Event

In recent months the economic clouds hanging over the Lebanese economy have grown darker. First of all, the gross reserves held by the central bank have been falling. Secondly, Fitch Ratings downgraded the sovereign rating by two notches to CCC – deep into junk territory. Thirdly, the last data (June 2019) on the stock of non-resident deposits at the commercial banks indicate that they have remained broadly flat. Furthermore, the government was only able to pass the 2019 budget at the end of July as it was opposed by various interest groups who were challenging the consolidation efforts included in the budget. Lastly, while the budget was approved and includes consolidation efforts, the IMF still predicts that it will lead to a deficit of 9.75% of GDP at the end of 2019. Infighting among coalition partners seems to be inhibiting deeper reforms. Most recently it was a dispute between two Druze parties that prevented the government cabinet to hold sessions for two weeks in the beginning of August.

Impact

For Lebanon these are all important elements to watch as they are indicative of the difficulty in which the economy finds itself. At the heart is the issue that the government keeps running large public deficits that have pushed up the public debt level to more than 150% of GDP by the end of 2018. Without strong and persistent consolidation efforts public debt is predicted to rise further to unsustainable levels. With the 2019 budget the Lebanese government for the first time claims to implement significant reforms. Nevertheless, deficits are expected to remain large. Furthermore, the large public deficits and the large import needs of the country have led to large current account deficits which the country funded by attracting non-resident deposits from the Lebanese diaspora living abroad, by borrowing abroad and by incentivising Lebanese banks to repatriate funds they previously held abroad. This explains why non-resident deposits at the commercial banks are an important indicator to watch as they are the most important lifeline funding the economy. When the inflow of deposits slowed in the past, Lebanese banks responded on multiple occasions by offering higher interest rates in coordination with the Lebanese Central Bank, a step that they also took in June of this year. The question is however if this is a sustainable policy.

In January 2019, the debt build-up combined with the political gridlock and the lack of reforms already made investors worry that a bond restructuring would be imminent, which created panic on the bond market. Panic only cooled with the formation of the government, the pledge of bold consolidation measures and the promise of financial support from the Gulf States. Currently we are witnessing a similar situation as the bond yields have risen to their highest rate in more than a decade. 

For Lebanon it is important to keep a steady inflow of non-resident deposits or at least avoid a reversal of deposits and thus avoid any confidence crisis in the banking sector erupting. As the Lebanese banks are overexposed to the sovereign, this means trust in the government’s repayment capacities should remain strong, something that is currently clearly under pressure. The availability of a bailout package is often seen as an important cushion that could provide support. In April 2018 western states agreed to put forward around USD 10 bn in concessional loans (and USD 0.8 bn in grants) as a bailout package. Whether the funds can act as a sufficiently large cushion is however unsure. First of all, the funds have not yet been released as the Lebanese government first needs to implement significant reforms. And it is not yet sure if the reforms taken in the 2019 budget will be seen as sufficient. Secondly, while the size of the aid package is large in absolute value, it is relatively small when taking into account the time period over which it will be released (12 years), the size of the Lebanese economy and the gross refinancing needs of the economy. Therefore additional bailouts are likely to be necessary. Here, the Gulf countries might play an important role, although obtaining additional bailout funds from Saudi Arabia and the United Arab Emirates is likely not to be a walk in the park given the strong role Hezbollah currently plays in the government.

Credendo already downgraded the MLT political risk category of Lebanon to category 7 in January 2019. Currently the main pressure is therefore on the short-term political risk classification, which is currently still in category 5. Pressure for a downgrade is increasing. Firstly, due to the fall in the gross foreign exchange reserves (although they remain large). Secondly, due to the deterioration and opacity of the balance sheet of the central bank given that it increasingly takes on foreign currency liabilities, but does not publish data on their size and term structure. Thirdly, due to the more difficult refinancing capabilities of both the sovereign and the Lebanese banking sector, and lastly due to the build-up in short-term external debt.

Analyst: Jan-Pieter Laleman – jp.laleman@credendo.com