Structural reforms continue in Egypt

In its annual report on Egypt, Moody’s Investors Service says its government bond ratings reflect the challenge of continuing to implement structural reforms while controlling social discontent and reining in fiscal profligacy.

Egypt‘s government bond ratings are Baa3 with a negative outlook in local currency and Ba1 with a stable outlook for foreign currency bonds.

“The Egyptian economy has traditionally been vulnerable to external shocks with growth constrained by the structure of the economy,” said Moody’s Senior Vice President Pierre Cailleteau, author of the report.

“Although many bottlenecks remain, evidence of a decisive break with the past is mounting.”

In particular, he cited a 6.8% rate of growth in FY 2005/06, up from 4.5% the previous year, and Moody’s forecasts real growth of 6% for the current fiscal year.

While this strong performance has been underpinned by high oil and gas prices and a robust tourism sector, the analyst argued that structural reforms introduced by the government also appear to be bearing fruit.

“Among the most significant reforms has been those that have opened the country up to foreign trade and reduced both personal and corporate taxation,” said Cailleteau.

“Since being installed in 2004, the government has demonstrated a bold reformist stance and Moody’s believes that the new and more business-friendly environment may help reverse the declining trend in investment since 1998.”

The positive policy momentum can be seen in the country’s increased foreign direct investment (FDI). From less than 3% of GDP in FY 2003/04, net FDI accelerated to 4.3% of GDP during FY 2004/05 and to almost 5.8% in FY 2005/06, including oil and gas investment.

Monetary policy reforms have helped improve Egypt‘s international credibility. Along with the creation of the Monetary Policy Committee in 2003, the government adopted the Unified Banking Law, enhancing the independence of the Central Bank of Egypt.

“After years of erratic targeting of the exchange rate, a pragmatic policy has been put in place and the central bank’s main objective is now price stability,” said Cailleteau.

“This does not preclude opportunistic interventions in the event of ‘misalignment,’ but the central bank appears committed to allowing the rate of the Egyptian pound to be largely determined by market forces,” added Cailleteau.

Politically, he said, it is unclear whether the limited liberalisation introduced by President Hosni Mubarak has strengthened the system by allowing pressure to be released in a controlled manner, or whether it will strengthen the organisation of destabilising political forces.

However, he explained that Moody’s views the risk of a chaotic succession with broadly negative economic consequences and new international alliances as very low. Regional political uncertainty continues to generate internal tension but is unlikely to destabilise the country.

Egypt’s public finances have been an issue of serious concern over recent years, resulting in Moody’s downgrading the government’s local currency bond rating to Baa3 and changing the outlook to negative in May 2005. The rating action was vindicated earlier this year by an accounting clarification that brought national finances in line with international standards while revealing a serious under-statement of deficits. The restated figures pushed the deficit from 3.8% to 8.5% — nearly 5% higher for the 2002-2006 period.

“The government target of reducing the deficit by 1% per year up to 2010-11, bringing the general government deficit below 4% of GDP, does not seem out of reach,” said Cailleteau.