Credit downgrade complicates financing for a struggling Egypt

Ahmed Feteha, Sunday 30 Oct 2011

Downgrades by Moody's and Standard & Poor's will have a serious effect on Egypt's ability to raise funds from the bonds market, but loans from the IMF and other organisations are unlikely to be harmed

Egypt's recent credit downgrades rendered tapping foreign bonds markets for funds a bumpy task (Photo: Reuters)

The downgrade of Egypt’s credit rating further towards junk territory will take its toll on the country’s ability to issue bonds domestically and internationally, according to experts.

However, borrowing from international financial organisations such as the IMF or the World Bank will feel little effect, as hikes in loan pricing and the placing of stiffer conditions are unlikely.
October was a worrying month for Egyptian finances, with international rating agencies Moody’s and Standard & Poor's (S&P) each slashing the country’s credit rating by at least one notch.
On 19 October, S&P cut Egypt’s foreign currency rating to BB-minus from BB -- the same rating assigned to Bangladesh, Angola, El-Salvador, Gabon and Vietnam.
The local currency rating was cut by two notches, to BB-minus from BB-plus. 
S&P said the transition to a new government had increased risks to macroeconomic stability, warning another downgrade is possible if the political transition does not go smoothly.
Moody’s did the same on 28 October, slicing Egypt’s rating to B1 from Ba3. Moody’s rating is still one level below that of S&P.
Both agencies have a negative outlook on their ratings, which indicates further downgrades are expected in future.
Fitch, another rating agency, has the highest rating for Egypt -- BB -- but still has a negative outlook on the country’s debt repayment ability.
Experts believe the downbeat ratings will have adverse effects on Egypt’s status in local and international money markets.
“What is more harmful than the downgrade is the negative outlook -- it suggests the potential for drops in the future,” says Hany Genena, chief economist at Pharos Holding.
Genena explains that the S&P rating of BB-minus indicates uncertainty for repaying long and medium term debt, but a solid ability for paying short-term commitments. 
"We are now on the borderline -- a downgrade to B can be very problematic."
The recent downgrades could have a twofold effect on Egypt; one for the existing portfolio whose pricing might increase if it is stipulated by bond deal covenants. The second is the increase of the cost of raising new debt.
The existing portfolio will not be affected by the downgrade as the bond deals fixed the required yield from the issuer, but the price of Egypt’s bonds will drop, according to Ahmed Atta, managing director of Piraeus Egypt, an asset management company.
Sources inside Egypt’s ministry of finance told Ahram Online that there are no intentions to issue sovereign bonds denoted in Euro or Dollar in the coming period.  
Egypt issued $1.5 billion in Eurobonds in 2010, which included $1 billion in 10-year bonds and $500 million in debt due to mature in 2040. Former finance minister, Samir Radwan, talked last May about plans to sell $1 billion in Eurobonds, but these plans never materialised.
Should Egypt consider tapping foreign bonds markets for funds, however, it will not be an easy task.
“Risk averse institutions might move away from Egypt’s debt altogether, smothering demand and raising prices. In all cases, it will cost Egypt more to borrow,” Genena says.
Along with the drop in demand and the result increase in yields, the cost of insuring Egyptian debt instruments will also surge on the increased risk.
In September, the country’s insurance rate on sovereign debt grew to 506 basis points, Bloomberg reported, attributing the surge to the worsening of Europe’s debt crisis and local political turmoil that raised doubts on a possible delay of parliamentary elections due in November.
The risk data compiled by data provider CMA, said that contracts were at 435 points on 24 October, giving Egypt a 26 per cent probability of default on government debt in the next five years. During the 18 day revolt that erupted in January, insurance cost on sovereign debt grew from 307 to 410 points.
Egypt is the riskiest in the Middle East, followed by Dubai, according to CMA data.
The same reaction seen in insurance cost is also present in bond yields.
Yield on the Egypt’s 10-year dollar bond due in 2020 reached a post-uprising high of 6.93 per cent in March when political uncertainty rocketed after President Mubarak was forced from office. The bond was initially priced at 5.75 per cent.
In October yields reached 5.8 per cent, but Atta expects yields to rise again on the back of recent downgrades.
Meanwhile, the cost of borrowing from international finance bodies is not expected to rise.
"These loans are aimed at helping the economy, so by nature they are priced at low rates with lenient conditions. It is unlikely that the downgrade will affect them," says Magda Qandil, executive director of the Egyptian Centre for Economic Studies.
In June, Egypt nearly concluded an agreement with the IMF for a $3.2 billion loan with a 1.5 per cent interest rate. The deal, however, had to be scrapped due to the ruling military council’s objection to increasing the country’s exposure to foreign debt.
Egypt is currently renegotiating with the IMF for a similar facility, along with other facilities from multilateral development lenders.
For his part, Genena also excludes the possibility of hardened conditions on an IMF loan.
He explains that a foreign injection might even result in a better outlook for Egypt’s economy, because of its projected effect on stabilising the exchange rate and curbing inflation.
The downgrade could also translate to further reliance on local borrowing to finance budget deficit which is expected to reach 8.6 per cent of GDP in the current financial year. 
Yields on treasury bills have reached a near three-year high and the government has had to cancel three auctions since June due to high yields requested by buyers.
Last week, Egypt sold five and seven-year treasury bonds, denoted in the Egyptian pound, at yields that were lower than expected by analysts.  
The five-year treasury bonds were priced at an average yield of 14.26 per cent. Average yields on seven-year notes was 14.52 per cent, compared with an estimate of 14.8 per cent.
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