Moody's Investors Service has downgraded Egypt's foreign and local currency government bond ratings by one notch to Ba3 from Ba2. The outlook on these ratings remains negative.

Today's rating action was prompted by 'the prolonged political uncertainty in Egypt since our last rating action on  January 31, and our concerns about whether a transition to an effective and stable government will be achieved,' the agency said.

'The adverse impact this political uncertainty is having on the country's fiscal position and broader economic performance is; and the deterioration of the political situation in Libya, which has negative implications for Egypt's economy and security,' it said.

In Moody's opinion, these developments have caused a further erosion of Egypt's credit fundamentals relative to rating peers.

Moody's has also downgraded the country ceiling for foreign currency bonds to Ba1 from Baa3 and the country ceiling for foreign currency bank deposits to B1 from Ba3. The outlook on these ratings remains negative.

The short-term country ceiling for foreign currency bonds was downgraded to NP from P-3. The local currency bond and deposit ceilings were downgraded to Baa3 from Baa1.

The primary driver of today's downgrade of Egypt's sovereign bond ratings is the continued volatility in the country's domestic politics in the wake of the ousting of former president, Hosni Mubarak, in February, Moody's explained.

Although the country's Higher Military Council has outlined a timetable for transition to a civilian government, the process is fraught with uncertainty. Moreover, the make-up of the cabinet has been fluid, and sporadic protests and violence have continued amid fragile domestic security. In Moody's opinion, this extended period of political disturbance undermines Egypt's institutional strength and raises event risk, at least over the short term. Over the longer term, it remains to be seen whether an effective and stable government will be formed at the end of the announced transition phase.

Moody's decision to downgrade was also informed by the uncertain prospects for economic recovery, which in turn very much depend on the country's unpredictable politics. Additionally, a number of strikes and the departure of Egyptian workers from Libya are likely to have a negative impact on Egypt's economy.

Moody's believes that the country's growth prospects, fiscal position and balance of payments have all deteriorated. Data from the central bank until the end of February indicate that there has been a substantial fall in official foreign assets, likely related to capital outflows and the defence of the currency. Egypt's stock market has been closed since January 27th and has yet to reopen, generating fears that there could be a renewed drain of capital when it does. Inflation remains stubbornly high.

A further driver of today's rating action is the deterioration in Egypt's regional security environment in light of the ongoing civil war in Libya.

Moody's believes that the above risks are now better reflected by a Ba3 government bond rating for Egypt.

Moody's decision to maintain a negative outlook on Egypt's sovereign ratings reflects the uncertainty of the political outlook and the resulting downside risks to the country's credit fundamentals. The rating agency would move the outlook back to stable if the political situation were to stabilise and if the transition phase were followed by the formation of an effective government that seemed committed to addressing Egypt's significant social and economic challenges. These include a high level of unemployment and inflation, together with impaired growth and a wide fiscal deficit.

Moody's would consider downgrading Egypt's bond ratings further in the event of a substantial fall in foreign exchange reserves, signs that the government were facing difficulty in funding its wide fiscal deficit, or a political deterioration that threatened the transition to an effective government.

Moody's stresses that Egypt's ratings continue to be supported by a number of important factors, which is why today's downgrade is limited to one notch. These include a still substantial stock of official foreign exchange reserves, a well-diversified economy and a favourable public debt structure with little marketable foreign currency sovereign debt.
 
Moreover, the country as a whole has limited external debt. There is a possibility that donor countries could step up financial assistance to Egypt in case of serious difficulty, although that would depend on the external relations of the government in place.

Egypt also benefits from being a marginal net hydrocarbons exporter, thereby limiting the sensitivity of the balance of payments to fluctuations in global oil prices. The government has previously shown a high degree of willingness to repay and has never defaulted on its bonds.

Moody's last rating action affecting Egypt was implemented on January 31, 2011, when the government's bond ratings were downgraded by one notch to Ba2 from Ba1.-TradeArabia News Service