S&P Global Ratings revised its outlook on the Republic of Lebanon to stable from negative.
At the same time, we affirmed our 'B-/B' long- and short-term foreign and local currency sovereign credit ratings on Lebanon.
“The outlook revision reflects our view that bank deposits in Lebanon will increase sufficiently to support the government's borrowing requirement (26 per cent of GDP in 2016) and the country's external financing requirement (89 per cent of GDP or 151 per cent of current account receipts [CARs] in 2016). We expect bank deposits will increase by at least four per cent in 2016.
“In our analysis, the Lebanese government's debt-servicing capacity depends materially on the domestic financial sector's willingness and ability to add to its holdings of government debt, which in turn relies on bank deposit inflows.
Domestic banks support the government debt market in two ways. First, they buy Lebanese government debt directly. Banking system claims on the public sector account for about 20 per cent of total banking system assets.This means bank creditors hold about one-half of the total government debt.
Second, Lebanese banks buy certificates of deposit issued by the Banque du Liban (BdL; the central bank), which in turn buys government debt. As of year-end 2015, the BdL held 37 per cent of the government's outstanding treasury bills, which amounted to 23 per cent of total government debt. Although we view the concentration of government financing from these sources as a structural weakness, at the current rating level these flows are an essential support.
“The financial system is key in meeting the country's external financing requirement. Approximately two-thirds of Lebanese bank deposits are in foreign currency and nearly one-fourth is externally sourced, mostly from the Lebanese diaspora. The banks induce the inflows by paying on average about six per cent on Lebanese pound deposits and three per cent on U.S. dollar deposits.
Last year, the inflows covered 2x net government debt issuance. We note that, as a consequence, banks' external positions have deteriorated. We expect banks' net external debtor positions will almost double in 2016 to $13 billion (44 per cent of CARs), compared with $7 billion in 2013 and a net creditor position in 2010.
Nonresident retail deposits constitute the bulk of banks' external liabilities (about 83 per cent as of year-end 2015), the rest being cross-border interbank deposits. To meet the 2016 gross external financing requirement, we expect banks and corporations will add to their external borrowings, and the government has returned to the Eurobond market.
We also note that BdL's international reserves (excluding gold) decreased by about $2.4 billion in the 12 months ended June 30, 2016, to stand at $38.2 billion. Additional drawings could be made to finance part of Lebanon's 2016 $47 billion gross external financing requirement.
“That said, there are ongoing risks to these deposit inflows. Bank deposit growth slowed to about 5.2 per cent annually at year-end 2015 from 11.5 per cent at year-end 2010, as result of the civil war in Syria and, to a lesser extent, the economic slowdown in the Gulf Cooperation Council region (GCC; Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates).
Inflows are sensitive to swings in confidence. In February 2016, the government of Saudi Arabia announced its curtailment of its $4 billion grant for military procurement for Lebanon, and the GCC states placed restrictions on their citizens' travel to Lebanon. Still, these measures seem to have had a softer impact on depositor confidence than the 2005 assassination of Prime Minister Rafic Hariri, which prompted nearly $2 billion in withdrawals from the banking system; or the 2006 war with Israel that triggered about $3 billion in withdrawals.
The withdrawals from these earlier, more perilous periods lasted only a few weeks, were in the low-single-digit percentages of total bank deposits, and were more than compensated by returning inflows. If, however, deposit growth slowed or reversed, due to a more severe political shock than these past incidents or a redomiciliation, for example, the fiscal and external pressure on the ratings would mount.
“We also see longer-term constraints on Lebanon's deposit and economic growth, largely stemming from a divisive political environment organized along confessional lines. The presidency has been vacant since President Michel Sleiman's term ended in May 2014. Since then, the Lebanese parliament has failed on 43 consecutive occasions to elect a president, most recently in August 2016.
The parliament itself is led by a national unity government comprising both the March 14 and March eight political alliances, which back opposing sides in the Syrian civil war. The absence of a sitting president did not, however, prevent the parliament, whose term was due to end in June 2013, from extending its term twice, most recently in November 2014. The next parliamentary elections are scheduled for May 2017. The split political environment can thwart policymaking even on relatively minor issues, such as garbage collection, turning them into much larger social problems.
