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      FRIDAY, 15/09/2023 - Scope Ratings GmbH
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      Scope downgrades Egypt’s ratings to B- and maintains Negative Outlook

      Higher external liquidity risk and weakening debt affordability amid limited progress on reforms drive the downgrade. A resilient economy and robust relations with official creditors support the ratings.

      For the Rating Review Annex, click here.

      Rating action

      Scope Ratings GmbH (Scope) has today downgraded Egypt’s long-term foreign- and local-currency issuer and senior unsecured debt ratings to B-, from B, and maintained the Negative Outlook. Scope has also affirmed the short-term issuer ratings of S-4 in foreign- and local- currency with a Stable Outlook.

      Summary and Outlook

      The downgrade of Egypt’s credit ratings to B- reflects:

      1. Higher external liquidity risk due to uneven performance on IMF policy conditionality in terms of exchange rate flexibility and the sale of state-owned assets;
      1. Weakening debt affordability as downward pressure on the pound is likely to increase an already high interest burden amid challenging funding conditions.

      Egypt’s government faces narrowing policy options as the necessary adjustment of the exchange rate to rebalance external accounts and bolster international reserves is likely to weaken debt affordability. Slower-than-expected progress on IMF policy conditionality puts the official sector’s assistance at higher risk, which could weigh on investor sentiment, especially given the upcoming presidential election in February 2024 and the less favourable debt service profile on international bonds. Scope views Egypt’s debt servicing capacity in foreign- and local-currency as increasingly contingent on the execution of the reform agenda, primarily in terms of exchange rate flexibility, inflation targeting and private investment-led growth.

      The Negative Outlook represents Scope’s view that risks to the ratings are titled to the downside over the next 12 to 18 months. This reflects delays in IMF disbursements and uncertainties surrounding next year’s presidential election.

      The ratings could be downgraded if, individually or collectively: (i) significant shortfalls in the execution of the reform agenda underlying the official sector’s financial assistance reduced net international reserves and aggravated foreign currency shortages; and (ii) a firm upward trajectory in the interest burden and/or the public debt-to-GDP ratio undermined debt servicing capacity due, for example, to limited fiscal consolidation and/or lower GDP growth.

      Conversely, the Outlook could be revised to Stable if, individually or collectively: (i) the successful execution of IMF policy conditionality led to a sustained reduction in external risks, such as higher net international reserves and improved foreign currency liquidity; and (ii) a sustained fiscal consolidation and/or higher-than-expected GDP growth lowered the interest burden and/or placed the debt-to-GDP ratio on a firm downward trajectory surpassing current expectations.

      Rating rationale

      The first driver supporting the downgrade of Egypt’s ratings to B- reflects higher external liquidity risk due to uneven performance on IMF policy conditionality in terms of exchange rate flexibility and the sale of state-owned assets. Delays before the completion of the first review of the IMF programme threatens the medium-term financing strategy and increases the risk of renegotiating the programme over the implementation period.

      A permanent shift to a flexible exchange rate and the divestment of state-owned assets is at the core of policy conditionality attached to the 46-month Extended Fund Facility approved by the IMF in December 2022 (USD 3.1bn), with the strategic objective of unleashing private sector activity.

      The Central Bank of Egypt (CBE) has executed multiple devaluations since March 2022, enabling to lower the pound by 49% versus the US dollar. It also announced the introduction of a long-term flexible exchange rate regime in October 2022. However, the CBE has effectively re-pegged the pound at a lower level (EGP 30.9 per USD1) and perpetuated regular interventions to stabilise the local currency. The overvaluation of the pound is reflected in the parallel exchange market and 12-month forward rates running at around EGP 41 per USD, or an implied devaluation of 25% versus the official rate. Downward pressure on the pound stems from substantial gross financing needs projected to exceed USD 20bn in 2023 (equivalent to 5% of GDP or more than half of gross international reserves). Although hydrocarbon exports provide a cushion, the current account deficit is projected at almost 3% of GDP on average between 2023 and 2026, alongside rising debt service on international bonds from USD 3.2bn in 2023 to USD 3.5bn in 2024 and USD 3.9bn in 20252. Downward pressure is further exacerbated by vulnerability to geopolitical risks such as the end of the Black Sea Grain Initiative. Yet, President Abdel Fattah El-Sisi has ruled out another devaluation due to high social and fiscal costs.

