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Rating Action:

Moody's changes outlook on Lebanon's rating to negative, affirms B3 rating

13 Dec 2018

New York, December 13, 2018 -- Moody's Investors Service ("Moody's") has today changed the outlook to negative from stable on the Government of Lebanon's issuer ratings and affirmed the ratings at B3.

The negative outlook reflects an increase in risks to the government's liquidity position and the country's financial stability, in large part as a consequence of domestic and geopolitical risks that have become more intractable. In particular, in the absence of fiscal consolidation measures that would allow the release of some international loans and partly reverse the widening in risk premia observed in recent months, Lebanon's fiscal metrics that have already been among the weakest of all the sovereigns rated by Moody's would weaken further, contributing to yet higher liquidity and financial stability risks.

The affirmation of the B3 rating reflects Moody's assumption that a government will be formed in the near term and will implement some fiscal consolidation that would unlock the CEDRE ("Conférence économique pour le développement, par les réformes et avec les entreprises") public investment package, which in turn would support GDP growth and ease liquidity risks. The rating affirmation also takes into account the central bank's demonstrated capacity to maintain a degree of financial stability despite very large macroeconomic imbalances and through times of political tensions, although the effectiveness of its financial operations may be diminishing.

Moody's has also affirmed Lebanon's (P)B3 senior unsecured Medium Term Note Program rating and its (P)Not Prime other short-term rating.

The foreign and local-currency bond and bank deposit ceilings remain unchanged. Specifically, the foreign-currency bond ceiling is unchanged at B1, the foreign-currency bank deposit ceiling is unchanged at B3, and the local-currency bond and deposit ceilings are unchanged at Ba2. The short-term foreign-currency bond and deposit ceilings are also unchanged at Not Prime.

RATINGS RATIONALE

RATIONALE FOR THE CHANGE IN THE OUTLOOK TO NEGATIVE FROM STABLE

HEIGHTENED POLITICAL TENSIONS AND DELAY IN FISCAL CONSOLIDATION JEOPARDIZE DONOR DISBURSEMENTS, WEIGH ON INVESTOR SENTIMENT

The negative outlook on Lebanon's rating reflects an increase in domestic and geopolitical tensions that is hindering the authorities' capacity to halt the widening of fiscal and external imbalances. This situation has a negative impact on Lebanon's access to financing from international donors. More generally, heightened political risk contributes to wider risk premia and higher funding costs.

One main risk is that political tensions and the policy standstill continue to further jeopardize capital inflows and committed donor disbursements, with significant repercussions on Lebanon's ability to maintain financial stability and service its debt at sustainable costs.

On the domestic side, a resolution of the political deadlock that prevents a government formation since the May 6, 2018 parliamentary elections is a prerequisite in order to unlock the $11 billion public investment support package committed by the international donor community during the CEDRE conference held in April 2018 in return for fiscal consolidation measures worth 1% of GDP per year over the next five years.

As regards geopolitical risks, Moody's assessment is that they have increased in light of the withdrawal of the United States (Aaa stable) from the Joint Comprehensive Plan of Action (JCPOA) agreement signed between Iran (unrated) and the permanent members of the UN Security Council plus Germany (Aaa stable), followed by the imposition of sanctions on Hezbollah in late October which target not only the organization's political and militant arm, but also "foreign persons and government agencies that knowingly assist or support Hezbollah". These secondary sanctions further increase uncertainty among investors and in the international donor community in light of the group's anticipated participation in Lebanon's cabinet.

Largely as a result of the domestic and geopolitical risks, Moody's estimates that the risk premia on Lebanon's government's international debt have widened by 300 basis points since April to around 800 basis points, marking a significant increase in the cost of international debt.

SLOWING DEPOSIT GROWTH AS BUDGET DEFICITS REMAIN WIDER FOR LONGER EXACERBATES GOVERNMENT LIQUIDITY RISK

Moody's expects the budget deficits to remain wider for longer than it previously expected, raising the government's debt burden, at a time when banks' deposits, that have been channeled by the central bank to finance the government's needs, are slowing.

Without any government to implement some fiscal consolidation, the budget deficit is likely to stand at 10.5% of GDP in 2018, compared with 8.9% previously expected by Moody's. Higher interest payments, larger transfers to the loss-making Electricité du Liban due to higher oil prices through most of the year, and lower revenue all contribute to a wider deficit compared to 2017.

For 2019 and 2020, Moody's anticipates a limited narrowing of the fiscal deficit, to 9.5% and to 9.0% of GDP, respectively. Taking into account subdued real GDP growth, around 1-2% in the next three years, Moody's estimates that the government's debt burden --excluding domestic debt holdings of public entities accounting for about 11% of GDP— will continue to increase to over 150% of GDP by 2021 from an anticipated 141% in 2018.

Reflecting the government's intention to issue domestic debt closer to market rates starting 2019, debt affordability, as measured by interest/revenue, will exceed 50% next year and stay around these levels, the weakest amongst all Moody's-rated sovereigns. Such weak debt affordability makes Lebanon's fiscal and credit profile particularly vulnerable to a prolonged increase in the cost of debt.

Persistently wide deficits and large debt refinancing needs will keep the government's borrowing needs above 30% of GDP. Beside larger than earlier expected financing needs, government liquidity risks are exacerbated by a slowdown in commercial banks' private sector deposit growth and the above-mentioned wider risk premia on international debt.

