LEBANON. On Sept. 11, 2015, Standard & Poor’s Ratings Services revised its outlook on the Republic of Lebanon to negative from stable. At the same time, we affirmed our ‘B-/B’ long- and short-term foreign and local currency sovereign credit ratings.
RATIONALE
The outlook revision stems from our view that political uncertainty in Lebanon and regional tensions will continue to weigh on economic growth in the medium
term. In our view, the proper functioning of the Lebanese government is impaired. The parliament, whose term was due to end in June 2013, has voted for a second time to extend its term of office to 2017. It has also failed to elect a president since May 2014, and has not passed a budget since 2005.
We expect private consumption and investment to be constrained, with tourism, financial services, trade, and foreign direct investment subdued. However, we believe that higher disposable income, due to lower oil prices, will continue to support modest real GDP growth of about 3% in 2015-2018, as will a third Banque du Liban (BdL) stimulus package of $1 billion for 2015, aimed at supporting private-sector growth and small and midsize enterprises.
In our view, there are substantial shortcomings and material gaps in the dissemination of macroeconomic data and reporting delays. Official national accounts data for 2013 are the latest available, and were published in December 2014.
The national unity government consists of two political alliances, one formed on March 14, 2005, led by former Prime Minister Hariri, who opposes the Assad regime in Syria; and the other created March 8, 2005, by Hezbollah, whose military arm is actively supporting the Assad regime. The sectarian divides in Lebanon hamper policymaking, in our view. We do not expect the government will use lower oil prices and the fiscal space this allows to pursue structural reforms that might promote sustainable economic activity.
We understand that a constitutional crisis would develop if Lebanon’s prime minister, Tammam Salam, were to resign as he has recently suggested. It is unclear how a new prime minister could be appointed without a sitting president.
We expect the general government deficit to widen in 2015 to close to 10% of GDP, despite expected savings of about 1.5%-2% of GDP as low oil prices reduce transfers to the electricity company Electricite du Liban (EdL), which have averaged over 4% of GDP in recent years.
Lower transfers to EdL will be somewhat offset by lower value-added tax and customs duties. The Syrian crisis, now in its fifth year, and the flow of refugees to Lebanon (1.1 million registered as of August 2015) continue to impose a heavy burden on Lebanon’s public finances and infrastructure.
We expect that Lebanon’s 2015 revenues will show a shortfall compared with those in 2014, which benefitted from one-time developments, and we project that net general government debt will increase to 127% of GDP by 2018.
In our view, public finances and fiscal flexibility will remain constrained by structural expenditure pressures, including transfers to EdL, as well as by high interest payments, which account for about 40% of general government revenue. We do not expect any major progress on structural reforms that would lead to a sustained fiscal adjustment. The Ministry of Finance is targeting longer debt maturities and higher foreign currency borrowing as part of its public debt strategy.
The Lebanese government’s debt servicing capacity is to a significant extent determined by the domestic financial sector’s willingness and ability to continue buying government debt, which in turn is heavily influenced by the strength of deposit flows into the financial system. As of June 2015, 61% of the government’s gross debt was denominated in local currency. Domestic banks support the government debt market by buying instruments directly or by purchasing the BdL’s certificates of deposit.
In turn, the BdL buys government debt instruments. The banking sector’s claims on the public sector accounted for 21% of total banking system assets, and bank creditors held 48% of the government’s outstanding local currency debt. We view the concentration of government financing from these sources as a structural weakness that increases Lebanon’s vulnerability to adverse business, financial, and economic conditions.
In our view, confidence in Lebanon’s financial system remains strong, supported by the BdL’s policy of maintaining high foreign currency reserves that cover about 80% of the local currency money supply, as well as a favorable interest rate differential versus the U.S. The BdL has amassed important foreign-exchange reserves in recent years, which help maintain confidence in the financial system and could provide a cushion against a slowdown in foreign currency financial flows.
The central bank’s foreign assets reached $39 billion at the end of August 2015 and total foreign assets, including gold, totaled $49 billion. The banking system’s funding features a high proportion of retail deposits that have shown resilience through various crises.
Resident and nonresident private-sector deposit growth was 6% in 2014, and we expect similar levels in 2015. In our view, this should be sufficient to enable Lebanon’s financial sector to fund the large government deficit and meet the demand for private-sector credit.
We understand that, after a $2.2 billion Eurobond issued in February 2015, the Ministry of Finance has obtained approval for another $1.3 billion Eurobond issue later this year, which is the amount remaining under a $3.5 billion program. We also understand that sufficient legislative leeway is available for the government to issue foreign currency debt to refinance upcoming debt maturities until the first quarter of 2016. However, the government will need to pass new legislation to allow for further foreign currency debt issuance after that time.
There are limited available external trade, balance of payments, and international investment position data on Lebanon. We forecast that the current account deficit will approach 25% of GDP in 2015 and narrow gradually over the medium term, primarily due to a smaller import bill stemming from lower oil prices. The strengthening U.S. dollar will also reduce the cost of imports from the eurozone, which accounts for 34% of Lebanon’s imports.
We note that sizable positive net errors and omissions, averaging 10% of GDP in 2015-2018, could mean that the current deficit is overstated. The last official balance of payments data were published in 2013. Lebanon’s foreign currency inflows are highly dependent on remittances. A significant portion reportedly comes from the Gulf Cooperation Council (GCC), but we do not expect the inflow to decrease significantly in the near term because of the slowdown in the GCC.
Stock-flow discrepancies between the country’s balance of payments and its international investment position continue to make the analysis of Lebanon’s external position difficult, in our view.
OUTLOOK
The negative outlook reflects our view that protracted political instability could further dampen economic growth in Lebanon and limit policymakers’ ability to address medium- and long-term macroeconomic reforms. We could lower the ratings over the next 12 months if economic growth is slower than we anticipate or if the current political upheaval were to escalate, resulting in domestic conflict or acute risks to institutional stability.
We could revise the outlook to stable if Lebanon’s economic growth prospects improved, along with more sustainable public finances and a stable, more predictable policymaking framework.
About Standard & Poor’s Ratings Services
Standard & Poor’s Ratings Services, a part of McGraw Hill Financial (NYSE: MHFI), is the world’s leading provider of independent credit risk research and benchmarks. We have approximately 1.2 million credit ratings outstanding on government, corporate, financial sector and structured finance entities and securities. With nearly 1,400 credit analysts in 26 countries, and more than 150 years’ experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information and independent benchmarks that help to support the growth of transparent, liquid debt markets worldwide.
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