No Surprises, Useful Guidance from Global Ratings Organizations
When we were in Lebanon this summer, discussions about the economy included likely scenarios of Lebanon being downgraded by the world’s financial rating organizations. This was and is of concern because their ratings have an impact on how investors perceive the risk worthiness of countries and institutions, as well as companies and organizations that are the subject of their evaluations. Being downgraded affects the entities capacity to manage borrowing to maintain its credit and fiscal worthiness. Lebanon’s political leaders mentioned the upcoming ratings in remarks these past two months.
The end of summer brought with it the much anticipated ratings that provide a measure of the various indicators of Lebanon’s fiscal and monetary health. Standard & Poor’s Global Ratings, according to the Byblos Bank Economic Research and Analysis Department, was not the devastating drop that many had expected, but it was not good news nevertheless. The report noted that “Challenges to public finances persist and include vested political interests, weak economic growth, and public opposition to austerity measures,” which will be a significant factor in the drafting of the 2020 budget due this fall.
While S&P gave Lebanon’s long- and short-term foreign- and local-currency sovereign credit ratings a B-/B, it maintained a ‘negative’ long-term rating. It gave the Bank of Lebanon (BdL) significant credit for garnering sufficient foreign reserves to cover the government’s debt servicing in the near term. It also noted that the ratings take into account the country’s wide fiscal and external deficits, elevated public debt level, political divisions, and regional security risks.
In an example of the outsized nature of public sector expenditures, the Ministry of Finance noted that the compensation of public-sector personnel equaled 65.4% of the total fiscal receipts in the 1Q2019 and absorbed 47.5% of overall fiscal spending in the 1Q2019 compared to 35% in the same period in 2018.
Lebanon’s liquidity begins with the BdL’s ability to attract deposits from non-residents, meaning the amount of money that will be deposited into the banking system by overseas Lebanese and others attracted by the high interest rates being offered. These dollars are then deposited with the BdL by the banks that earn very high rates (8-15%) from the BdL to hold the dollars. This enables Lebanon to finance its debt within the banking system rather than expand public debt held externally (by overseas banks and institutions). Considering that there was a deposit outflow of about $2.5 billion in the 1H2019, this is a risky strategy but one that BdL has managed well.
The report said that “It anticipated non-resident depositors and foreign investors to remain cautious of Lebanon unless the government is able to resolve the political divergences and implement structural reforms to narrow the fiscal deficit and improve economic activity.” Among positive signs, it pointed to the approval of the 2019 budget, a plan for reforming the electricity sector, and plans to draft the 2020 budget on schedule. The caveat, of course, is that “Lebanon’s fragile political landscape will continue to hamper policy-making in the country.”
The likelihood of improving its ratings depends on “If the Lebanese government takes credible steps to implement its fiscal consolidation and electricity sector reform plans, which would strengthen foreign investor confidence.”
Fitch Ratings looked at the same data and downgraded Lebanon’s long- and short-term foreign and currency default ratings, indicating a declining level of confidence in the country’s capacity to support its bonds, both those guaranteed by the BdL and those that are unsecured. “It added that the downgrade reflects pressures on banking sector deposits and BdL’s foreign currency reserves, given the government’s reliance on the BdL to finance its domestic debt and repay Eurobond maturities.” As with S&P, it credited BdL with managing the country’s debt by holding a large part of the country’s public debt and building deposits from non-resident Lebanese.
“It noted that the increase in private sector deposits [key to providing the foreign reserves], has slowed down due to domestic political instability, government ineffectiveness, low economic growth, as well as to geopolitical risks,” and “It added that improving public debt dynamics, through fiscal tightening or stronger economic growth,” as well as environmental, social, and governance indicators such as the control of corruption, institutional and regulator quality, and the rule of law, constitute key drivers of Lebanon’s sovereignly ratings,” which reflect the credibility of its ability to borrow.
Whether or not Lebanon will improve its ratings in the coming months will require more than simply acquiring more foreign deposits. It will require passing a credible budget, adherence to promises it has made regarding reforms to entities such as the electricity sector, implementation of a rigid and transparent process for cutting expenditures and raising revenues, and embarking on the CEDRE programs and the National Industrial Policy to put Lebanon on track to fiscal restraint, economic growth, and an inclusive and sustainable economic strategy serving the people of Lebanon.