Rating Action:
Moody's downgrades Lebanon's rating to Caa2, maintains review for downgrade
05 Nov 2019
New York, November 05, 2019 -- Moody's Investors Service ("Moody's") has today downgraded the Government of Lebanon's issuer ratings to Caa2 from Caa1. The ratings remain on review for downgrade.
The downgrade to Caa2 reflects the increased likelihood of a debt rescheduling or other liability management exercise that may constitute a default under Moody's definition since opening the review for downgrade of the Caa1 ratings at the start of October. Widespread social protests, the resignation of the government and loss of investor confidence have further undermined Lebanon's traditional funding model based on capital inflows and bank deposit growth, threatening the viability of the peg and macroeconomic stability.
The review period will allow the rating agency to assess the likelihood of a debt restructuring scenario that could lead to losses for private investors that are larger than is consistent with a Caa2 rating.
Moody's expects to complete the review within three months.
Moody's also downgraded Lebanon's senior unsecured Medium Term Note Program rating to (P)Caa2 from (P)Caa1, and affirmed the other short-term rating at (P)NP. The (P)Caa2 rating is also on review for downgrade.
Lebanon's long-term foreign currency bond and deposit ceilings have been lowered to Caa1 and Caa3, respectively. The long-term local-currency bond and deposit ceilings have been lowered to B2. The short-term foreign currency bond and deposit ceilings remain Not Prime.
RATINGS RATIONALE
INTENSIFICATION OF CRISIS FURTHER UNDERMINES THE FRAGILE FINANCING MODEL OF THE GOVERNMENT AND ECONOMY, THREATENS MACROECONOMIC INSTABILITY
Since placing the then Caa1 ratings on review for downgrade at the start of October, Lebanon's economic, social and political crisis has further intensified. In the absence of rapid and significant policy change, a rapidly deteriorating balance of payments and deposit outflows will bring GDP growth to or below zero, further stoking social discontent, undermining debt sustainability and increasingly threatening the viability of the peg.
Widespread social protests and the recent resignation of the government have diminished the likelihood of the passage of the 2020 budget and implementation of the agreed reforms necessary to unlock confidence-enhancing external support packages via Conférence économique pour le développement, par les réformes et avec les entreprises (CEDRE) investments and/or secure financial support from Gulf Cooperation Council (GCC) allies that are essential to ease immediate liquidity risks and allow the economy to recover over the longer term.
In general, external financing conditions have tightened further with Eurobond yields rising to distressed levels and signs of decreasing confidence in the sustainability of the peg against the US dollar.
The Lebanese economy has traditionally relied on foreign direct investment and remittance inflows from the diaspora to sustain economic activity and fund the fiscal and current account deficits. Declining cross-border capital inflows over the past few years have led the Banque du Liban (BdL, the central bank) to draw on its existing stock of foreign exchange reserves to ensure foreign currency debt service payments by the government, while maintaining the currency peg and financial sector stability.
Moody's expects that, in line with previous political risk shock episodes, the pace of deposit outflows will increase, further depleting the country's usable liquid foreign exchange resources and threatening the viability of the peg. The emergence of a parallel exchange rate and the trend toward deposit dollarization which as of September 2019 stood at 73% from 65% in June 2016, already indicate the fragility of the exchange rate regime.
At present, according to Moody's estimates, the BdL has a usable foreign exchange buffer of about $5-10 billion left to draw from based on the sum of changes in the economy's net foreign assets in the past, or when adjusting the stock of foreign exchange reserves at $29.3 billion as of September 2019 for banks' negative net foreign asset position at over $25 billion. In the absence of new net inflows, these $5-10 billion will likely be consumed by the government's forthcoming external debt service payments estimated at $6.5 billion this year and next, including the $1.5 billion November 28 maturity.
In this extremely fragile environment, the Caa2 rating and review for further downgrade reflect the increasing likelihood of a debt rescheduling or other credit negative liability management exercise that could result in private sector holders of government liabilities suffering significant losses.
The central bank's holdings of government securities imply that Lebanon has options for debt management in the near-term that would limit losses borne by the private sector in case of a default event. Although insufficient to restore debt sustainability, Moody's estimates that maturity extension or debt cancellation options involving the BdL's debt holdings amounting to 50% of GDP could act as first loss vehicle as long as the currency peg remains in place. However, those options are diminishing the longer Lebanon's economic and political crisis persists.
The review period will allow the rating agency to assess Lebanon's capacity to manage the Eurobond maturities this year and early next year. The review will also allow Moody's to take stock of the political leadership's progress in restoring some stability that is necessary for a government to agree reforms to unlock the CEDRE lending, and potentially financial support from the GCC, and allow for deposit inflows to stabilize. This would ease currently severe liquidity pressures, and potentially restore confidence in the peg.
