Fitch Ratings, the international rating agency, assigned Lebanon's forthcoming USD bonds a 'B- rating with a stable outlook. The ratings are in line with Lebanon's 'B- sovereign long-term foreign currency rating.
Lebanon is nearing the end of parliamentary elections, which will have an important bearing on the process of economic and political reform. However, it is too soon to say how events may unfold after the election. Fitch believes Lebanon's current 'B- rating reflects the balance of weak, though stable, fiscal fundamentals, political challenges and uncertainty surrounding the priorities of the new government.
The assassination of former Prime Minister Hariri in February set in train rapid political change, culminating in the withdrawal of Syrian troops and intelligence personnel in May. Political uncertainty will not disappear even when the elections are concluded. The political temperature could also increase if the new parliament attempts to replace President Lahoud, whose term was extended for three years last September in a controversial constitutional amendment.
Compliance with UN Resolution 1559, which demands the disarmament of the remaining Hizbollah militias, also remains a domestically contested issue, The new government may want to draft a new election law to govern future elections, which will be controversial and time-consuming given Lebanon's complex and diverse sectarian make-up.
Against this background, it is not clear that the government will be able to focus quickly on the economic and structural reforms which could improve sovereign creditworthiness. This is not to deny that important progress has been made, particularly in the fiscal area, in recent years. The introduction of VAT in 2002 has significantly improved tax collections and helped generate a primary surplus. With the additional benefit of strong economic growth of an estimated 5% in 2004, public debt fell last year as a ratio to GDP for the first time in over a decade. The government is still operating under last year's budget and this has allowed the authorities to continue a policy of spending restraint this year. Thus, despite the slowdown in activity since February, the primary surplus has improved slightly and Fitch projects the public debt ratio will remain stable this year. Nevertheless, with the public debt ratio at 184% of GDP - amongst the highest of any rated sovereign - public debt dynamics remain the key driver of Lebanon's ratings. A comprehensive reform programme which brings the credible prospect of a significant and permanent reduction in the debt burden is required before positive rating action can be contemplated.
International reserves and non-resident deposits in the banking system both fell in the period immediately following the February assassination. However, confidence was restored once the decision was taken to proceed with elections to the original timetable and reserves and deposits have since recovered strongly. Debt-servicing pressures have been eased by last year's debt management operations which postponed a significant proportion of 2005 maturities to future years. Lebanon continues to have an unblemished external and domestic debt service record. Nevertheless, the growth of the banking system's deposit base and its willingness to hold and buy further public debt issues is a crucial rating consideration. Events this year have demonstrated the important support the banking system can provide to the public debt market. However, any significant reduction in the deposit base and/or prolonged disruption to the government's domestic sources of finance could bring negative rating action in the Lebanese context of a currency peg with high dollarisation and large non-resident deposits.