S&P affirms Egypt’s ‘B/B’ ratings, but says coronavirus to cause plunge in its economic activity

Rating agency S&P Global affirmed on Friday its ‘B/B’ long- and short-term foreign and local currency sovereign credit ratings on Egypt, with a ‘stable’ outlook.

However, S&P warned that the coronavirus pandemic will cause a sharp decline in Egypt’s economic activity and current account receipts, while large capital outflows are weighing on foreign exchange reserves.

“We are affirming the ratings because we expect Egypt’s external buffers, built up since 2016, will allow it to withstand a temporary external shock resulting from the COVID-19 pandemic.” a S&P statement said.

“We expect foreign exchange reserves (including gold) will decline from a high of $45.5 billion at end-February to about $37 billion by the end of fiscal 2020 (year ending June 30, 2020) and remain broadly stable at about this level in fiscal 2021, covering about five-to-six months of current account payments.”

The rating agency added that it expects a substantial decline in the current account receipts (CARs) during final-quarter fiscal 2020 and first-half fiscal 2021.

“The decrease comes on the back of a COVID-19-induced shutdown of tourism (which represents about 16 percent of CARs) since March, as well as lower merchandise exports and Suez Canal receipts following a slowdown in global trade, and a drop in remittances from the Gulf-based diaspora.”

At the same time, S&P said the global financial market volatility has led to large capital outflows from emerging markets, including Egypt.

“We understand there were portfolio outflows of $13 billion in March (nearly 50 percent of total foreign investment in treasury bills and bonds), which resulted in a decline of the Central Bank of Egypt’s (CBE) foreign exchange reserves and domestic banks’ foreign assets.”

Amid these external pressures, foreign exchange reserves declined by $5.4 billion in March, while the currency exchange rate remained largely stable, indicating central bank intervention, in S&P’s view.

“We anticipate the CBE will continue to gently shore up the currency to manage inflationary pressures and maintain financial stability. Potentially greater currency intervention would further weigh on foreign exchange reserves, and currency overvaluation could limit the recovery in non-oil exports and services receipts.”

“We assume the CBE will not implement capital controls, given its buffers.”

External debt maturities

Egypt’s near-term government and central bank external debt maturities are large at about $6.5 billion in second-half fiscal 2020 and $12.7 billion in fiscal 2021. However, S&P expects a large portion of the bilateral loans will be rolled over.

“About $11 billion represents maturing deposits in the CBE from Saudi Arabia, the United Arab Emirates, and Kuwait, which we expect will be extended again. The central government has $2.1 billion of concessional loans due in fiscal 2021, which will be replaced by upcoming disbursements of a similar amount from the World Bank, African Development Bank, Japan International Cooperation Agency, and Arab Monetary Fund.”

“We assume the government will repay its $1 billion Eurobond maturing in April through its existing foreign assets. The next Eurobond maturity is $2.5 billion in January 2022. Egypt’s short-term external debt includes a $2.7 billion swap facility with China that was extended in 2019 for three years, but has not yet been drawn. We forecast a sharp rise in Egypt’s external debt, adjusted for liquid external assets, to above 100% of CARs in fiscal 2021, followed by a gradual decline.”

S&P expects Egypt to approach IMF

S&P also said it anticipated that Egypt will approach the International Monetary Fund (IMF) for a standby credit facility programme or borrow from its emergency financing (Rapid Credit Facility). The additional funds would help to shore up foreign exchange reserves and partly fund the government’s fiscal response to the pandemic, it explained.

“The government’s temporary policy measures to soften the economic blow from the coronavirus outbreak will strain already-weak public finances.”

The Egyptian government has announced a stimulus package of 100 billion Egyptian pounds ($6.3 billion) or 2 percent of GDP. The package includes higher wage allowances, pensions, and targeted cash transfers under the Takaful and Karama programmes, higher spending allocation for the health sector, monthly salaries for day labourers of 500 pounds for three months, lower energy costs for the industrial sector, and tax relief for affected sectors.

