as well as a commitment to the gradual phase-out of fuel and energy subsidies over the coming five years.
Egypt’s social fabric is fragile due to the combination of high levels of poverty, widespread inequality, high unemployement rates, and political instability. Egypt’s poverty index rose to 27.8% during 2015, according to statistics issued by the Central Agency for Public Mobilisation and Statistics (CAPMAS), while rural poverty stood just north of an estimated 50%.
While Egypt’s Gini coefficient had previously placed the country’s level of inequality somewhere close to Austria’s, a revised methodology relocated it to the XX-47 range, ranking Egypt among the 25 most unequal countries in the world. The World Bank had estimated an unemployment rate of 13.2% in Egypt, with more than 40% of that belonging to the youth category. It is worth noting that Egypt scored extremely low on the World Bank’s political stability index in 2015, coming in as number 177 out of 191 surveyed countries.
Moody’s on their part noted that the government has grown more effective recently, now that risks to policy making have diminished and the overall political situation appears to be “broadly stable”. Moody’s research, however, also stressed that security concerns and high unemployment rates may result in increased government spending and continue to pose a threat to fiscal and economic reform initiatives.
Positive indicators moving forward
Despite the setbacks and challenges Egypt faces, Fitch and Moody’s have commended the Central Bank of Egypt (CBE) for its responsiveness to the crisis in balance of payments, but expressed concerns over the inflexibility of Egypt’s monetary policy, which escalates the risks in the case of internal shocks, especially in light of the banking system’s heightened exposure to the government. The CBE has described the systematic devaluation of the Egyptian pound as a part of its efforts to shift to a more flexible exchange-rate regime. Forecasts see the devaluation continuing on a slow but gradual path in the medium-term.
Commenting on the CBE’s future contributions to the reform and recovery process, the IMF stated, after reaching a staff-level agreement with the government, that “the CBE’s monetary and exchange rate policies will aim to improve the dynamics of the foreign exchange market, increase foreign reserves, and bring down inflation to single digits. Moving to a flexible exchange rate regime will strengthen competitiveness, support exports and tourism, and attract foreign direct investment.”
S&P estimates that debt repayment will likely consume 1/3 of government expenditure between 2016-2019. Spending on public wages, salaries, subsidies, and social transfers and debt service represent 80% of total state expenditure in the 2015/16 budget. These spending requirements are almost nonnegotiable, leaving little room for cuts. Fitch said the government has channeled savings from subsidy reforms into sectors such as health, education, and scientific research.
The three agencies have all stated that, at least for the time being, Egypt can still depend on further support from Gulf Cooperation Council (GCC) countries, whose contributions to new projects, issuance of concessionary loans to purchase petroleum products, and $25bn bank deposits have alleviated much of the pressure associated with funding needs. While the slump in oil revenues may make support less forthcoming, and therefore affect liquidity in the country, Egypt is deemed too strategic an economy to fail.
Investors are also comforted by the absence of debt restructuring from Egypt’s recent history. Many have also commended the government for addressing energy shortages and the rise of public-private investment activities. S&P applauded the government’s success in increasing the power supply, but still views the postponement in implementing the VAT and the tax on capital gains as major threats to Egypt’s financial position.
The VAT is slated for implementation in October 2016.
The impact of the Egypt and IMF staff-level agreement
An IMF report to the May 2011 G8 Summit stated that Mubarak-era neoliberal reforms are the country’s only path forward, due largely to deep budget constraints. The report added that overcoming the high rate of unemployment will necessitate a faster pace of economic growth, which is achieved through a combination of additional investment and improved productivity. While some increases in public investment may be required – to improve the quality of infrastructure and services in less developed rural areas, for example – the private sector will play a primary role in attracting foreign direct investments. Government policies going forward should help create an environment that would allow the private sector to flourish.
Moody’s said that Egypt’s “stable” rating renews international creditors’ confidence in the reform process and has helped Egypt reach its staff-level agreement with the IMF. The firm says it hopes the loan’s conditionality will encourage the government to hasten its reform procedures. Moody’s also sees the IMF loan as credit supportive because it will contribute to the external financing needed for progress on economic reform, which “will foster growth and jobs and reduce financing needs,” according to the IMF.
The underlying factor behind Moody’s “stable” outlook is the credit positive staff-level agreement with the IMF over a $12bn facility that is expected to be approved in 6-8 weeks. The loan is expected to avail additional financing and increase pressure on the government to continue implementing reforms, especially with regards to the VAT and a more flexible exchange rate programme, given their direct correlation with the government’s access to the funds.
“Structural reforms will aim at improving the business environment, deepening labor markets, simplifying regulations and promoting competition. The ambition is to significantly improve Egypt’s ratings in Doing Business and Global Competitiveness. In this context, the reform measures being implemented target creating a competitive business environment, attracting investment, and increasing productivity to provide fertile ground for private sector activity,” the IMF said in a statement.
