Financial situation

Fitch downgrades Lebanon to ‘CCC’. S & P maintains its ratings

While there is no danger on the short term, the situation could deteriorate rapidly if Lebanese leaders do not launch "credible" reforms, warn experts.

The street of the banks, in Beirut. REUTERS/JAMAL SAIDI/File

The feeling of suspense dragged on all week, but the end result was quite predictable. On Friday evening, shortly after 11 pm, Fitch and Standard & Poor's (S & P), two of the top three US rating agencies along with Moody's, released updates on their ratings of Lebanon's sovereign rating. While Standard and Poor’s Global Ratings kept the country's rating at "B-" with a "Negative" outlook, Fitch for its part, decided to devalue the country's bonds, which are now rated "CCC" (the outlooks do no apply to this category of notes, as per the agency’s nomenclature). Today’s events, were two of the top three foreign observers of the country’s financial situation downgraded Lebanese bonds, were preceded by Moody's, which downgraded the country's sovereign rating to "Caa1" with a "stable" outlook in January.

The international rating agency’s downgrading is another blow to the country’s already struggling economy that is suffering from one of the world’s highest debt ratios, high unemployment and little growth. As a reminder, the country's public debt flirted with the $ 86 billion mark at the end of June (an increase of 3.4% in one year for a debt / GDP ratio hovering around 150% according to estimates).

"Fitch's reaction shows that the measures adopted in the 2019 budget are unconvincing, and that leaders must intensify their efforts in order to reduce public spending by 2020," Nassib Ghobril, the director of the research department in Byblos Bank, said to L’Orient-Le Jour. "The country's priorities have been clear for a long time, and it is regrettable that we have reached this point," he said, citing as an example the need to improve governance or to fight corruption (which has cost Lebanon $ 5 billion in 2018, according to a governmental study).

A financial expert spoken to -on condition of anonymity- by L’Orient-Le Jour claimed that Friday’s two updates do not fundamentally change Lebanon’s situation after the first tremor caused by Moody's decision in January. "The deterioration of Lebanon's sovereign rating had already had an impact on the prices of Eurobonds - foreign currency debt issued by Lebanon. The deterioration decided by Fitch will impact the solvency ratios of banks, which will go from 16% to 11.5%, which remains above the minimum threshold set by the Basel Committee (10.5%). Banks however, will need to recapitalize and will probably do so by keeping the dividends on their balance sheet in unallocated earnings, and by continuing to reduce their loan portfolios to improve the solvency ratio," he says. "If there is no short term danger, the situation will clearly deteriorate if the government continues to vacillate between tensions and total inactivity and apathy," warned the financier.

0.2% growth in 2019 for S & P

In the report, S & P makes it clear that its decision to maintain the sovereign rating is nothing less than a reprieve for the Lebanese government. The agency noted with concern the erosion of "confidence" in the country, which is reflected in deposit activity (down 0.7% at the end of June, to 172.1 billion dollars) or the foreign exchange reserves of the Bank of Lebanon (BDL). After losing $ 3.3 billion in the first six months to stand at $ 36.4 billion, they began to rebound in July.

Beyond these indicators, S & P also questioned the real capacity of Lebanese leaders to launch the projects required to redress the country’s financial situation: projects they committed to implement at the April 2018 Paris Conference (CEDRE). "Non-resident depositors and investors will remain wary unless the government is able to overcome the political differences within it and put in place structural reforms to reduce the public deficit (6.2 billions of dollars in 2018, or more than 11% of GDP), as well as to improve the business environment,” S & P said.

In fact, the agency's decision to maintain its current valuation seems to be due to two factors: first, the fact that BDL's foreign currency reserves are still sufficient to finance the public deficit ($ 2,39 billion at the end of May, -18.3% in one year) and that of the trade balance ($ 8.4 billion over the same period, + 5% in one year) for the next 12 months.

Second, the fact that Lebanese leaders have already laid the foundations for some projects, including the electricity reform adopted in the spring, and the reduction of certain public expenditures recorded in the budget for 2019, and voted on in parliament on July 19. S & P states that it did not take into account in its assessment the possible results of the first drilling in block 4 of Lebanon's exclusive economic zone, as part of the exploitation of offshore hydrocarbon on the Lebanese coast.

In terms of forecasts, S & P is banking on a growth (real, which takes into account inflation) of 0.2% in 2019, a deficit-to-GDP ratio of 10% for this year (far from the 7.6% recorded in the budget), and a debt-to-GDP ratio of 146%.

EDL’s deficit to 1.9% of GDP in 2021, for Fitch

Fitch, on the other hand, paints a bleaker picture, pointing out that the downgrading of Lebanon's rating reflects "the growing pressure on the Lebanese financial model and the risks to the government's ability to service the country’s debt". It also emphasizes that the country's "growing dependence" on BDL's "unorthodox" financial transactions to attract deposits - in July, the governor, Riad Salame confirmed that its financial engineering operations that had been ongoing since 2017 - were one of the manifestations of these pressures.

The agency also considers that the measures adopted in the 2019 budget are insufficient and called for the development of a medium-term strategy that is "credible" to stabilize the debt-to-GDP ratio - which it estimated at 152% by the end of 2018.

For Fitch, the deficit-to-GDP ratio is expected to stabilize at around 9.2% at the end of the year, and the agency stated that the budget's revenue forecasts look "optimistic given the economic situation” - the agency expects nominal growth (not counting inflation) of 3.3%, against 5.7% for the government in the 2019 budget- and the "inefficiency" of the state at collecting taxes. The agency also believes that even if the objectives set in the budget were all achieved, this would be "only a first step" towards a sustainable stabilization of the country's debt.

Among the few positive points, Fitch nonetheless notes the existence of a "real political will" to solve the electricity problem (which has absorbed nearly $ 2 billion advances from the Treasury in 2018), recalling that this is one of the main commitments that will enable the country to release more than the 11 billion dollars of loans and grants pledged at the CEDRE conference by the country's supporters. The agency estimates that the state will be able to reduce the country’s electricity deficit from 3% of GDP in 2018 to 1.9% in 2021.

Finally, Fitch called on the government to take several important steps that would improve the country’s ranking in the future. “Lebanon requires substantial capital inflows to fund its large twin budget and current account deficits. We estimate gross external financing needs at 24% of GDP in 2019,” it said.

For its part, S&P warned that the negative outlook meant the agency would not hesitate to lower the ratings on Lebanon in the next six to twelve months if banking system deposits and the Central’s Bank foreign exchange reserves continued to fall, which would likely reflect a weak policy environment and weak market access.

Khalil: "We are convinced that we will overcome the crisis"

"Lebanon remains committed to reform and will deal responsibly with Fitch's report," Finance Minister Ali Hassan Khalil told Reuters on Friday evening. He added that the rating reports served as a reminder of the utmost need for the government to work on enacting reforms. “There should be no slacking for a single moment,” he said.

(This article was originally published in French in L'Orient-Le Jour on the 24th of August)

The feeling of suspense dragged on all week, but the end result was quite predictable. On Friday evening, shortly after 11 pm, Fitch and Standard & Poor's (S & P), two of the top three US rating agencies along with Moody's, released updates on their ratings of Lebanon's sovereign rating. While Standard and Poor’s Global Ratings kept the country's rating at "B-" with a "Negative"...

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