Will Egypt’s credit ratings downgrade lead to liberalisation of the pound’s exchange rate?

Just days after the reports were out, S&P lowered the ratings of the three largest Egyptian banks – the National Bank of Egypt, the Bank of Egypt and the International Commercial Bank – from "stable" to "negative."

The move came as an automatic consequence of the reduction of Egypt's sovereign rating. But the agency kept the country's sovereign asset rating at BB, meaning a subsequent downgrade could be announced.

In the agency's view, the targeted banks would not be able to withstand any default on sovereign debt repayment without also defaulting on their financial obligations.

Pressure tactic?

This is the fourth downgrade since the start of the Russian war in Ukraine. Economists believe that this reduction has nothing to do with banks, but rather with the rating of government debt.

Many observers suggest that credit rating agencies are pressuring Egyptian institutions to enact a full floating of the Egyptian pound against the dollar.  

Meanwhile, Egyptian Prime Minister Mostafa Madbouly reiterated his country's commitment to pay its debts and continue to implement the government's initial public offering (IPO) programme during the next two months, which is expected to raise at least $2bn.

Negotiations over certain targeted companies have been concluded, while others are on the way. In addition, 10 army-owned companies will be listed on the stock exchange.

Madbouly pointed out that the government will implement a package of financial, monetary and structural measures to deal with concerns related to the rise in international financing needs, which led international credit rating agencies to downgrade the Egyptian economy's outlook from stable to negative.

Egypt, according to S&P, needs massive funding estimated at about $17bn during the current fiscal year and $20bn during the next fiscal year (2023-2024).

Foreign exchange shortage

Egypt liberalised its currency three times between March 2022 and January 2023, causing the Egyptian pound to plummet by 95%.

Despite this, the country continues to face a shortage in foreign exchange, especially in light of high inflation, the high cost of domestic borrowing and the lack of a flexible exchange rate – as the country struggles to attract foreign direct investment and inflows into the domestic debt market.

In principle, the outlook for Egyptian banks is affected by the country's credit rating, but according to economist Hani Toufic, "there's nothing new (in the outlook) and, therefore, there's no fear currently on the deposits of Egyptians in the banks."

"However, the ratings demonstrate the urgency of reforming the country's entire economic system," he added.

Medhat Nafeh, a former member of the Higher Committee of the Egyptian Stock Exchange and economic expert, said the downgrading of the three banks "is a routine measure that always comes after any lowering in the credit rating of the country itself."

Nafeh told Al Majalla: "The outlook was expected to be negative for the economy," adding that the reason was probably "the uncertainty regarding the Egyptian pound's exchange rate, and especially, the government's delay – referred to by the IMF in more than one statement – in taking the steps required to end its role in economic activity, primarily through the programme of subjecting state-owned assets to IPOs."

Nafeh underscored the importance of implementing some other measures that international financial institutions deem necessary, including a further reduction of the Egyptian pound's exchange rate.

Much of the crisis is due to the fact that it's not known just how low the pound will reach, as dollar scarcity is not expected to end anytime soon, he explained.

Nafeh says he expects negative repercussions on the IPO programme and further negative repercussions — not on future credit ratings, but on the dollar exchange rate in the parallel market.

Nafeh said there was no clear information about the floating exchange rate.

He said: "Usually, a foreign investor doesn't invest in dollars unless they have clear information about the exchange rate to be adopted for asset valuation; whenever the pound falls against foreign currencies, it's in the interest of the foreign investor."

The economist pointed out that S&P and other rating agencies resort to negative outlooks when they expect the next credit rating review to point to more risks.

This requires an additional downgrade if there are no positive changes, he said, adding that the next rating is likely to be lower than the current rating due to continued uncertainty in the markets.

This is why the IMF delayed wiring its second loan instalment to the Egyptian government, Nafeh explained, adding that S&P based its downgrade on the government's failure to meet the IMF's conditions between January and March, which is a very short amount of time.

