Republic of Lebanon outlook revised to negative; 'B-' long-term, 'C' short-term ratings affirmed; off watch

At the same time, the 'B-' long-term and 'C' short-term sovereign credit ratings on Lebanon were affirmed.

"The removal of Lebanon from Creditwatch with negative implications reflects the reduced risk of a sovereign downgrade in the immediate future," said Standard & Poor's credit analyst Farouk Soussa. "The Lebanese economy and public finances have withstood the immediate threat posed by the conflict with Israel that left much of Lebanon devastated."

Outflows from the banking system during the conflict amounted to $2 billion (or 2.7% of total deposits), and these were partially offset by an inflow of $1.5 billion in official financial assistance from the governments of Saudi Arabia and Kuwait. The Lebanese government continued to service all financial obligations, aided by improved treasury management prior to the conflict, including a prefinancing policy that eased immediate liquidity pressures.

Nevertheless, the medium-term challenges for Lebanon remain severe. Initial very approximate estimates put the fiscal impact of the war as high as 6% of GDP, but the final figure will depend on how quickly the economy recovers and the extent of donor support for the rebuilding effort. The outcome of a donor conference, planned to convene by year-end to address Lebanon's historically precarious financial position, including any potential debt restructuring deal, will be particularly important. Central government deficit and debt ratios, at 10% and 180% of GDP, respectively, in 2005, were already among the highest of any rated sovereign, even before the conflict.

The outlook could revert to stable, and positive ratings momentum could return, if uncertainties regarding the political situation, the rate of economic recovery, and the magnitude of international support, are resolved over time with a favorable outcome. If economic recovery proves slower than expected, fiscal outturns worsen, and support from the international community falters, however, then the sovereign ratings on Lebanon could be lowered. Standard & Poor's will also monitor the terms of any debt restructuring to emerge from a future donor conference, to ensure that any adverse treatment of commercial creditors is reflected in the rating.