Fitch changes Lebanon's outlook to positive
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Fitch changes Lebanon's outlook to positive

Confidence in Siniora's reform programme

Fitch Ratings has changed the Republic of Lebanon's outlook to positive from stable. At the same time, the long-term foreign and local currency ratings are affirmed at 'B-' (B minus) and the Short-term foreign currency rating is affirmed at 'B'.

"The assassination of former Prime Minister Rafik Hariri last February has proved to be a political watershed. Although the new political environment presents risks and new challenges, on balance we believe it more likely than not that a programme of economic, structural and political reforms will gain domestic approval and attract the support of international donors in the coming weeks and months," says Richard Fox, Senior Director in Fitch's Sovereign Department.

"This could have a decisive impact on Lebanon's public finances and broader economic and political development. But political support for and implementation of the programme will be paramount to the progress of Lebanon's ratings," adds Mr. Fox.

The government headed by Prime Minister Fouad Siniora, which came to power in June, is working on a multi-pillared reform programme expected to be submitted to the Cabinet in the near future. Details are still under discussion and the final programme will inevitably be influenced by the political process now in train. Nevertheless, Fitch considers that in the new political environment following the Syrian withdrawal, there is a broad political consensus in favour of reform, although the extent and pace of change remains to be seen. Crucially, this makes it less likely that expectations will be disappointed, in contrast to the experience following the Paris II conference in 2002. Efforts are also to be made to garner popular support for the programme, which will be important given that many of the problems that will eventually need to be addressed will be politically challenging. These include stemming the losses of electricity company, EdL, and the loss of excise taxes associated with the cap on petrol prices. Moves to privatise the mobile phone companies could have a major impact on the debt burden and plans here will be closely watched.

The new government has acted to stem the damage to public finances following the slump in economic activity in the spring; the primary surplus in the third quarter was two-thirds higher than in the first half. Together with continuing benefits from the concessional finance gained from Paris II, Fitch expects the overall budget deficit to show a further fall to around 8% of GDP this year. Unfortunately, this will not prevent a rise in the ratio of public debt to GDP this year, but that ratio will nevertheless remain within the 165%-170% of GDP range seen for the past five years, notwithstanding the fall in GDP growth to almost zero this year. The broad stability of the debt ratio reflects improved public debt dynamics following an almost 10% of GDP improvement in the primary fiscal balance in recent years, and not just the impact of Paris II. However, a decisive reduction in the debt ratio that could support a rating upgrade relies on the implementation of further fiscal and structural reforms.

The assassination of Mr. Hariri is generally acknowledged to have been Lebanon's severest stress test since the civil war. Fortunately, the starting point was reasonably robust, with Lebanon having enjoyed two years of 5%-6% GDP growth in a supportive external environment. International reserves reached an all time high in 2004. So although the banking system suffered some deposit flight in February/March and international reserves fell by USD2 billion, high liquidity meant that these pressures were manageable and short-lived. Reserves have already recouped their losses and the deposit base of the banking system, which enables Lebanon to support such a high level of public debt, is growing again. Further political shocks that test Lebanon's financial system anew cannot be ruled out. However, Fitch notes these risks are already well encapsulated in the 'B-' (B minus) rating.

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