Monday 04, September 2017 by Georgina Enzer

Moody's downgrades Lebanon's rating to B3, changes outlook to stable from negative

Moody's Investors Service has today downgraded Lebanon's long-term issuer ratings to B3 from B2 and changed the outlook to stable from negative.

The rating downgrade is based on Moody's view that a B3 rating appropriately captures Lebanon's credit risk profile. The ongoing erosion of Lebanon's very weak government finances will continue to constrain the rating pending further clarity on whether recent and prospective fiscal reforms will be effective given the evolving political environment. While Lebanon's external liquidity position continues to be strong, and banking liquidity ample, rising external imbalances, coupled with a weak growth outlook increase Lebanon's vulnerability to external shocks.

The stable outlook reflects the return to a fully-functioning government, which will support reform momentum going forward. Lebanon has a strong track record of servicing debt under stressed conditions, and its external buffers have continued to strengthen in recent years, supported by new deposits and the Central Bank's operations.

Lebanon's local-currency bond and deposit ceilings are unchanged at Ba2. The foreign currency deposit ceiling is lowered to B3 from B2 and the short term foreign currency deposit ceiling remains at NP. The foreign currency bond ceiling was changed to B1 from Ba3. These ceilings reflect a range of undiversifiable risks to which issuers in any jurisdiction are exposed, including economic, legal and political risks. These ceilings act as a cap on ratings that can be assigned to the foreign and local-currency obligations of entities domiciled in the country.

Lebanon's senior unsecured Medium Term Note programme is also downgraded to (P)B3 from (P)B2 while its other short term rating is affirmed at (P)NP.

RATINGS RATIONALE

DRIVERS OF THE DOWNGRADE TO B3: A FURTHER WEAKENING OF DEBT METRICS

The principal driver of the downgrade is the rise in the country's debt burden. Moody's estimates Lebanon's 2018 government debt to reach close to 140 per cent of GDP, the third highest among all rated sovereigns. Government debt has risen inexorably since 2011, when it bottomed out at 121 per cent of GDP, reflecting a deterioration in the fiscal balance. Other fiscal and debt metrics, such as annual gross financing needs, interest payments as a share of government revenue and debt to revenue, also illustrate the very high burden. For instance, Moody's projects government debt will remain close to 700 per cent of government revenues next year.

In Moody's view, recent fiscal reforms are very unlikely to reduce the deficit in 2017 and 2018. The recent revenue package approved by parliament is credit positive as it demonstrates the emerging consensus among decision-makers, but its purpose is simply to offset the planned upward adjustment in public sector salary scales; further action will be needed to reverse the rising debt trajectory. The absence of an approved budget continues to impede the formulation and implementation of debt-stabilising reforms. No budget has been in place since 2005, and while the recent agreement on a budget within the cabinet raises the prospect of one now being passed by parliament, its likely impact is unclear and its approval comes too late to halt the erosion in fiscal strength.

External imbalances are wide and rising again. The trade deficit reached $13.6 billion in 2016, or 26.2 per cent of GDP, up from $13.1 billion, or 25.8 per cent of GDP last year. Although Lebanon has benefitted from a decrease in hydrocarbon prices and continued remittances inflows, tourism receipts have not recovered. As a result, the current account deficit reached $8.4 billion, or 18.8 per cent of GDP in 2016, and will remain similarly high in 2017.

While the reserves position remains strong, the rising pressure on the authorities to sustain the large foreign currency inflows needed to support the external deficit was illustrated by the recent operations by the Central Bank to raise reserves.

The cost of hosting Syrian refugees, combined with a deterioration in infrastructure and limited donor support have dampened growth to an annual average of 1.6 per cent over the past three years. Even though Moody's expects growth to pick up to close to 3 per cent this year and next, the legacy of years of underinvestment and political instability leave potential growth well below previously high growth levels. Even if political stability consolidates after the May 2018 elections, the economy will remain vulnerable to external shocks.

DRIVERS OF THE OUTLOOK CHANGE TO STABLE: POLITICAL CONSENSUS SUPPORTS

MEDIUM-TERM REFORMS AND DEPOSIT INFLOWS

Signs of an emerging political consensus offer the prospect of greater political stability, with supportive implications for both institutional strength and future growth. In October 2016, Lebanon's parliament voted to elect a president, filling a post that had been vacant since May 2014.

This was accompanied by the formation of a cabinet in December 2016, and a new electoral law was approved in June 2017, all of which suggest a lower level of polarisation among political parties and an end to the political paralysis that has undermined government effectiveness and resulted in persistent delays in reforms.

The restored political process has allowed the cabinet to start implementing long-delayed reforms. Moody's expects an acceleration in economic and fiscal reforms, including buttressing the energy sector. Early signs of willingness to enact fiscal reforms offer the prospect of further measures which could support long-term debt sustainability.

Renewed political consensus is also likely to attract support from the international donor community.

Lebanon has proven its willingness to pay debt in stressed conditions and maintains adequate reserves. Although the debt position and sustainability metrics compare poorly even with B3 credits, liquidity risks are contained. External buffers have increased and support the exchange rate peg. Excluding gold reserves, Central Bank reserves were close to $40.2 billion as of May 2017, up from $38.9 billion one year earlier. Substantial financial inflows -- in particular foreign deposit inflows which continue to supply foreign exchange deposits of commercial banks held with Banque du Liban -- more than offset the current account deficit and continue to bolster foreign-exchange reserves.

A loyal depositor base and donor support underpin debt sustainability, and improvements in the political scene have boosted deposit flows. Looking at the recent history of deposit flows to Lebanese banks, deposit inflows have demonstrated remarkable resilience to political shocks. In order to sustain financial stability, Lebanon requires deposit inflows of around $9 billion this year, and it already received $5.5 billion in new deposits in the first half of 2017. In June 2017, year-on-year growth in private sector deposits reached 8.6 per cent from just 4.8 per cent one year earlier.

WHAT COULD MOVE THE RATING UP/DOWN

Moody's would upgrade Lebanon's rating if fiscal reforms led to a durable reversal in the debt trajectory, and if a significant improvement in the country's large external imbalances were to materialise. Conversely, Lebanon's rating would be adjusted downwards if significant pressure on foreign-exchange reserves materialised, including in the unlikely event of a material fall in deposit inflows, which suggested a heightened risk of a balance of payments crisis and which threatened the banking sector's ability to continue to finance the government.

GDP per capita (PPP basis, $): 18,525 (2016 Actual) (also known as Per Capita Income)

Real GDP growth ( per cent change): 1.8 per cent (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI,  per cent change Dec/Dec): 3.1 per cent (2016 Actual)

Gen. Gov. Financial Balance/GDP: -8.1 per cent (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -18.8 per cent (2016 Actual) (also known as External Balance)

External debt/GDP: 98.3 per cent (2016 estimate)

Level of economic development: Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since Moody's records began in 1983.

On 23 August 2017, a rating committee was called to discuss the rating of the Lebanon, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength are stable. The issuer's institutional strength/framework, have materially increased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased.

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