The Outlook on both ratings is Negative. The agency has also downgraded the Country Ceiling to 'BB-'. The Short-term foreign currency IDR has been affirmed at 'B'.

"The downgrade and Negative Outlook reflect the substantial and continuous erosion of Egypt's international reserves in 2011, which accelerated in October/November. Ongoing political turbulence is also delaying economic recovery and has contributed to worsened debt dynamics," says Richard Fox, Head of Middle East and Africa Sovereigns at Fitch.

International reserves have fallen by 44 per cent in 2011, to just over $20bn in November, from USD36bn in December 2010. Although reserves remain above three months of current external payments, the pace of decline is a concern in the absence of substantive external assistance which has been promised but awaits definitive decisions by the government, particularly regarding IMF borrowing.

The reserve decline has also returned the Egyptian government to being a net external debtor, for the first time since 2004, reversing what had been a key support to Egypt's rating. However, the country as a whole remains a net external creditor due to the net creditor position of the banking system.

The continuing reserve loss is due to the dramatic weakening of the capital account since February, with a drying up of FDI and substantial exit of foreign portfolio investment, at a time when the central bank has aimed to preserve exchange rate stability. Meanwhile, most of the substantial amounts of promised external support have not yet materialised. This has also put pressure on domestic financing, with EGP T-bill and bond yields rising to 14%-15%, compared to inflation of 9 per cent.

The provision of external support and a turnaround in foreign investment are key to stabilising international reserves and the rating.

The Egyptian authorities decided against IMF borrowing in June but are now reconsidering the position.

Public finances, long a key rating weakness for Egypt, have further weakened, with the general government debt/GDP ratio trending up again and likely to breach 80 per cent in 2012.

This year's budgeted deficit of 8.6% of GDP will be substantially overshot, largely due to weaker than expected revenue performance.

Even with recently announced spending cuts, the government has said that this year's deficit will exceed 10 per cent of GDP.

Fitch forecasts a figure of over 11 per cent. Key to stemming the deterioration of creditworthiness will be controlling the fiscal deterioration and the resumption of fiscal consolidation in the FY2012/13 budget, notwithstanding likely additional pressures arising from the newly empowered electorate's increased aspirations for jobs and improved living standards.

Elections are going well, with high turnout and results widely accepted as credible.

Nevertheless, the political transition is proving turbulent and taking longer than initially expected, raising policy uncertainty and damaging confidence.

Islamist parties will have a majority in parliament but the government is likely to be a coalition including secular parties. However, the precise shape of the new government will not be known until the elections conclude in January.

Upper house elections will not be completed until March. The constitution will then be rewritten before presidential elections are held in June. Meanwhile, the ruling military council and newly elected parliament are likely to continue vying for power.

The constitutional debate over their various powers and those of the president is likely to be heated. Meanwhile, some protestors are demanding an early end to the military government.

A stable political system is unlikely to emerge until mid year at the earliest and possibly much later.

Growth in FY2011/12 is likely to be no stronger than last year, at under 2 per cent. Unemployment, a contributor to the February 2011 regime change, is rising, at a time when aspirations have been raised. The global slowdown will be a further drag.

The ratings will remain under pressure until the political situation stabilises and a government is able to implement a comprehensive economic programme which attracts external support and foreign investment. Such a programme, effectively implemented, could stabilise the rating.

Further delay to the government transition timetable would be ratings negative. Significant further reserve loss, in the absence of promised external support would exacerbate exchange rate pressures and also bring negative rating action, as would further worsening of debt dynamics and any deterioration in the macroeconomic policy framework.