A negative outlook was assigned to Egypt's sovereign rating by emerging markets rating agency Capital Intelligence. The current long-term rating is BBB- and the short-term A3. The move reflects deterioration in economic fundamentals and the sluggish pace of reform.
A yawning trade gap, weak foreign investment inflows and increasing deposit dollarization—driven partly by currency devaluation expectations—have applied downward pressure on the exchange rate and official foreign exchange reserves in the past few years.
The policy response to date has been largely reactive rather than proactive and involved an awkward mix of incremental adjustments to the exchange rate, administrative barriers to trade, and public sector cutbacks on overseas procurement.
However, foreign currency shortages persist and an unofficial parallel market for foreign exchange continues to operate. High real interest rates and currency risk have substantially weakened private sector investment since 1999.
In addition, a rapid increase in the public sector wage bill and sluggish tax revenue growth due to much weaker economic activity has caused a substantial widening of the budget deficit. The deficit is expected to average over five percent of the Gross Domestic Product (GDP) in each of the years 2001-2003 having stood at 2.9 percent in 1999.
In the absence of developed capital markets, the authorities are continuing to finance the budget largely by borrowing from the central bank—a policy, which is inconsistent with a pegged exchange rate.
While the current balance of payments shock is expected to be mitigated by loans and grants from donor countries, the authorities must do more to support the diversification of the export base in order to reduce the volatility of foreign currency earnings.
Tackling structural impediments to growth (including the costly public sector and barriers to trade) is essential if the economy is to successfully absorb a labor force growing at around three percent per annum.
The authorities are aware of the problems and have recently taken steps to widen the tax base, increase central bank autonomy, establish a network of primary dealers in government debt and boost exports through a free trade agreement with the European Union (EU) and new legislation aimed at cutting red tape. Nonetheless, the pace of reform remains slow.
Egypt's creditworthiness is supported, however, by adequate international liquidity and a modest debt service burden. Official reserves, though falling, are nearly double the sum of the projected current account deficit and external debt amortization for 2002.
In addition the public sector foreign debt stock is relatively small and highly concessional. The ratio of foreign debt service to current account receipts was 7.4 percent in Egyptian Fiscal Year 2001 and is expected to be a still comfortable 8.3 percent in FYE2002.
The country's difficult economic conditions have predictably impacted Egyptian banks. Following a period of rapid credit growth in the years preceding the economic slowdown, asset quality is coming under pressure as problem loans continue to rise in the banking system.
Earnings difficulties are being exacerbated by the need to create additional loan-loss provisions, putting further strain on banks' profitability. Conversely, this is being offset by slowly improving liquidity and acceptable levels of capitalization, though a few banks may face difficulty in meeting the new 10 percent capital adequacy requirement stipulated by the central bank of Egypt.
Since banks' foreign currency ratings are constrained by the country's sovereign ceiling, a negative outlook is assigned to all Egyptian banks and their ratings placed on review. — (menareport.com)
© 2002 Mena Report (www.menareport.com)