      Moreover, the privatisation of state-owned assets has fallen short of initial expectations and is driving uncertainty about Egypt’s capacity to sustain this momentum in the longer run. Egypt has sold stakes in state-owned businesses worth USD 1.9bn, of which USD 1.6bn is in USD. Delays in reaching IMF targets as of end-June result mainly from the cautiousness of potential investors, particularly those from the Gulf Cooperation Council (GCC). Their caution relates to the exchange rate used in corporate valuations given the misalignment of the pound with its market clearing level. Slower-than-expected progress on privatisation plans has delayed the approval of the first review of the IMF programme, initially set for March 20233, and increased the risk that Egypt could miss future targets (a cumulative USD 8.7bn) that are projected to cover more than half of the financing gap (around USD 17bn) by 2026-273.

      Uneven performance in the early stages of implementing the IMF programme contrasts with increasingly ambitious targets. The IMF programme is designed such that the sales of state-owned assets rise from USD 2.0bn in 2022-23 to USD 4.6bn in 2023-24 before declining to USD 1.8bn in 2024-25. Between October 2023 and June 2024, the authorities plan to attract USD 5bn in foreign investment from the partial or full privatisation of state-owned companies4. In addition, net international reserves (NIR) are expected to increase by USD 6.0bn in 2022-23, USD 10.6bn in 2023-24, and USD 16.9bn in 2024-26, with the objective of replenishing NIR by more than USD 40bn by the end of the IMF programme. However, the evolution of NIR fell short of the USD 23bn target as of end-June 2023. NIR, approximated by net foreign assets (NFA) of the CBE plus foreign currency reserves, are estimated at USD 17bn in June and USD 16bn in July 2023, versus more than USD 18bn in December 2022. Pressure on external liquidity is also reflected in the NFA position of the banking system (i.e., CBE plus commercial banks). Aggregated NFA reached a record low of negative USD 27.1bn in June 2023. This decline of more than USD 5bn since January 2023 is due to the lower position of commercial banks (negative USD 4.1bn to negative USD 17.1bn), much like the decline of the CBE (negative USD 1.0bn to negative USD 10.0bn).

      Scope believes slower-than-expected progress on IMF policy conditionality could undermine the accumulation of international reserves if capital outflows exceed foreign direct investment. Slow progress on the sale of state-owned assets may reflect the reluctance of the authorities to gradually relinquish state control of the economy. This is despite measures to introduce a level playing field between public and private investors, for example by eliminating tax exemptions for state entities. Moreover, diverging views between the government and the IMF ahead of the completion of the first review, particularly around the sequencing of reforms, raise concerns about the execution of the programme over the longer run. This includes support from other partners and potential disbursements under the Resilience and Sustainability Facility. Next year’s presidential election could further complicate the execution of the reform agenda. Uneven performance raises the likelihood that the programme ending September 2026 will be renegotiated, possibly with a different set of macro-fiscal assumptions and policy conditionality to close the financing gap identified over the implementation period.

      The second driver supporting the downgrade of Egypt’s ratings to B- relates to weakening debt affordability as downward pressure on the pound is likely to increase an already high interest burden amid challenging funding conditions.

      General government debt is projected to peak at 99% of GDP in 2023 and remain relatively high around 80% of GDP by 2028. With more than 20% of government debt denominated in foreign currency, a devaluation and/or a permanent shift to a flexible exchange rate regime will trigger valuation effects on foreign currency liabilities. Moreover, funding conditions on international markets are sensitive to slower-than-expected progress on the IMF programme, with yields on 10-year international bonds around 18%. This could undermine the government’s strategy to diversify external funding, including through official sector guarantees. In addition, domestic borrowing costs, with yields on 12-month treasury bills around 25%, are exposed to rising monetary policy rates (up 100 bps in August to 19.25% for the overnight deposit rate5). Scope considers additional policy rate hikes likely given negative real interest rates (around 20%), a rising inflation rate (39.7% year-on-year in August, 38.2% in July 2023) that exceeds the CBE’s target (7% ±2 pp on average by Q4 2024) and inflationary pressure associated with a potential adjustment of the exchange rate.

