Standard & Poor's Ratings Services today affirmed its 'BB+/B' foreign currency and 'BBB-/A-3' local currency sovereign credit ratings on the Arab Republic of Egypt. The outlook on the ratings is stable.
As inflationary pressures ease, the sharp deterioration in external demand now poses the principal threat to Egypt's creditworthiness. Standard & Poor's expects economic growth to fall to around 5.5% in fiscal 2009 (ending June 30, 2009) and 4.4% in fiscal 2010, from an average of 7% in the past three years, because of a slowdown in tourist arrivals, static workers' remittances, and weakening demand for manufacturing exports.
Slower growth will, in turn, put pressure on public finances and we expect the general government deficit to widen slightly to 7.9% of GDP in fiscal 2009. We also expect Egypt's external position to weaken. Compounded by a fall in traffic passing through the Suez Canal, we believe the current account will register a deficit of 2% of GDP in fiscal 2009, widening to 3.4% in fiscal 2010, following years of surpluses. Inward foreign direct investment will likely decline (albeit from a strong 8% of GDP in fiscal 2008) while substantial net outflows from the debt and equity markets have already occurred.
However, Egypt is better placed to weather external shocks than it was before the cabinet, installed in mid-2004, launched its program of fiscal reform, banking sector consolidation and privatization, and the central bank simultaneously embarked on an overhaul of monetary policy. Though public finances remain weak, gross debt-to-GDP has maintained a steady downward trajectory, to 71% at end-fiscal 2008 from 105% in 2005. On the external side, the substantial build-up of central bank reserves and other foreign currency assets gives the monetary authorities greater capacity to mitigate the shock of falling external demand.
Strengthening institutional capacity along with improved credibility should allow the central bank to employ greater flexibility in managing the exchange rate. The exposure of the banking sector to the global financial crisis is limited, with external liabilities low and a loan-deposit ratio of just 54%. Crucially, the cabinet has built up considerable credibility and momentum since 2004, leaving Egypt relatively well placed to attract investment once external conditions improve.
However, the government will be reticent to see growth fall too sharply, because of the social impact. Consequently, the deeper and longer lasting the external slowdown, the more difficult it will be for the authorities to maintain reform momentum and prevent a more substantial reversal in the trend of fiscal consolidation.
The stable outlook reflects our belief that the Egyptian government will meet the challenge of weakening external demand without a substantial deterioration of public finances or veering from its commitment to economic reform. The outlook also reflects the improving credibility of the central bank and declining inflation which together should allow the authorities to dampen the impact of the external shock through employing greater exchange rate flexibility.
The ratings could come under pressure if fiscal discipline and commitment to reform weaken in the face of the slowdown in external demand. A disorderly process of presidential succession would also bring downward pressure on the ratings. The ratings could be raised over the longer term if the government demonstrates its ability to deliver on its target of steady reduction in the fiscal deficit, pays down the heavy debt burden, and maintains structural reform momentum.
