Moody’s Investors Service said Friday it continues to review for downgrade the Government of Egypt’s B3 long-term foreign-currency and local-currency issuer ratings.
The credit rating agency said the review balances progress on the government’s privatization, fiscal, and structural reform agenda against evidence of a further weakening in external liquidity through a drawdown of commercial banks’ net foreign assets at a scale that exceeds recently concluded asset sales.
Moody’s said the continuation of the review reflects its concerns about the persistence of foreign exchange shortages, as reflected in a parallel currency market, and the materialization of new terms of trade shocks in the food and energy sectors.
These factors, the agency said, increase the likelihood of a renewed official currency devaluation that could drive inflation, borrowing costs, and the general government debt ratio to levels more consistent with a lower rating level.
The extended review period for Egypt’s downgrade will focus on the extent to which the proceeds of the recently concluded asset sales help restore foreign currency liquidity buffers evident in foreign exchange reserves, the monetary system’s net foreign asset position, FDI inflows, as well as exchange rate dynamics.
It will also focus on the government’s ability to successfully secure disbursements under the IMF program based on the structural reforms undertaken with respect to fiscal and business environment reforms, in addition to the recently concluded asset sales.
Sufficient confidence in the ability of the government to generate necessary foreign exchange inflows, e.g. with the privatization program, to meet increasing external debt service payments over the next two years and bolster the economy’s foreign exchange reserves would be credit positive.
According to Moody’s, an ability to prevent, or at least limit, an increase in debt affordability challenges would engender confidence in Egypt’s ability to navigate continued depreciation risks.
However, an inability to arrest a further drawdown in foreign currency liquidity in the monetary system or improve the foreign exchange reserve position that could worsen depreciation pressures or jeopardize IMF financial support notwithstanding progress in the privatization program and the improvement in the current account, would likely lead to a downgrade.
Egypt’s persistent external liquidity drawdown could negate asset sales
Moody’s Investors Service said that Egypt’s persistent external liquidity drawdown could negate the proceeds of recent asset sales.
The credit rating agency said that the Egyptian government has announced $1.9bn in asset sales, of which $1.65bn in foreign exchange proceeds. This comes as part of the IMF program and financing strategy which aimed at raising $2bn by the end of June, followed by $4.6bn in fiscal 2024.
Egypt’s government has also announced the prospect of an additional $1bn in asset sales to be finalized in the fall. Supporting the future privatization strategy, the government has on 18 June contracted the International Finance Corporation (IFC) as an asset sale advisor, benefiting from IFC’s private sector development experience in emerging market countries across the globe.
Moody’s expects the proceeds of these asset sales to be recorded at the Central Bank of Egypt, supporting its net international reserve position according to IMF program targets. However, the agency warned that the volume of new NFA drawdowns points to persistent FX liquidity shortages in the economy and indicates the potential neutralization of asset sale proceeds.
“If sustained, continued net outflows could potentially undermine the goal to sustainably replenish the economy’s foreign exchange liquidity buffers ahead of increased debt service payments in fiscal 2024 and 2025,” the statement added.
In addition, at $27.1bn as of June the monetary system’s net foreign liability position for the first time exceeds available liquid foreign exchange reserves (i.e., gross official FX reserves minus gold minus SDR) at $27bn in June and $26.5bn in July, indicating in Moody’s view increased counterparty risks for exposed Egyptian banks to continue borrowing from correspondent banks abroad.
In line with this assessment, public and private sector Egyptian banks have started offering higher-yielding US-dollar certificates of deposits to attract additional US-dollar liquidity from abroad that currently bypasses the banking system, generating additional US-dollar funding requirements at maturity.
The statement continued by saying that “the persistence of foreign exchange shortages, as reflected in a parallel currency market, and the materialization of new terms of trade shocks in the food and energy sectors, increase the likelihood of a renewed official currency devaluation that could drive inflation, borrowing costs and the general government debt ratio to levels more consistent with a lower rating level.”
Egypt’s parallel exchange rate market persistence increases likelihood of devaluation
Moody’s Investors Service said that the persistence of Egypt’s parallel exchange rate at EGP38 per $1, against the official rate at EGP30.9 per $1 amid continued foreign exchange outflows increases the likelihood of renewed official currency devaluation.
The credit rating agency said that a further devaluation could drive inflation, increase borrowing costs, and the general government debt ratio to levels more consistent with a lower rating level.
Moody’s said that the improvement in Egypt’s current account deficit to below 2.5% of GDP on an annualized basis recorded in the first quarter of 2023, according to Moody’s estimates, from 3.5% in fiscal 2022, may be adversely impacted by the materialization of renewed terms of trade shocks in the food and energy sectors.
This comes following Russia’s suspension of the Black Sea Grain Initiative on 17 July and the expected weakening in Egypt’s hydrocarbon trade balance as compared to last year in light of increased domestic demand. This could reverse some of the import compression achieved as a result of the 50% nominal devaluation since early 2022 and exert increased pressure on the currency.
Another 20% depreciation, as implied by the parallel exchange rate, would likely further increase domestic borrowing costs from already-record highs at 23.5% in August for the 91-day T-bill rate and weigh on already-weak economic growth.
The government’s demonstrated capacity to raise revenue and generate continued primary surpluses –Moody’s projects 1.7% of GDP for fiscal 2023–would mitigate the deterioration, but would not prevent the adverse valuation effect driving the debt/GDP ratio toward 100% from about 95% in fiscal 2023 – levels indicating a very high shock exposure and potentially more consistent with lower-rated peers.
In addition, Moody’s believes the pass-through to higher inflation would further undermine households’ purchasing power and exacerbate social risk.
Delayed IMF review risks undermining confidence
The credit rating agency indicated that the delayed IMF review of Egypt’s economic reform program risks undermining confidence in the country’s ability to secure external financing and support its credit profile.
The credit rating agency said that Egypt has made significant progress on the reform agenda under the $3bn, 46-month IMF program approved in December 2022, including raising the primary surplus target for fiscal 2024 to 2.5% of GDP and ratifying a law that eliminates preferential taxes and customs treatment for state-owned enterprises.
However, Moody’s said that the IMF has not yet completed the first and second reviews of the program, which is due to the disagreement over the modalities of currency flexibility implementation.
The agency said that a lack of progress on the IMF review over the remaining review period would be an indication of a potential weakening of external financial support, which otherwise provides key support to Egypt’s credit profile at the current rating level.