The one-notch downgrade, which places Egyptian bonds in the category of assets that are "subject to very high credit risk," was sparked by the ongoing "unsettled political conditions" that have "significantly weakened" the country's economy, Moody's said in a statement.
The downgrade was announced a few hours before Egypt's central bank hiked the overnight deposit rate and overnight lending rate by 50 basis points to 9.75% and 10.75% respectively to fight the threat of inflation.
Egypt has been in negotiations with the International Monetary Fund (IMF) for an agreement for two years, but, despite an announcement on March 17 that the government had renewed efforts to clinch a deal, the rating agency noted that two previous attempts to reach an agreement failed, in June 2011 and in December 2012.
"Overall, even if the Egyptian government's third attempt in two years to gain IMF support were to succeed, Moody's believes that the risks facing a successful completion of a stand-by arrangement have risen in light of the economic and political challenges that have intensified as Egypt's revolution has unfolded," the rating agency said.
"As a result, there is more uncertainty over Egypt's ability to regain macroeconomic stability and shore up its external and fiscal positions."
The risk of default by Egypt has increased because the worsening in the country's external payments position and government finances has "reached a level at which the country's vulnerability to economic or political shocks has widened," it added.
'DEEP POLARIZATION'
The "deep polarization" between the democratically-elected government and the opposition diminishes the government's ability to govern effectively, restore social stability and avert a worsening of the economy, Moody's said.
It noted that economic growth slowed to a low single digit from mid-to-high single digits, while the budget deficit rose into the double-digits after the Arab spring. The recent decision by the Administrative Court to suspend legislative elections that were due to be held between April and June for the lower house further highlights the country's political difficulties.
The weakening of Egypt's external payments position was the second factor behind the downgrade.
Egypt has gross reserves of $13.5 billion, including $4.5 billion of gold and IMF Special Drawing Rights, which for the present time cover the debt falling due in the next 12 months on a one-year residual maturity basis, Moody's said.
But, it added, "the cushion could wear thin if external financial support is not forthcoming or from capital flight, and if a longer time horizon than one year is taken into consideration."
The future stability of the external payments position could be undermined if the governments of countries within the Gulf Cooperation Council, especially Saudi Arabia and Qatar, "decide not to be as generous in providing financial support in the future as they have been over the past year or so," the statement said.
The third factor behind the downgrade is the unpredictability of Egypt's economic and fiscal policies, Moody's said.
The downgrade places Egypt's rating in the same category as Cyprus, Ecuador, Jamaica and Pakistan.
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