Moody’s Investors Service downgraded its credit rating for Lebanon deeper into junk territory, the first time in more than two decades, citing concerns over the government’s ability to pay or restructure its debt amid a liquidity crunch that raises the risk of default.
“Moody's decision to downgrade the ratings to Caa1 from B3 reflects the heightened risk that the government's response to increased liquidity and financial stability risks will include a debt rescheduling or other liability management exercise that may constitute a default under Moody's definition,” it said.
Tuesday's downgrade puts Lebanon on par with Gabon, Zambia, Iraq and Ukraine. The cut led to the yield on Lebanese 2021 bonds to rise 11 basis points, according to Bloomberg data. In December, Moody's changed the outlook on Lebanon's then B3 issuer ratings to negative on the back of "rising liquidity and financial stability risks”.
Lebanon, which is being governed by a caretaker administration for the past eight months, is saddled with the world’s third highest debt to GDP ratio – 150 per cent – and is struggling to control its finances amid a stagnating economy and pressure from hosting over a million Syrian refugees. Political bickering has blocked the formation of a new government and is adding to the economic uncertainty.
“The high political event risk and very low fiscal policy effectiveness embedded in Lebanon's credit profile reflect Moody's assessment that the capacity for a government to implement significant fiscal consolidation is limited, even if a government were formed in the near future,” Moody’s said. “A continuing delay in the formation of a government would add to Lebanon's liquidity pressures, increasing the potential size, perimeter and urgency of such a liability management exercise in future.”
The country's existing woes worsened when earlier this month the country’s finance minister spooked markets with talk of a debt restructure only to deny the plans to various media outlets a day later.
Ali Khalil’s statements made it more costly to insure Lebanon’s debt and rattled investors holding Lebanese paper, with bond prices plunging to a record low, only to recover later.
"The downgrade is the cost of the procrastination and obstructionism in the formation of the government," said Nassib Ghobril, chief economist of Byblos Bank.
However, Mr Ghobril also criticised the rating agency for not waiting for end-of-year indicators, like the balance of payments, the balance sheet of commercial banks, or the fiscal outcome, as the Finance Ministry has only published budget results up until September 2018 and not for the full year, and as the latest balance of payments results and the balance sheet of commercial banks are for November.
"Another reason for the downgrade is rather unconvincing, as the agency considers that measures that Lebanese authorities might take to reduce debtservicing cost would consist of an implicit default on Lebanon’s obligations. However, the government has not specified any measures yet, and efforts to reduce debt servicing cost are usually a positive step," added Mr Ghobril.
Lebanon’s debt to GDP ratio could balloon to 180 per cent by 2023 if the government does not undertake the necessary reforms to narrow its fiscal deficit, which may reach 10 per cent of GDP amid the current geopolitical tensions, the International Monetary Fund said in February last year.
Qatar pledged to buy $500 million (Dh1.83 billion) worth of Lebanese bonds this week, helping Beirut’s eurobonds rally the most since September.
In 2018, Lebanon received pledges of about $11bn in soft loans and grants from donors at the Cedre conference in Paris in return for implementing reforms.
However, the delay in forming a government has hampered disbursement of the aid.
“An event of default may be avoided if, upon its formation, a new government takes some fiscal consolidation measures that unlock the Cedre public investment package,” Moody’s said.
“Alternatively or in conjunction with Cedre inflows, more financial interventions by the central bank could contribute to avoiding a default event if that is achieved while maintaining broad financial stability.”
Moody's said the formation of a government is essential to coming up with plans to reduce spiralling debt and narrow the widening fiscal deficit.
Lebanon’s gross financing needs exceed 30 per cent of GDP, among the highest in the world, according to Moody’s. Debt servicing costs eat up nearly 50 per cent of government revenue.
“In the absence of significant fiscal consolidation and in the context of markedly slowing capital inflows and bank deposits, reliance on the Banque du Liban (the central bank) to suppress the government’s financing costs in order to prevent a yet higher debt servicing bill is increasingly challenging to reconcile with the central bank’s objective of maintaining financial stability,” Moody’s said.
“Covering this year’s fiscal deficit and eurobond maturities without drawing on foreign exchange reserves would require bank deposit inflows of $6bn to 7bn, compared to $4bn to 5bn estimated in 2018.”
That scenario stands in stark contrast to 2008-2009 when the country was able to survive the global financial crisis with high interest rates on deposits that garnered monthly inflows as high as $1.5bn.