EGYPT. Standard & Poor's Ratings Services today placed its 'B' long-term foreign- and local-currency sovereign ratings on the Arab Republic of Egypt on CreditWatch with negative implications. At the same time we affirmed the short-term foreign- and local-currency ratings at 'B'.
The recovery rating on Egypt's senior unsecured debt is unchanged at '3', indicating our expectations of meaningful (50%-70%) recovery in the event of a default. Egypt's transfer and convertibility assessment remains 'B'.
The CreditWatch placement reflects our view that pressures on fiscal and external indicators have heightened. We view the dissolution of the elected parliament and the concentration of legislative power in the hands of the ruling military council, the Supreme Council of the Armed Forces (SCAF), as potentially reducing the effectiveness and flexibility of the government.
We also expect tensions to remain high between the military and the parties driving the post-Mubarak political transition, including the dominant Muslim Brotherhood, which could see a further deterioration in Egypt's economic, fiscal, and external performance. This notwithstanding the conciliatory statements made by the SCAF and the Muslim Brotherhood following the announcement on June 24, 2012, of the victory of the Muslim Brotherhood's candidate, Mohamed Morsi, at the presidential election, with 51.7% of the vote.
The outcome of the presidential election seems to have been settled. However, significant uncertainty remains with regard to the political transition process. On June 14, the Supreme Constitutional Court (SCC) effectively dissolved parliament. The SCC ruled that the law governing the parliamentary elections was unconstitutional because party members had been allowed to contest seats in the lower house, which were to have been reserved for independents.
The conclusion of the parliamentary elections in January 2012 had been an overwhelming majority vote for the Islamist parties. The Muslim Brotherhood, which won 47% of the parliamentary seats in January, is among those who do not accept the authority of the SCC's ruling.
By decree, the SCAF has extended its control to encompass legislative as well as military affairs until parliamentary elections are re-held. The SCAF announced that a new parliament would be elected once a new constitution is passed. The SCAF has given itself a significant role in running the 100-member assembly, which is set to draft the country's new constitution. In our view, it is likely to attempt to curtail the president's powers.
The timing of the announcement of the new constitution and the parliamentary elections is unclear. As such, the incoming president is likely to take office without a parliament being in place, and without a permanent constitution to define his powers and duties. We understand, however, that the president will be able to form and dismiss a government, and ratify and reject laws. Still, we believe the SCAF will remain in overall control.
It now seems less likely that the political transition from the military-dominated Mubarak era to a fully democratic government will take place smoothly or in the near term. We view the potential confrontation between the SCAF and the Muslim Brotherhood over the levers of power as weakening the effectiveness of the executive and its ability to pursue policies to address Egypt's structural challenges. Furthermore, political instability, resulting also from potential popular disappointment with the direction of the political transition, could unsettle investors, tourists, and official donors.
This would increase the likelihood of further deterioration of Egypt's economic indicators and, ultimately, sovereign creditworthiness. We are concerned that the flow of external funding sources and foreign currency generating activities, which we view as necessary to support the ratings at their current level, are now less likely.
The CreditWatch placement reflects our view of at least a 50% likelihood of a downgrade over the next three months. This could occur if escalating political tensions, and the authorities' ongoing ineffectiveness in addressing economic, fiscal, and external challenges, further weaken key economic and external indicators while also undermining donors' and multilateral lending institutions' willingness to extend support.
We may lower the long-term ratings if we assess the main political actors as having limited willingness and ability to compromise sufficiently to improve Egypt's economic structure and growth prospects, and reduce pressures on fiscal and external indicators. We do not expect a change of more than one notch unless the political situation becomes extremely divisive.
Or, we could remove the CreditWatch and affirm the ratings if "turmoil fatigue" or other factors usher in a period of relative stability that gives the authorities room to achieve political and policy consensus sufficient to facilitate the necessary external and domestic financing.