Lebanon hit by double rating downgrades as likely debt restructuring looms

Both Moody's Investors Service and S&P Global cut the country's ratings as restructuring appears more likely to happen given fiscal and external pressures

A Lebanese demonstrator waves the national flag during a protest in Beirut. AFP

S&P Global and Moody's Investors Service downgraded Lebanon deeper into junk territory, as the country facing its worst economic crisis in three decades, is on the edge of default and will most likely have to restructure its debt.

S&P lowered Lebanon's ratings to CC/C from CCC/C with a negative outlook.

"We are lowering our ratings because we believe restructuring or non-payment of Lebanon's government debt is virtually certain, regardless of the specific time to default," said Zahabia Gupta, S&P's primary credit analyst. "The government's funding model has collapsed following substantial deposit outflows from the banking system."

Lebanon was able to escape the 2008 global credit crisis relatively unscathed due to a high interest rate regime, which lured more than $1 billion (Dh3.67bn) a month in capital flows that financed its fiscal and current account deficits. The country's economy, which has long suffered due to domestic politics, rapidly deteriorated following the outbreak of war in neighbouring Syria in 2011, which slowed the flow of funds and led to negative deposit growth at Lebanese lenders.

"The deposit dollarisation rate rose to 76 per cent at year-end 2019, from 71 per cent a year earlier, as residents sought to convert local currency to dollars amid evaporating confidence in the financial system and the currency peg," S&P Global said. "The run on deposits could have been more severe, if not for the restrictions on FX [foreign currency] withdrawals and transfers imposed by banks."

Moody's cut Lebanon's government issuer rating on Friday to Ca from Caa2. The rating agency also downgraded Lebanon's senior unsecured medium term note programme rating to (P)Ca from (P)Caa2. The country's long-term foreign currency bond and deposit ceilings have both been lowered to Ca from Caa1 and Caa3, respectively.

The downgrade further into non-investment grade or junk territory reflects expectations that “domestic and external private creditors will likely incur substantial losses in what seems to be an all but inevitable near-term government debt restructuring”, Moody’s said. Rapidly deteriorating economic and financial conditions are increasingly “threatening the sustainability of the government's debt and [the country’s] currency peg”.

Moody's estimates the restructuring would likely entail losses for private domestic and external creditors in the 35 per cent to 65 per cent range. The agency's stable outlook classification for Lebanon reflects its assumption so far that a debt restructuring may happen in coordination with creditors and under the umbrella of an economic adjustment programme agreed with the International Monetary Fund, which sent a team to the country over the weekend.

Fitch Ratings on Tuesday also said Lebanon's financial position points to a likely restructuring of its debt and the country’s financial sector.

The Lebanese economy has entered its third consecutive year of negative growth and its public debt has risen to unsustainable levels. In the period from 2011-19, real GDP growth averaged only 0.5 per cent, the current account deficit exceeded 21 per cent of GDP and the fiscal deficit reached 9 per cent of the economy's output.

Public debt increased from 131 per cent of GDP in 2012 to 164 per cent of GDP at end-2019, according to the latest estimates from the Institute of International Finance. The country's public debt increased 7.6 per cent to $91.64b year-on-year as of the end of December 2019.

The Lebanese pound has already lost more than a third of its value against the US dollar in the black market amid mass protests against the government that began in October last year as lenders implements capital flows and restricted the withdrawal of dollars. Last month, the IIF estimated Lebanon will require at least an $8.5bn bailout package from the IMF to break its economic impasse, help it meet financing needs and restore growth. However, the political elite of the country is against an IMF bailout package that may require a devaluation of the currency and the implementation of taxes along with a string of other measures.

An IMF team is in Lebanon until February 23 for technical consultations to gauge the policy response to the ongoing crisis, although the country has so far not formally asked for a bailout from the IMF. Lebanon reached out to the fund earlier this month seeking technical advice as it faces a looming deadline to repay $1.2bn in eurobonds that hit maturity on March 9. Another $700 million is due in April and a further $600m in June.

If the current crisis continues for another six months, the government may not have a choice but to ask for a bailout, Garbis Iradian, chief economist for the IIF said in Riyadh on Friday.

Despite the informal capital controls implemented by commercial banks starting November, bank deposits at the end of last year had declined by $15.7bn - almost 30 per cent of GDP - from a year earlier, of which $11.4bn in the last quarter alone.

The country’s foreign exchange reserves have fallen below $30bn and Moody’s estimates only about $5bn to $10bn of the total are usable reserves to meet future foreign currency debt servicing requirements at $4.7bn in 2020, followed by over $4bn in 2021 including the country’s eurobond maturities.

"Given that Lebanon's debt is mostly held by residents, a potential debt restructuring will have ripple effects across the domestic financial system, including depositors, and the economy," S&P said. "We expect that social unrest, a contracting economy, and intensifying liquidity pressures in the private sector will make it politically difficult to repay creditors in 2020 ... deep sectarian divisions in the political system and high regional security risks will continue to hamper policymaking, in our view."