How will the US credit rating downgrade affect Egypt?

Ahmed Feteha, Sunday 7 Aug 2011

The decision to cut the US's top-tier credit rating by a notch could mean a hit for Egypt's stock exchange, foreign direct investment and overseas trade, say local experts

The most direct impact of the world crisis will be seen in Egypt's stock market, FDI and foreign trade

The United States’ credit downgrade could have an impact on Egypt far beyond reducing the value of its dollar-held foreign reserves, with the stock exchange, foreign direct investment and overseas trade all taking a hit, say experts.

Hany Genena, chief economist at Pharos Holdings, says Egypt will see the most significant effects in the stock market where he expects large capital outflows from foreign investors. On Sunday, the first trading session since the downgrade, the Egyptian stock exchange's main index dropped 4 per cent.

Genena doesn’t, however, expect much further difficulty in sales of governmental securities.

"Selling Egypt government debt is already difficult this year due to foreign reluctance - there isn’t much more damage that could be inflicted there," he says.

The balance of payment might also be adversely hit by the deterioration of world economies, especially those that have heavy investment and trade ties with Egypt.

"Egypt will probably witness a severe drop in capital flow from foreign investors, especially Americans," Samir Makary, economics professor at the American University in Cairo, explains.

"Foreign investors will prefer to direct their investment locally in their countries as their surpluses will be limited."

Makary adds that American investors in particular have a commitment towards the Far East which is where their money would go should they invest abroad.

The trade balance could face disruption if the crisis acts to dampen American and European demand, as both economies are among Egypt's top trade partners.

Standard & Poor’s cut the United State’s top-tier AAA credit rating a notch to AA-plus on Friday in an unprecedented blow resulting from concerns about the nation's budget deficits and climbing debt burden.

Reserves might be at risk

Another point of concern is Egypt's foreign reserves, which reached US$25.7 billion at the end of July.

While the breakdown of how reserves are invested is not disclosed on periodical basis, some analysts believe they are heavily invested in US government securities, which could prove risky if the US starts having trouble meeting its commitments.

Hany Tawfik, chairman of the Arab Union for Venture Capital, says that Egypt has been investing a large portion of its reserves in US Treasury-bill purchases, which will be difficult to redeem if the US debt crisis intensifies, Al-Shorouk daily reported.

However, Egypt's finance minster, Hazem El-Beblawi, said Sunday that foreign reserves are not only in dollars and that the basket of international reserves is quiet varied. He refrained from giving more details. 

Egypt's international reserves are mainly made up of foreign currencies, accounting for over 90 per cent of the total by the end of 2010. Egypt also keeps gold reserves whose share grew from around 4.5 per cent in 2006 to 6 per cent in 2010. 

Over the past few years, Egypt’s central bank has modernised its asset management methods and employed sophisticated models for risk mitigation. It successfully overcame the Greek economic crisis by swiftly shifting Egyptian assets at risk with Greek securities to safer instruments.

Dollar depreciation: good or bad?

Egypt could also face risks from the depreciation of the US currency, which might bring a loss in real value for Egypt's foreign investment.

Most experts, however, exclude the possibility of major drops in the value of the dollar, as this would have a devastating effect on most of the major economies worldwide, including China and Japan.

"Some countries rely on their weak currencies relative to a strong US dollar to ensure the competitiveness of their exports," Genena told Ahram Online.

In addition, China holds massive reserves that make up around 30 per cent of the world's total -- soaring above US$3 trillion -- out of which it keeps big chunks in dollar-dominated securities.

A fall in the value of the US dollar would mean huge losses for the world's second largest economy.

Japan, also, keeps a watchful eye on the value of the US dollar. Only last week, the Japanese government stepped into the currency market on to weaken the yen in an effort to help its economy recover from the 11 March earthquake and tsunami.

For his part, El-Beblawi, sees a possible window of opportunity if the dollar slumps. As Egypt's foreign debts are in dollars, a drop in value “is not quiet harmful for us", he told a press conference in Cairo on Sunday.

Makary also touched on this point, explaining that if the dollar plunges Egypt will have to spend less resources to keep an "artificial exchange rate of the Egyptian pound against the dollar."

Short link: