Bloomberg News

Deficit Drives Egypt Swaps Above Dubai as S&P Cuts: Arab Credit

October 19, 2011

Oct. 19 (Bloomberg) -- Egypt’s inability to rein in spending drove the risk of holding the nation’s bonds above Dubai’s for the first time in a month and prompted Standard & Poor’s to cut the rating on the most populous Arab country.

The cost of protecting Egyptian debt against default for five years rose eight basis points to 448 yesterday as S&P reduced the credit ranking by one level to BB- on the nation’s growing budget deficit and sliding foreign reserves. The cost dropped to 445 basis points today. Egyptian credit-default swaps trade 16 basis points above those for unrated Dubai, the most since August, according to data compiled by CMA.

Protests are reviving in Egypt and the economy is deteriorating eight months after President Hosni Mubarak was ousted sparking unrest across the region. Since military rulers took over in February, violence has continued in the Arab nation, which had a budget shortfall equal to 9.5 percent of gross domestic product in the year to June. Yields on one-year treasury bills surged to the highest level in almost three years in September.

“The Arab Spring nations are having revolutions that are good for promoting democracy but are bad for their ratings,” Win Thin, the global head of emerging-markets currency strategy at Brown Brothers Harriman & Co. in New York, said by phone yesterday. “There’s not a quick, easy fix. It’s a concern.”

Egypt’s revolution followed a similar revolt in Tunisia and helped stoke popular uprisings in Bahrain, Yemen and Syria. The nation’s economy grew 1.8 percent in the fiscal year ended June 30, the weakest performance in at least a decade.

Yield Spread

Egypt’s benchmark stock index, the EGX 30, gained 1.2 percent today in Cairo, paring the decline for the year to 40 percent.

The country’s credit default-swaps have held above Dubai’s since Oct. 14, and have jumped 203 basis points, or 2.03 percentage points, this year, compared with a 14 basis point- advance in the emirate’s swaps, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The last time the swaps traded higher than Dubai’s for more than a day was in September.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Dubai received a $20 billion bailout in 2009 from its central bank and neighboring Abu Dhabi as the government and its state-owned companies ran up debt of at least $129 billion developing the emirate’s property and tourism industries. The sheikhdom had at least $113 billion of liabilities at the end of 2010, according to International Monetary Fund data.

Risk of Another Cut

Egypt’s economic growth shrank 4.2 percent in the first quarter as revenue from industries including tourism plummeted. The balance of payments in the fiscal year to June recorded a $9.8 billion deficit, compared with a surplus of $3.4 billion the previous year. The central bank’s foreign-currency reserves have shrunk by a third in 2011 to $24 billion.

“The downgrade reflects our opinion that risks to macroeconomic stability have risen during the transition period for Egyptian political reform,” Trevor Cullinan, a London-based analyst at S&P, wrote in a report e-mailed yesterday. “A further downgrade is possible if the political transition toward a more pluralistic society does not proceed as smoothly.”

Pound Drops

The rating cut puts Egypt at the third-highest non- investment grade level and equal to Lebanon, Vietnam and El Salvador globally. New York-based S&P maintained a negative outlook on the rating.

Egypt, which counts on foreign visitors for 16 percent of its gross domestic product and 14 percent of jobs, lost 80 percent of revenue in the last holiday season, Tourism Minister Mounir Fakhry Abdel Nour told Jordan’s Ad Dustour newspaper on Oct. 1. The government expects tourism revenue to fall to $10 billion this year, from $12.5 billion in 2010.

The Egyptian pound’s decline to 5.9749 per dollar today added to its 4 percent drop over the past 12 months, the biggest decline among the 11 Middle East currencies tracked by Bloomberg.

Twelve-month non-deliverable forwards on the pound were at 6.68 per dollar, reflecting investors’ expectations that the currency will weaken 11 percent versus the greenback in the next year. NDFs are also an indicator of interest-rate differentials and are used by companies to hedge against currency fluctuations.

‘Negative Implications’

The Egyptian government’s borrowing costs have risen to the highest level in almost three years, with the yield on one-year treasury bills soaring 344 basis points since the start of the revolution to 13.882 percent on Sept. 27, the most since November 2008. The yield was at 13.72 percent at an auction on Oct. 13.

The yield on the country’s 5.75 percent 10-year dollar- denominated bonds due in 2020 has climbed 49 basis points to 5.85 percent from its post-revolution low reached on Sept. 19, prices compiled by Bloomberg show.

“The geopolitical risk has flagged itself with negative implications to the economy,” Michael Roche, an emerging-market strategist at MF Global, said in a telephone interview from New York. “Egypt has underperformed its peer group if you look at the deterioration of the economy in the past six months.”

The unrest escalated in central Cairo on Oct. 9, when a night of clashes between Coptic Christian protesters and the security forces left at least 25 people dead. The Arab Spring has cost countries in the region more than $56 billion, with Egypt, Libya, Syria and Tunisia hard hit, according to economic consultants Geopolicity Inc.

Looming Elections

Several thousand Egyptians rallied in Cairo’s Tahrir Square on Sept. 30 to demand that the nation’s military council announce a schedule for handing power to civilians. The Arab country is due to hold parliamentary elections in November, the first after the popular revolt that ousted Mubarak.

Delays in Egypt’s transition to democracy are slowing its economic recovery, Fitch Ratings said on Oct. 7, adding that the company “had expected significant external support to have begun flowing by now.” Fitch raised Egypt to BB, the second- highest junk grade, on June 28.

Egypt’s political turmoil is occurring at a time when concern over global growth and the worsening European sovereign debt crisis wiped $10 trillion from global equity markets in the third quarter. Average yields on emerging-market bonds have jumped 66 basis points in 2011 to 7.16 percent, and hit the highest level since May 2010 on Oct. 4, data compiled by JPMorgan show.

“The rest of the world is slowing down, so this is not a good time,” said Brown Brothers’ Thin. “To this point it hasn’t moved to a democracy. There’s not great stability.”

--With assistance from Ahmed A Namatalla in Cairo. Editors: Emma O’Brien, Laura Zelenko

To contact the reporter on this story: Tal Barak Harif in New York at tbarak@bloomberg.net

To contact the editor responsible for this story: Tal Barak Harif at tbarak@bloomberg.net


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