Fitch raises alarms on risks spreading from Gaza conflict

January 29, 2024 (MLN): The prolonged war in Gaza and the related spread of conflict to nearby areas is adding to the risks facing neighboring sovereigns, says Fitch Ratings.

The intervention by Yemen’s Houthi forces has highlighted the potential for the conflict to increase headwinds to external finances, a challenge felt acutely in Egypt, but also to a lesser extent in Jordan.

Strong growth in receipts from tourism and Suez Canal transits helped to narrow Egypt’s current account deficit in the fiscal year ending June 2023 (FY23), with both rising more than 25%.

Tourism earnings reached $13.6 billion (around 3.5% of GDP), and canal-related receipts $8.8 billion (2.2% of GDP), compared with a current account deficit of $4.7 billion.

The Gaza conflict and the Houthis’ disruption of canal traffic have curbed these earnings, adding to Egypt’s external financing challenges and downward pressure on its rating.

Fitch's baseline, which incorporates some hit from the war in Gaza, sees tourism and canal earnings of $12.7bn and $9bn, respectively, in FY24, but if disruption is sustained throughout 1H24, the entity estimates those could fall to around $11bn and $7.5bn, respectively, widening the current-account deficit to 3.5% of GDP, from our baseline of 2.7%.

Intensified or broadened conflict could result in even worse outcomes.

Foreign exchange shortages recently led JP Morgan to exclude Egypt from its benchmark government Bond Index-Emerging Markets (GBI-EM) index. Fitch believes this could add to the country’s external financing requirement in 2024 due to associated outflows.

These trends have put added pressure on Egypt’s currency, with the parallel rate reaching about EGP60/USD1 recently, further complicating the task of liberalizing the official exchange rate, which stood at EGP30.9/USD1 on January 19.

"We believe exchange rate reform remains key to unlocking IMF funding, which in turn could catalyze another financing," it added.

Foreign partners may be willing to increase support for Egypt in response to conflict-related fallout, and its IMF program could be enlarged.

However, the government faces increased debt maturities this year of $8.8bn, from $4.3bn in FY23, and delays in the distribution of funding support could result in significant erosion of Egypt’s official reserve buffers.

If the conflict broadens further or is sustained beyond 1H24, risks to Jordan's economic growth and fiscal consolidation would also increase.

The 2024 current account deficit could be moderately wider than 7% of GDP, but the new $1.2bn IMF Extended Fund Facility (approved in early 2024), should mitigate external financing risks and support reform momentum and investor confidence.

Fitch expects Jordan’s external financing position and external buffers to remain consistent with its latest rating, bolstered by a record of strong support from bilateral and multilateral financing partners through several external shocks over the past decade and a half.

The government anticipates foreign assistance commitments of $3.5bn in 2024 (around 9.1% of GDP).

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