Standard & Poor’s Ratings Services affirmed the long- and short-term foreign and local currency sovereign credit ratings on the Republic of Lebanon at B/B. The outlook remains negative.
The ratings on Lebanon are constrained by a divisive political environment and a high public debt burden. After decreasing for five years, the government debt burden reversed in 2012 due to wage and pension increases as well as rising subsidies, which pushed the primary balance into deficit. The ratings are supported by a large and stable resident and non-resident depositor base, which finances much of the government’s borrowing needs.
Sectarian tensions are high and rising. Despite a government policy of “neutrality” and “disassociation” from the Syrian civil war, Lebanon’s sectarian groups have become increasingly divided along pro- and anti-Assad lines as the Syrian conflict enters its third year. “We don’t see the escalation of violence in Syria as having markedly weakened Lebanon’s own domestic security. Nor do we believe it has exacerbated Lebanon’s own domestic political tensions or undermined confidence in its banking system. That said, we view the domestic political situation as being in flux, as evidenced by the resignation of Prime Minister Najib Mikati in March 2013, which led to the second government collapse since 2011,” S&P in a statement said.
“We believe that the swift approval of a new prime minister, Tammam Salam, whose nomination was supported by both the March 14 and March 8 political alliances and who is seen as a consensus figure, will help defuse tension in the near term. We note, however, that the new prime minister will be challenged to form a new cabinet. He has pledged to head a government of “national interest” and the first tasks of the new government will be the very same ones that caused Mikati to step down–namely, to have parliament adopt a law to govern the election scheduled for this summer and to extend the tenure of the country’s head of internal security.”
“The main growth engines for Lebanon, tourism and financial and other high-end services, have been depressed since the start of the crisis in Syria. The situation worsened in 2012 as violence began to spill into northern Lebanon and after the Gulf States issued travel warnings for their citizens, further hurting tourism and investment flows. While the economy may have benefitted from an increase in domestic demand growth from the influx of middle- and upper-class Syrian refugees–and from the increase in public sector wages and pensions–these were one-off boosts to growth that we do not expect to see repeated in 2013.”
“In our view, growth this year could benefit from increased transfers to municipalities and the planned salary scale adjustment; although in our base case we do not expect the latter to be implemented, at least not without offsetting budgetary measures. A prolonged period of government formation would also undermine growth. Moreover, the Lebanese economy will have to absorb between 400,000 (United Nation’s estimate) and one million Syrian refugees, which is weighing on Lebanon’s already weak infrastructure and security environment.”
“The key ratings vulnerability is the high general government debt burden. After a steady reduction in the debt burden to 137% of GDP in 2011 (from 182% in 2006), public finances deteriorated significantly in 2012. The general government deficit widened by 3.4% of GDP to 9.4% and the primary fiscal balance turned negative (0.7% of GDP) for the first time since 2006. Debt is estimated to have increased to 138% of GDP in 2012.”
“No budget has been approved since 2005, which has diminished the accountability, predictability, and flexibility of fiscal policy. In 2012, interest payments consumed nearly 40% of revenues and personnel costs were one-third of spending. The latter increased by 22% last year, largely due to a one-off cost-of-living adjustment for public-sector wages and increased pensions due to the rising number of pensioners. Underinvestment in infrastructure, constrained by a lack of capital investment budgets, has pushed up subsidies to Electricite du Liban (EdL) to more than 5% of GDP.
“We expect the general government to record a deficit of about 8% of GDP in 2013. We assume that the government will either raise revenue to match a proposed 2.5% of GDP wage increase, which includes the cost-of-living adjustment already adopted in 2012 and the proposed salary-scale adjustment in 2013, or scrap the increase altogether,” S&P added.
In our view, confidence in the Lebanese financial system, the strength of which underpins the ratings, remains strong and is not likely to be significantly affected by domestic political developments, short of major domestic strife. The banking system’s funding profile features a high proportion of retail deposits that have shown resilience through various crises. Excess funds–mainly customer deposits, including non-resident and resident deposits, represent about 3.3x system loans on Jan. 31, 2013–are largely channeled to Lebanese government debt. This debt dominates both the domestic capital market and the banks’ balance sheets. Lebanese banks, however, have been in a net external debtor position since 2011, as part of Lebanon’s high current account deficits has been financed through the banks and because the banks have reduced their exposure to Syria.”
“The negative outlook reflects our view that risks to political and economic stability will remain significant while the conflict in Syria remains unresolved and absent a major breakthrough on the domestic political front akin to the 2008 Doha Agreement, which ended violent sectarian clashes,” S&P further added.
“If a broad-based cabinet were formed without delay, we believe this would help support the ratings at their current level. On the other hand, the ratings could come under pressure if the government goes through with the planned public-sector wage increase without offsetting revenue measures, or if, contrary to our expectations, the Syrian civil war materially affects investor confidence in Lebanon.”