• US-based Moody’s Investors Services upgrades outlook of Egyptian banking system to stable, but keeps B3 rating
  • The decision is based on an imporving economy and business-friendly reforms
  • High exposure to government bonds is a key concern

US-based Moody’s Investors Services has improved Egypt’s banking system outlook to stable and affirmed its B3 rating.

The Egyptian economy is improving and Moody’s expects the country’s GDP to increase to 4.5 per cent in 2015 and 5 per cent in 2016.

This will give plenty of opportunities for banks to grow, as well as having a positive impact on non-performing loans, which make up 8 per cent of gross loans.

The government is also planning a series of economic and fiscal reforms.

However, Egyptian banks are heavily exposed to local government bonds, which Moody’s recently upgraded to a B3 rating. The total exposure was E£843bn ($118bn) as of December 2014, accounting for around 43 per cent of their total assets, or almost seven times the total equity in the banking system.

This means capital buffers are modest, with an equity to asset ratio of just 6.6 per cent.

It also constrains Egyptian banks’ ability to lend, especially when it comes to financing the government’s massive infrastructure investment, which Moody’s expects to stimulate the economy.

“There are a lot of infrastructure projects planned,” says Melina Skouridou, CFA Moody’s lead analyst on Egyptian banks. “Local banks have the capacity to lend in domestic currency but there is a shortage of US dollars.”

Egypt is already in a stalemate with UAE-based investors in the new Capital City project over sources of funding. The first phase is expected to cost $45bn, which the government is insisting comes from abroad.

Foreign investors are reluctant to enter Egypt due to doubts over the availability of hard foreign currency.

Loan growth has accelerated from below 5 per cent in mid-2014 to 14 per cent in December 2014. Moody’s predicts it will rise further to 20 per cent as reforms and economic growth kick in.

This strong demand from the public and private sector will push banks to deploy more of their core liquid assets to fund their growth. Moody’s expects that the erosion in core liquidity will be relatively modest and banks will maintain adequate liquidity.

“Due to higher loan growth, which has increased to 19 per cent a year in March, there will be some reduction in core liquidity,” says Skouridou. “Especially as banks are maintaining or increasing their exposure to government bonds.”