Goldman says Lebanon at risk of crossing distress threshold with further rating cut

Lebanon’s sovereign ranking will plunge deeper into junk territory if S&P downgrades it in next review on Friday, the US lender says

Lebanese government led by Prime Minister Saad Al Hariri is struggling to shore up the country's foreign exchange reserves. Reuters

Lebanon’s sovereign ranking will probably be cut deeper into junk by S&P Global Ratings within days, putting its bonds into a category considered vulnerable to nonpayment as the country struggles to claw back enough foreign currency to stabilise its foreign reserves, according to Goldman Sachs Group.

One of the world’s most indebted nations is on negative outlook at S&P, which is due to publish a review on Friday and currently rates Lebanon B-, six steps below investment grade and one notch higher than Moody’s Investors Service.

“The steady deterioration in Lebanon’s FX liquidity position indicates a likely downgrade to CCC,” Goldman analysts including Farouk Soussa said in a note last week. Issuers in the CCC category are deemed dependent on favourable conditions to make good on their debt.

To keep its banks stable and defend the dollar peg, Lebanon relies on bank deposits, mainly from the millions of Lebanese living abroad, with the central bank using what it describes as “financial engineering” to keep up an inflow of hard currency. While the latest such effort in late June may have helped to shore up foreign assets in reserves, deposit growth turned negative in May for the first time in more than a decade, according to Goldman Sachs.

What’s more, recent political tensions “threaten to derail the economic agenda and further depress appetite for Lebanese risk”, it said. The US bank also lowered its forecast for Lebanon’s economic growth this year to 1 per cent from 2.2 per cent.

Investor worry about Lebanon’s prospects has played out in the market. Its credit risk, measured by credit-default swaps, has jumped 327 basis points since the start of the year and surged past 1,000 points for the first time ever in August.

The average extra yield investors demand to hold its debt over US Treasuries also surpassed 1,000 basis points last week, the most in over a decade.

The International Monetary Fund projects Lebanon’s public debt burden will rise further to near 180 per cent of economic output by 2023. Lebanon has never defaulted on its obligations.

When S&P cut Lebanon’s outlook to negative in March, it said the country’s rating could be lowered within the next year “if political stasis causes fiscal deficits to rise while banking system deposit inflows - the government’s key funding source - slow further”.

In July, Lebanon passed an overdue 2019 budget touted as the most austere in the country’s history in the hope of appeasing investors, donors and rating companies.

But the government headed by Prime Minister Saad Hariri has failed to convene since the end of June. A minister in the cabinet claims he was the target of assassination and is insisting, along with his allies, to refer the case to the judicial council. His opponents reject that idea. Efforts are underway to resolve the issue and resume work.

Political hurdles are nothing new to Lebanon but this time they could delay implementation of urgent fiscal and structural reforms. Lebanon’s average economic expansion hasn’t exceeded 1 per cent in the past five years and is projected at 1.2 per cent in 2019, according to the finance minister. In June, central bank governor Riad Salameh put growth at zero so far this year.