Fitch Affirms Egypt at ‘B-‘; Outlook Stable

Fitch Ratings has affirmed Egypt’s Long-term foreign and local currency Issuer Default Ratings (IDR) at ‘B-‘. The Outlooks are Stable. 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 IDRs reflect the following key rating drivers: The new president, Abdelfattah Al-Sisi, was overwhelmingly elected on a turnout of 47.5% in June 2014 in polls that passed peacefully. President Sisi is backed by the powerful military, which has restored and is expected to maintain relative political stability.

Nonetheless, significant sections of the population are disaffected, some parts of the country are affected by sporadic violence and sequencing adequate economic reforms while preserving social stability will be challenging. Financial assistance from some GCC governments has eased external and fiscal strains and boosted business confidence.

Fitch assumes further support will be forthcoming following the election of President Sisi. GCC inflows have pushed up external debt, but it remains low, and the new funds are on a concessional basis, so external debt stock and service indicators are still stronger than peers. GCC grants are forecast to narrow the general government deficit in FY14 (to end-June 2014) to around 12% of GDP, among the highest of all Fitch-rated sovereigns.

Consolidation measures, including subsidy reform and a broadening of the revenue base, are likely to be pursued gradually and new spending commitments and a greater emphasis on social justice will limit the pace of deficit reduction. Fitch forecasts a deficit of 8.5% of GDP for FY16. General government debt will therefore remain high at around 90% of GDP. Fitch considers that domestic banks have the capacity and willingness to finance the deficit. Reserves have stabilised at around three months of import cover due to foreign exchange rationing and GCC inflows. Arrears to foreign equity investors have been cleared and payment delays of profits to energy companies are being reduced.

The outlook for the balance of payments is weak, with the modest improvements in tourism revenues and foreign investment forecast likely to be insufficient to end rationing given high demand. Fitch assumes import cover will stay low over the forecast period, although GCC support will provide an important backstop. Political uncertainty pulled real GDP growth down to 1.2% in 2H13. Indicators for 2014 are weak, with the PMI pointing to a contraction in four of the first five months.

Shortages of foreign exchange and power, fiscal consolidation and crowding out will hamper a revival. Fitch forecasts growth rising to 4% by 2016, which is well below the level that would absorb new labour force entrants. Exchange rate depreciation and subsidy reforms are expected to push inflation into double digits, from the current level of 8.2%, despite significant spare capacity.
Investment and World Bank Doing Business and governance indicators have all deteriorated in recent years and are below peers.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are currently balanced. The main factors that could lead to positive rating action, individually or collectively, are: – Material progress on fiscal consolidation. – Improved political stability, potentially supported by efforts to accommodate currently marginalised groups.

The main factors that could lead to negative rating action, individually or collectively, are: – Disruption to GCC inflows that strains the balance of payments and fiscal position. – A failure to reduce the fiscal deficit significantly or a weakening of the willingness or ability of local banks to finance the deficit. – A serious breakdown of public order or a severe and sustained period of political violence that further damages the economy.

KEY ASSUMPTIONS

Egypt is assumed to continue to receive GCC financial support, in a variety of forms, over the forecast period. It is expected that the GCC will encourage Egypt to step up reform to gradually diversify sources of donor funding.

Fitch assumes that the authorities will draw up a home-grown economic programme that will facilitate funding from bilateral and multilateral donors. The political environment is assumed to be more stable than recent years, although ongoing tensions and sporadic violent incidents are likely to prevent a sustained recovery in tourism. Fitch forecasts that oil prices will decline modestly, to an average of USD95/b (Brent) in 2016, easing some upward pressure on the subsidy bill.

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