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The rising exit of foreign investors poses a major risk to the Egyptian debt service payment on the back of low external reserves caused by about $14 billion in non-resident outflows.
There is a thin line between Egypt’s external reserve and debt service payments which is nearing maturity, according to Moody’s rating note. And borrowing cost has been worsened by the stubborn inflation rate in the country.
Foreign currencies outflow in Egypt has been pressured by the twin global issue including the pandemic and then the Russia-Ukraine war which makes investors quite uncomfortable.
Rising domestic borrowing costs is projected to worsen liquidity risks and debt affordability challenges, both long-standing weaknesses of Egypt’s credit profile.
In its recent rating note on the sovereign, Moody’s affirmed the long-term foreign- and local-currency issuer ratings of the Government of Egypt at B2 and changed the outlook to negative from stable.
Also, the global rating agency affirmed Egypt’s foreign-currency senior unsecured ratings at B2, and its foreign-currency senior unsecured MTN program rating at (P)B2.
According to the rating note, Moody’s said the negative outlook reflects the rising downside risks to the sovereign’s external shock absorption capacity in light of a significant narrowing in the foreign exchange reserve buffer to meet upcoming external debt service payments.
“While the economy’s external position remains supported by significant financial commitments pledged by Gulf Cooperation Council (GCC) oil-exporting sovereigns and the prospect of a new IMF program, tightening global financing conditions increase the risk of weaker recurrent inflows than Moody’s currently anticipates to shore up Egypt’s external position.
“Susceptibility to event risks is broad-based and includes political risk, especially in the context of a sharp increase in food price inflation which, if not mitigated, could raise social tensions according to Moody’s assessment of the relevance of social risks for sovereign credit”, Moody’s stated.
Meanwhile, the rating noted that the rising domestic borrowing costs, if sustained, will exacerbate liquidity risks and debt affordability challenges, both long-standing weaknesses of Egypt’s credit profile. The rating note reads that the B2 rating remains supported by the government’s pro-active crisis response and track record of economic and fiscal reform implementation over the past six years.
Egypt’s broad and dedicated domestic funding base helps weather tightening financing conditions. Egypt’s strong trend GDP growth supports economic resiliency and the prospect of attracting foreign direct investments in line with the government’s privatization strategy. It noted that Egypt’s local currency (LC) and foreign-currency (FC) ceilings remain unchanged.
“The LC ceiling at Ba2, three notches above the sovereign rating, acknowledges the public sector’s large footprint in the economy that inhibits private sector development and credit allocation, mitigated by a growing track record of implementation of structural competitiveness reforms.
“The FC ceiling at Ba3, one notch below the LC ceiling, reflects the progressive removal of remaining barriers to capital in- and outflows and a more flexible exchange rate which in Moody’s view signal a low risk of transfer and convertibility restrictions, notwithstanding the tighter foreign currency liquidity environment”, according to the rating note.
Moody’s explained that the capital market dislocation triggered by Russia’s invasion of Ukraine, compounded by tightening global monetary policy, has led to a renewed bout of capital outflows by non-resident investors across frontier markets. This impacted Egypt’s local currency market, further drawing down the economy’s external liquidity buffers which had already been weakened during the pandemic.
“The narrow foreign exchange reserve buffer in comparison with upcoming external debt service payments, and net foreign liability positions at the central bank and in the commercial banking system raise downside risks to the sovereign’s external shock absorption capacity amid tight global funding conditions”, Moody’s said.
It is also noted that the fallout from the Russian invasion of Ukraine has triggered non-resident outflows of almost $14 billion as of mid-April from holdings of $31 billion in mid-February. In contrast to previous instances of sharp capital outflows driven by external shocks such as in the second half of 2018 or at the onset of the pandemic in March 2020.
It noted that the most recent external shock materialized when the economy’s liquid foreign exchange reserve buffer at $29.3 billion in April was already weakened by the pandemic and higher imports to fuel the recovery.
The absorption of capital outflows through the banking system has created a net liability position in the monetary system comprising both the central bank and commercial banks of $12 billion in March, a reading not recorded since before the flotation of the pound in November 2016.
In Moody’s assessment, the coverage of this net liability position with foreign exchange reserves to buttress banks’ counterparty risk standing reduces the amount of usable reserves to meet renewed external shocks.
Immediate balance of payment risks are mitigated by $22 billion in financial commitments by GCC sovereigns – of which $11 billion are already deposited in support of FX reserves, and the remainder pledged as Foreign Direct Investment (FDI) and asset purchases – and by the prospect of a new IMF program.
However, in Moody’s assessment continued foreign exchange reserve coverage of upcoming external debt service payments over the next three years at about $25-30 billion (including short-term plus medium/long-term external debt maturities) will depend on continued inflows from abroad.
While Moody’s expects the government’s privatization strategy aiming for $10 billion in FDI inflows annually over four years to help bolster Egypt’s FX reserve buffer in the future, the likelihood of renewed large-scale inflows is low in the near future in Moody’s assessment, raising downside risks.
Inflation Shock Raise Borrowing Costs
Already weak debt affordability as measured by interest/revenue is exacerbated by higher domestic borrowing costs amid rising inflation, increasing funding needs and, over time, crowding out spending for social, investment or security purposes.
Egypt’s debt affordability as measured by general government interest/revenue Moody’s estimates at over 45% and interest/GDP at about 9% in fiscal 2022 is very weak globally, exposing fiscal accounts to tightening borrowing costs.
Over the past two months, the central bank of Egypt has raised the monetary policy rate by a cumulative 300 basis points in response to surging inflation at 13.1% year over year in April.
Moody’s noted that driven by the fallout from pandemic-related supply disruptions, soaring global food and energy prices, and the repercussion of the depreciation of the Egyptian pound by about 14% in March.
The already large interest bill and the large gross borrowing requirements at over 30% of GDP characterize Egypt as among the sovereigns most sensitive to tightening funding conditions, especially in the local currency market.
While Moody’s projects the central bank’s monetary policy actions to keep inflation expectations in check thereby contributing to stabilization and eventual improvement in debt affordability, over time, the larger interest bill crowds out another spending for social, investment or security purposes.
Combined with the negative impact of inflation on living standards – food accounts for more than 30% of the consumption basket -, this points to potentially increasing social risks in Moody’s assessment.
Moody’s said the B2 rating incorporates Egypt’s track record of economic resiliency based on strong economic growth projected at 5.5% in fiscal 2022 and 4.5% in fiscal 2023 before reverting to trend growth at 5% thereafter, and on the government’s crisis management capacity underpinning its institutions and governance strength.
The track record of improved policy effectiveness supports the government’s structural economic reform agenda to enhance export competitiveness, broaden the revenue base, and a shift to targeted income support measures as well as the maintenance of primary surpluses underpinning Moody’s expectation of a renewed reduction in the debt/GDP ratio starting fiscal 2023.
Despite the larger interest bill, Moody’s projects the general government debt ratio to resume its downward trajectory toward 85% of GDP in 2025, after a renewed increase to 93.5% of GDP in fiscal 2022 as a result of the valuation effect from the currency depreciation.
The B2 rating also incorporates the large and dedicated domestic funding base to meet the government’s large borrowing requirements, including during times of non-resident outflows, supported by a lengthening maturity profile, a more diversified investor base and the maintenance of market access.
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