CAIRO - 18 April 2019: Moody's Investors Service (Moody's) upgraded the long-term foreign and local currency issuer ratings of the Government of Egypt to B2 from B3, and changed its outlook to stable from positive.
The rating agency attributed this decision to its expectation that ongoing fiscal and economic reforms will support a gradual but steady improvement in Egypt's fiscal metrics and raise real GDP growth.
According to the statement, the decision to upgrade the rating primarily reflects :
i) Moody's expectation that ongoing fiscal and economic reforms will support a gradual but steady improvement in Egypt's fiscal metrics and raise real GDP growth.
ii) Moody's increasing confidence that factors such as Egypt's large domestic funding base support its resilience to refinancing shocks notwithstanding the government's very high borrowing needs and interest costs.
The stable outlook balances the downside risks posed by very weak debt affordability and large financing needs alongside the longer-term challenges to a shift to a more inclusive, private sector-led growth model, against the possibility that strong reform commitment could deliver higher growth and lower borrowing needs and shore up resilience to changing financing conditions to a greater extent than currently assumed.
At the same time, Moody's has upgraded Egypt's foreign currency senior unsecured ratings to B2 from B3, and its foreign currency senior unsecured MTN program rating to (P)B2 from (P)B3.
Moody's has also changed Egypt's foreign-currency bond ceiling to B1 from B2, the foreign-currency deposit ceiling to B3 from Caa1, and the local-currency bond and deposit ceilings to Ba1 from Ba2. The short-term country ceilings for foreign-currency bonds and deposits remain unchanged at Not Prime (NP).
RATIONALE FOR THE B2 RATING
ECONOMIC AND FISCAL REFORMS POINT TO A GRADUAL DECLINE IN THE DEBT BURDEN, FROM HIGH LEVELS, AND TO STRONGER GROWTH POTENTIAL
Moody's expects a steady improvement in Egypt's fiscal metrics, albeit from very weak levels. In particular, maintained primary budget surpluses combined with strong nominal GDP growth will contribute to reducing the general government debt/GDP ratio to below 80% by fiscal 2021 (the fiscal year ending in June 2021) from 92.6% in fiscal 2018.
Moody's assumes that the fuel subsidy reform will be completed in fiscal 2019, via another round of energy price hikes in order to establish full cost recovery and the extension of the quarterly automatic price adjustment mechanism to other fuel products following the application on the Octane 95 type starting in March 2019. Together with the fiscal reforms implemented in the last few years that have led to better targeting of income support, higher investment, and a reduced wage bill, this will allow the government to maintain the primary budget balance in surplus in the next few years. Restraint on and targeting of government spending in the last few years now provide some space for higher investment and social spending, while maintaining fiscal prudence.
Budget execution data for fiscal 2019 indicate that the government is on track to achieve its 8.4% of GDP general government deficit target from a peak of 12.9% in 2013, and a primary surplus that Moody's estimates at 0.8% after a history of primary deficits that peaked at 5.6% of GDP in 2013. Moody's expects a further improvement in the general government financial balance to 7.5% and 6.8% of GDP over the next two years and a primary surplus converging to 2% of GDP over the medium term.
Despite this improvement, Egypt's fiscal metrics will remain very weak compared to the sovereigns rated by Moody's. In particular, the interest bill will continue to absorb nearly 45% of revenue. However, absent a severe and lasting shock to the cost of debt, the trend decline in the debt burden is increasingly likely to be maintained.
The further decline in the debt burden will result in large part from strong nominal GDP growth, with robust real growth and gradually declining inflation. Moody's projects real GDP growth of 5.5% in fiscal 2019, converging to 6% in the next few years, supported by economic reforms and renewed credit extension to the private sector.
Higher growth will help reduce the unemployment rate further, which, at 8.9% in December 2018, was back at its 2010 levels and close to the lowest readings since 2003. A steady decline in unemployment is essential to shore up acceptance of a relatively tight fiscal and monetary policy stance in the next few years.
Moody's expects further progress on structural business environment reforms, mitigating key long-standing constraints to private sector development, to further improve Egypt's competitiveness. These reforms focus on strengthening of the competition framework, fostering a more transparent and competitive bidding process in public procurement, establishing improved governance standards at state-owned enterprises including via higher private sector participation, and upgrading the industrial land allocation process to minimize misallocations and perceptions of corruption.
