Fitch Ratings has revised the Outlook on Egypt's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable, and affirmed the IDR at 'B+'.
Key Rating Drivers
Weaker Liquidity, Financing Risks: The revision of the Outlook to Negative reflects the deterioration in Egypt's external liquidity position and reduced prospects for bond market access, leaving the country vulnerable to adverse global conditions at a time of high current account deficits (CADs) and external debt maturities.
Decline in Reserves: Central Bank of Egypt (CBE) reserves were down to less than USD32 billion by October 2022, from USD35 billion in March and USD40 billion in February, although they have stabilised in recent months. At just over three months of current external payments, reserve coverage is weaker than the 'B' median (four months). CBE's foreign-currency assets not in reserves, mostly deposits at local banks, had recovered to USD2 billion by October, from USD1.5 billion in March, still well below their February level of USD9 billion.
Non-resident Portfolio Outflows: The drop in external liquidity has been driven by outflows of non-resident investment in locally-issued government debt, which dropped to about USD13 billion by September 2022, from over USD17 billion in March and over USD30 billion in 2021. Some recovery is likely on recent exchange rate devaluation, policy rate hikes, and agreement on a new 46-month USD3 billion IMF extended fund facility. Nevertheless, at over 40% of reserves, these portfolio holdings remain a significant vulnerability, in our view.
External Deficit Narrowing; Still Large: We expect the CAD to narrow to 3.1% of GDP (USD13 billion) in the fiscal year ending June 2023 (FY23), from 3.5% of GDP in FY22 and 4.4% of GDP in FY21. The improvement in FY22 was helped by growth in shipping through the Suez Canal, a rebound in travel receipts and a widening hydrocarbon trade surplus. Further improvements in FY23 will be driven mainly by higher Suez Canal shipping fees and further growth in tourism.
Large Funding Needs: Egypt's financing challenge is compounded by public external debt maturities of about USD6 billion in FY23 and USD9 billion in FY24, excluding bilateral debt such as GCC deposits, which is likely to be rolled over. The government has identified USD6 billion in external non-market funding for FY23. This would cover Egypt's funding needs in FY23, assuming some return of non-resident portfolio flows and USD10 billion in foreign direct investment supported by the government's privatisation plan, mostly from the GCC.
Large Central Bank Liabilities: The CBE's net foreign assets (NFA) remain significantly weaker than gross reserves, declining to a liability position of nearly USD9 billion at end-September 2022, from nearly USD6 billion in March and an asset position of over USD8 billion in February. We believe the negative NFA represents a constraint on Egypt's external financing flexibility and shock-absorption capacity, although we continue to view gross reserves as the most relevant indicator of its external liquidity.
Most CBE liabilities are medium- to long-term and tend to be rolled over. Aside from bilateral GCC deposits, which increased by USD13 billion to USD28 billion in March 2022, CBE liabilities include a currency swap with the People's Bank of China and repurchase agreements with international banks.
Bank External Position Also Weaker: Bank NFA had weakened markedly prior to the Ukraine shock as public-sector banks effectively funded Egypt's CAD and maturities, keeping CBE reserves stable. Bank NFA weakened further to negative USD14 billion in September 2022, from negative USD7 billion in March and negative USD12 billion in February. However, as with the CBE, the majority of bank external liabilities are long-term in nature.
Strong International Support: Egypt's 'B+' ratings reflect support from bilateral and multilateral partners. In addition to the USD13 billion in GCC deposits received in March, which may be converted into longer-term investments, Egypt is expecting further investments from the GCC, with a total of USD3.6 billion of equity acquisitions finalised so far in 2022. Egypt has performed well on past IMF programmes.
High Fiscal Deficits Despite Reforms: We forecast wider general government fiscal deficits of 6.3% of GDP in FY23 and 7.3% of GDP in FY24, from 6.2% of GDP in FY22, wider than the 'B' median, as growing primary surpluses are offset by higher interest costs in the near term. Tax revenues will be supported by recent reforms, including amendments to VAT and customs laws, while higher inflation will support revenues and should allow for an erosion of spending in real terms, as happened after the last major devaluation in 2016.
High Debt, but Falling: Devaluation will keep government debt/GDP high at around 87% in FY23, in line with FY22, but we expect debt to decline gradually afterwards, on the back of primary surpluses and nominal GDP growth. Debt metrics are well above 'B' medians, with interest/revenue at about 40%, but most external debt is owed to multilaterals, and domestic banks are large captive investors in local debt.
Large Economy, Solid Growth: Egypt's ratings are supported by its large economy and robust growth, which we expect will remain above the 'B' median at 4.5% in FY23 and FY24, after 6.6% in FY22. Tighter monetary conditions and funding availability pose significant risks to growth.
Inflation, Monetary Tightening: The switch to a more credible floating exchange rate regime and currency depreciation at end-October leaves the EGP/USD exchange rate about 30% weaker compared with 2021 levels. This will further stoke inflation after an earlier round of devaluation and rising commodity prices. We expect overall consumer price growth to average 17% yoy in FY23 and 12% yoy in FY24, assuming modest appreciation of the Egyptian pound from EGP24/USD, but risks are skewed to the upside. The CBE has hiked policy rates by a cumulative 500bp since end-2021, to 13.25%, and further hikes are possible.
Political, Social Risks: The potential for political instability remains a significant tail risk, in our view, given structural problems, including weaknesses in governance and high youth unemployment. The government has sought to mitigate this through targeted social spending and economic reforms, while the space for political opposition and freedom of expression is restricted, in our view.
ESG - Governance: Egypt has an ESG Relevance Score of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Egypt has a low WBGI ranking in the 28th percentile.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- External Finances: Further external financing strains undermining recovery of international reserves and other liquidity buffers.
- Public Finances: Failure to resume a path of narrowing the fiscal deficit and reducing government debt/GDP, for example, due to higher interest rates and weaker growth.
- Macro: A prolonged hit to economic growth and/or backsliding on the country's economic reform programme, for example on exchange rate flexibility, which could result in greater risks to macroeconomic stability and could undermine Egypt's IMF programme or progress on debt reduction.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- External Finances: Reduction in external vulnerabilities, for example, through improved bond market access, narrowing of the current account deficit, and build-up of international reserves or other liquidity buffers, supported by a credible exchange rate framework.
- Public Finances and Macro: Progress on fiscal consolidation and economic reforms supporting IMF programme performance and a further reduction in the gross general government debt/GDP ratio to a level closer to the 'B' median over the medium term.
- Structural: Significant improvement across structural factors over the medium term, such as governance standards, the business environment and income per capita, to levels closer to 'B' and 'BB' rated sovereigns.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
Fitch's proprietary SRM assigns Egypt a score equivalent to a rating of 'B+' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM score to arrive at the final LT FC IDR.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
