August 23, 2012 / 2:18 PM / 5 years ago

TEXT-S&P: Egypt off credit watch, ratings affirmed, outlook negative

Overview
     -- We believe that the Muslim Brotherhood--Egypt's dominant political 
group--and the senior ranks of the Egyptian military are moving toward a 
working arrangement. 
     -- In our view, this could lead to the authorities addressing some of 
Egypt's pressing structural challenges and stemming the deterioration in 
government and external finances.
     -- We are therefore affirming our 'B/B' long- and short-term sovereign 
credit ratings on Egypt. At the same time, we are removing the long-term 
ratings from CreditWatch, where they were placed with negative implications on 
June 25, 2012.
     -- The negative outlook reflects our view that we could lower the ratings 
if political or social tensions were to escalate again. In our view, 
uncertainties remain over the authorities' political goals and the status of 
key state institutions. We also think domestic unrest could resurface when the 
new constitution is drafted, or when new parliamentary elections are held.
Rating Action
On Aug. 23, 2012, Standard & Poor's Ratings Services affirmed its long- and 
short-term foreign and local currency sovereign credit ratings on Egypt at 
'B/B'. At the same time, we removed the ratings from CreditWatch, where they 
were placed with negative implications on June 25, 2012. The outlook is 
negative.

The transfer and convertibility (T&C) assessment is 'B' in line with the 
sovereign ratings. The recovery rating on the unsecured foreign-currency debt 
remains unchanged at '3', indicating our expectation of 50%-70% recovery in 
the event of a default.
Rationale
The ratings affirmation reflects our opinion that a working relationship 
between the military and the dominant political group, the Muslim Brotherhood, 
is gradually being reached. In our view, this could pave the way for an 
improvement in medium-term policymaking. We therefore project that Egypt's 
weak public sector finances and external position could stabilize.

The negative outlook reflects our view that there is a one-in-three likelihood 
of a downgrade should political or social tensions escalate once more. If this 
happened, the current short-term approach to policymaking would likely 
continue, and foreign exchange reserves would likely decline further absent 
foreign donor inflows.

We placed our long-term foreign and local currency sovereign credit ratings on 
Egypt on CreditWatch with negative implications on June 25, 2012. In our view, 
political tensions had been escalating between the ruling Supreme Council of 
the Armed Forces (SCAF) and the Islamist political groups following the 
dissolution of parliament on June 14, 2012. At that time, we believed that 
these tensions might exacerbate and prolong the authorities' ineffectiveness 
in addressing economic, fiscal, and external challenges. In our view, this 
would have further weakened key economic and external indicators while also 
undermining donors' and multilateral lending institutions' willingness to 
extend support. 

However, events have since unfolded to give recently elected president Mohamed 
Morsi what we understand to be full executive and legislative powers:

     -- On June 17, the SCAF had issued a decree extending its control to 
encompass legislative, as well as military, affairs until such time as 
parliamentary elections were re-held.
     -- On June 24, Egypt's election commission declared that the Muslim 
Brotherhood's candidate Mohamed Morsi had won the presidential run-off. The 
Muslim Brotherhood had already won more votes than any other political group 
(38%) at parliamentary elections held November 2011 to January 2012.
     -- On Aug. 12, President Morsi reversed the SCAF's June 17 decree, and 
regained the presidential powers that enabled him to make changes to senior 
military personnel.

President Morsi has used these powers to retire the head of the SCAF, Field 
Marshal Tantawi, and his chief of staff. We understand that the president now 
has full executive and legislative powers until parliament is reconvened. We 
understand that, constitutionally, the military can now only exercise 
executive power when national security is threatened. 

We believe, however, that President Morsi would not have been able to make 
such a move without the acquiescence of senior officers in the military, who 
were content to see power shift from individuals associated with the Mubarak 
era to a new guard. In our view, the military gave consent to the changing of 
the guard as a compromise to reduce tensions between it and the new political 
powers. At the same time, we understand that the privileges and business 
interests of the military remain protected.

We now expect a relatively stable few months ahead. In our opinion, this could 
give the authorities room to achieve political and policy consensus sufficient 
to facilitate the external and domestic financing necessary to fund the 
government deficit and support the Egyptian pound. The government projects net 
borrowing at EGGBP135 billion (7.6% of GDP) in the state's 2012/2013 budget. We 
estimate that it could be as much as EGGBP163 billion (9.1%). Media reports 
quote the finance minister Momtaz al-Saieed as saying that the government is 
prepared to cover EGGBP75 billion of this year's budget deficit, and will use 
IMF funds to cover the remaining portion.

However, the balance of power remains delicate. With full legislative powers 
now in the president's hands, we see potential for the other main political 
actors--namely the military and the non-Islamist groups--to become frustrated 
with the transition process and for domestic conflict to resume, undermining 
investor and donor confidence.

Outlook
The negative outlook reflects our view that we could lower the ratings if 
political or social tensions were to escalate again. Moreover, the willingness 
of international donors/lenders and multilateral lending institutions to 
extend much-needed support could weaken if the Egyptian authorities are unable 
to effectively address ongoing economic, fiscal, and external challenges.

Conversely, if Egypt's political transition strengthens the social contract 
and if external pressures ease--an indication of which would be an increase in 
net international reserves--we could revise the rating outlook to stable.

Related Criteria And Research
     -- Sovereign Government Rating Methodology And Assumptions, June 30, 2011
     -- Criteria For Determining Transfer And Convertibility Assessments, May 
19, 2009
     -- Introduction Of Sovereign Recovery Ratings, June 14, 2007

Ratings List

Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
Egypt (Arab republic of)
 Sovereign Credit Rating                B/Negative/B       B/Watch Neg/B
 Senior Unsecured                       B                  B/Watch Neg


Ratings Affirmed

Egypt (Arab republic of)
 Transfer & Convertibility Assessment
  Local Currency                        B                  
 Short-Term Debt                        B                  
 Recovery Rating                        3                 

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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