He expected the rating agency to change its view before July once the Egyptian government implements Madbouly's pledges. The government has previously announced its intention to sell government stakes in 32 companies between the first quarter of this year and the end of the first quarter of 2024.

Read more: Egypt takes bold steps to boost its private sector

It was recently announced that the shares of two companies belonging to the armed forces — Watania and Safi — would be subjected to an IPO.

More than 10 other companies belonging to the armed forces are also being prepared for an IPO through the government's programme, which opens companies and banks with IPOs and direct share sales to strategic investors.

An international advisory entity, along with investment banks, will be appointed to assist the Egyptian government in completing the programme.

Egypt is awaiting the IMF's announcement of its quarterly review, which was supposed to be published in late March. The IMF seems to be waiting for more clarity on economic reform programme promised by Egypt as part of its recent agreement with the IMF.

The programme includes a comprehensive liberalisation of the pound's exchange rate and the sale of stakes in banks, companies and state-owned enterprises to strategic investors or subjecting them to IPOs to encourage further investment and enhance the private sector's role in the economy.

However, these reforms have a significant impact on the lives of the majority of Egyptians because of price hikes that reduce their purchasing power and consumption; this leads to lower sales and production and higher poverty rates.

Egyptians turn to gold

Some Egyptians are turning to gold bullions and gold pounds as a refuge to preserve value, and at the same time, a means to offset the sky-rocketing inflation rate. The dollar exchange rate in the parallel market varies between EGP 35 and EGP 39, while it has been stable on the official market at EGP 31 (spot) and EGP 42 (futures).

One of the largest US banks, Goldman Sachs International, said in a report on the dangers posed to the Egyptian pound by the parallel market, that the refusal to move to a flexible exchange rate for the pound against other foreign currencies will lead to further distortions.

It could also possibly lead to an unsustainable economy due to the continued existence of a parallel foreign exchange market where the pound is being traded at an informal rate.

One of the main risks addressed in the report is the diversion of foreign exchange flows away from the official market to the parallel market, including remittances from Egyptians working abroad, which account for about one third of current account inflows.

The remittances fell by 23% during the first six months of the current fiscal year (2022-2023) to record about $12bn.

The persistence of the informal currency market encourages practices that are harmful to the economy, such as excessive imports, low exports and declining foreign and domestic investment. This means that the potential advantage of maintaining a relatively strong currency is lost.

Conflict in Sudan

The outbreak of the conflict in Sudan between the Sudanese army and Rapid Support Forces has also strained the Egyptian economy. There are signs of significant economic consequences for Egypt and neighbouring countries.

Moody's has warned against this, expecting a decline in credit ratings of neighbouring countries with negative repercussions for the Egyptian economy which, in turn, creates new problems.

Trade between Egypt and Sudan is currently facing major crises.

Sudan is a gateway for Egyptian exports to the markets of Nile Basin countries and East Africa. But as war and insecurity continue, the volume of trade between the two countries, which rose 18.2% last year to $1.434bn from $1.212bn in 2021, is likely to be affected.

The volume of trade between Egypt and African markets is estimated at $2.12bn during the first quarter of this year, and the value of Egyptian exports to the continent amounted to $1.61bn in the same period, according to the General Authority for Export and Import Control.

Tourism boost

Amid the pound's fall, tourism is on the rise and the government is counting on the sector to help boost dollar revenues in the country. It seeks to increase the number of visitors to 30 million annually.

The government expects 2023 to be the best year for tourism in Egypt, with tourism revenues accounting for about 12% of the gross domestic product and about 15% of Egypt's foreign exchange revenues. Tourism is the third largest source of foreign currencies after exports and remittances of Egyptians working abroad.

Tourism revenues jumped in the first six months of the current fiscal year 2022-2023 to $7.3bn — an increase of 25% from $5.8bn in the same period during the last fiscal year.

This presents a golden opportunity to attract more tourists to the country to help ease the pressure on Egypt's struggling economy.