Egypt’s Global Competitiveness Index (GCI) has been on a downtrend due to an extremely poor macroeconomic environment, labor efficiency, and low technological readiness and innovation, particularly in the wake of the Arab Spring. Egypt’s GCI has since shown signs of improvement thanks to stronger institutional assessment, higher levels of physical security, a more efficient legislative system, a more developed financial market, and better protection of property rights.
The GCI believes those improvements came about as a reflection of “recent reforms, [that included] a reduction of energy subsidies, tax reforms, and a strengthened business environment, as well as greater political stability after years of turmoil.” However, they also note that “continued reforms are needed to create favourable conditions for private-sector growth… These include more openness to trade and investment, reduction in tariff duties, non-tariff barriers, and a more favourable environment for foreign direct investment.” For the latter, the main concern remains the laws that govern the repatriation of funds, a difficult and burdensome procedure.
Moody’s believes that government spending is expected to remain in check due to increases in the price for electrical power usage and the implementation of the Civil Service Law. While the government’s reform agenda has been on hold since April, creditors expect that the introduction of the VAT as well as tightening tax compliance regulations will increase government revenue and support a reduction in the fiscal deficit to 10% of GDP by 2019. The Egyptian government, however, said that it expects the deficit to drop to 10% of GDP by the end of 2017.
The downside to credit rating clairvoyance
In a publication titled “The Uses and Abuses of Sovereign Credit Ratings”, the IMF explains that researchers have argued that credit ratings and outlooks are reactionary rather than anticipatory, and that reading and observing markets over time is much more significant to investor decisions than official, certified ratings and ranks. Despite that, credit ratings are still widely used in financial activities and decision making processes.
Reviews and outlooks play a much bigger role than they should in investor decisions, rather than the overall certification.
Forecasts moving forward
S&P, Moody’s, and Fitch acknowledge that financial assistance from official lenders such as the World Bank, IMG, GCC, the African Development Bank, and sovereign bond issuance fronts will be the primary source of liquidity for the government over the next three years, with additional funds coming in from domestic banks and other local institutions. They determined, however, that these sources of funding will not be enough to cover the trade deficit. S&P identifies this as a key point of vulnerability in the near-term and has flagged it as the reason why the IMF and World Bank are requiring Egypt to raise $6bn in additional funds in order to qualify for the loan.
Funds flowing in from the GCC are likely to cover near-term cash needs, but Egypt may not be able to depend on these sources in the medium- and long-term, a factor that holds weight in investment decisions, especially as Egypt takes on a new loan. Egypt’s international reserve position will likely remain at a precarious $17bn marker.
S&P’s macroeconomic indicators suggest that debt will increase to 91% of GDP in the next three years, while GDP growth will remain stifled at 3%, and the current account deficit will widen to 4.8% of GDP by 2017. Fitch said debt will reach an estimated 90.5% of GDP and sees the country’s GDP growth growing to 3.6% in the coming year, while the deficit will remain at 11.6%. Moody’s estimate was the highest, setting debt-to-GDP-ratio at an estimated 98% for the three next three years.
The Zohr gas field is expected to drive economic growth in Egypt by encouraging investment and improving the country’s trade imbalances. Yet, while Egypt had repaid much of its debt to oil and gas companies, a remaining $3bn still weighs on the country and failure to pay could prevent further expansion in the sector. S&P said that government expenditure on interest will represent 1/3 of total expenditures between now and 2019.
Egypt’s political transition was formally concluded in January 2016, after a new parliament was elected into office. S&P and Fitch have, however, pointed out that the there is increased political risk associated with government crackdowns on various social groups. World Bank governance indicators have been deteriorating over the last three years and have seen Egypt trail far below its peers, a fact that could affect investor confidence, particularly now after the Arab Spring.
Egypt’s credit rating could improve, according to Moody’s, if the country implements measures to lower its fiscal deficit and government debt, increase growth to pre-revolution levels, reduce inflation, increase foreign reserves, decrease reliance on external financing, and improve the domestic state of security. The agency said it would even consider downgrading Egypt’s credit rating if the above issues were not addressed or if the IMF reform programme was delayed or reversed.
S&P and Fitch expressed similar views, saying that ratings will degrade further if external imbalances increase while reserves decrease, financing from the Gulf is halted, domestic fiscal funding options diminish, or political risk increases, weakening the institutional environment. S&P stated that the only indicators that could catapult Egypt’s rating are a higher GDP growth rate and a reduction in external and fiscal deficits.
Government’s response
The government’s plan, Egypt Vision 2030, has taken into account the above structural weaknesses that prevent the country from scoring a higher credit rating and hamper its full recovery. The first strategic goal announced was ensuring economic stability through the reduction of state debt and budget deficit, increases in GDP growth, and the development of a competent and efficient institutional framework that adapts to changes in the local and international economic scenes, and ensures energy security and decreases its consumption.