“As a result, we expect the general government fiscal deficit will increase to 8.3 percent of GDP in fiscal 2020 and 8.5 percent in fiscal 2021, from 8 percent in fiscal 2019.”

“The reversal in fiscal consolidation, as per our forecasts, will increase government debt to 89 percent of GDP in fiscal 2021, compared with our previous estimate of 83 percent. However, we expect government debt will gradually decline from 2022, supported by the removal of temporary stimulus measures and energy and electricity subsidies, and lower debt servicing costs.”

S&P: Egypt’s real GDP growth to slow to 2.8% this year

The rating agency said the ongoing health crisis, partial lockdown in Egypt, and external developments will constrain economic output. Therefore, it expects a significant slowdown in real GDP growth to 2.8 percent in the current fiscal year and 0.1 percent in fiscal 2021 – representing a contraction of 1 percent during calendar year 2020, from 5.6 percent in fiscal 2019.

“The most severely affected sector, tourism, was on a promising rebound until recently and made up about 12 percent of GDP and 10 percent of total employment. Growing domestic natural gas production had allowed Egypt to become self-sufficient and a net exporter of gas. However, the sector is showing signs of deceleration owing to the COVID-19 pandemic and slower global economic activity. Prolonged weakness in global oil and gas prices could affect further investment in the sector.”

Small economic recovery in H2 – FY21

Nonetheless, S&P expects a small economic recovery from the second half of fiscal 2021, supported by a revival in consumption and public and private investment.

“Ongoing efforts by the government to improve the business operating environment, such as a new public procurement law, industrial land allocation mechanism, export promotion measures, and the privatization of state-owned enterprises could boost private sector activity in the medium term.”

The CBE has introduced several measures to support the economy, including a reduction in policy rates by 300 basis points, lower interest rates on loans to SMEs, industrial and tourism sectors, and social housing, as well as deferred payment schemes for SMEs and affected sectors.

At the same time, two public banks raised their rates on certificates of deposits to 15 percent from 12 percent, possibly to limit dollarization.

“While lower policy rates will reduce the government’s borrowing costs, it could also decrease the attractiveness of local currency securities for nonresidents if inflation levels rise amid supply-side disruptions and currency depreciation, and real returns diminish.”

The CBE also recently implemented temporary restrictions on daily cash and deposit withdrawals of Egyptian pounds.

“We understand these measures were accompanied with removal of online transaction and transfer fees to discourage cash hoarding, and do not represent capital controls on foreign currency.”

“Our ‘B/B’ ratings on Egypt reflect wide fiscal deficits, a large public debt (albeit gradually declining from 2021) and interest burden, and low income levels that keep social risks elevated. Egypt’s debt-to-GDP and interest-to-revenue ratios will remain high and sensitive to exchange rate movements in either direction.”

The ratings are supported by strong medium-term growth prospects, underpinned by the implementation of fiscal and economic reforms since 2016, the rating agency noted.

“We also believe that Egypt’s monetary framework is gradually improving from a weak base.”

Outlook

S&P’s stable outlook reflects its expectation that the fall in Egypt’s GDP growth will be temporary, and the rise in external and fiscal imbalances will remain contained.

“We expect external and government debt metrics will gradually decline from 2022.”

The rating agency presented two scenarios for Egypt’s economic activity amid the coronavirus pandemic.

Downside scenario

“We would consider a negative rating action if the impact of the COVID-19 pandemic on Egypt’s external position and economic activity is more severe and/or prolonged than expected, resulting in a substantial decline in foreign exchange reserves and reduced ability to service debt.”

Rating pressure could also emerge if Egypt’s plan to gradually reduce the government debt-to-GDP ratio is derailed by fiscal slippages, higher borrowing costs, or more pronounced currency depreciation than expected, S&P added.

Upside scenario

“We could consider a positive rating action if Egypt’s economic expansion significantly outperforms our forecasts, or if larger-than-anticipated improvements in the current account position reduce Egypt’s external financing requirements and external debt levels.”

“We could also consider a positive action if Egypt’s reform programme materially reduces government debt while it maintains a track record of stronger governance.”