Fitch Ratings-Hong Kong/London: Lebanon's draft 2019 budget targets fiscal consolidation, but we do not expect full implementation, and additional fiscal and structural reforms would be required to stabilise government debt/GDP, Fitch Ratings says. Proposals to issue T bonds at below-market rates, most likely to the central bank, reflect the difficulty of cutting spending and tight liquidity in the financial system. Lebanon's external finances also remain under pressure, illustrated by declines in foreign reserves and bank deposits in the four months to April.
The budget agreed by the cabinet late last month targets a deficit of 7.6% of GDP, from 11.1% in 2018. However, revenue projections for tax measures may be optimistic given minimal economic growth and inefficient tax collection. Expenditure controls relating to new hiring and bonuses may prove difficult to enact. We will reduce our deficit forecast for 2019 by about 1.5pp, to around 9% of GDP. Even if the budget plan were fully realised, it would only be a first step towards stabilising government debt/GDP (151% at end-2018), which would require the deficit to narrow to at least 5.5%.
https://infogram.com/fw-lebanon-budget-june-2019-1ho16vdprpo86nq
Half the budget's expenditure effort, or 0.6% of GDP of the overall planned consolidation, involves the government issuing T bonds at 1%, well below market rates (currently 7% on a two-year T bond). Details of how this will happen remain unclear, but it seems that Banque Du Liban (BdL) will buy these bonds and will attempt to structure the transaction in a way that minimises the hit to its balance sheet. (In 2018, the government issued LBP8.3 trillion (9.7% of GDP) of T bonds to BdL at 1% as part of a wider transaction.)
Lebanon's finance minister, Ali Hassan Khalil, initially suggested that commercial banks would be involved, but banks have said that they will not buy such low-interest-rate T bonds, which would be negative for their profitability. While borrowing at an artificially low rate would save the government money (interest costs are 30% of total government spending), it also indicates a degree of financial stress and raises questions about the government's debt sustainability, especially given the greater reliance on the central bank for financing.
Deteriorating public finances and rising pressure on Lebanon's financing model were among the reasons for our December revision of the Outlook on Lebanon's 'B-' rating to Negative. The formation of a government in January has failed to buoy key indicators such as bank deposit growth and foreign reserves. It remains to be seen whether the government's budget, or its electricity sector reforms announced in April, will bolster confidence among depositors or foreign investors. Prospects for the authorities' ability to execute plans to reduce financing and external vulnerabilities without further damaging confidence and undermining the government's funding model will be key to resolving the Negative Outlook.
Total private-sector commercial bank deposits have declined since end-2018 and in yoy terms were just 0.7% higher in April, while FX deposit growth (4%-5%) partly reflects conversion of LBP deposits to dollars. Furthermore, given that the average interest rate on LBP deposits was 8.6% and on FX deposits 5.7%, April data suggests that net of reinvested interest earnings, the stock of deposits has fallen considerably, even in yoy terms.
https://infogram.com/fw-lebanon-deposits-june-2019-1hxr4znmxwkq4yo
Monthly BdL balance-of-payments numbers show a deficit of USD3.3 billion in 4M19. At end-April, BdL's gross FX reserves totalled USD31.5 billion - still a large stock although down by USD1 billion since end-2018. BdL also holds USD6.4 billion of less liquid FX assets and USD11.9 billion in gold. But it has large FX liabilities to banks, which we estimate at around USD60 billion, although a significant proportion have long maturities.
Reserves will likely have decreased in May following a USD650 million Eurobond repayment. Lebanon's next Eurobond maturities are USD1.5 billion in November and USD2.5 billion in 1H20. BdL has the gross reserves to meet these repayments if Lebanon cannot issue fresh Eurobonds. But continuing reserve declines could further erode confidence in the financial system.
Contact: Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@thefitchgroup.com
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