Republic of Lebanon FC/LC ratings lowered to 'CCC+' on political impasse; outlook stable

The outlook is stable. The short-term ratings were affirmed at 'C' and the transfer and convertibility assessment was affirmed at 'B+'.

"The ratings on Lebanon were lowered as a result of the political impasse that has raised tensions within Lebanon, and for which no easy resolution appears in sight,"

Standard & Poor's credit analyst Ben Faulks said.

"This stand-off has increased political instability, which could shake confidence in the financial sector, thereby compromising domestic banks' ability to lend to the government, and could delay reforms crucial for putting Lebanese public finances on a more sustainable path."

That said, several factors continue to support Lebanon's creditworthiness. The fiscal outturn in 2007--a primary surplus of above 3% of GDP--was better than the IMF had targeted in its Emergency Post-Conflict Assistance program (EPCA), and the ratio of debt to GDP declined. Resident banks, which are by far the government's largest creditor, have continued to buy government debt despite their stated threats to desist unless the political confrontation is resolved and economic reform launched in earnest.

There also remains a strong possibility that foreign supporters of the Siniora government, primarily from among Gulf Arab countries, will step in to provide further financial aid. Moreover, the authorities met most of the targets set for 2007 under the EPCA program--largely preparatory steps for more far-reaching reform.

Nevertheless, these supporting factors threaten to be eclipsed by the political crisis. Despite a stated consensus that the head of the army, Michel Suleiman, should become the next president, deep divisions between the ruling March 14th coalition and the opposition (comprising primarily Hizbullah and the Free Patriotic Movement of former army general Michel Aoun), and between their respective external supporters, are preventing his election and the formation of a proposed national unity government. Consequently, the risk of instability has in our view increased, and with it the risk of capital flight.

A protracted stand-off between the factions might also delay the passage of the most important economic reforms promised at the Paris III donor conference held in January 2006. These reforms, primarily the sale of the two state-owned GSM licenses and the overhaul of the state-owned electricity company Electricité de Liban, are an essential starting point to redress precarious public finances, with general government debt remaining above 170% of GDP.

"The stable outlook balances Lebanon's political and fiscal pressures against the likelihood of third-party support and the country's economic resilience," Mr. Faulks said. "The ratings will be lowered should civil unrest break out or if the political deadlock causes protracted policy inertia. The ratings could be raised in the event of the election of a president and the formation of a cabinet by consensus accompanied by some success in advancing the program of economic reforms pledged at the Paris III conference."