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Fitch affirms Lebanon 'B,' rating, outlook stable.

Summary: Fitch Ratings Wednesday affirmed Lebanon's long-term foreign and local currency Issuer Default Ratings at "B" and short-term foreign currency IDR at "B" and provides a stable outlook for the country.

BEIRUT: Fitch Ratings Wednesday affirmed Lebanon's long-term foreign and local currency Issuer Default Ratings at "B" and short-term foreign currency IDR at "B" and provides a stable outlook for the country. The agency has also affirmed the Country Ceiling at "B," Fitch said in a statement.

"The affirmation of Lebanon's ratings reflect the fact that its substantial foreign exchange reserve buffers, lower debt levels, and reduced interest costs, relative to the previous decade, mitigate the downside risks to political stability, growth and public finances in 2011," Purvi Harlalka, Director in Fitch's Middle East and Africa Sovereign Ratings Group said.

"However, an outbreak of violent conflict resulting from either internal political strife or a spillover of tensions from neighboring Syria could put the rating under negative pressure."

Output rose briskly (7 percent) in 2010, fueled by rising nonresident deposits (up 11.5 percent), record numbers of tourist arrivals (2.2 million, up 17 percent from 2009) and a robust property market.

The inflows continued to push down interest rates and dollarization and drive up private credit growth to 24 percent -- the highest rate in the Middle East. They also shored up the balance of payments to a surplus of $3.5 billion, causing Lebanon's stock of foreign exchange reserves to reach an all-time high of $42 billion (including gold).

However, the collapse of the national unity government in January and the wave of Arab uprisings caused a drop in confidence.

The growth in nonresident private deposit inflows, which are a key driver of activity, slowed to 14 percent year-on-year in the first quarter of 2011 from 34 percent. Nevertheless, this slowdown comes off a high base ($18.5 billion at end 2010). Meanwhile tourism (-13.4 percent year-on-year) and property sales also declined significantly in the first quarter of 2011 and dollarization increased slightly to 66.2 percent in April, from 63.2 percent in December 2010. Together with high oil prices, these trends led to a quarterly balance of payments deficit ($400 million in the first quarter of 2011).

As a result, the growth outlook for 2011 has deteriorated to 2.5 percent, as per Fitch estimates, from the 7-8 percent of 2008-10. The deteriorating situation in Syria also bodes ill for economic prospects, given its potential to further impact confidence. Although Lebanon's direct exposure to Syria is small (only 5.6 percent of Lebanon's exports and 1.9 percent of its imports went to/came from Syria in 2010), a lot of its goods exports are transported through Syria.

But the formation of a new government in June, under the leadership of Najib Mikati, a business-friendly politician, restores some stability and could improve the economic and fiscal outlook for the first half of 2011.

On current trends, a cut in gasoline taxes (0.7 percent of GDP), slowing consumption and investment, and an increase in spending on public wages and roadwork means that the fiscal deficit is likely to widen to between 9 and 10 percent of GDP in 2011 from 8 percent in 2010.

Despite this, Fitch expects debt to stabilize below 135 percent of GDP in 2011 where it would nevertheless remain the third-highest of all Fitch-rated sovereigns after Japan and Greece. General government debt fell to 137 percent of GDP in 2010 from 179 percent in 2006.

A sustained reduction in sovereign debt brought about by strong growth and fiscal discipline would improve Lebanon's creditworthiness. By contrast, a sustained increase in debt would cause the rating to be lowered.

Debt sustainability is supported by the size and depth of the local banking sector (3.35 x GDP in 2010), which is the main holder of Lebanese paper (56 percent of the total outstanding by end-2010). The resilience of this investor base, which mediates the funds repatriated by the wealthy Lebanese diaspora into the economy and government debt, underpins the stability of public finances and is vital to the rating.

As a result, the risk of sustained deposit flight prompted by political instability is the primary risk to Lebanon's rating. Although deposit flight is not unprecedented during periods of turbulence, such as in the wake of Rafik Hariri's assassination in 2005 and the war with Israel in 2006, it is usually temporary and deposit inflows tend to return quite quickly.

On the domestic front, the refusal by Hezbollah, which has two ministers in the current government, to arrest the individuals named in the indictment issued by the Special Tribunal for Lebanon, which is investigating the Hariri killing, could inflame tensions and curtail government effectiveness.

Meanwhile, the worsening of unrest in Syria could adversely affect Lebanon. Fitch's base case does not envisage the outbreak of sustained episodes of violence but such an outcome would adversely affect the rating.

Lebanon's high per capita income, liberal business environment, and the credibility of its exchange rate regime support its creditworthiness. The latter is especially relevant in the context of the high rates of dollarization and Lebanon's vulnerability to political and external shocks.

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Publication:The Daily Star (Beirut, Lebanon)
Geographic Code:7SYRI
Date:Jul 7, 2011
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