FT Alphaville » Another Egypt downgrade – S&P cuts to BB

Just when things were beginning to look up for Egypt…

… Standard & Poor’s has followed Moody’s and downgraded the country’s ratings.

The statement, with our highlights, below:

Rating Action On Feb. 1, 2011, Standard & Poor’s Ratings Services lowered its long-term foreign currency sovereign ratings on the Arab Republic of Egypt to ‘BB’ from ‘BB+’, and its long- and short-term local currency ratings to ‘BB+/B’ from ‘BBB-/A-3′. The short-term foreign currency rating of ‘B’ was affirmed. We have also placed the long-term local and foreign currency ratings on Egypt on CreditWatch with negative implications.

The recovery rating on Egypt’s senior unsecured debt is unchanged at ‘3′, indicating our expectations of meaningful (50%-70%) recovery of principal, on a net present value basis, in the event of a default or restructuring of Egypt’s commercial debt.

At the same time, we lowered to ‘BB+’ from ‘BBB-’ Egypt’s transfer and convertibility assessment, our opinion on the likelihood of the sovereign restricting access to foreign exchange needed for debt service by borrowers other than the government.

Rationale

The rating actions reflect our expectation that the violent demonstrations of the past week will persist, despite the appointment of a vice-president and the dismissal of the government by President Hosni Mubarak on Jan. 29, 2011. At present, a state of political impasse appears to exist in the country: President Hosni Mubarak refuses to cede power, security forces are struggling to contain ongoing demonstrations, the imposed curfew is being ignored, while the protestors continue to rally against the Mubarak administration because of their dissatisfaction with the political system and poor living standards.

We think it likely that the army will play a key role in resolving this current impasse. We believe the presence of the military, which is respected by the public, has so far helped to defuse some of the violence. The military has so far not intervened in the protests and has allowed violations of the curfew to continue.

We expect the current political instability and violent conflict to affect Egypt’s economic growth in 2011 and beyond, not least through the adverse impact on the important tourism sector. This follows real GDP growth of close to 5% over the past two years. We think the conflict and the ensuing uncertainty may also weigh on Egypt’s balance of payments if inward foreign direct investment (FDI) or remittances were to decrease.

We are of the view that the government will eventually take measures to alleviate poverty by increasing fuel and food subsidies. We believe this will have negative implications for the public sector deficit, and it will likely be difficult to tackle the deterioration of public finances given Egypt’s limited fiscal flexibility. The general government has an official deficit target of about 8% of GDP this year, which in turn reflects heavy capital-spending commitments. Given that subsidies for food and fuel already account for just over one-fifth of government expenditure, we think that the government may offset an increase in these subsidies by cuts in capital spending. On the other hand, we consider that revenues could also decline the longer the political crisis continues. As a result, in the absence of emergency spending cuts in other areas, the budget deficit in 2011 could reach double digits, in our view. This will be difficult to finance while political uncertainty prevails. We estimate that Egypt’s gross general government debt stood at almost 74% of GDP last year, well above the ‘BB’ median of 42% of GDP.

Egypt’s external position appears quite strong. The current account position has been at near balance in recent years. This mainly reflects movements in the trade deficit, as well as improved Suez Canal revenues and higher tourist receipts. However, the trade deficit is currently being pressured by higher oil and food import costs. Moreover, receipts from the tourism industry are likely to decline at least during 2011 given the ongoing violent protests in the country and foreign government travel warnings deterring visitors. In addition, the inflow of private remittances, which amount to about 4% of GDP, may weaken.

FDI is an important factor supporting the overall balance of payments, with net FDI inflow equating to about 5% of GDP in 2010. In our view, the uncertainties surrounding political stability, if prolonged, may undermine investor confidence in long-term project financing. Egypt is also dependent upon volatile capital flows, such as portfolio investments, which are also vulnerable to reversal. International reserves are currently about $36 billion, equal to between five and six months’ coverage of current account receipts (CARs).

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