The ratings agency Moody's Investors Service has downgraded Lebanon's long-term issuer ratings to B3 from B2 although it changed the outlook to stable from negative.
Moody's said the downgrade was based on its view that a B3 rating more accurately reflects Lebanon's credit risk profile.
"The ongoing erosion of Lebanon's very weak government finances will continue to constrain the rating pending further clarity on whether recent and prospective fiscal reforms will be effective given the evolving political environment," the agency said.
"While Lebanon's external liquidity position continues to be strong, and banking liquidity ample, rising external imbalances, coupled with a weak growth outlook increase Lebanon's vulnerability to external shocks."
Moody's said the upgrade to a stable outlook reflected "the return to a fully-functioning government, which will support reform momentum going forward".
The principal driver of the downgrade to B3 was the rise in the country's debt burden, it added. Moody's estimated Lebanon's 2018 government debt to reach close to 140 per cent of GDP, the third-highest among all rated sovereigns. "Government debt has risen inexorably since 2011, when it bottomed out at 121 per cent of GDP, reflecting a deterioration in the fiscal balance," it said. "Moody's projects government debt will remain close to 700 per cent of government revenues next year."
In the agency's view, recent fiscal reforms are very unlikely to reduce the deficit in 2017 and 2018.
"The recent revenue package approved by parliament is credit positive as it demonstrates the emerging consensus among decision-makers, but its purpose is simply to offset the planned upward adjustment in public sector salary scales; further action will be needed to reverse the rising debt trajectory. The absence of an approved budget continues to impede the formulation and implementation of debt-stabilising reforms."
No budget has been in place since 2005, and while the recent agreement within the cabinet raises the prospect of a budget now being passed by parliament, Moody's said its likely impact was unclear and its approval comes too late to halt the erosion in fiscal strength.
External imbalances are wide and rising again. The trade deficit reached US$13.6 billion in 2016, or 26.2 per cent of GDP, up from $13.1bn, or 25.8 per cent of GDP last year. Although Lebanon has benefited from a fall in hydrocarbon prices and continued remittances inflows, tourism receipts have not recovered.
The cost of hosting Syrian refugees, combined with a deterioration in infrastructure and limited donor support have dampened growth to an annual average of 1.6 per cent over the past three years, the agency added.
"Even though Moody's expects growth to pick up to close to 3 per cent this year and next, the legacy of years of under-investment and political instability leave potential growth well below previously high growth levels. Even if political stability consolidates after the May 2018 elections, the economy will remain vulnerable to external shocks."
Regarding the outlook upgrade to stable, Moody's said that was driven by its expectations of an acceleration in economic and fiscal reforms, including buttressing the energy sector.