Moody’s explains Egypt upgrade

Emerging Markets, May 2015

The rating agency Moody’s has explained to Emerging Markets the rationale for upgrading Egypt after four difficult post-revolution years, and says many of the country’s indicators now outstrip its regional peers.

“We think all the Arab Spring countries are witnessing some degree of political stabilisation,” says Steffen Dyck, senior analyst at Moody’s Investors Service. “But Egypt has achieved the most, coming out with an economic reform agenda, a stabilising political situation, a commitment to fiscal consolidation and positive external donor support.

On April 7 Moody’s upgraded Egypt to B3 (stable), ending a period of relentless decline in which the sovereign was downgraded by six notches in the space of three years, falling to Caa1 (negative) by December 2013. No other Middle East or North African sovereign rated by Moody’s fell so far. The stable rating is also a stand-out, as Lebanon and Tunisia are both on negative watch. Both Fitch and Standard & Poor’s upgraded the country in late 2014, to B and B- respectively.

The improvement in sentiment reflects a number of attributes. While Egypt has struggled enormously with its political environment, it has never quite stopped growing, and averaged 2.7% per year in GDP growth from 2010 to 2014. While that is hardly outstanding for an emerging market, it is well ahead of Tunisia (1.9%) and more or less level with Jordan (2.8%). Real GDP growth has picked up, helped by recovering consumption and investment. Consensus forecasts expect 4.5% growth in 2015, and 5% in 2016.

Egypt is, however, the country with the highest inflation pressures among its peers, and faces continuing worries about its foreign exchange reserves, although they have at least stabilised ($15.3 billion at the end of March). Its fiscal deficit is the worst in its peer group (leaving aside Libya, whose finances can scarcely even be calculated with any accuracy now), and its government debt as a percentage of GDP, at well over 80%, lags only that of Lebanon. The government is financing itself in the very short-term in the domestic markets, with an average maturity of debt around two years.

“Egypt has run fiscal deficits in excess of 10% of GDP for a long time now: this is not something that started in the revolution,” says Dyck. A medium-term strategic paper released in October pledges fiscal consolidation and a deficit of less than 4% of GDP within five years, which Dyck considers constructive. “The overall emphasis is not on promising what’s unachievable, but clearly outlining the balancing act they have to make between longer-term sustainability and addressing current issues,” he says.

Moody’s view on the banking system changed alongside the sovereign, though risks remain. “You still see all these challenges: high credit risk, capital buffers, the reliance of bank profitability on government securities,” says Olivier Panis, senior bank analyst at Moody’s. 38% of the asset portfolio of Egyptian banks is in government securities, he says, a major risk, and also makes apparently high tier one ratios somewhat misleading. “But the sovereign upgrade reflects an improved capacity for the government to support its banks in times of need.”

There is a lot at stake for Egypt, because improvements in its outlook have not yet convinced portfolio flows. Prior to the revolution, foreign investors made up 10-14% of the government securities market; today the figure is less than 2%. An improvement in both portfolio flows and FDI would achieve a lot: it would show confidence, improve foreign exchange reserves, and spur growth. Dyck, though, says this will take time. “There is no quick fix, but the direction is on the right path.”