Moody's Egypt downgrade reflects growing economic fears

Demonstrations continue as concern increases over the wider effects of unrest in the country, which is mired in debt. But some analysts maintain Cairo's revenue from the Suez Canal may help avert disaster.

Concerns are mounting over the economic fallout from Egypt's political upheaval after street protests continued for a seventh day yesterday and Hosni Mubarak, the president, struggled to keep his grip on power.

Moody's Investors Service, a credit ratings agency, downgraded Egypt's government bonds yesterday. The cost of insuring against the default of Egyptian debt has also rocketed in recent days, reflecting growing worry among investors that the unrest in the country could have long-lasting consequences. Banks and stock markets have been closed since Sunday.

In addition to the market forces that sent stocks plunging 16 per cent last week and led to a flight of capital and top executives from the country, Egypt is mired in debt worth almost 80 per cent of its GDP, which was US$216.83 billion (Dh796.44bn) last year, according to IMF estimates.

The country's plan to raise about $683 million this week through debt auctions was also put on hold as a result of the political crisis, Bloomberg reported yesterday.

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The Moody's downgrade to "Ba2", or two notches below investment grade, "was prompted by the recent significant rise in political event risk and concern that the policy response could undermine Egypt's already weak public finances," the agency said.

It noted that efforts to contain discontent may include a looser fiscal policy and heavier subsidies for basic goods that could stretch the country's public finances even more.

"A background of rising inflationary pressures further complicates fiscal policy by threatening to increase the high level of budgetary expenditure on wages and subsidies," Moody's said.

Egypt's ability to service its debt is likely to come under strain if the political instability sets back the country's growth prospects, economists say. Lower economic growth would be likely to prompt international investors to demand a higher risk premium to buy the country's bonds or other debt issues, pushing up interest rates and debt-servicing costs for the government.

An alternative would be to encourage domestic banks to buy debt that could, in turn, constrain their lending capacity to the private sector, said Tudor Allin-Khan, the chief economist at Alembic HC Securities in Dubai.

Egypt's plans to cut its fiscal deficit this year were likely to unravel because of the need to keep subsidising food and energy as prices rise, Mr Allin-Khan said. It had hoped to trim its fiscal deficit from 8 to 7.7 per cent this year.

But Alessandro Magnoli Bocchi, the chief economist of the Kuwait China Investment Company, said Egypt's government revenues should be enough to address the deficit despite recent turmoil.

"Egypt has the Suez Canal and revenue from that should be enough to help pay for a fiscal deficit," Mr Bocchi said.

Still, investors are already factoring in an increased likelihood of a government debt default. Credit default swaps, a form of insurance on debt, rose by 43.3 per cent last week to 429 basis points. That means it would cost an investor about $42,900 to protect $1m of Egyptian debt.

The civil unrest in Egypt was sparked by rampant youth unemployment, discontent with the government and high prices - the same factors that inspired the so-called Jasmine Revolution that toppled the government in Tunisia, and protests in Algeria, Yemen and other parts of the region in recent weeks. Inflation stands at 10.3 per cent in Egypt.

Observers expect the economic distress to persist long after banks and markets reopen unless leaders can address deeply entrenched social issues quickly. The fall out is already affecting other regional stock markets, and could have implications for the Gulf, home to hundreds of thousands of Egyptian expatriates.

Investors have been withdrawing from the country, although Egypt's central bank governor said recently the country had adequate foreign currency reserves - about $36bn - to handle any withdrawals.

"Workers' remittances - largely from the Gulf region and which account for more than $9bn in foreign exchange revenues annually, could also be negatively affected as long as the uncertainty persists," Ann Wyman, the head of emerging markets research at Nomura, said in a recent note.