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Fitch Ratings – London – 01 Nov 2024: Fitch Ratings has upgraded Egypt’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B’ from ‘B-‘. The Outlook is Stable.
A full list of rating actions is at the end of this rating action commentary.
Key Rating Drivers
The upgrade reflects the following key rating drivers and their relative weights:
HIGH
Lower External Risk, Policy Adjustment: Egypt’s external finances have been bolstered by the Ras El-Hekma foreign investment, non-resident inflows into the debt market, and new IFI financing, facilitated by improved policy settings, including greater exchange rate flexibility and tighter monetary conditions. FX buffers have recovered, and we have somewhat greater confidence that the more flexible exchange rate policy will prove more durable than in the past. Risks to public finances are moderately reduced by measures to curb off-budget public investment and widen the tax base, while we anticipate a marked reduction in Egypt’s extremely high domestic debt interest burden.
Replenished External Buffers: International reserves rose USD11.4 billion in 9M24, to USD44.5 billion, and the banking sector net foreign asset position recovered to near balance, from a deficit of USD17.6 billion in January. This reflected USD24 billion of new foreign-currency (FC) from the Ras El-Hekma deal (which also added to Egypt’s record of support from GCC partners), and an estimated near USD17 billion increase in non-resident holding of domestic debt since February. The remaining USD11 billion of Ras El-Hekma investment converted existing UAE FC deposits held at the Central Bank of Egypt (CBE), reducing external debt.
New Capital Inflows: IFI financing unlocked since March includes the augmented USD8 billion IMF Extended Fund Facility (EFF) and EUR7.4 billion three-year EU support. We project FDI averages USD16.5 billion across fiscal year ending June 2025 (FY25) and FY26, with new investment from Saudi Arabia, and in Ras El-Hekma. These help finance the current account deficit, which widened 4.2pp in FY24 to 5.4% of GDP and we project will narrow to 5.2% in FY25 and 4% in FY26, constrained by only partial recovery of gas production, and depressed Suez Canal receipts. Fitch projects FX reserves at 4.4 months of current external payments at end-FY26, from 5.0 at end-FY24, still above the ‘B’ median of 3.8 months.
More Flexible Exchange Rate: IMF programme monitoring helps maintain the greater degree of exchange rate (XR) flexibility. There is no evidence of CBE FX intervention since the 38% depreciation of the official rate in March, and the parallel market rate has not diverged. Interbank FX volumes have risen by around 10x from their stressed level prior to currency unification, and there is no reported FX backlog at banks. While it is possible that FX demand management measures have contributed to recent very low XR volatility, we do not consider significant currency misalignment has resulted. Nevertheless, an external shock would provide a greater test of the authorities’ commitment to greater flexibility.
MEDIUM
Falling Inflation, Extreme Debt Interest: Inflation fell to 26.4% in September from 35.7% in February, and Fitch forecasts it slowing to 12.5% at end-FY25, supported by large base effects, better-anchored expectations and broad currency stability, and 10.6% at end-FY26. We project the policy interest rate, held at 27.25% following increases of 800bp in 1Q24, is cut to levels consistent with a real rate of near 4%. Given the short maturity of domestic debt, this will drive a fall in general government debt interest/revenue (which is lower than at the central government level) to near 37% in FY29 from a peak of 61% in FY25, albeit still almost treble the current ‘B’ median of 13.9%.
Initial Steps to Contain Fiscal Risks: Financing for large capex projects has slowed, alongside a decree capping overall public investment at EGP1 trillion (a real-terms cut on EGP0.88 trillion in FY23). Planned inclusion of 59 economic entities into the general government perimeter from the FY25 budget should also help improve management of broader public spending. Fitch has not made any adjustment to fiscal metrics to incorporate this definition (which would include a near halving of the interest/revenue ratio). Measures to improve tax administration, increase VAT, and cut fuel subsidies will help contain the general government deficit, which outperformed expectations in FY24 at an estimated 3.4% of GDP.
Egypt’s ‘B’ IDRs also reflect the following key rating drivers:
Greater Geopolitical Risk: Further escalation of regional conflict represents a key risk, primarily through lower Suez Canal and tourism revenue. We forecast the former recovers only gradually to around half of the FY23 level in FY26, mitigating risks. Tourist revenue has been relatively resilient, broadly unchanged in FY24. Escalating conflict represents a moderate risk to our base case that the government contains any large-scale influx of refugees. In addition, high inflation and structural challenges that include weak governance and high youth unemployment give rise to lingering risks of greater social instability, which could constrain reform.
