Moody's Investors Service has today downgraded Egypt's government bond ratings to B3 from B2, while maintaining the rating on review for further possible downgrade.
Today's one-notch downgrade was prompted by the following factors:
1) The economic impact of the intensification of civil unrest, as reflected by the recent decree announcing a state of emergency.
2) The further weakening in Egypt's external payments position given the large drop in January in the level of international reserves held by the Central Bank of Egypt (CBE).
3) The continued uncertainty surrounding the Egyptian government's ability to secure financial support from the International Monetary Fund (IMF).
As part of today's rating action, Moody's has also lowered the B3 country ceiling for foreign-currency bank deposits by one notch to Caa1, the Ba3 country ceiling for foreign-currency bonds by one notch to B1, and the Ba1 local-currency bond and deposit ceilings also by one notch to Ba2. The short-term country ceiling for foreign-currency bonds remains unaffected at Not-Prime (NP).
RATINGS RATIONALE
The main factor behind Moody's decision to downgrade Egypt's government bond ratings is the country's ongoing unsettled political conditions and recent escalation of civil unrest in the form of violent clashes between protesters and security forces, resulting in many deaths. This situation culminated in President Morsi's declaration of a state of emergency in three Egyptian cities along the Suez Canal on 27 January. Moreover, the polarization and divide between the democratically elected government and those in opposition appears to be deepening, thereby casting doubt over the government's ability to govern effectively, restore social stability and avert a worsening of the already severe economic disruptions.
The second factor underlying Moody's one-notch downgrade is the further weakening in Egypt's strained external payments position. In January, the country's international reserves dropped by $1.4 billion to $13.6 billion, the largest decline in 12 months and a sharp departure from the semblance of stability seen throughout most of 2012. This has occurred despite the deposits made to the CBE by the governments of Saudi Arabia and Qatar, and despite the CBE's imposition of selected capital controls on 30 December 2012, with the aim of limiting foreign-currency cash withdrawals and cross-border transfers for current transactions. Strains in the balance of payments are reflected in the depreciation of around 8% against the dollar that resulted from the greater exchange-rate flexibility brought about by the introduction of capital controls.
The third driver underpinning the rating action and the maintenance of the review for further possible downgrade of Egypt's sovereign bond rating is the government's postponement of a preliminary, staff-level agreement that was reached with the IMF in mid-December. This credit-negative delay jeopardizes the fragile stability that the country has slowly rebuilt in recent months, because an IMF program would have directly provided $4.8 billion in financial support and, more importantly, would have helped to shore up investor confidence through a monitored program of economic reform. Although the IMF and Egyptian government expressed their commitment on 7 January 2013 to pursue a new agreement, Moody's notes that the political challenges facing the government complicate both the reaching of an agreement with the IMF, as well as the ability of the government to adhere to a program of fiscal austerity, even if only gradually and cautiously.
FOCUS OF THE REVIEW FOR FURTHER POSSIBLE DOWNGRADE
Moody's will monitor the evolution of the above factors to assess whether to implement a further downgrade of Egypt's government bond rating or to confirm it at its newly adjusted B3 level.
Egypt's rating could be downgraded further, depending on the severity of possible adverse developments, in the event of one or a combination of the following factors:
1) The absence of substantial and predictable external financing support;
2) an assessment of a likely further weakening of the external payments position and further run-down of official international reserves;
3) instability in the banking system, which may prompt the imposition of tighter capital controls on domestic deposits or foreign-exchange transactions; or
4) a sharp rise in the government's funding costs above previously elevated levels to a level that significantly heightens refinancing risks.
Moody's would consider leaving Egypt's rating unchanged and confirming it at its current level in the event of:
1) A sustained strengthening in the balance of payments and external payments position -- in particular, a replenishing trend in the country's official international reserves.
2) A reduction in government debt-financing costs.
3) A sustained recovery in Egypt's economic growth towards pre-revolution trends.
4) Success in securing an IMF support program, which would likely be complemented by augmented financial support from western and regional governments.
PREVIOUS RATING ACTION
Moody's previous action affecting Egypt's government bond rating was implemented on 18 January 2013, when the rating agency placed Egypt's B2 ratings on review for possible downgrade.
Source: Moody's
