Egypt has made further progress in implementing economic and fiscal reforms, which are driving improved macroeconomic stability, fiscal consolidation and stronger external finances. The authorities will complete the three-year IMF Extended Fund Facility (EFF) in 2019. It seems likely these reforms will continue to generate better economic outcomes beyond the IMF agreement. General government debt/GDP is on a downward path, underpinned by structural improvements to the budget and the emergence of primary budget surpluses. We expect spending on wages, subsidies and interest to fall by almost 5% of GDP from June 2016 to June 2020. Monetary policy is targeting single-digit inflation and international reserves have risen to six months of current external payments.
We expect the budget sector deficit to narrow to around 8.6% of GDP in FY19 (fiscal year ending June 2019), with a primary surplus of 1.6% of GDP, close to the government target of 2% of GDP. In 1HFY19 (July-December 2018) spending on subsidies and social benefits was flat in nominal terms. We expect subsidies and social benefits spending to fall by 1.1% of GDP in FY19. Interest spending continued to limit consolidation, but was in line with budgeted amounts. Overall, revenue grew by 28% yoy and expenditure by 17% yoy.
For FY20 the proposed budget again targets a 2% of GDP primary surplus and a budget deficit of 7.3% of GDP. The consolidation will mostly come from lower interest payments because of the disinflation trend, lower interest rates and lower debt as well as another round of subsidy reforms, including the introduction of an automatic fuel tariff adjustment mechanism. Further moderation of the wage bill/GDP and continued efforts to improve the tax administration will also contribute.
In Fitch's view, there is political commitment for further fiscal consolidation and there have been significant structural improvements in the budget that are likely to persist. In FY20 we expect wages and compensation to fall below 5% of GDP, down from an average of 8% in FY15-FY16, underpinned by the civil service law. We expect subsidies and social spending to fall to 5.3% in FY20, from 8% in FY17, following several rounds of tariff hikes across utilities and other regulated prices. Interest payments are likely to peak in FY19 at 10.2% of GDP, before falling by at least 1pp of GDP in FY20. The main risk to policy slippage would be a return of political instability and/or a negative shock to economic growth.
For the medium term, by FY22 the government aims to narrow the deficit to 4.5% of GDP by continuing to run 2% of GDP primary surpluses. We forecast smaller primary surpluses, but nevertheless that consolidated general government debt/GDP will decline to 83% in FY20 from 93% in FY18 and a peak of 103% in FY17. A risk to this forecast is if a portion of government guaranteed debt (around 20% of GDP) crystallises on the government balance sheet.
Macroeconomic stability has improved, with stronger growth and disinflation. Average consumer price inflation dropped to 14.4% yoy in 2018 from almost 30% in 2017, following sharp depreciation of the Egyptian pound in November 2016. The CBE's target has shifted down from 13% (+-3%) in 4Q18 to 9% (+-3%) in 4Q20. We forecast average inflation of 12% and 10% in 2019 and 2020 respectively, building in another round of subsidy reforms in June-July 2019. CBE cut its overnight deposit rate by 100bp to 15.75% in February 2019, maintaining positive real interest rates. We forecast that real GDP growth will remain robust at 5.5% in FY19 and FY20, with risks tilted slightly to the downside.
We estimate that the current account deficit (CAD) moderated to 2.5% of GDP in 2018 from 3.5% in 2017, with the CAD plus net FDI close to balance. We forecast that the CAD will average 2.3% of GDP in 2019-2020, supported by growth in tourism revenues, non-oil exports and rising gas production which has eliminated the need to import gas for now. Stronger overall import growth will nonetheless prevent a smaller CAD.
The CBE's official international reserves rose to USD42 billion at end-2018 (covering an estimated six months of current external payments), from USD36 billion at end-2017, despite USD11 billion-USD12 billion of outflows on non-resident holdings of Egyptian pound government debt in April-December 2018. These outflows hit the net foreign asset position of the banking sector and the CBE's other FX assets (deposits) not included in official reserves. The CBE uses these other reserves as a buffer to limit volatility in the headline number for official reserves. Official reserves increased further to USD44 billion at end-February and the CBE's other FX assets (deposits) increased to USD7.4 billion (from USD5.2 billion). This followed USD4 billion in bond issuance and a USD2 billion IMF tranche.
We project Egypt's external debt service to average around USD10 billion or 12% of current external receipts in 2019-2020, in line with the current 'B' peer median. Within this we forecast sovereign external amortisation and interest costs at around USD7.5 billion on the average in 2019-2020. This assumes further rollover of the majority (75%) of projected maturing GCC deposits at the central bank.
The sustained health of Egypt's external finances will depend on the flexibility of the Egyptian pound, which has not displayed much volatility since the large depreciation in 2016. Inflation in 2017-2018 has eroded a large part of the initial competitiveness gains. The CBE's cancellation in December of the profit repatriation mechanism, which in Fitch's view mitigated potential upward or downward pressures on the currency from portfolio inflows, should herald greater Egyptian pound volatility. The pound weakened only modestly, by 1.7%, against the US dollar between mid-April and end-December, during the period of portfolio outflows. With the return of portfolio inflows in 2019 (equivalent to a quarter of the previous outflows), the Eqyptian pound has appreciated by 3% against the US dollar up to mid-March.
Egypt's ratings also reflect the following key rating drivers:
Relatively weak governance together with security and political risks continue to weigh on the rating. Egypt scores below the 'B' median on the composite World Bank governance indicator. The potential for political instability remains a risk, in Fitch's view, given the economic adjustment programme and ongoing structural problems including high youth unemployment and deficiencies in governance, as well as intermittent security issues, which have previously harmed tourism. The government has sought to mitigate the risk of discontent by bolstering social safety nets (including cash transfer schemes), maintaining food subsidies and boosting electricity provision, while the space for political opposition and freedom of expression is restricted, in Fitch's view.
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 (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macro: +1 notch, to reflect material improvements in macroeconomic stability (in particular disinflation), driven by improvements in both the fiscal and monetary policy frameworks, which are 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.
The main factors that, individually or collectively, could lead to an upgrade are:
- Significant improvement across structural factors, such as governance standards, the business environment and income per capita.
- Sustained progress on fiscal consolidation leading to further large reduction in government debt/GDP.
The main factors that, individually or collectively, could lead to negative rating action are:
- Failure to narrow the fiscal deficit and put government debt/GDP on a downward path.
- Reversal of fiscal and/or monetary reforms, for example in the face of social unrest.
- Renewed downward pressure on international reserves due to strains on the balance of payments.
The political environment is assumed to be relatively stable, although underlying political and social tensions will remain.
Fitch forecasts Brent crude to average USD65/b in 2019 and USD62.5/b in 2020.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR upgraded to 'B+' from 'B'; Outlook Stable
Long-Term Local-Currency IDR upgraded to 'B+' from 'B'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'B'
Short-Term Local-Currency IDR affirmed at 'B'
Country Ceiling upgraded to 'B+' from 'B'
Issue ratings on long-term senior unsecured foreign-currency bonds upgraded to 'B+' from 'B'
Issue ratings on long-term senior unsecured local-currency bonds upgraded to 'B+' from 'B'
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