“Nevertheless, we note that parliament passed some key laws at the end of 2015, such as legislation permitting the government to borrow in foreign currency in 2016. In March 2016, the Lebanese government approved a temporary emergency plan to help partly solve the garbage crisis that started in July 2015 and led to a series of demonstrations. Also, we note that municipal elections (the first local polls since 2010) were successfully held in May 2016.
“We believe that Lebanon's economic growth will remain relatively weak as long as the domestic political standstill persists and the Syrian civil war continues. The Syrian crisis entered into its sixth year--without a resolution in sight--and we expect that Lebanon's political, security, and economic trajectories will remain entwined with those of its larger neighbour. We therefore anticipate that Lebanon's traditional growth drivers--tourism, real estate, and construction--will remain subdued, despite favorable terms of trade (see "S&P Lowers Its Hydrocarbon Price Deck Assumptions On Market Oversupply; Recovery Price Deck Assumptions Also Lowered," published Jan. 12, 2016, on RatingsDirect).
We project economic growth over 2016-2019 at just over 2.3 per cent on average. In our view, the productive capacity of the Lebanese economy is below that of peers. We estimate growth in real per capita GDP (which we proxy by using the 10-year weighted-average) at negative 2.3 per cent during 2010-2019. We estimate nominal per capita GDP at $8,600 in 2016.
“We expect that the current account deficit will remain large, but narrow to average about 14 per cent of GDP in 2016-2019, due to a smaller import bill stemming from lower oil prices and weaker domestic economic activity. We note that the deficit may be overstated due to unrecorded public and private transfers and border trade. The strengthening U.S. dollar (to which the Lebanese pound is pegged) will also reduce the cost of imports from the Euro zone, which accounts for about one-third of Lebanon's imports.
On the other hand, exports, tourism, and net remittances will remain constrained because of the Syrian crisis. We note that the World Bank announced in July this year that its grant and loan program for Lebanon would reach $1.5 billion over the next three years.
“We estimate Lebanon's public- and financial-sector external assets will exceed the country's external debt by an average 57 per cent of CARs between 2016 and 2019, albeit on a declining trend. We estimate that gross external financing needs will average 118 per cent of CARs plus usable reserves over the same period.
“The Syrian civil war and the flow of refugees to Lebanon continue to impose a heavy burden on Lebanon's infrastructure. Registered refugees reached 1.1 million, according to the UN High Commissioner for Refugees, but private estimates range up to about two million, compared with the estimated population living in Lebanon of about 5.9 million according to the government.
“We expect the general government to post a modest primary fiscal surplus through the forecast horizon. The broader deficit, however, will likely widen to 8.7 per cent of GDP in 2016 compared with 6.2 per cent in 2014. We note that government revenues in 2014 benefited from a one-time receipt of about two per cent of GDP due to exceptionally high telecom transfers. The deficit includes transfers to the electricity company Electricité du Liban (EdL), estimated at about two per cent of GDP in 2015 compared with four per cent of GDP in 2014, with EdL requiring less government support due to lower oil prices.
“In our view, Lebanon's public finances and fiscal flexibility will remain constrained by structural expenditure pressures, including transfers to EdL.
“Still, even without a fully functioning government, current expenditures were contained at about 23 per cent of GDP in 2015, while capital expenditures were cut to one per cent of GDP in the same year, notwithstanding Lebanon's significant infrastructure needs. Interest payments account for more than two-fifths of general government revenues. Monetary conditions are tight and create headwinds for growth. The real effective exchange rate has appreciated by about 30 per centbetween 2011 and 2015. Real effective interest rates on government debt, as measured by the consumer price index, spiked in 2015 at over 10 per cent due to an unexpected fall in prices. We expect inflation to rise at a quickening pace through the forecast horizon and government debt to stabilize in 2017 at just under 130 per cent of GDP, net of liquid fiscal assets.
“Lastly, we note that 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 availability and quality of official external data are also limited, in our opinion.
“The stable outlook on Lebanon reflects our expectation that continued deposit inflows to the financial system will remain sufficient to support the government's borrowing requirement and the country's external financing gap, despite the difficult internal and external political environments.
“We could lower our ratings on Lebanon if, over the next 12 months, deposit inflows significantly slowed or foreign-exchange reserves declined much further than we currently expect. If the domestic political gridlock escalated to a more destabilizing situation, we could also lower the ratings.
“We could raise our ratings if Lebanon's policymaking framework became more predictable, supporting foreign capital inflows and improving the sustainability of public finances.”
By Matthew Amlôt
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