S&P revises Egypt Outlook to Positive, citing ‘Gradual Economic Recovery’

Ratings provider, Standard and Poor’s updated its outlook on Egypt from “stable” to “positive” on Friday, citing “gradual economic recovery.”

“The rating action reflects our view of Egypt’s gradual economic recovery, supported by improving, albeit still fragile, political stability, alongside policymakers’ commitments since 2014 to embark on economic reforms,” said S&P. “These include subsidy and income tax reforms, a new law on investment, and the announced value-added tax (VAT) system on goods and services. In addition, we expect some Gulf states will continue to provide the Egyptian Government with sufficient foreign currency funds to manage the country’s short-term fiscal and external financing needs.

“Our ratings on Egypt remain constrained by wide fiscal deficits, high domestic debt, low income levels, and institutional and social fragility. The ratings are supported by positive growth prospects and financial support from the Gulf states.

“According to preliminary government estimates, Egypt’s real GDP growth rose to 5.6 per cent year-on-year during the second half of 2014, supported by improved political conditions compared with the same period a year earlier. The services, tourism, and manufacturing sectors have mainly fueled the country’s recent economic performance. In addition, we expect growth will be bolstered by inward foreign investment that we estimate could exceed an annual average of $10 billion over the next three years, particularly in the energy, real estate, and transport and logistics sectors. We think growth will average about 4.3 per cent per year in 2015-2018, compared with just 2.1 per cent in the previous four years.

“In early 2015, Saudi Arabia, the United Arab Emirates (UAE), and Kuwait pledged a further $12.5 billion in economic and financial assistance to Egypt. They have already demonstrated support to Egypt by providing substantial financing–totaling close to $25 billion–in grants, aid, and concessionary loans, over the past three years. We understand that the Central Bank of Egypt

(CBE) received, at the end of April 2015, $6 billion in deposits from the Gulf states, which has helped increase Egypt’s foreign currency reserves to $20.5 billion from $15.3 billion.

“Mr. Abdel-Fattah El-Sisi, formerly Field Marshal and Chief of Army Staff, was sworn in as president in June 2014. Since then, the Egyptian political landscape has seen a broad return to stability, albeit with underlying unresolved issues surrounding social inclusion. Egypt has indicated it will hold parliamentary elections between June and September of this year, and these will be the third and final milestone in the country’s current political roadmap. This socio-political improvement remains fragile, however, with sporadic incidents of hostility occurring between the government and supporters of the now-outlawed Muslim Brotherhood, and tensions in Northern Sinai.

“In addition to the stabilizing security situation and stimulating growth, the Government has launched a number of fiscal reforms, including raising administered fuel and electricity prices. It plans to gradually phase out fuel subsidies over the next five years. The government also raised taxes on higher income earners, corporations, and property, and introduced taxes on capital gains and dividends. It has announced plans to impose a value-added tax to replace the existing goods and services tax and generate higher revenues. These measures target a deficit reduction over the next few years, but are partially counterbalanced by spending on health, education, and scientific research that is now mandatory under the new constitution.

“We expect Egypt’s fiscal deficits and domestic debt ratios to remain high. The Government is targeting a fiscal deficit of 10.5 per cent of GDP in 2014-2015 (July-June), below the estimated 12.8 per cent recorded in 2013-2014. We project Egypt’s fiscal deficit will stabilize at a still-high 10 per cent on average between 2015 and 2018. We consider the government’s ability to significantly cut spending as limited, particularly given Egypt’s shortfall in basic services and owing to constitutionally mandated expenditures.

“We estimate the annual change in general government debt will average about 10 per cent of GDP in 2015-2018. We expect net general government debt will average about 82 per cent of GDP in 2015-2018, having risen sharply from an average of 73 per cent in the past four years. We project general government interest expenditure will average about 34 per cent of general government revenues in 2015-2018, exceeding the 27 per cent average in 2010-2014. We understand the government plans to raise $1.5 billion during the first half of 2015 through a Eurobond offering, and aims to issue Sukuk in fiscal 2015-2016 to diversify its funding sources.

“The Egyptian banking system is heavily exposed to the sovereign, with net claims on the government amounting to 75 per cent of net domestic assets in 2014, compared with 51 per cent in 2010, on the back of high fiscal deficits. Egyptian banks have so far remained keen buyers of government debt, and have chosen to invest their excess domestic currency liquidity in government debt offerings in recent years. Their customer deposit bases have continued to grow strongly, while private-sector credit remained relatively flat. This situation could however change if banks want to consider more diversified loan portfolios by expanding their private sector lending to new projects, alongside those announced during the conference.

“We forecast current account deficits to average 4.4 per cent of GDP in 2015-2018. Over the same period, we estimate external debt net of liquid assets will average a relatively modest 25 per cent of current account receipts (CARs). However, we expect Egypt’s overall net external liability position to exceed 125 per cent of CARs in 2015 and then 150 per cent in 2018. We take the view that support from Gulf donors and foreign direct investments will continue to provide the Egyptian Government with sufficient foreign currency resources to mitigate external vulnerabilities. Notably, Saudi Arabia, the UAE, and Kuwait disbursed to Egypt $16.4 billion in 2013-2014 (equivalent to 5.7 per cent of GDP), and an additional $8.4 billion in 2014-2015 (about 2.7 per cent of GDP). About 65 per cent of the funds received between 2013 and 2015 was in the form of grants and deposits at the CBE, while the remaining 35 per cent was delivered in the form of energy products.

“We assess Egypt’s monetary policy flexibility as low, reflecting our view of the CBE’s intermittent interventions in the foreign exchange market and its exposure (along with that of the banking system) to the government, and an annual inflation rate exceeding 10 per cent. Notwithstanding the CBE’s interventions, the Egyptian pound has depreciated by about 27 per cent against the U.S. dollar since January 2012, including a slide of about 7 per cent since the beginning of the year.

“The positive outlook reflects the possibility that we could raise our long-term ratings on Egypt over the next 12 months if the economic recovery outperforms our current expectations, or if narrower-than-expected current account deficits lead to a stronger external position.

“We could revise the outlook to stable if we come to believe donor support is likely to be much lower than we currently expect, which would exacerbate Egypt’s external vulnerabilities. We could also revise the outlook to stable if we think recently improved political stability is threatened by political strife that could hamper the economic recovery.”

Source: CPI Financial