Egypt’s Draft Budget Hints at Slower Fiscal Consolidation, a Credit Negative

Cairo, Egypt (Capital Markets in Africa) — Last Thursday, Egypt’s (B3 stable) Ministry of Finance announced the draft budget for the 2016 fiscal year that starts 1 July. The draft budget, which the cabinet approved and awaits sign-off from President Abdel Fattah el-Sisi, projects a fiscal deficit of 9.9% of GDP, down from the revised budget deficit of 10.8% during the current fiscal year. However, the budget hints at a slower fiscal consolidation pace than projected under the government’s Medium-Term Macroeconomic Policy Framework, and the government’s pre-budget statement for fiscal 2016, which estimated a budget deficit of 9.6% of GDP.

This slowdown in fiscal consolidation, while small, is credit negative because it will translate into a smaller reduction of Egypt’s already high government debt and keep the government’s gross borrowing needs precariously high for a longer period.

The current government has taken steps toward fiscal consolidation, predominantly in fuel subsidy rationalization. We expect that lower oil prices in fiscal 2015 will reduce the fuel subsidy bill to around EGP70 billion (around 3% of estimated GDP), compared with EGP100 billion in the original budget, and government projections for the coming fiscal year point to a further reduction to around EGP61 billion.

However, the fiscal space created by lower oil prices is mostly offset by additional expenditures. The draft budget projects a 20% increase in spending over the current fiscal year to EGP885 billion. The key areas of expenditure increases include the following:

• A 12% increase in social program allocations to EGP431 billion, which is almost 50% of total public expenditures. These measures comprise spending on direct cash support programs, health insurance, the bread and food commodities support system, and education
• Growth of 14% for public-sector wages and salaries, which constitute 26% of total expenditures
• A 66% increase in public investment spending to EGP75 billion. This figure only makes up 8.5% of total spending and accounts for just 9% of the overall spending increase.

Although the increased social spending is part of the government’s economic and political strategy, the 26% projected revenue increase to EGP612 billion and the envisaged rise in the tax share to 70% of total revenues from 57% in fiscal 2014 will depend on a swift implementation of tax reforms.

We expect that tax revenues will be lower than what the draft budget outlines. Some revenue-enhancing measures have yet to be implemented: the introduction of a value-added tax has been delayed because of postponed parliamentary elections. Other measures have been modified or reversed, with the government recently lowering the top income tax rate and suspending for two years capital gains distribution taxes on profits.

In addition, Egypt is facing declining budgetary grants, which, according to the draft budget, will decline to EGP2.2 billion in fiscal 2016 from EGP25.7 billion in fiscal 2015 and EGP95.9 billion in fiscal 2014.

A smaller reduction in the fiscal deficit than what the government expected will translate into a slower reduction in the government debt burden, which was 90.4% of GDP in fiscal 2014. Although Egypt successfully issued a $1.5 billion international 10-year bond on 11 June, the government’s gross financing requirements, which we estimate to be around 55% of GDP in fiscal 2015, will remain among the highest in the world.

Source: Moody’s Credit Outlook Report, 25 June 2015