The credit rating of Egypt's local currency debt was downgraded, the outlook for the foreign currency is appraised as negative. Sherine Abdel-Razek reports on the reasons and repercussions of those moves The American rating agency Standard and Poor's lowered Egypt's long-term local currency credit rating earlier this week. Although S & P chose not to change the long- term foreign currency or short-term ratings in both foreign and local currencies, their outlook was revised to "negative". Macroeconomic concerns were cited for the moves. "The lowering of the long-term local currency rating reflects the projected deterioration of the budget deficit and the consequent reduction in domestic financing flexibility," noted a S&P statement. The downgrade concerns LE13 billion worth of government bonds of varying duration mostly held by public and private banks. The level of the local debt, represented in both the bonds and the shorter duration bills, caused anxiety locally during May and June when the new budget for the year 2003-2004 was discussed. The government came under fire due to its policy to resorting to local borrowing to finance its expanding deficit and thus constraining future budgets with debt servicing rather than finding ways to tighten the deficit. So, the move is "justified" according to Joseph Iskandar, investment analyst in Prime Securities. "Rating agencies change their ratings according to different criteria, one of which is the percentage of the deficit to the gross domestic product (GDP). In Egypt we have a double whammy in this particular criteria as our deficit is ballooning while our GDP growth is shrinking." S&P said that Egypt's government deficit reached 6.3 per cent of the GDP in the 2002/2003 fiscal year and is expected to comprise 7.3 per cent in 2003/2004, due to slow economic growth, a high public wage bill, and burgeoning interest payments. Meanwhile, the average GDP growth rate for the past three years comes around 2.5 per cent. "This is minimal compared to an average range of 3.5-5.5 per cent for emerging markets," pointed out Iskandar. The downgrade of the local currency debt, however, will have a limited impact on the market. The government bonds issues are mainly subscribed in by public sector banks that are a part of the government apparatus and thus consider the debt of very low risk, according to Noureddin Mohamed, a Fixed income sales trader at EFG-Hermes. As for the foreign banks with branches in Egypt, Mohamed believes that they might reconsider their investments in government bonds and ask for higher yields to compensate for the added risk, which means higher levels of debt services in a spiralling downward cycle for the government budget. The average current yield on the government bonds is eight per cent. Nevertheless, it is not the downgrade of the local currency debt that is raising concern now, but rather the outlook revision of the foreign currency debt. Revising the outlook of the foreign debt reflects the likelihood of further downgrading in the country's sovereign rating, which measures the creditworthiness of any debts the government is currently trying to finance in the foreign markets. S&P's rating for Egypt's external debt is its highest speculative grade rating, not in the less riskier investment grade category. Speculative grade borrowers have access to a much narrower pool of potential investors than investment grade borrowers. "If our sovereign grade is revised even one notch lower, we will be deprived from a lot of investment opportunities as other emerging countries in the region like Turkey were upgraded," said EFG's Mohamed. "International Fund mangers distribute investments in their portfolios among countries according to certain weightings that are highly dependent on their credit ratings," Mohamed explained. The negative outlook is considered an ominous indicator by most market watchers and was immediately felt in the transactions on Egypt's Eurobond market as selling orders increased soon after the revision. The Eurobonds have been on the slide since May, while Egypt's 2006 dollar bond, its short term benchmark, has fallen 2.6 per cent in value since 23 May. The longer term benchmark has fallen 1.2 per cent during the same period. In a parallel move S&P also revised its outlooks on National Bank of Egypt (NBE) and Commercial International Bank (CIB) to negative from stable. NBE is Egypt's largest public sector bank while CIB is its number one private sector bank with regards to the assets value. According to Iskandar, it is standard procedure when they rate a country to assess its banking sector and being Egypt's largest banks, NBE and CIB are generally representative of the overall sector health. "The ratings on NBE and CIB will continue to depend directly on the ratings on Egypt, and indirectly on the economic environment," said Standard & Poor's credit analyst Emmanuel Volland in a press release. "The Egyptian banking sector faces asset- quality pressures due to fallout from the attempted economic restructuring of domestic industries and signs of stress in some key economic sectors." In spite of the bank's strong commercial position, and adequate liquidity, NBE is seen by S&P to be burdened by an increasing portfolio of bad loans, while below-average information technology (IT) capabilities represent an additional drawback. The rapid expansion of NBE's lending business is also pressuring the bank's capitalisation. As for the CIB, the ratings are constrained, by the risks inherently associated with operating in the problematic Egyptian economy. "CIB's competitive position and core corporate franchise are likely to remain strong in coming years as a result of investment in technology and commitment to both new services and product diversity," Mr Volland said. "A significant slowdown in the economy, however, could have a major impact on the bank's asset quality." Iskandar believes that the revision will definitely affect the cost of borrowing for the two banks if they decide to resort to the foreign markets. The shares of CIB dropped noticeably on the first day of trading after the announcement of the revision, losing 0.73 per cent of its value. NBE is not a listed company in the local stock exchange.
