Moody’s affirms Egypt’s B3 rating; maintains stable outlook

CAIRO (Capital Markets in Africa) – Moody’s Investors Service has today affirmed the Government of Egypt’s long-term issuer and senior unsecured bond ratings at B3. The outlook remains stable.

The rating affirmation is based on Moody’s view that the B3 rating appropriately captures Egypt’s credit risk profile. Very weak government finances will continue to constrain the rating pending further clarity on the sustainability and impact of the reform programme. While Egypt’s external liquidity position has significantly improved over the past 12 months, the increase in international reserves has been mainly driven by debt-creating inflows, thus also raising the level of external debt and foreign-currency denominated debt.

The stable rating outlook reflects Moody’s view that upside and downside risks to the rating are balanced. Reform progress has been impressive. However, while political stability has improved to some degree, reform momentum may face headwinds, including from the presidential election set to take place by May 2018. Visibility on the extent to which the reform programme will materially improve the sovereign credit profile in the coming years remains limited.

In today’s rating action Moody’s has also affirmed the provisional senior unsecured (P)B3 Medium-Term Note programme rating. Egypt’s country ceilings stay unchanged 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.

Ratings Rationale
Rationale for Affirming the Rating at B3: Moody’s expects Egypt’s credit profile to remain heavily influenced by the government’s very weak government finances for a sustained period, with already high fiscal deficits continuing to grow in nominal terms over the coming years and declining only gradually as a percentage of GDP. Based on preliminary estimates, the general government fiscal deficit reached around 11% of GDP in fiscal year 2017 (ended 30 June 2017), down from 12.1% in 2016, and will decline to around 10% in the current fiscal year according to the rating agency’s forecast. Moody’s estimates that the general government’s primary deficit shrank to 1.8% of GDP in fiscal 2017 from 3.7% the year before, and will start to show small surpluses from 2019 onwards.

As a consequence, Egypt’s government financial strength will remain very weak for the foreseeable future, with debt and debt affordability metrics continuing to exceed by some margin the median for B3-rated sovereigns. The debt-to-GDP ratio likely peaked at 100% in fiscal 2017 and Moody’s expects that it will decline to about 90% by 2019, still a very high level.

Monetary tightening in response to rapidly rising inflation has driven up the government’s domestic funding costs, with the cumulative 700 basis points rise in the Central Bank’s policy rate having driven one-year T-bill rates to above 20%. Moody’s expects interest payments to remain very high, accounting for close to 40% of revenues over the coming two to three years.

Set against that negative driver, macroeconomic stability has been broadly maintained despite the negative inflation shock resulting from the credit-positive foreign exchange regime liberalization on 3 November 2016. Moody’s projects that real GDP growth has held up well, at 4% in fiscal 2017, and that it will continue to pick-up in the coming years.

External liquidity has also improved. Reduced uncertainty about exchange rate policy, elimination of the parallel market and unlocking of multilateral funding following the exchange-rate liberalization has led to an increase of the Central Bank of Egypt’s net international reserves to $36 billion at the end of July from $15.5 billion a year earlier. The increase in reserves was largely the result of debt-creating inflows, with external debt almost doubling to an estimated 33% of GDP in fiscal 2017 from around 17% the year before. However, repatriation of private remittances through the formal banking system, and to a lesser extent foreign investor participation in the stock market and FDI inflows also contributed to the increase.

Rationale for the Stable Outlook: The stable rating outlook signals that upside and downside risks to the rating are balanced. Reform progress has been impressive and political stability has improved. Ongoing structural economic reforms should, if implemented as intended, improve the business environment and lift domestic and foreign direct investment. Moody’s expects Egypt to continue to comply with the programme targets under the IMF Extended Fund Facility. Despite the sharp rise in inflation as result of the currency devaluation and fiscal reforms there were no large-scale protests, and the broadly stable security situation bodes well for the tourism sector.

However, downside risks exist. The presidential election set to take place by May 2018 could create uncertainties around future reform momentum; while Moody’s expects continued reform commitment by the government, there is a risk that the large, young and growing population, which is facing high unemployment and inequality, could exert pressure that slows or even reverses reforms (e.g., increasing the public sector workforce or re-instating certain subsidies).

Last year’s introduction of a value-added tax (VAT) has been the main revenue side reform. Further fiscal consolidation is focused on increasing revenue efficiency, keeping spending growth under control, and improving the structure of government spending. Current expenditure items including subsidies & social benefits and compensation to public sector employees, together with interest payments, represent more than 90% of total spending. Although the government has made progress with regards to energy subsidy reforms, any increases in energy and food prices would likely drive up subsidy spending; in this respect, the government’s plan to move towards an automated, market price-based fuel price adjustment mechanism is credit positive but will take some time before being realized.

Moody’s views the probability of another public uprising as low, though the impact of any such event on the economy and government finances would clearly be very high.

Overall, Moody’s has concluded that further time is needed to assess the implementation of structural reforms, and their impact on economic and financial strength.

Factors that could cause the rating to move up/down
Faster-than-currently expected progress under the reform programme would be credit positive. In particular, more rapid fiscal consolidation and improvements in debt metrics, while preserving social stability, would be a key driver for a potential positive rating action. In addition, early signs of successful implementation of structural economic reforms would include rising FDI inflows, increasing exports in higher value-added goods, and a meaningful reduction in unemployment. Continued strengthening of external buffers, including further rebalancing of the net international reserve structure away from deposits in Egyptian banks’ branches abroad, and moving away from reliance on concessional financing and external debt towards FDI and higher value-added goods and services exports as main source of foreign exchange inflows would also support a positive rating action.

Any signs of reform slowdown would jeopardize the stable outlook. Depending on the form and speed of reversals and the implications for government finances and external liquidity this could even lead to downward pressure on the rating. Renewed social and political instability or a material deterioration in the security situation could also lead to a negative rating action.