Fitch: Public Finances Remain Key Challenge after Egypt Vote

Big 5

The victory of Abdul Fattah al-Sisi in this week’s Egyptian presidential election does not alter Fitch Ratings’ expectation that the authorities will be cautious in addressing the large fiscal deficit. Egypt’s public finances are the main weakness for its sovereign credit profile. Sisi’s victory was not in doubt. Initial indications are that turnout was around 46%, lower than 52% at the election won by Mohammed Morsi in 2012 and despite three days of polling. Very high turnout might have enhanced the legitimacy of the return to military rule in domestic and international eyes, but we do not think economic policy, or Egypt’s relations with GCC countries that have provided grants and loans following the removal of President Morsi, will be affected.

According to a statement released by the rating agency on Friday, Sisi has not set out a detailed economic programme. But the interim government’s actions, and Sisi’s broad pronouncements on the need to maintain growth and make Egyptian society more equitable, suggest the authorities are mindful of the risks of popular opposition to fiscal consolidation, which would initially focus on subsidies. In the final budget draft submitted to the interim president the government planned to cut spending on petroleum subsidies, but expected the budget deficit to widen in fiscal year ending June 2015, to 12% of GDP, from 11.5% forecast for FY14.

The authorities will probably continue the small steps towards subsidy reform taken by the interim government. These were aimed at controlling consumption rather than allowing prices to rise. Smart-card terminals have been installed in all petrol stations and are used for transactions between wholesalers and retailers. A project to reduce the bread subsidy has been implemented in Port Said and is set to be expanded.

The improvement in budgetary performance in the first nine months of FY14, with the fiscal deficit narrowing to 7.1% of GDP from 10% in the same period last year, mostly reflects higher government revenues driven by grants. These constituted 2.5% of GDP, up from 0.2% a year earlier. This improvement therefore may not be sustainable, while the sensitivities around reducing subsidy spending mean the deficit will stay in or close to double digits over our ratings horizon.

Tax revenues have risen by 8% year on year, below inflation, and have not kept pace with an 11% spending increase. Wages, subsidies and interest payments rose significantly in recent years and represented 84% of spending in the first nine months of FY14.

These outturns are in line with our view that Egypt’s fiscal and economic performance has stabilised, but at a low level. In January, we revised the Outlook on Egypt’s long-term rating to Stable after three years on Negative, and affirmed it at ‘B-‘ due to tentative improvements in political stability and economic conditions. These were partly driven by bilateral fund inflows that eased pressure on the budget, reserves and exchange rate. The next scheduled review of the rating is on 27 June 2014.

The low rating reflects substantial risks to Egypt’s credit profile, chiefly its weak public finances. Without significant fiscal reform, general government debt will remain above 90% of GDP, well above the median for Egypt’s ratings peers.