Moody's Investors Service said it has downgraded Egypt's government bond ratings to Ba2 from Ba1 and has cut the outlook to negative from stable warning that the escalating political tensions may dent the country's public finances.

Moody's said the downgrade was driven by the recent significant rise in political risk and concern that the response to the political unrest could undermine Egypt's already weak public finances.

Moody's has also downgraded the country ceiling for foreign currency bonds to Baa3 from Baa2 and the country ceiling for foreign currency bank deposits to Ba3 from Ba2. The outlook on these ratings was changed to negative from stable. The short-term country ceiling for foreign currency bonds was downgraded to P-3 from P-2. The local currency ceilings were downgraded to Baa1 from A3.

Moody's downgrade follows a similar action by Fitch Ratings on Friday. Fitch has revised the rating outlook on Egypt to negative from stable. However, the agency has affirmed Egypt's long-term foreign currency Issuer Default rating (IDR) at 'BB+', long-term local currency IDR at 'BBB-', short-term foreign currency IDR at 'B' and Country Ceiling at 'BB+'.

The outlook revision reflects the recent upsurge in political protests and the uncertainty this adds to the political and economic outlook ahead of September's elections, says Richard Fox, Head of Middle East and Africa Sovereign Ratings at Fitch.

A continuation or intensification of significant unrest that seriously threatened economic and financial performance and the economic reform process would lead to a rating downgrade, Fitch said in a statement.

Egypt is suffering from escalating political tensions following the recent uprising in Tunisia, with large-scale anti-government protests taking place. Meanwhile, embattled Egyptian president Hosni Mubarak's son, Gamal Mubarak, who has been widely seen as his successor, has reportedly fled the country.

Moody's said Egypt suffers from deep-seated political and socio-economic challenges, including a chronic high rate of unemployment, elevated inflation and widespread poverty. These, together with a desire for political change, have fueled popular frustrations.

Political risk has always been a consideration in Egypt's ratings and the recent events in that country could serve as a reminder that political changes can erupt unexpectedly and with uncertain consequences.

The recent protests seen in Cairo and other cities have increased political risk and uncertainty ahead of September's presidential elections, which will be a constant focus for protest in the coming months and tensions could increase or be defused, depending on the government's response.

Meanwhile, President Mubarak has not yet announced whether he will stand for re-election and the ruling National Democratic Party is not due to announce its candidate until July.

There is a strong possibility that fiscal policy will be loosened as part of the government's efforts to contain discontent. A background of rising inflationary pressures further complicates fiscal policy by threatening to increase the high level of budgetary expenditure on wages and subsidies, Moody's said in a statement.

Most governance indicators, as measured by the World Bank, are weaker than peer group medians, while per capita income and human development, as measured by the UN, are also relatively weak.

Moody's noted that the public finances in Egypt are already stretched and are significantly weaker than Ba rating peers. For example, Egypt's fiscal deficit approximates 8 percent of GDP, compared with a median for the Ba rating category of around 4 percent of GDP. Egypt's public debt also exceeds the Ba median by a considerable margin.

On the positive note, Moody's said Egypt's ratings continue to be supported by a number of important factors, including a relatively robust external position, a well-diversified economy and a favorable public debt structure with limited refinancing risk.

The government has shown a high degree of willingness to repay and has never defaulted on its bonds, Moody's noted.

Moody's said it would revise the outlook to stable if the current political tensions and attendant fiscal and economic risks abate.

Conversely, Moody's would downgrade Egypt's sovereign ratings again if there were a substantial escalation of political volatility, a large fiscal slippage, or evidence of lasting economic damage that threatened to impair credit fundamentals relative to Ba2 rating peer.

Moody's last rating action affecting Egypt was implemented on April 26, 2010, when a Ba1 rating was assigned to the government's dollar-denominated senior unsecured bonds worth $1.5 billion. In August 2009, the rating agency changed the outlook on Egypt's sovereign ratings to stable from negative.