Fitch Ratings-Hong Kong-30 May 2016: Fitch Ratings has affirmed Egypt’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B’ with a Stable Outlook. The issue ratings on Egypt’s senior unsecured foreign- and local-currency bonds have also been affirmed at ‘B’. The Country Ceiling has been affirmed at ‘B’ and the Short-Term Foreign-Currency IDR at ‘B’.
KEY RATING DRIVERS
Egypt’s ratings balance a high fiscal deficit and general government debt/GDP ratio, low foreign-reserve coverage of imports and recent volatile political history, with low external debt and gradual progress in implementing an economic and fiscal reform programme.
We estimate a budget sector deficit of 11.6% of GDP in FY16 (to end-June), broadly the same as in FY15. This is larger than budgeted for a number of reasons. These include the failure to introduce VAT as planned (estimated to raise revenue of about 1% of GDP), the devaluation in March and surging interest payments. An important reason for the failure to introduce the VAT was the parliamentary elections in October-December 2015 and a decision to wait for parliament to be operational. There has been some spending restraint, especially in regard to wages.
The draft budget for FY17, which is still subject to approval by parliament, aims to reduce the deficit to 9.8% of GDP, helped by the belated introduction of VAT and further reform of fuel and electricity subsidies. We expect the budget sector deficit to remain larger than the draft target, owing to our weaker growth assumptions and implementation risk, but nevertheless to narrow to 11% of GDP.
General government debt increased to an estimated 90.3% of GDP in FY16, well above the peer median. Government external debt is relatively low, although the devaluation of the Egypt pound in March has an upward effect on the debt stock. We expect debt/GDP to edge up to 90.5% in FY17, given only modest deficit reduction and assuming some further exchange-rate weakness. Thereafter, we forecast that deficit reduction and robust nominal GDP growth will put the debt/GDP ratio on a gentle downward trend.
Foreign-exchange reserve coverage remains low at around three months of current external payments. Security incidents have dealt a blow to tourism inflows in 2015-16, while other lines of the current account have also struggled. FDI increased in 2015, and is likely to rise this year; some further support is coming in, both multilateral and from the Gulf Cooperation Council (GCC). The Central Bank of Egypt responded to the strain on the balance of payments by devaluing the currency in mid-March by 14% against the US dollar, and further exchange-rate weakness is likely.
Gross external debt has been rising, due largely to concessional support from the GCC, but it remains below peers. We forecast it will rise to around 18% of GDP by end-2016. Net external debt will remain just below 7% of GDP, compared with a ‘B’ median of 26.3%. The bulk of external debt is on a concessional basis, and while Egypt’s external liquidity ratio has been worsening it remains stronger than peers. The rating is supported by the absence of a recent history of debt restructuring.
Real GDP growth has slowed in FY16 to an estimated 3.2%, owing to declines in tourism and shortages of foreign exchange. This is after strengthening to 4.2% in FY15, from an annual average of around 2% since the Arab Spring in 2011. However, energy shortages are being addressed, and public and private investment is rising. Fitch assumes growth will strengthen slightly to 3.6% in FY17 and further the following year. Inflation is above peers, and we forecast that it will remain in double-digits in 2016-2017, with structural rigidities aggravated by the weaker exchange rate.
A new parliament started work in January 2016, following elections that formally completed the political transition. While the existence of a functioning parliament should be a positive step for Egypt, some signs of rising public discontent together with a crackdown on dissent are areas to watch. Serious security incidents have occurred, and remain a risk factor. World Bank governance indicators have deteriorated in the last few years, and are below those of its peers.
SOVEREIGN RATING MODEL and QUALITATIVE OVERLAY
Fitch’s proprietary sovereign rating model (SRM) assigns Egypt a score equivalent to a rating of ‘B’ on the Long-Term Foreign-Currency IDR scale.
Fitch’s sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch’s qualitative overlay (QO) is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the ratings are currently balanced.
The main factors that, individually or collectively, could lead to a negative rating action are:
– Failure to anchor the fiscal deficit on a downward trend towards levels closer to the peer median.
– Strains on the balance of payments, which prevent an improvement in the level of international reserves.
– Serious security incidents that undermine economic activity.
The main factors that, individually or collectively, could lead to a positive action are:
– A track record of progress on fiscal consolidation leading to a decline in debt/GDP.
– Sustained stronger economic growth supported by reforms to the business environment which lead to increased investment and employment.
Fitch assumes local banks remain willing and able to finance the deficit.
The political environment is assumed to be more stable than in 2011-2013, although sporadic and at times serious attacks on security forces are assumed to continue and underlying political tensions will remain.
The preceding was a press statement and does not reflect the editorial policy of The Cairo Post.