The FINANCIAL -- London-01 July 2011: In a new Special Report, Fitch ratings says that
Egypt's decision to rein in its budget deficit in FY2011/12 sends a
strong signal at a politically sensitive time, when expectations are
high, that Egypt sees the need to resume fiscal consolidation as soon as
possible.
However, the deficit and debt remain outliers among peers and a key rating weakness.
Fitch affirmed Egypt's 'BB' Long-term foreign currency Issuer Default Rating (IDR) on 28 June, removed it from Rating Watch Negative and assigned a Negative Outlook.
Egypt aims to reduce the budget deficit in fiscal year ending June 2012 (FY2011/12) to 8.6% of GDP. This is significantly down on the likely 9.5% or more in FY2010/11 and an even bigger drop compared with the 10.9% of GDP draft budget. The government was concerned about running too large a deficit and associated higher external debt, despite substantial offers of external financial support, exceeding USD30bn. The decision also reflects a desire not to overly commit whatever government emerges from this year's elections.
With a lower deficit comes lower external borrowing, and Egypt has turned down loans from the IMF and World Bank of over USD5bn. IMF backing for Egypt's economic programme would have boosted confidence during the political transition, but the government says it will proceed with its main provisions anyway. This includes paving the way for the introduction of VAT and reduction in energy subsidies - central to major fiscal consolidation but now even more sensitive due to their impact on inflation and real incomes. The incoming government will find them just as hard to implement as its predecessors. Other multilateral support will still go ahead and bilateral support from Saudi Arabia and the US has already begun to flow. Pledged external support still exceeds USD20bn (7% of GDP).
The cost of the political events of January-February 2011 was much higher than initially estimated. GDP declined by 8.8% qoq and 4.2% yoy in Q111, much the biggest contraction on record. Tourism was hardest hit, down 80% in February, and investment dropped by 26%, with a net outflow of FDI. Tourism is a key economic driver, so the recovery since February is encouraging. Arrivals are still down a third yoy but 4x higher than in February. The economy could still contract yoy in Q211 and growth for FY2010/11 will be around 1.5%, rising to perhaps 3% in FY2011/12.
The current account deficit did not widen appreciably in Q111, despite the drop in tourism, as exports continued to grow, workers remittances held up and higher oil prices helped. However, reserves still fell by almost a quarter by May as FDI dried up and foreign portfolio investment exited. The reserve decline slowed in May, as outflows stabilised, tourism recovered and oil prices rose further. External support will now start to bolster reserves, but further falls are quite likely. Fortunately, Egypt entered the crisis with substantial external liquidity. Although this has weakened, it remains comfortable. But it will be a long time before FDI once again covers the current account deficit, which Fitch forecasts to increase to 3% of GDP.
Parliamentary elections will take place in September 2011 and presidential elections by year-end. The outcomes are very uncertain, but will be crucial for the pace of economic recovery. The policy stance of the new government on fiscal consolidation and structural reform will be the key to Egypt's future credit profile.
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