LONDON Moody's Investors Service cut its rating on Egypt's sovereign debt on Monday, saying the government might damage its already weak finances by increasing social spending to calm mass protests.
"There is a strong possibility that fiscal policy will be loosened as part of the government's efforts to contain discontent," Moody's said as it announced the one-notch downgrade, to Ba2 with a negative outlook from Ba1.
"A background of rising inflationary pressures further complicates fiscal policy by threatening to increase the high level of budgetary expenditure on wages and subsidies."
President Mubarak, who sacked his inner circle of ministers on Saturday, ordered his new cabinet on Sunday to preserve subsidies, control inflation and provide more jobs, state television reported.
The protest movement is driven in large part by public anger at rising prices, unemployment and the huge disparity between rich and poor.
That means any successor administration to Mubarak, should he be forced from power, would might well keep subsidies in place and boost social spending to reward its power base.
"Given that around half of the government's expenditure is spent on subsidies and wages, there is clearly a risk that the public finances could deteriorate significantly," Tristan Cooper, Moody's head analyst for Middle East sovereigns, told Reuters in an email.
One analyst suggested the Moody's cut, coming as protesters camped out in central Cairo vowed to stay until they had toppled President Hosni Mubarak from power, was overdue.
"Finally the rating agencies wake up. Egypt rated flat with Turkey was always a joke," said Timothy Ash, head of CEEMEA research at RBS.
On Friday Fitch Ratings cut the outlook on Egypt's BB+ country ceiling to negative, saying the political turmoil would likely undermine the country's economic reform program.
Egypt's budget deficit in the fiscal year to June 2010 was 8.1 percent of gross domestic product. It aims to keep the deficit at 7.9 percent of GDP this fiscal year, falling to between 3.0 and 3.5 percent in 2014/15, state news agency MENA quoted officials as saying last July.
There is rising unease among rating agencies at the impact of political tensions across swathes of North Africa.
Standard and Poor's said on Thursday that political and fiscal uncertainty were weighing on the sovereign ratings of several Middle Eastern and North African countries, with Egypt, Algeria and Jordan most vulnerable to unrest similar to the protests which occurred this month in Tunisia.
Fitch said on the same day that it would decide in three to six months whether to cut its rating on Tunisia, following weeks of unrest that forced a change of government and hit economic growth.
(Reporting by Andrew Hammond and Martin Dokoupil; writing by John Stonestreet; Editing by Toby Chopra and Andrew Torchia)