Egypt Debt Buoyed by Obama Guarantee for Eurobonds: Arab Credit

Egypt Debt Buoyed by Obama Guarantee for Eurobonds
Egypt is rated Ba3, three levels below investment grade, by Moody’s, which lowered the rating for a second time this year in March. Photographer: Khaled Desouki/AFP/Getty Images

President Barack Obama’s guarantee on $1 billion of Egyptian Eurobonds is poised to reduce the country’s borrowing costs, helping the transition to democracy after six decades of autocratic rule.

The support that Obama pledged last month may cut yields on the five-year debt by 200 basis points, or the equivalent of $100 million, according to the median estimate of five fund managers surveyed by Bloomberg. Yields on Egypt’s one-year bills jumped to the highest level since November 2008 following the uprising that ousted President Hosni Mubarak in February. The country last sold international debt in April 2010.

“The American backing is a complete game changer,” Michael Cirami, who helps manage $12 billion in assets for Boston-based Eaton Vance Corp., said in a telephone interview. “There may be a spill-over effect that it’s going to reduce the risk premium of their non-guaranteed debt and help them re-enter the market eventually on their own.”

Obama is offering assistance for the planned Eurobond sale as the International Monetary Fund forecasts Egypt’s economy may grow 1 percent this year, the slowest pace since 1992, and Moody’s Investors Service says the country’s public finances are “significantly” weaker than countries with similar credit ratings. The budget may post its biggest deficit in at least a decade in the fiscal year ending this month, hampering efforts to create jobs and reduce the poverty rate, reasons that sparked the anti-Mubarak revolt, according to the Finance Ministry.

Presidential Vote

Egypt will hold presidential elections this year to elect what could be the first civilian leader since the military took power in a 1952 coup, according to surveys from organizations including Washington-based Pew Research Center.

Obama’s May 19 pledge, part of a package that also includes $1 billion in debt forgiveness, was followed by a $3 billion loan agreement with the IMF, a plan for a $2.2 billion loan from the World Bank and $4 billion in economic and budgetary aid from Saudi Arabia.

The commitments helped bring Egypt’s default risk down to the lowest level since Jan. 14, the day when a popular revolt toppled Tunisian President Zine El Abidine Ben Ali, triggering the protests against Mubarak on Jan. 25.

Default Swaps

Egypt’s credit default swaps, which had peaked at 442 basis points, or 4.42 percentage points, on Jan. 31, plunged to 306 basis points today, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The yield on Egypt’s 10-year dollar bonds maturing in April 2020 has tumbled 46 basis points since May 19 to 5.73 percent. The rate had peaked at 7.07 percent on Jan. 31, according to data compiled by Bloomberg.

The extra yield investors demand to hold Egypt’s international debt over U.S. Treasuries also fell, declining 37 basis points since May 19 to 313. Middle Eastern debt yields are on average 349 basis points more than Treasuries, according to the JPMorgan EMBIG index.

Egypt needs to sell a five-year Eurobond soon to diversify the way it raises debt because the local market is “squeezed” after the government increased borrowing to plug the deficit, Finance Minister Samir Radwan said by telephone on May 23.

“Egypt’s rising borrowing needs, to finance the widening budget deficit after the revolution, have put a lot of pressure on the local treasury-bill market,” Mohamed Abu Basha, an economist at Cairo-based EFG-Hermes Holding SAE, the biggest publicly-traded Arab investment bank, said by telephone. “Diversifying should lower the overall cost of borrowing.”

Rising Yields

The Ministry of Finance has failed to raise the targeted amount in the last eight sales of one-year bills, according to data compiled by Bloomberg. The yield on the notes surged 230 basis points this year to 12.97 percent, central bank data show.

The country last tapped international markets with the sale of $1.5 billion of bonds in April 2010. Egypt has $1 billion in 8.75 percent Eurobonds maturing in July this year, according to data compiled by Bloomberg. The yield on those bonds declined 70 basis points since May 19 to 3.217 percent.

Egypt is rated Ba3, three levels below investment grade, by Moody’s, which lowered the rating for a second time this year in March. Standard & Poor’s rates Egypt BB, in line with Turkey, Jordan and Guatemala.

Persian Gulf

Yields are falling in oil-rich Persian Gulf nations that have avoided Egypt-style revolts. The average yield on Gulf debt tumbled 38 basis points this year to 4.9 percent on June 13, according to the HSBC/NASDAQ Dubai GCC Conventional US Dollar Bond Index that tracks 85 securities in the region. Credit default swaps for Saudi Arabia, the world’s biggest oil producer, have climbed 19 basis points this year to 94 today, less than one-third of Egypt’s default risk.

The U.S. currently gives Egypt $1.5 billion a year in aid, including $1.3 billion for its military. The U.S. last forgave Egyptian debt -- $6.7 billion worth -- in 1990 following the Arab country’s participation in the coalition that ended the Iraqi occupation of Kuwait.

Credit default swaps for Morocco, which is rated Ba1 at Moody’s, trade at 171 basis points, according to CMA. The North African kingdom’s total debt is below 50 percent of economic output. Egypt has a debt-to-GDP ratio of more than 70 percent.

The cost to protect debt from Bahrain, the island-kingdom where anti-government protests this year prompted other Persian Gulf countries to send a military force to restore order, from default through credit-default swaps is at 233 basis points. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

Budget Support

The Egyptian government has sought $9.5 billion in budget support from international sources, according to a document on the Finance Ministry’s website detailing the government’s plan for the fiscal year that starts next month. The government projects the budget shortfall may reach 11 percent of gross domestic product compared with about 10 percent this year.

“Egypt suffers from deep-seated political, socio-economic challenges,” Moody’s said in a statement May 24. “These include chronic high rate of unemployment, elevated inflation and widespread poverty.”

Unemployment rose to 11.9 percent in the first quarter this year, compared with 8.9 percent in the previous three months. Food prices, one of the reasons that sparked the revolt against Mubarak, have risen about 20 percent this year, according to the government’s statistics agency.

Lack of details on the timing of coming aid, as well as concern over the formation of the next government after September’s elections, may make donor nations and international lenders hesitant to fulfill their pledges, said Liz Martins, Dubai-based senior economist at HSBC Holdings Plc.

‘Urgent’ Situation

“Most creditors will be wary of lending to an administration that does not yet exist,” she said in an e-mailed response to questions. “In the meantime, the fiscal situation for Egypt is urgent, and banks are having to step up to finance the growing deficit.”

Local lenders have increased purchases of treasury bills after foreign investors trimmed their holdings of Egyptian securities by $4.9 billion in the first quarter this year, according to central bank data.

The U.S. backing will help reduce the risk and spur demand among investors, said Sergey Dergachev, who helps manage the equivalent of $8.5 billion in emerging-market debt at Union Investment Privatfonds in Frankfurt.

“The U.S. guarantee helps to get more interest from investors and calm investors’ nerves a little bit,” he said in an e-mailed response to questions. “But underlying credit risks for Egypt are nevertheless very high.”

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