Fitch affirms Egypt rating at B+ with ‘stable’ outlook

Fitch Ratings has on Monday affirmed Egypt’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘B+’ with a stable outlook.

Egypt’s ratings are supported by a recent track record of economic and fiscal reforms, and improvements to macroeconomic stability and external finances, Fitch said in its release.

However, Fitch said the ratings are constrained by still large fiscal deficits, high general government debt/GDP and weak governance scores – as measured by the World Bank governance indicators – which underscore political risks.

Egypt’s macroeconomic performance strengthened further in 2019, with real GDP growth firming to 5.6 percent and inflation falling to single digits. Prudent monetary policy, base effects, lower oil prices and currency appreciation have fostered disinflation.

Fitch said it forecast Egypt’s inflation to average 9.5 percent in 2019 and 8 percent in 2020-2021, down from 14.4 percent in 2018. Real interest rates remain comfortably positive, even after the Central Bank of Egypt (CBE) has cut its main policy rate by a cumulative 450 basis points in 2019, to 12.25 percent. The rating agency said it expects CBE will seek to maintain positive real interest rates, marking a shift from the monetary policy stance before the reforms of late 2016.

It also said it forecast real GDP growth will remain robust at around 5.5 percent in financial year 2019/2020 ending in June 2020 and financial year 2020/2021, with balanced risks to this forecast. Investment and net exports have driven faster growth, while private consumption growth has been weak, edging above 1 percent year-on-year in recent quarters.

“Lower interest rates should lend support to private-sector investment, employment and private consumption, while strong contributions from other drivers over the last two years may start to taper.” Fitch said.

However, recent employment growth readings have been lacklustre and the business environment, while improving, remains challenging (Egypt climbed eight places to 120th in the 2019 World Bank Ease of Doing Business Ranking).

Fitch also expects Egypt to remain committed to its reform programme, following completion of its $12 billion three-year Extended Fund Facility with the International Monetary Fund, which officially ends in November 2019. The final disbursement occurred in July. Egypt and the IMF will likely agree a new arrangement in the coming months, most likely a non-loan agreement, possibly with precautionary liquidity.

“This should maintain high levels of technical assistance and help anchor structural and fiscal reforms, even if benchmarks are not linked to disbursements.”

The government hit its fiscal targets in the financial year 2018/2019, with preliminary numbers indicating a budget deficit of 8.2 percent of GDP, down from 9.7 percent in 2017/2018, and a primary surplus of 2.0 percent of GDP. Expenditure restraint was at the heart of the improvement, with spending on wages and subsidies and social spending both falling as a share of GDP (2.4pp combined).

“This allowed space for a sizeable increase in capex, as well as in pensions. The government’s medium-term fiscal plan is built on maintaining primary budget surpluses of 2 percent of GDP, with the aim of reducing debt to 80 percent of GDP in FY21.”

“We forecast the budget deficit to narrow in FY20 to 7.6 percent of GDP, helped by lower interest spending in particular, but to remain slightly wider than the government target (7.2 percent of GDP), given lower revenue projections and weaker assumptions for real GDP growth and nominal GDP.”

Nonetheless, this still implies a further decline in government debt/GDP, to around 83 percent, an improvement of 20pp from the peak of 103 percent in FY17. Fitch added. A downside risk to this forecast is if a portion of government-guaranteed debt (23 percent of GDP) crystallises on the government’s balance sheet, although this currently seems a contained risk. “An upside risk to our fiscal projections stems from government efforts to enhance revenue collection, including the formulation of a medium-term revenue strategy.”

Egypt’s external finances have improved since the exchange rate reform of late 2016, although Fitch forecasts that the current account deficit (CAD) will widen to around 3.2 percent of GDP in 2021, from 2.3 percent in 2018, placing modest downward pressure on foreign reserves and the exchange rate.

“Nonetheless, we expect reserves to remain more than 4.5 months of current external payments (CXP). This assumes that Egypt continues to roll over the vast majority of maturing GCC deposits at the CBE (the outstanding stock is $17.4 billion, with $10 billion that was due to mature in 2019 being rolled over).”

Net external debt has risen sharply, but at 16 percent of GDP it remains lower than the current ‘B’ peer median of 28 percent of GDP. Around 60 percent of sovereign external debt is multilateral, bilateral or in the form of GCC deposits, Fitch said.

Foreign reserves were $45 billion at end-October, up from $42 billion at end-2018, helped by renewed portfolio inflows and substantial external borrowing as the government has issued $8 billion of Eurobonds in 2019. In addition, CBE reports $6.1 billion of foreign-currency deposits, which are not included in official reserves. Foreign participation in Egyptian pound-dominated treasury bills was the equivalent of $15.2 billion at end-September (4 – 5 percent of GDP; around 17 percent of the total stock of local currency-dominated T-bills), up from $10.7 billion at end-2018.

The Egyptian pound has strengthened around 11 percent against the US dollar YTD in 2019, following the cancellation of the profit repatriation mechanism in late 2018.

“The currency displayed minimal volatility in 2017-2018. The next test for exchange-rate flexibility will be when there is depreciation pressure.”

Given nominal appreciation and the ongoing positive inflation differential with trade partners, the Egyptian pound has appreciated more strongly in real effective terms (CPI-based), eroding some more of the competitiveness gains from the 2016 devaluation.

“Relatively weak governance, together with security and political risks, continue to weigh on the rating. Egypt scores below the ‘B’ median on the composite World Bank governance indicator, although it registered some improvement in 2017-2018.”

The potential for political instability remains a risk, in Fitch’s view, given ongoing structural problems including high youth unemployment and deficiencies in governance. In mid-September rare public protests broke out in Cairo and several other Egyptian cities. Intermittent security issues have previously hit the economy via the tourism sector.

The government has sought to mitigate the risk of discontent by bolstering social safety nets (including cash transfer schemes), maintaining food subsidies, increasing the minimum wage and pensions, boosting electricity provision and implementing some structural reform measures to improve the business environment, while the space for political opposition and freedom of expression is restricted, in Fitch’s view.