      However, Egypt’s ability to withstand a rise in interest payments is hindered by an already high interest-to-revenue ratio. Interest payments accounted for more than 60% of central government revenue over the period of July 2022 to May 20236, and this ratio rises to around 66% on a 12-month rolling average, close to the historical highs reached during the Covid-19 pandemic. Net interest payments at the general government level are projected to average 47% of revenues or 9% of GDP by 2028.

      Moreover, exchange rate flexibility may cloud the fiscal outlook via a rise in social expenditures. A devaluation and/or a permanent shift to a flexible exchange rate regime is likely to increase subsidies, grants and social benefits as the government shields the most vulnerable from a cost-of-living crisis, particularly in food products and energy. Social spending accounted for 26% of central government revenues over the period of July 2022 to May 2023. This ratio could rise further because of widespread poverty, power cuts and a reform agenda increasing sociopolitical risks ahead of next year’s presidential election.

      Egypt’s draft budget for fiscal year 2023-24 targets a primary surplus of 2.5% of GDP, which is above the average performance of 1.2% of GDP between 2019 and 2021. However, the headline deficit is projected at 7.0% of GDP. This reflects a modest revenue base (below 20% of GDP) and heavy reliance on debt-creating flows, with new borrowing accounting for almost half of revenues for fiscal year 2023-24. High public debt and pressure on expenditures, including a rising interest burden, weigh on general government gross financing needs estimated at more than 35% of GDP on average by 2028.

      At the same time, Egypt’s B- ratings reflect the following credit strengths:

      First, Egypt has a resilient economy as demonstrated during the Covid-19 pandemic and Russia-Ukraine crisis. The economy is relatively large (USD 475bn in 2022) and well diversified based on robust manufacturing and service sectors. The GDP growth rate is projected to decelerate to 4.0% in 2023 as growing uncertainty around reform implementation and next year’s presidential election weigh on domestic demand. It should then pick up to 5.0% in 2024. Downside risks to this outlook primarily relate to delays in implementing the IMF programme, monetary policy tightening, and foreign currency shortages leading to import compression. High inflation feeding through to domestic prices, the downsizing of infrastructure projects and sustained power cuts could weigh on economic activity into the medium term, although the development of hydrocarbon production and the expansion of nuclear power could provide a cushion. In the long run, limited progress in spurring the private sector is a risk for growth potential, which is estimated at above 5%.

      Second, Egypt has robust relations with official creditors. Despite delays in the execution of the reform agenda, the country is expected to continue to benefit from the support of the IMF and the GCC via disbursements, rolling over of deposits at the CBE, and investment pledges. This reflects the authorities’ track record under previous IMF programmes, the IMF and the GCC’s large financial exposure to the country, and Egypt’s importance in terms of trade, energy, and regional security. Robust relations with official creditors are illustrated by the contract with the International Financial Corporation7 to advise on asset sales; the credit facility for wheat purchases extended by the Abu Dhabi Exports Office; the loan from the Arab Monetary Fund to support financial sector and banking sector reforms; and possible guarantees from the Asian Infrastructure Investment Bank8 and the African Development Bank9 on Egypt’s planned bond issuances in CNY.

      Core variable scorecard (CVS) and qualitative scorecard (QS)

      Scope’s core variable scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an initial indicative rating of ‘b+’ for Egypt. Egypt receives no positive adjustment for reserve currency considerations. As a result, the ‘b+’ indicative rating can be adjusted by the qualitative scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses compared to a peer group of countries.

      For Egypt, credit strengths relate to: i) the growth potential of the economy. In addition, the following relative QS credit weaknesses are indicated: i) fiscal policy framework; ii) debt sustainability; iii) debt profile and market access; iv) current account resilience; v) resilience to short-term shocks; vi) financial imbalances; vii) social factors; and viii) governance factors.

