LONDON (Standard & Poor's) Jan. 31, 2012--Standard & Poor's Ratings Services said today that it affirmed its 'B' long-term and 'B' short-term foreign- and local-currency sovereign credit ratings on the Republic of Lebanon. The outlook is stable. The recovery rating is '4'. The transfer and convertibility (T&C) assessment remains at 'BB-'.
The ratings on the Republic of Lebanon are constrained by the country's high public debt burden, large current account imbalances, and the divisive political environment. The ratings are supported by Lebanon's stable resident and nonresident depositor base, which in our view supports the country's comparatively strong and well-regulated financial system and meets both the banks' and the government's funding needs.
While we believe that Lebanon has maintained a greater degree of stability than a number of its neighbors in the Middle East and North Africa (MENA) region, it has not been immune from the political and economic turmoil in the region. Moreover, unlike previous crises in recent years, which we consider had a positive effect on the Lebanese economy--for example by capturing tourism and capital outflows from neighboring countries, thereby boosting the financial sector and in turn helping to drive growth--the growing instability in Syria, and the uncertainty caused by the Lebanon's extended political transition during the first half of 2011, have depressed investment.
These factors have weighed heavily on the tourism and financial services sectors in particular, despite the limited direct trade links between Lebanon and Syria.
We therefore estimate that GDP growth reached 1.5% in 2011, after an average of 8.2% between 2007-2010. We expect real GDP growth to recover to 3.5% in 2012, rising to 5% by 2014, supported by a recovery in tourism and levels of investment.
We assume that regional instability, particularly the turmoil in Syria, will continue to constrain Lebanese consumer and investment sentiment in the near term, but that the Lebanese government will not collapse. We could revise our growth projections downward if the regional geopolitical situation worsens.
We do not expect growth to reach pre-2011 levels in the medium term, since those levels largely resulted from a convergence of key factors, including political and macroeconomic stability, and the global low interest environment, which drove capital inflows into Lebanon.
Lebanon's fiscal profile is weak in our view. The government has not passed a budget since 2005, which we consider has constrained expenditure growth and contributed to many years of underinvestment in Lebanon's productive infrastructure. Higher oil prices have pushed subsidies to Electricité du Liban (EdL) to more than 4% of GDP in 2011.
Although Lebanon's primary fiscal balance remains in surplus by more than 2% of GDP, interest payments on the debt consume more than 40% of government revenues and just below 10% of GDP, resulting in an overall general government deficit of 7% of GDP in 2011. We expect Lebanon to run fiscal deficits of this size for the forecast horizon.
Notwithstanding the high deficits that the government is experiencing, the ratio of gross general government debt to GDP has declined to 133% in 2010 from 180% in 2006. We consider this is due to high real (and nominal) economic growth and modest real interest rates, but not to fiscal reform.
With weaker growth over 2011-2012, we estimate that gross general government debt will remain flat at 132% of GDP in 2011, 39% of which is denominated in foreign currency, but predominantly held by domestic banks. We expect the debt burden to stabilize at this level.
Private sector deposits amount to 230% of GDP, and we expect them to rise at a faster pace than economic growth, reflecting financial deepening. This large and growing deposit base, coupled with limited lending opportunities domestically, provide the government with strong domestic demand for its funding needs.
As a consequence, the banking sector is highly exposed to government debt (over 50% of local currency government debt is held by commercial banks; 32% by the Banque du Liban, BdL). Although we note that banks have somewhat reduced the share of government debt on their balance sheets this year in favor of private sector lending, we note that the BdL has had to pick up the slack. The banking system remains sound and profitable, with a capital adequacy ratio of 13.4%.
After the collapse of the March 14 unity government in January 2011, a new government has been formed, led by the March 8 Alliance with Najib Mikati as prime minister. Expectations that the new government, composed of relatively like-minded parties compared with the previous government, would be able to make greater inroads on key reforms than its predecessor have so far not been realized.
We note that the payment to the UN Special Tribunal for Lebanon (STL), which is investigating the 2005 assassination of former Prime Minister Rafik Hariri, remains a contentious issue, and could become even more so in March this year when Lebanon has to renew its protocol.
In this respect, we note that private bank contributions, rather than a government disbursement, largely funded the November payment to support STL's work. We consider that the government's management of this issue underlines a certain level of pragmatism and is an indication to us that it may be able to reach some compromise on the many needed, but contentious, reform issues in the future.
Stock–flow discrepancies between the country's balance of payments and international investment position make the analysis of Lebanon's external position difficult, in our view. International reserves, excluding gold, reached historic highs of $32 billion at year-end 2011. However, the financial sector moved into a small net external debtor position last year and reported current account deficits exceeded 20% of GDP in 2010 and 2011. Although unallocated remittances and border trade may mitigate these deficits somewhat, we consider that Lebanon's balance of payments remains vulnerable in both the current and financial accounts.
We equalize our local- and foreign-currency sovereign credit ratings on Lebanon. This is because significant dollarization of deposits and claims constrain monetary policy options, which underpin a sovereign's flexibility in its own currency. Our T&C assessment is two notches above the foreign-currency rating, which reflects our opinion that the likelihood of the sovereign restricting access to foreign exchange needed by Lebanon-based non-sovereign issuers for debt service is slightly lower than the likelihood of the sovereign defaulting on its foreign-currency obligations.
The recovery rating on Lebanon's senior unsecured debt is '4.' This indicates our expectation of a 30%-50% recovery in the event of a default on Lebanon's commercial debt. The estimate draws on a scenario--not a base case--of heightened political crisis and armed conflict, which would result in a loss of confidence by domestic banks and international investors. In turn we believe this would result in acute financing pressure for the government, a running down of reserves, and an inability to defend the peg.
The stable outlook reflects our view that the rising resident and nonresident deposit base will continue to support the government's financing needs. It also takes into account our expectation that tourism and foreign direct investment will rebound once the region stabilizes, although we do not consider this likely before next year.
We could lower the ratings if domestic or regional security deteriorates to an extent that deposit levels fall, in turn straining public finances and the BdL's ability to maintain its currency peg. We could raise the ratings if the government demonstrates significant progress on fiscal reform, raising the primary surplus and thus accelerating the government debt-to-GDP ratio's declining trend.
Similarly, we could raise the ratings if there were an improvement in domestic stability and government cohesion, the government established a track record of structural reforms and infrastructure investment, and if there were an improvement in Lebanon's potential growth rate as a result.