Define your generation here. Generation What
Egypt among 5 countries most likely to default on debt: Bank of America
Courtesy: shutterstock.com
 

Egypt has the fifth riskiest sovereign debt in the world, according to the Bank of America’s Transforming World Atlas released earlier this month.

Risk, in this case, is measured by calculating the cost of credit default swaps (CDS) to ensure Egypt’s government-issued bonds against default.

How do credit default swaps work?

A credit default swap involves three parties. The debtor — in this case, the Egyptian government — borrows money by selling sovereign bonds. Although the fiscal health of the debtor is a key element of a CDS, the debtor is not actively involved in the swap.

The buyer is someone who holds a debt instrument* such as a government bond. The buyer agrees to pay a regular fee to a CDS seller (usually a bank) to purchase a kind of insurance against default by the debtor.

If the Egyptian government isn’t able to pay off the bond on time, the bank who sold the CDS reimburses the bondholder for the value of the bond. If Egypt does pay its debt on time, the bank who sold the CDS gets to keep the fees.

The fee a bondholder has to pay, known as the “spread,” depends on the perceived risk of the loan. In this way, it’s like insurance.

An elderly, obese chain smoker with a history of illness will have to pay more for health insurance than a fit and healthy 25-year-old, because the insurance company believes the smoker is more likely to rack up large medical bills. Likewise, the spread for a CDS is higher if the country issuing the debt is perceived to be a greater financial risk.

The spread on a CDS reflect how high the “insurance” fees are compared to the value of the debt being ensured. Spreads are quoted in basis points, which is a fancy way of saying .01 percent. So, a spread of 100 basis points means annual fees are equal to 1 percent of the value of the debt.

As of July 31, the spread on Venezuela’s debt was almost 5,000 basis points, or 50 percent of the value. This means banks think the country is touch-and-go financially.

With a spread hovering around 300 points, Egypt is somewhere in the chain-smoker level of risk: far from death’s door, but not the safest bet either.

*people can also buy CDSs purely speculatively, without even owning any of the debt

Credit history

On the eve of the January 25, 2011 revolution, Egypt held a relatively comfortable 21st place on risk rankings, with a CDS spread of 238 basis points. However, this isn’t the first time Egypt has made it into the top five riskiest countries. The CDS spread on Egypt’s debt shot up in the summer of 2013, climbing above 700 during the lead up to the overthrow of former President Mohamed Morsi, and peaking above 900 basis points when the military-backed interim government took over.

The country closed the second quarter of 2013 with an average spread of 881.1 basis points, putting it at number 5 on S&P Capital’s global debt risk report — the same position it currently ranks in the Transforming World Atlas index.

By the end of September 2013, Egypt had dropped down to seventh place, with an average spread of 672.77 basis points, according to S&P Capital.

This means that even though the cost of insuring its debt is now about half of what was in late 2013, Egypt still has a worse ranking. This is because the rankings are relative. Argentina, which held the bottom spot in 2013, went on to default on its loans, removing itself from the ranking entirely. Meanwhile, Cyprus, which used to be perceived as risker than Egypt, is limping its way back after a 2013 bailout, bringing down its CDS spread.

AD