Standard & Poor’s Ratings Services says its credit ratings on the Republic of Lebanon (B-/Stable/C) should weather the near-term financial and political pressures resulting from the assassination of former prime minister Rafik Hariri, on February 13, 2005.


“A favourable economic conjuncture, underpinned by replenished reserves, accelerating economic growth, robust financial sector liquidity, and active debt management, mitigates the risk of an immediate financial crisis,” says Standard & Poor’s credit analyst David Cooling. “That said, medium-term prospects continue to hinge on maintaining political stability and reinvigorating Lebanon’s burgeoning structural reform agenda.”


Despite a stream of negative news in recent months – including the passage of a UN Security Council resolution demanding an end to Syria’s military and political roles in Lebanon (in September 2004), and Hariri’s resignation (in October 2004) – indicators of economic activity have remained positive. Real economic growth averaged 5% in 2004, while capital flows from the Gulf have favoured Lebanon, averaging almost 11% of GDP annually since 2001.


Moreover, recent improvements in external liquidity provide the Banque du Liban (BDL; the central bank) with ample flexibility to weather the expected pressure on the Lebanese pound once domestic markets reopen.
Gross foreign exchange reserves, excluding commercial banks’ reserves and gold, amounted to an estimated US$13.8bn at year-end 2004, providing almost 11 months of import coverage in 2005.


Active debt management – including debt swaps, which have lowered 2005 foreign currency maturities by US$1.2bn – has substantially reduced the government’s gross financing requirements in 2005.


Assuming a central government deficit equivalent to 5.7% of GDP in 2005, Lebanon’s gross financing requirement amounts to an estimated US$7.9bn (38% of GDP) compared with US$16bn (82% of GDP) in 2004.


A total of US$1.7bn in Eurobonds – of which US$718mn are zero-coupon bonds issued to commercial banks under the November 2002 Paris II agreement – mature in 2005.


Further debt swaps are planned for 2005 to lengthen the maturity structure of the debt, and lower interest costs.


In addition, the financial sector continues to enjoy ample liquidity, enabling banks to continue to finance the government’s near-term needs. Resident and nonresident deposits, which provide the government with financing via the domestic banks, grew by more than 10% in the first 11 months of 2004. The government’s foreign currency maturities ahead of parliamentary elections in May 2005 amount to an estimated US$650mn, and are largely confined to the zero-coupon bonds issued to the banks in support of the Paris II agreement. Domestic banks hold an estimated 51% of Lebanon’s government debt.


A sustained period of fiscal consolidation, encompassing privatisation, and the reform of loss-making state-owned enterprises, subsidies, and social security payments, is essential to maintain recent improvements in Lebanon’s debt dynamics. The general government debt-to-GDP ratio is expected to fall to 163% of GDP at year-end 2005, from a peak of 177% of GDP at year-end 2003. Under the assumption of real economic growth averaging 3.5% annually, and real interest rates of 7.3%, primary surpluses equivalent to 5.1% are required to stabilise the debt-to-GDP ratio.


In this context, caught in a power struggle with his long-time rival, President Emile Lahoud, Hariri had been largely unable to achieve his policy objectives in recent years. In contrast to many of his potential successors, however, Hariri had developed a framework for structural reform.
“Failure to step up the implementation of long-awaited reforms, after parliamentary elections in May 2005, would undermine growth and investment inflows, eroding confidence and heightening the risk of a financial crisis, bringing the ratings on Lebanon under downward pressure,” says Cooling. “Conversely, a prolonged period of fiscal consolidation would strengthen debt sustainability, underpin confidence, promote Lebanon’s economic renaissance, and strengthen its credit-standing.”