Private sector deposits have been a main source of indirect financing for the government. Through a series of financial operations starting in May 2016, the Banque du Liban (BdL), the central bank, incentivized commercial banks to attract new deposits and park their liquid foreign assets at the BdL. The objective has been to stabilize the economy's net foreign asset position in the context of the reduced pace of cross-border inflows that started in 2011 in the wake of the regional Arab Spring upheavals. This centralization of liquidity at the BdL has allowed it to maintain interest rates low and stable by purchasing the government debt which is not absorbed by the banking system. The BdL's domestic debt holdings have thus expanded to 50% of the government's total local currency debt as of September 2018 from about 27% at the end of 2010.

After a strong acceleration between mid-2016 and late 2017, deposits have slowed down, despite ongoing incentives provided by the BdL. Based on banks' balance sheet data up to October 2018, Moody's estimates that annual private sector deposit growth will be around 3% in 2018, equivalent to about $5 billion instead of the $6.5 billion anticipated before, and lower than the fiscal deficit at $6 billion.

Heightened political risk, higher interest rates by the US Federal Reserve, and lower confidence in sustained financial stability as highlighted by the increased trend toward deposit dollarization, are likely to have accounted for the slowdown in deposit growth and are indicative of the diminishing effectiveness of the BdL's policies.

Unless depositors' confidence in political and financial stability is restored, the government's access to funding will remain constrained, with prospects of further liquidity and fiscal pressure reflected in the negative outlook.

WIDENING EXTERNAL IMBALANCES WEIGH ON FOREIGN EXCHANGE RESERVE BUFFER REQUIRED TO ENSURE EXCHANGE RATE AND FINANCIAL STABILITY

Tightening financing conditions in international debt markets and declining net foreign assets at the BdL point to higher external vulnerability risks and financial stability risks for Lebanon.

Lebanon's very wide current account deficit, which Moody's expects to remain above 20% of GDP in the next few years, has long highlighted the country's external vulnerability. This has been mitigated by a large stock of foreign exchange reserves, which, at $34.6 billion as of October 2018, provides ample coverage of goods and services imports (at over 13 months). At an average of about 65% of M2 over the past three years, the stock of foreign exchange reserves also provides coverage for significant local currency deposit conversions to US-$ in a stress scenario.

However, foreign exchange reserves are less ample when assessing financial stability risks related to potential deposit outflows or lower inflows. In particular, the ratio of net foreign assets to the M3 broad money measure (including foreign currency deposits) is declining toward the 20% upper threshold deemed prudent under IMF reserve adequacy metrics for countries with large banking systems, from almost 50% in 2011. Another measure of reserve adequacy relates short-term external debt to foreign exchange reserves. BdL's practice in recent years to maintain a floor for foreign exchange reserves at $30-32 billion and intervene when that level looked like it may be breached, is consistent with maintaining adequate coverage of short-term external debt.

The deteriorating balance of payments dynamics observed in 2018 which reflect commercial banks' worsening net foreign asset position partially in response to their participation in BdL's operations, highlights the economy's gradually diminishing external shock absorption capacity captured in the negative outlook.

RATIONALE FOR RATING AFFIRMATION AT B3

The affirmation of the B3 rating is based on Moody's baseline assumption that a government is formed and able to implement some fiscal consolidation that diminishes the fiscal, liquidity and external stress explained above. The B3 rating also takes into account BdL's demonstrated capacity to ensure financial stability and channel financing to the government, albeit now at increasing costs.

More generally, Lebanon's institutions have a track record of supporting the government's willingness and capacity to meet their debt payments, even through highly challenging economic, social and political periods including a civil war in 1975-90.

With some fiscal consolidation back on track, Lebanon's economy would be supported by the disbursement of significant donor commitments of over $11 billion over the next five years (equivalent to about 3-4 percentage points of GDP per year) that would boost investment. Donor disbursement would happen conditional on a reduction in the fiscal deficit by one percentage point of GDP per year over the next five years. Evidence that fiscal consolidation is underway would also likely shore up investors' and depositors' confidence.

WHAT COULD CHANGE THE RATING UP

The negative outlook indicates that an upgrade is unlikely.

Moody's would likely change the outlook to stable if significant reforms unlocked the CEDRE public investment package, raised GDP growth prospects, and durably restored investors' and depositors' confidence and deposit growth. This would support the effectiveness of the central bank's measures aimed at channeling financing for the government at sustainable costs while maintaining financial stability.

WHAT COULD CHANGE THE RATING DOWN

Moody's would likely downgrade Lebanon's ratings if in the absence of credible and effective fiscal consolidation prospects, possibly as a result of continued domestic political deadlock and/or intensified geopolitical pressures, the government's access to financing at affordable costs became further impaired. In particular, a further significant slowdown in deposits would denote lower policy effectiveness and point to increasing risks to financial stability, putting downward pressure on the rating.

GDP per capita (PPP basis, US$): 19,565 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 1.5% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 5% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -6.9% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -22.9% (2017 Actual) (also known as External Balance)

External debt/GDP: 104.1% (2017 Estimate, excluding non-resident deposits)

Level of economic development: Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 10 December 2018, a rating committee was called to discuss the rating of the Government of Lebanon. The main points raised during the discussion were: the systemic risk in which the issuer operates has materially increased. The issuer has become increasingly susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Elisa Parisi-Capone
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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