The government has expressed its desire to increase spending on fields that support economic growth and has already taken important steps to invest in areas such as healthcare and education. Additionally, the state has committed itself to restructuring subsidies and is beginning to work on expanding the private sector’s contribution to GDP from a current 60% up to 70%.
By 2030, the government is hoping to achieve a GDP growth rate of 12%, decrease internal debt from 92.7% to 75%, reduce the budget deficit from 11.5% to 2.28%, reduce inflation from 11.8% to a range of 3-5%, increase Egypt’s Global Competitiveness ranking from 116 to 30, and promote an industrial growth rate of 10%. The plan also involves increasing Egypt’s efficiency ranking from 20 to 70 and its index for ease of doing business from 59.5 to 80. They also plan on tackling the issue of “social fragility” through a number of programmes and inclusive measures designed to enhance Egypt’s political and social cohesion. Social and environmental development, however, will rest mainly on the recovery of the economic system.
| Fitch | Standard& Poor’s | Moody’s | IMF | Government Target | |
| Current Account Deficit | 4.4% | 4.8% | 5% | 4.3 | 0-2020 |
| Fiscal Deficit | 11.6-2017 | 11-2017 | 10.3-2019 | 10.5-2017 | 10-2017 |
| International Reserves | No Change | Less than $17bn | $15.5bn | N/A | N/A |
| Government Debt to GDP | 90.5% | 91% | 98% | 88% | 75% – 2030 |
| External Debt | 7.9 | 24 | 14.6 | N/A | N/A |
| GDP Growth | 3.6 | 3.0 | 4.2 (average for next 4 years) | 3.5 | 10%-2020 |
The US government’s POV
The United States has had much to say on Egypt’s reform since the 2011 uprising. President Barrack Obama’s 2009 speech at Cairo University devoted much talking room to the future of economic development in Egypt and the entire region. Aside from vows to support “freedom and democracy” was an announcement that the US intends to provide Egypt with $15bn in loans and aid packages.
“As momentous as the current security and political restructuring challenges may be, it is absolutely critical that the transition authorities…place a high priority on deepening and accelerating structural economic reforms,” the Institute of International Finance (IIF), a policy and lobby organisation that brings together the largest financial institutions in the world, noted in early May. “Transition and subsequent governments must articulate a credible medium-term reform and stabilisation framework, [and] focus on creating the legal and institutional environment for fostering entrepreneurship, investment, and market-driven growth.”
The IIF went on to identify this acceleration of structural adjustment as the “context” in which aid to Egypt would be provided.
In confidential emails that found themselves on Wikileaks, Hillary Clinton had urged both the SCAF-led transitional government and the Mohammad Morsi government to implement the reforms necessary to acquire a loan from the IMF. Jacob Sullivan, Clinton’s top foreign policy advisor, had said that “the objective was not a deal that would just barely meet the minimum IMF conditions but rather reforms that would solve Egypt’s serious financial problems and generate confidence among investors.” The most pressing concern that had been mentioned in the emails was the issue of fuel and diesel subsidies.
President of the Carnegie Endowment William J. Burns had stated then that the US must “prepare to engage ambitiously on economic issues as soon as a new government is in place, ideally to come in right behind an IMF deal with debt relief, cash transfer, and maybe even reopening the door to FTA [Free Trade Agreements].”
The Morsi government had hoped that by fulfilling the US’ wishes of reform, it could unlock the necessary support needed for his Nahdah project, which entailed the development of “100 major infrastructure projects” (over a billion US dollars each). However, “not the fund or any international actor would find a higher-value agreement credible if it were not accompanied by meaningful budget reforms,” Sullivan had said.
The United States was specifically interested in financing SMEs and had pressed the Egyptian government to provide licensing to CHF International, an SME financing company. The Egyptian government was hesitant to make a move prior to parliament’s instatement, and the US took a proactive move to add CHF to an existing Egyptian institution in collaboration with the Ministry of Investment.
The pursuit of a pro-SME growth policy has been tied to the region’s democratic transition, deregulation, privatisation, and the government’s eventual exit from economic matters.
Former World Bank president Robert Zoellick’s had said in 2011 that, “the key point I have also been emphasising…is that it is not just a question of money. It is a question of policy.” In the same speech, he referenced Tunisia’s Mohamed Bouazizi, who is viewed as the trigger of the Arab Spring, reminding his audience that it was “red tape” that drove him towards his suicide.
“One starting point is to quit harassing those people [like Bouazizi] and let them have a chance to start some small businesses,” Zoellick added.
On 26 August, during a phone conversation with Egyptian counterpart Sameh Shoukry, US secretary of state John Kerry “welcomed the recently-signed [tentative] deal between the Egyptian government and the IMF, stressing that the US supports such an important step on the path of economic reform in Egypt.”
