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Rating Action:

Moody's downgrades Lebanon's rating to Ca, changes outlook to stable

21 Feb 2020

New York, February 21, 2020 -- Moody's Investors Service ("Moody's") has today downgraded the Government of Lebanon's issuer rating to Ca from Caa2 and changed the outlook to stable. This concludes the review for downgrade that was initiated at the time of the 5 November 2019 rating action.

The Ca rating reflects Moody's expectation that domestic and external private creditors will likely incur substantial losses in what seems to be an all but inevitable near-term government debt restructuring in light of rapidly deteriorating economic and financial conditions that increasingly threaten the sustainability of the government's debt and currency peg.

The stable outlook balances Moody's assumption so far that a debt restructuring may happen in coordination with creditors and under the umbrella of an economic adjustment program agreed with the IMF that unlocks external funding, with the possibility that external funding is not forthcoming given subsequent governments' extremely weak track record on policy implementation, leading to larger losses for investors.

Moody's also downgraded Lebanon's senior unsecured Medium Term Note (MTN) Program rating to (P)Ca from (P)Caa2, and affirmed the other short-term rating at (P)NP. The senior unsecured MTN program rating was also on review for downgrade.

Lebanon's long-term foreign currency bond and deposit ceilings have both been lowered to Ca from Caa1 and Caa3, respectively. The long-term local-currency bond and deposit ceilings have been lowered to Caa1 from B2. The short-term foreign currency bond and deposit ceilings remain Not Prime.

RATINGS RATIONALE

RAPIDLY DETERIORATING ECONOMIC AND FINANCIAL CONDITIONS POINT TO DEBT RESTRUCTURING WITH SIGNIFICANT LOSSES FOR INVESTORS

The prospect of a deepening economic and financial contraction that undermines the sustainability of the peg points to government debt restructuring in the near term that Moody's estimates would likely entail losses for private domestic and external creditors in the 35-65% range.

Despite the formation of a government in January, with a mandate to prepare an economic and fiscal reform plan, Lebanon's deep economic contraction is likely to continue, driven by declining broad monetary aggregates reflecting a sharp acceleration in deposit outflows during the last quarter of 2019, despite the informal capital controls implemented by commercial banks starting November. At the end of December 2019, bank deposits had declined by $15.7 billion (i.e. almost 30% of GDP) from a year before, of which $11.4 billion in the last quarter alone. In turn, the sharp recession makes the chances that government policies lead to an effective turnaround extremely remote.

The deposit outflows have contributed to the continued deterioration in the overall balance of payments and in the Banque du Liban's (BdL) foreign exchange (FX) reserves which have declined to below $30 billion at the end of 2019. When netting foreign exchange reserves against commercial banks' negative net foreign asset position, and after drawing on the economy's net foreign assets accumulated in the past in the absence of new net inflows, Moody's estimates that only about $5-10 billion are usable FX reserves to meet future foreign currency debt service requirements at $4.7 billion in 2020, followed by over $4 billion in 2021 including Eurobond maturities. FX reserves would also be needed to support key imports.

The ensuing shortage of US dollar liquidity for daily business transactions is contributing to rapid growth of a parallel exchange rate market, implying a depreciation of about 40% compared to the official pegged exchange rate. In turn, the weaker exchange rate that applies to a range of consumer purchases fuels inflation and threatens the stability of the official peg.

This precarious situation is not sustainable. Moody's estimates that a near-term restructuring of government debt, currently worth around 160% of GDP, is all but inevitable. Moreover, in this extremely fragile environment, including heightened fragility of the peg, the Ca rating reflects the likelihood of private creditors incurring substantial losses in eventual debt restructuring.

The central bank's holdings of government securities imply that Lebanon has options for debt management in the near term that would limit losses borne by the private sector in case of a default event. Although insufficient to restore debt sustainability, Moody's estimates that a maturity extension on BdL's debt holdings amounting to over 50% of GDP could act as first loss vehicle.

However, even such options involve significant economic and financial costs that have already compounded on the BdL's balance sheet, which could in turn raise the extent of losses facing private creditors. Already, the BdL is paying only 50% of the interest earned on US dollar deposits and on US dollar-denominated certificates of deposits in local currency, and has instructed commercial banks to do the same with their existing US dollar deposits.

RATIONALE FOR THE STABLE OUTLOOK

PROSPECT OF AVAILABILITY OF EXTERNAL FUNDING ENHANCED BY IMF INVOLVEMENT, REDUCED BY WEAK POLICY IMPLEMENTATION TRACK RECORD

The stable outlook reflects Moody's assumption that a government debt restructuring will be facilitated by the IMF's coordinating role between private and official creditors, depositors and the Lebanese public sector in order to keep the process as orderly as possible, ensure burden sharing and minimize the risk of protracted litigation by minority investors.

The government's request for IMF technical assistance to develop a credible economic and fiscal reform agenda also increases the likelihood that a debt restructuring would unlock financial assistance either via disbursements under the CEDRE package and/or possibly via a funded IMF program.

These prospects are balanced by Lebanon's weak policy implementation track record that could reduce creditors' willingness to continue to finance the government, contributing to a cycle of heightened liquidity pressure exacerbating the economic recession, widening the size of the policy adjustment needed to restore some stability. In this context, a sudden breakdown of the pegged exchange rate would multiply the burden of the government's foreign-currency debt and heighten pressure on capital flows further, making achievement of debt sustainability even more remote.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental considerations are relevant for Lebanon's credit profile in particular through the impact of climate change on the tourism industry. Water shortages will likely become more frequent and pervasive due to increased demand from agriculture and industry, constraining growth unless they are addressed by effective policies.

Social considerations are one of the key credit drivers of the sovereign rating. Sectarian fragmentation leads to frequent protracted negotiations between political parties and government stalemates that contribute to economic and financial instability, reflected in Moody's assessment of heightened domestic political risk.

Sectarian fragmentation also impacts governance, which is partially alleviated by the BdL's non-partisan policy focus. However, the BdL's reduced monetary and financial policy effectiveness in light of mounting fiscal and external headwinds adds to the government's weak fiscal policy track record thus driving Moody's weaker overall governance assessment.

WHAT COULD CHANGE THE RATING UP

Moody's would consider an upgrade if financing conditions stabilize and the risk of restructuring involving large losses for private creditors were to diminish. This would likely require a highly credible policy path to persistent primary surpluses, reform implementation in the electricity sector, and an achievable plan to control the public sector wage bill.

WHAT COULD CHANGE THE RATING DOWN

Moody's would downgrade the rating in the event of persistent economic and fiscal policy reform implementation challenges that prevent a disbursement of official external funding support to accompany government debt restructuring, thus increasing the likelihood of significant additional losses accruing to private investors. An even more destabilizing adjustment than Moody's currently assumes, possibly accompanied with a sudden de-pegging of the currency, could also be consistent with larger losses than assumed in the Ca rating and lead to a downgrade.

GDP per capita (PPP basis, US$): 14,689 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -1.9% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 4% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -11.4% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -22.3% (2018 Actual) (also known as External Balance)

External debt/GDP: 138.7% (2018 Estimate)

Economic resiliency: b3

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

On 19 February 2020, a rating committee was called to discuss the rating of the Government of Lebanon. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, has materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially declined. The issuer has become increasingly susceptible to event risks.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019. 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, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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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