Consistent with the experience of many governments attempting similar reforms, Moody's has taken into account the likely hurdles to an effective implementation of these wide-ranging reforms, in particular when that runs against long-standing vested interests.
RESILIENCE TO EXTERNAL REFINANCING SHOCKS DESPITE LARGE GROSS BORROWING REQUIREMENTS
The steady improvement in Egypt's fiscal metrics will, over time, reduce the sovereign's vulnerability to financing shocks. In the meantime, increasing evidence that such vulnerability is already lower than the fiscal metrics alone would suggest also supports a higher rating at B2.
Together with other emerging markets, Egypt experienced large capital outflows in the second half of 2018. While these confirmed the sovereign's exposure to shifts in investors' portfolio allocation, the experience also supports the view that the country's large financial sector mitigates the credit implications of financing shocks.
Between April and December 2018, capital outflows amounted to over $10 billion (about 4% of GDP), reflected in a fall in non-resident T-bill holdings to about 15% of the total from 30% during that period. With gross financing needs of 30-40% of GDP, the government's overall cost of debt is highly sensitive to reduced demand from foreign investors. In the event, while domestic borrowing costs increased substantially, the large domestic banking sector, supported by the domestic non-bank financial sector, helped avoid a larger and more prolonged increase in the cost of debt. Financial stability was maintained, with the exchange rate and foreign exchange reserves remaining broadly stable. Since the beginning of the year, capital inflows have resumed, government bond yields and spreads have narrowed.
Looking ahead, the completion of energy subsidy reforms should allow headline inflation to decline toward single digits, allowing the Central Bank of Egypt gradually to reduce borrowing costs while continuing to anchor inflation expectations. In turn, this will support the government's efforts to extend the average maturity of domestic debt beyond the current 2-3 years, reducing rollover needs and mitigating the debt trajectory's high sensitivity to interest rate shocks.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook signals that upward and downward rating pressures are balanced.
On the downside, debt affordability will remain very weak and financing needs very large, around 30-40% of GDP, in the next few years, leaving Egypt's credit profile vulnerable to a sharp and sustained tightening in financing conditions.
Moreover, over the longer term, the removal of structural impediments to a shift to a more inclusive, private sector-led growth model will be a gradual process that remains exposed to long-standing vested interests or to the risk of reform reversal captured by a moderate political event risk assessment.
On the upside, the track record of the last few years denotes strong reform commitment that could deliver higher sustained growth than Moody's currently expects. A structural reduction in the current account deficit in light of renewed natural gas exports may also reduce the economy's borrowing needs and shore up resilience to changing financing conditions to a greater extent than currently assumed.
WHAT COULD CHANGE THE RATING UP/DOWN
Over the medium term, a marked improvement in debt affordability and reduction in gross financing needs, resulting from a lengthening track record of credible and effective fiscal, economic and debt management, would likely lead Moody's to upgrade the rating. Evidence of a sustained improvement in the labor market and in non-hydrocarbon exports would also support an upgrade by signaling higher competitiveness that would facilitate a more rapid improvement in fiscal metrics and boost Egypt's resilience to shocks.
Conversely, an erosion in policy effectiveness and credibility, resulting in either sustained lower growth levels or in higher inflation that raises the cost of government debt and erodes competitiveness, would put negative pressure on the rating. Relatedly, evidence that the government was unable to mitigate a negative financing shock in a way that prevented a sharp worsening of debt affordability could also lead to a downgrade of the rating, particularly if accompanied by sustained heavy pressure on foreign exchange reserves.
GDP per capita (PPP basis, US$): 12,698 (fiscal 2017 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 4.2% (fiscal 2017 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 29.8% (fiscal 2017 Actual)
Gen. Gov. Financial Balance/GDP: -10.4% (fiscal 2017 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -6.3% (fiscal 2017 Actual) (also known as External Balance)
External debt/GDP: 33.4% (fiscal 2017 Actual)
Fiscal 2017 refers to 1 July, 2016 to 30 June, 2017.
Level of economic development: Moderate level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 15 April 2019, a rating committee was called to discuss the rating of the Government of Egypt. The main points raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.
The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating.
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