Lebanese economy still under pressure despite budget approval

Proposed taxes on banks would be credit-negative, says Moody's analyst

epa07944038 A protester waves a lebanese flag alongside a barbed wave set up to protect the government palace in downtown Beirut, Lebanon, 23 October 2019. Protesters announced they will continue demonstrations and the closure of roads until the resignation of the government and parliament and until new parliamentary elections will be held, after Lebanese Prime Minister Saad Hariri announced a series of economic measures adopted by the government and approved the 2020 budget without any new taxes.  EPA/NABIL MOUNZER
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The Lebanese government's approval of fiscal reforms in the wake of massive protests over proposed austerity measures highlight the "enormous challenge" authorities and the central bank face, according to ratings agency Moody's.

As the Lebanese army moved on to the streets on Wednesday to remove protesters and counter-protesters after a week of disruptions, the government and the Banque du Liban are trying to simultaneously achieve "fiscal consolidation to preserve government debt sustainability, maintain financial sector stability and the currency peg with the US dollar, and appease the demands of an increasingly restless population", said Elisa Parisi-Capone, a vice president at Moody's.

On Monday, Lebanon's government passed a budget which cut the heavily-indebted nation's budget deficit to 0.6 per cent, which it said would be achieved without the imposition of any new or additional taxes on people. The measures announced included a 50 per cent cut to the salaries of senior politicians, a higher tax on bank profits and a plan to cancel interest rates on local currency debt holdings to provide-much needed liquidity given the pressure the Lebanese pound has faced in recent weeks because of the scale of the country's debt obligations.

"Additional financial sector taxes would be credit negative for banks, further pressuring the poor returns that Lebanese banks are seeing in light of previous rounds of tax increases, and therefore their ability to absorb shocks, while further reducing shareholders’ incentives to invest in Lebanon and incentives for banks to attract deposits and invest in government paper,” said Alexios Philippides, another Moody’s vice president.

Lebanon is one of the most indebted countries in the world, with a debt to gross domestic product ratio of more than150 per cent.

"The underlying problem is that the authorities have continually failed to tackle the wide budget shortfall," Jason Tuvey, senior emerging markets economist at Capital Economics in London said in a note on Wednesday, pointing out that the country's deficit has averaged 11 per cent since the turn of the millennium.

He said that there are four ways for Lebanon to address its high debt levels – faster growth, higher inflation, austerity and debt restructuring or default, but that only the latter seems viable. GDP growth has been weak for a decade, higher inflation would undermine its dollar peg and austerity looks undeliverable given the current political climate.

"The upshot is that debt restructuring appears to be the government’s only viable route out of its debt problem," Mr Tuvey's said.

He said the only question was that whether this restructure would be orderly, with the support of the International Monetary Fund (whose director of the Middle East and Central Asia department, Jihad Azour, told The National last week that its door was open if needed), or disorderly via a default.

"In the absence of an IMF deal, capital flight would accelerate," the Capital Economics note said.

Given that the central bank has limited resources to defend its dollar peg, this could put pressure on the regulator to abandon it by devaluing the currency, which "could simply make it too expensive for the government to service its foreign currency debts and it may have little other option but to default".

However, the note added that some form of restructure with IMF support was the most likely outcome.