      Combined relative credit strengths and weaknesses generate a two-notch downward adjustment and indicate B- long-term ratings for Egypt.

      A rating committee has discussed and confirmed these results.

      Factoring of environment, social and governance (ESG)

      Scope explicitly factors in ESG issues in its rating process via the Sovereign Rating Methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) and in the methodology’s qualitative overlay (QS).

      Environmental factors are explicitly considered in the ratings process via the environment subcategory in the ESG sovereign risk pillar. Egypt is highly vulnerable to climate change given coastal urban areas and dependence on the Nile Delta. Limited fiscal space and the exploitation of hydrocarbon resources could limit diversification of the energy mix. Yet, the authorities updated the Green Financing Framework following COP27 and launched the National Climate Change Strategy 2050, under which Egypt can count on financial support from multilateral partners. The European Bank for Reconstruction and Development’s country strategy for the period of 2022-27 aims at accelerating Egypt’s shift towards a green economy as a strategic priority. The Asian Infrastructure Investment Bank could provide an official guarantee on climate-related bond issuance. This underpins Scope’s ‘neutral’ assessment.

      Social factors are similarly captured under the CVS through the old-age dependency ratio and the labour force participation rate. The old-age dependency ratio (people aged 65 years or over as a percentage of those aged 15-64) is expected to remain low at 10% by 2035. However, a rapidly growing population represents a challenge in terms of labour market integration in view of a low participation rate and an elevated youth unemployment rate. Absent private sector development and more inclusive growth, social challenges are expected to drag on public spending via poverty mitigation measures such as conditional cash transfer programmes. Moreover, potential adjustment to the exchange rate is likely to exacerbate socioeconomic challenges. This underpins Scope’s ‘weak’ assessment.

      Under governance-related factors, Egypt has the lowest possible score based on the World Bank’s Worldwide Governance Indicators under the CVS. The country performs poorly in terms of voice and accountability, and control of corruption. Moreover, vested interests and the role the military plays in the economy might complicate the implementation of reforms. This supports Scope’s ‘weak’ assessment.

      Rating committee
      The main points discussed by the rating committee were: i) macroeconomic outlook; ii) fiscal risks and debt sustainability; iii) labour market and demographics; iv) external sector risks; v) financial sector developments; vi) ESG-related risks; and vii) peers.

      Rating driver references
      1. Central Bank of Egypt, Monthly Statistical Bulletin, May 2023
      2. Central Bank of Egypt, External Position of the Egyptian Economy, 2022/2023
      3. IMF, Request for Extended Arrangement Under the Extended Fund Facility, January 2023
      4. Arab Republic of Egypt, The Cabinet, December 2022
      5. Central Bank of Egypt, Press Release, August 2023
      6. Ministry of Finance, Monthly Finance Report, July 2023
      7. International Finance Corporation, Press Release, June 2023
      8. Arab Republic of Egypt, State Information Service, June 2023
      9. African Development Bank, Press Release, May 2023

      Methodology 
      The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      The model used for these Credit Ratings and Outlooks is (Sovereign CVS model version 2.1), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.
       
      Solicitation, key sources and quality of information
      The rated entity and its agents did not participate in the ratings process. The rating was not requested by the rated entity or its agents. The rating process was conducted:
      With Rated Entity or Related Third Party Participation    NO
      With Access to Internal Documents                                NO
      With Access to Management                                          NO
      The following material sources of information were used to prepare the credit rating: public domain.
      Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
      Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and outlook and the principal grounds upon which the credit rating and outlook is based. Following that review, the rating was not amended before being issued.

      Regulatory disclosures
      These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
      Lead analyst: Thomas Gillet, Director
      Person responsible for approval of the rating: Giacomo Barisone, Managing Director
      The Credit Ratings/Outlooks were first released by Scope on 31 March 2023.

      Potential conflicts
      See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

      Conditions of use/exclusion of liability
      © 2023 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.

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