Moderate Reform: Fitch forecasts GDP growth picks up from 2.4% in FY24 to 4% in FY25 on strengthening confidence, real incomes, remittances and FDI, and to 5.3% in FY26, moderately above Egypt’s trend rate. Deeper structural reform, including against IMF EFF measures to enhance private sector activity and competitiveness, is key to lift sustainable growth and avoid renewed build-up of external imbalances in the medium term. Fitch considers the current administration, which is somewhat more technocratic than the recent past, remains broadly committed to the EFF, despite its newly-stated intent to renegotiate some targets.
High but Falling Public Debt: Fitch forecasts the general government deficit to widen to 7.5% of GDP in FY25, reflecting last year’s one-off Ras El-Hekma revenue (of 3.3% of GDP), and higher debt interest and capex, offsetting revenue mobilisation efforts of near 1pp, before narrowing to 7.1% in FY25. We project general government debt falls to 78.9% of GDP in FY26, from 89.1% in FY24, still well above the ‘B’ median of 56.4%. These incorporate annual debt-increasing stock-flow adjustments of 1.5% of GDP to account for Egypt’s record of off-budget fiscal spending. Its large, complex, and still opaque broader public sector create sizeable additional contingent liability risk.
Banking Sector Resilience: The large and liquid banking sector provides financing flexibility for the sovereign. The loan-to-deposit ratio is low, at 60% at end-1H24 and Fitch expects strong deposit growth, helped by improving FC supply, and that banks deploy most of this liquidity in government securities. The CET1 ratio fell 150bp on the March currency depreciation before rebounding to 11.5% at end-1Q24, and we anticipate it improves further in 2H24 and net profits grow more than 50% in 2024.
ESG – Governance: Egypt has an ESG Relevance Score (RS) of ‘5’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Egypt has a low WBGI ranking at the 25th percentile, with a particularly low score for voice and accountability.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
– External Finances/Macro: Deterioration in external finances and/or confidence in macro-policy settings, for example, as a result of a weaker commitment to exchange rate flexibility, weaker international reserves and bank net foreign asset positions, a sustained large current account deficit, and more constrained access to external financing.
– Public Finances: Increased debt sustainability risks, for example, as a result of loosening of fiscal policy, failure to bring down interest/revenue and government debt/GDP in the medium term, or weaker financing flexibility.
– Structural Features: A further escalation of regional conflict increasing instability and security risk in Egypt, with larger negative spill-over impact on tourism, Suez Canal receipts, investor sentiment, or increasing the domestic socio-political challenge to implementing reforms.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
– External Finances: Further reduction in external vulnerabilities, for example, through a marked strengthening of the international reserve position, a sustainable narrowing of the current account deficit, structural reform that reduces risks of renewed imbalances, and improved international market access.
– Macro/External: Greater confidence in the durability of policy adjustments to support exchange rate flexibility and a marked fall in inflation closer to target.
– Public Finances: Lower debt issuance costs, and fiscal consolidation, potentially through greater revenue mobilisation and containment of off-budget spending, that sharply reduce debt interest/revenue and put public debt/GDP on a firm downward path over the medium term.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
Fitch’s proprietary SRM assigns Egypt a score equivalent to a rating of ‘CCC+’ on the Long-Term Foreign-Currency (LT FC) IDR scale.
In accordance with its rating criteria, Fitch’s sovereign rating committee decided not to adopt the score indicated by the SRM as the starting point for its analysis because the SRM output has migrated to ‘CCC+’, but in our view this is potentially a temporary or unsustainable deterioration. Consequently, the committee decided to adopt ‘B-‘ as the starting point for its analysis, unchanged from the prior committee.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LTFC IDR by applying its QO, relative to SRM data and output, as follows:
– Macro: +1 notch, added since the last review, to reflect a material improvement in macro-policy settings that underpin expectations for lower macroeconomic instability, in particular reduced distortions in the FX market and a marked fall in inflation, which is not yet fully captured in the SRM.
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 LT FC 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.
Country Ceiling
The Country Ceiling for Egypt is ‘B’, in line with the LTFC IDR. This reflects no material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting LC into FC and transferring the proceeds to non-resident creditors to service debt payments.
Fitch’s Country Ceiling Model produced a starting point uplift of 0 notches above the IDR. Fitch’s rating committee did not apply a qualitative adjustment to the model result.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Egypt has an ESG Relevance Score of ‘5’ for Political Stability and Rights as WBGI have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Egypt has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
Egypt has an ESG Relevance Score of ‘5’ for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as WBGI have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Egypt has a percentile rank below 50 for the respective Governance Indicators, this has a negative impact on the credit profile.
Egypt has an ESG Relevance Score of ‘4’ for Human Rights and Political Freedoms as the Voice and Accountability pillar of the WBGI is relevant to the rating and a rating driver. As Egypt has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
Egypt has an ESG Relevance Score of ‘4+’ for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Egypt, as for all sovereigns. As Egypt has a track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
The highest level of ESG credit relevance is a score of ‘3’, unless otherwise disclosed in this section. A score of ‘3’ means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.
