Fitch Ratings has cut its outlook on Egyptian debt from “stable” to “negative” due to “deterioration” in the country’s external liquidity position, it said yesterday. The rating agency maintained Egypt’s B+ rating on robust economic growth and “strong international support” from Gulf allies and multilateral partners but warned that it could downgrade it in the coming months if external funding strains persist or the government fails to cut the deficit and debt as a proportion of GDP.

Tl;dr: The move “reflects the deterioration in Egypt's external liquidity position and reduced prospects for bond market access, leaving the country vulnerable to adverse global conditions at a time of high current account deficits and external debt maturities,” Fitch wrote.

Fitch isn’t the first of the Big Three rating agencies to make this move: Moody’s also cut its outlook to negative in May. Meanwhile, S&P Global Ratings maintained a stable outlook in its most recent report last month due to the expected influx of IMF and GCC funding.

Portfolio outflows are the main culprit for the downgrade: Foreign portfolio investment in local debt fell to USD 13 bn as of September, down from more than USD 30 bn in 2021, the rating agency said. Egypt has been hard hit by portfolio outflows triggered by higher financing costs, rising inflation, and the shock caused by the war in Ukraine. This has contributed to foreign reserves falling to USD 33.4 bn by October, from USD 40.1 bn in February.

Things could get better, but it will take a while: “Some recovery [in portfolio flows] is likely on recent exchange rate devaluation, policy rate hikes, and agreement on a new 46-month USD 3 bn IMF extended fund facility,” Fitch said, while noting that foreign holdings remain a “significant vulnerability.” So far, markets have shrugged off the IMF loan and the central bank’s move toward a floating exchange rate amid continued sell-offs, with analysts expecting market access to remain limited in the near term.

Also making things difficult:

• Egypt needs a lot of hard currency: On top of needing to fund its current account deficit, Fitch says the country has USD 15 bn of public external debt coming due this fiscal year and the next.
• Banking liabilities make it harder for Egypt to absorb funding strains: The central bank’s net foreign assets were almost USD 9 bn in the red at the end of 3Q 2022 while banks had USD 14 bn in net foreign liabilities.

Key forecasts:

• Inflation to rise + the EGP to appreciate? The EGP devaluation will “further stoke inflation,” likely bringing it up to an average of 17% y-o-y during the current fiscal year, and 12% in FY 2023-2024 — assuming “modest appreciation” of the EGP from EGP 24 against the greenback. Fitch notes that risks are “skewed to the upside” and that the CBE could go for further rate hikes to tame inflation.
• More growth + a narrower current account deficit: Fitch sees the economy growing at a 4.5% clip in FY 2022-23 and FY 2023-2024, though “tighter monetary conditions and funding availability pose significant risks to growth.” The current account deficit could continue to narrow to 3.1% of GDP this year from 3.5% in FY 2021-2022, on the back of higher Suez Canal shipping fees and a rebound in tourism.
• Budget deficit backsliding: The budget deficit could widen to 6.3% of GDP this fiscal year and 7.3% of GDP next fiscal year, up from 6.2% in FY2021-2022, on the back of rising interest costs that could “offset” our primary surpluses.

The news got attention internationally: Reuters | Bloomberg.