September 1, 2017 / 12:39 PM / 3 months ago

Fitch Affirms Lebanon at 'B-'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, September 01 (Fitch) Fitch Ratings has affirmed Lebanon's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B-' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Lebanon's ratings reflect very weak public finances, high political and security risks and anaemic economic performance. The ratings also capture the country's strong external liquidity, resilient banking system and other structural strengths such as high GDP per capita and human development indicators. Political and security risk is high because of spillover effects from the war in neighbouring Syria, the delicate sectarian balance in Lebanese society and politics and other geopolitical risks, for example, of renewed conflict between Hizbollah and Israel. However, the political environment has improved since the election of Michel Aoun as president in October 2016 and the formation of a new government in December under prime minister Saad Hariri. Previously, the political system had been hamstrung without a president since May 2014. Policymaking has regained some momentum, although still faces the constraints of Lebanon's sectarian political system. The new government approved two decrees in January to resume its first round of oil and gas exploration licensing (delayed since 2013); sent a draft 2017 budget to parliament; and agreed finally in June on a new electoral law and settled a date for the next election (May 2018), narrowly averting a new political crisis. Parliament approved the new electoral law, followed by a salary scale adjustment, a raft of revenue measures, and a long-delayed PPP law. Also, in May the government renewed the term of the Central Bank governor, ending months of uncertainty over the matter. There have been no major security incidents recently, but the Syrian war continues to cast a shadow over Lebanon, with the ongoing presence of a large number of refugees (1 million-1.5 million, relative to a previous total population of 4.5 million), hindrance to trade and extra military spending. Public finances remain weaker than 'B' peers. General government debt is the third highest among Fitch-rated sovereigns at an estimated 148.2% of GDP in 2016. High debt levels have contributed to an exceptionally high and rising interest bill, equating to 48% of government revenues in 2016. The budget deficit widened to 9.8% of estimated GDP in 2016 (more than double the 'B' peer median), from 8% in 2015. Total spending rose by 10%, pushed higher by transfers to municipalities, the rising trend in interest payments and personnel costs. Weak economic activity continued to constrain budget revenue. The outlook for fiscal consolidation remains unclear, despite recently agreed fiscal measures by the government and the prospect of parliament approving a budget for the first time since 2005. The cost of the salary scale (wages and retirement benefits) is estimated at LBP1,300 billion (USD862 million), LBP882 billion of which relates to a cost of living adjustment that took place in 2012 and is already embedded in spending, according to the Ministry of Finance (MoF). The MoF therefore puts the additional cost from this agreement at LBP418 billion. At the same time, the MoF revenue directorate estimates that the revenue measures agreed to offset the salary scale will generate LBP1,700 billion annually (USD1,135 million). This would imply a consolidation of LBP1,280 billion in a full year (1.5% of forecast 2018 GDP), other things being equal. Details on the calculation of the estimate for additional revenue are not yet available. The revenue measures include an increase in the VAT rate to 11% from 10%, the corporate tax rate to 17% from 15%, and the tax rate on interest income from deposits to 7% from 5%; new taxes on cigarettes and on real estate transactions; a number of fees, including on air travel; plus other miscellaneous measures. We forecast that the budget deficit will narrow to 9.5% of GDP in 2017 and then to 8.9% of GDP in 2018-19. Government debt/GDP will rise close to 155% in 2019. This builds in a smaller consolidation than implied by MoF numbers, given the substantial uncertainty over these estimates. More details are likely to be provided once the 2017 budget is passed. The forecast also incorporates spending increases in other lines, especially interest expenditure. The government has continued to meet its high financing needs (around 30% of GDP in 2017) at broadly stable funding costs. Growth in deposits (a large part of which stems from the diaspora), which are channelled into government financing by domestic banks, is the cornerstone of Lebanon's public debt sustainability. If there was a sustained slowdown in deposit growth due to renewed political concerns and/or loss of confidence in the financial system or a shock triggering large outflows, it would place debt sustainability under greater stress. The only significant recent episodes of deposit outflows happened in response to shocks in 2005-06 and were temporary. Deposit growth has strengthened since mid-2016. Total deposits in commercial banks were 8.5% higher yoy in June 2017, up from less than 5% yoy growth in February-July 2016. Deposit growth regained momentum during the Banque du Liban's (BdL) financial engineering operation in 2H16 and benefited from the political breakthrough later in 2016. In absolute amounts, deposits increased by USD7.8 billion in 2H16 and USD5.2 billion in 1H17, compared with USD3.1 billion in 1H16. This level of deposit growth is sufficient to meet government financing needs (and allow for credit growth to the private sector, which was 6.2% in 2016). Lebanon has maintained a large stock of gross foreign reserves, USD33.9 billion (excluding gold worth USD11.5 billion) at end-June, despite persistently large current account deficits (19.4% of estimates GDP in 2016). Excluding gold, foreign reserves accounted for 61% of LBP deposits, up from a recent low of 57% in March 2016, prior to the BdL's financial engineering operation. The dollarisation rate of deposits, at 67%, has remained broadly stable since the outbreak of the Syrian crisis. The BdL maintains high gross foreign reserves to support confidence in Lebanon's currency peg against the USD. However, in keeping Lebanon's currency peg against the USD and its financing model running, BdL seems to have been incurring annual losses on its foreign-currency operations and a worsening capital position as it receives minimal returns on its FX reserves due to low global interest rates, while paying out higher rates to attract US dollar deposits. Growth prospects remain modest without improvements in the external environment or a stronger reform programme. Growth has averaged less than 2% in 2011-16 since the outbreak of the Syrian war, an extremely weak performance relative to historical trend. In 2000-2010 real GDP growth averaged 5.3%, with several years of growth in the 8%-10% band. GDP per capita and broader human development indicators are well above 'B' category peers and more in line with the 'BBB' median, although governance indicators are weaker than peers. The government also has an unblemished track record of public debt repayment. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Lebanon a score equivalent to a rating of B on the Long-Term FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - Structural features: -1 notch, to reflect political and security risks not fully captured in the SRM, related to the ongoing war in Syria, the delicate sectarian balance in Lebanese society and politics and other geopolitical risks, for example, of renewed conflict between Hizbollah and Israel Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently balanced. The main factors that could, individually or collectively, lead to positive rating action are: -An improvement in public debt dynamics, whether through fiscal tightening or improved economic performance. -Greater confidence in the sustainability of the domestic political environment and a sustained de-escalation of the war in Syria. The main factors that could, individually or collectively, lead to negative rating action are: -Diminished ability of the domestic banking sector to continue to attract sufficient deposits to keep funding the government. -A major destabilisation of Lebanon, for example, induced by spill-overs from the Syrian conflict or a severe intensification of sectarian tensions. KEY ASSUMPTIONS - Fitch assumes that sporadic security incidents will prevail as long as conflict in Syria continues, but that Lebanon will not itself descend into a full-scale civil conflict. - Fitch assumes that international oil prices will average of USD52.5/b in 2017, USD55/b in 2018 and USD60/b in 2019. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'B-'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'B-'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'B' Short-Term Local-Currency IDR affirmed at 'B' Country Ceiling affirmed at 'B-' Issue ratings on long-term senior-unsecured foreign-currency bonds affirmed at 'B-' Contact: Primary Analyst Toby Iles Director +852 22639832 Fitch (Hong Kong) Limited 68 Des Voeux Road Central Hong Kong Secondary Analyst Douglas Winslow Director +44 20 3530 1721 Committee Chairperson Michele Napolitano Senior Director +44 20 3530 1882 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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