June 22, 2017 / 11:35 AM / 2 months ago

Fitch Affirms Egypt at 'B'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, June 22 (Fitch) Fitch Ratings has affirmed Egypt's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' with a Stable Outlook. The issue ratings on Egypt's senior unsecured foreign- and local-currency bonds are also affirmed at 'B'. The Country Ceiling and the Short-Term Foreign- and Local-Currency IDRs are all affirmed at 'B'. KEY RATING DRIVERS Egypt's ratings balance a large fiscal deficit, a high general government debt/GDP ratio, and recent volatile political history, with renewed progress in implementing an economic and fiscal reform programme and improving external finances. The government has pressed on with its reform programme, which regained momentum in the second half of 2016, and remains on track with the USD12 billion three-year extended fund facility (EFF) signed with the IMF in November. In May 2017 the IMF and Egypt completed the first review of the EFF, which should lead to the second disbursement, of USD1.25 billion, in June or July. After the floatation of the EGP on 3 November, the Central Bank of Egypt (CBE) seems not to have intervened in the market and the authorities have been gradually removing a number of capital controls. The subsequent depreciation was the second-largest among Fitch-rated sovereigns in 2016. The pound, which was managed at EGP8.9:USD1 prior to 3 November, has averaged EGP17.9:USD1 since (up to 16 June 2017). The shift in exchange rate regime has proved a turning point for Egypt's external finances. CBE's stock of international reserves rose to USD31.1 billion in May 2017, from USD19.1 billion in October 2016 (and a recent low of USD15.6 billion in July 2016). Multilateral and bilateral assistance and substantial bond issuance have boosted reserves. Egypt issued USD4 billion of Eurobonds in January and another USD3 billion in May. There has been a renewal of foreign investment in government T-bills and T-bonds. Furthermore, there are some early signs of external rebalancing, with the current account deficit narrowing to USD3.5 billion in 1Q17, from USD5.7 billion in 1Q16. We estimate that current foreign reserves are now around six months of current external payments (CXP), up from less than three months during the period of 2012-15. The public finances will remain a key weakness of Egypt's credit profile, but we expect further gradual fiscal consolidation to start to reduce government debt/GDP in the fiscal year ending June 2018 (FY18). In the first nine months of FY17 the budget sector deficit narrowed to 8% of GDP from 9.4% in the year-earlier period. The primary deficit more than halved to 1.2% of GDP. The government has exercised restraint across some expenditure items, notably compensation for public sector employees, which only edged up in July-March, thus representing a large cut in real terms. The introduction of VAT (replacing the existing GST) in October 2016 has had a positive effect on revenue growth. In July-March VAT revenue from goods and services was 30% higher yoy, of which VAT from goods was 62% higher, because Egypt had a better administrative system in place for implementing the tax on goods. Subsidy spending, however, continued to rise strongly, by around 30% yoy, despite electricity and fuel price reforms, because the weakening of the EGP increased import costs. The IMF has commended the draft FY18 budget, which is targeting a budget sector deficit of 9% of GDP and a primary surplus of 0.3% of GDP. Budget sector primary deficits have averaged 3.6% in FY11 to FY17, so to reach a surplus would be a significant achievement. We forecast the budget sector primary balance will get close to balance, at -0.3% of GDP. VAT implementation should improve further in FY18, when it will also have a full-year effect and the rate will increase to 14% from 13%. While the government's budget assumptions are largely realistic, the projected inflation rate of 15.2% is likely to prove too low. FY18 inflation may be closer to 20%. In this context, there may be pressure to boost some expenditure items, to mitigate the risk of greater social tensions. This could lead to a larger-than-projected budget deficit. There is also uncertainty over the timing and extent of further energy price reforms, which have yet to be publicly announced. We forecast that general government debt/GDP will rise above 100% by end-FY17, owing to significant additions of external debt and the weaker exchange rate. This debt stock creates a large burden of interest payments for the government (more than 40% of government revenue). We forecast that government debt/GDP will moderate to 93% in FY18 and 87.9% in FY19, assuming faster real GDP growth (averaging 5%), declining but still high inflation, and a small primary surplus in FY19. The key risk to this outlook is that reform momentum weakens, as it did after a round of reforms in FY15. The level of guaranteed debt and contingent liabilities is currently unclear. The Ministry of Finance expects to release data on this later in 2017. Monetary and fiscal reforms are having a significant macroeconomic impact in Egypt, especially on inflation. Inflation has averaged 30% yoy in January-May, driven up by the weaker exchange rate, VAT and higher fuel prices. We forecast that inflation will remain above 20% for the remainder of 2017 and fall back to an average of 13.5% in 2018. CBE is pursuing monetary targeting, which is subject to indicative targets as agreed with the IMF, and has continued to raise its policy interest rates, most recently in May 2017. Headline real GDP growth has slowed in FY17, but has proved more resilient than we expected and is likely to be just under 4% for the year. Despite fiscal consolidation, we forecast stronger GDP growth in FY18, at 4.5%, as the exchange rate adjustment beds in, as gas production starts at the giant Zohr field, and with stronger investment. Fiscal and monetary reforms continue to present some risk of social backlash, especially given ongoing structural problems including high youth unemployment, deficiencies in governance and the business environment, as well as intermittent security issues. The government is seeking to mitigate these risks by emphasising that it is bolstering social safety nets (including cash transfer schemes) and that the reforms will deliver better economic performance and employment. Furthermore, food subsidy allocations have increased and electricity provision has improved markedly. 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 IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign Currency 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 Long-Term Foreign Currency 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. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently balanced. The main factors that, individually or collectively, could lead to a positive action are: - Continued progress on fiscal consolidation leading to declining government debt/GDP; - Sustained stronger economic growth supported by reforms to the business environment leading to increased investment and employment; - Further strengthening of international reserves following a sustained narrowing of the current account deficit and higher net foreign direct investments. The main factors that, individually or collectively, could lead to a negative rating action are: - Failure to narrow the fiscal deficit and put government debt/GDP on a downward trend; - Reversal of fiscal and/or monetary reforms, for example in the face of social unrest; - Renewed downward pressure on international reserves due to further strains on the balance of payments, including weaker access to foreign financing. KEY ASSUMPTIONS The political environment is assumed to be more stable than in 2011-2013, although sporadic, and at times serious, attacks on security forces are assumed to continue and underlying political and social tensions will remain. Contact: Primary Analyst Toby Iles Director +852 2263 9832 Fitch (Hong Kong) Limited 68 Des Voeux Road Central Hong Kong Secondary Analyst Jan Friederich Senior Director +852 2263 9910 Committee Chairperson James McCormack Managing Director +44 203 530 1286 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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