September 2019 witnessed the fastest deterioration in the private sector’s business conditions in Lebanon. Economic growth in Lebanon was capped between 0% and 0.5% by Sept.2019, as indicated by the PMI level while inflation eased. The BLOM Purchasing Managers’ Index (PMI) shows private sector activity stalled at an average of 46.8 by Sept. 2019, capped below the 50-mark separating contraction from growth. Meanwhile, inflation eased to 2.77% by August 2019, down from last year’s 6.29% mainly owing it to a 10.7% annual downtick in oil prices to $64.8/barrel.
The first 9 months of 2019 carried political, economic, and social headwinds. The formation of a government came by end Jan. 2019 after prolonged delays, in parallel to Moody’s downgrade of Lebanon’s rating to Caa1. Moreover, the budget for 2019 was not endorsed by parliament until the end of July, and by August 2019, Fitch Solutions had downgraded Lebanon’s rating to CCC from B- while Standard & Poor’s Global Ratings affirmed its long- and short-term foreign and local currency sovereign credit ratings for Beirut at B-/B, saying the country’s outlook remains negative.
In fact, Lebanon’s sovereign ratings have been driven by macroeconomic fundamentals and political risks. According to Cadastre’s latest data, the number of real estate transactions which may include one or more realties, dropped by a yearly 18.30% to stand at 31,131 transactions by August 2019. By the same token, the total number of construction permits also dropped by an annual 14.8% to 7,954 permits by Aug. 2019, which reflects the persisting slowdown in the sector. In turn, average interest rates on loans in LBP and in USD that reached highs of 11.13% and 9.9% by July 2019, compared to 9.97% and 8.57%, respectively, in December 2018 contributed to the crowding out of the private sector.
Lebanon’s balance of payments (BOP) deficit reached an all-time high in July 2019, but slid by August 2019 on the back of BDL’s initiative. The cumulative BOP deficit recorded $5.3B in the first 7 months of the year, up from July 2018’s $757.2M. In fact, 2019’s BOP deficit is a result of the prolonged delay in forming a government and the endorsement of the austerity draft budget to unlock CEDRE funds, coupled with the negative publicity on Lebanon’s credit rating to-date which weighed down on the already frail foreign investors’ confidence.
However, the central bank (BDL) launched an initiative towards the end of July to attract deposits, by which it offered commercial banks attractive rates on their fresh dollar deposits. The initiative resulted in the first monthly surplus of 2019 that amounted to $72.5M in July, compared to a deficit of $548.9M registered in July 2018. Moreover, in August 2019, Lebanon’s BOP recorded a surplus of $921.5M compared to a deficit of $408.1M in August 2018.
BDL’s net foreign assets (NFAs) declined on the back of settling Eurobonds maturing in April and May. The NFAs of Commercial banks and of BDL fell by $2.7B and $2.59B by July 2019, respectively, noting that BDL’s decline in NFAs was largely driven by the $500M and $650M payments of maturing Eurobonds on 23/04/2019 and 20/05/2019, respectively. However, the willpower to reform expressed by policy makers announcing Lebanon a state of economic emergency, followed by meetings being held with officials in France and the US may help unlock CEDRE funds, which can in turn, help break the vicious cycle of BOP deficit and attract capital inflows back into the economy.
The trade deficit grew and continued to fuel the BOP. As per the latest Customs statistics, the trade deficitwidened from $10.14B by July 2018 to $10.24B by July 2019 on the back of a yearly 3.67% uptick in total imports to $12.34B, while total exports added an annual 19.2% to $2.1B over the same period, as per the Customs’ data.
On the fiscal front, Lebanon’s public debt grew while the fiscal deficit narrowed. The cash-basis deficit totaled $2.42B in H1 2019, down from H1 2018’s $3B deficit. Correspondingly, the total primary balance registered a surplus of $308.9M by June 2019 compared to a $155.4M deficit in the same period last year. Nonetheless, gross public debt continued to grow, climbing by a yearly 3.4% to hit $85.7B by June 2019 and it further rose to $86B by July 2019.
On the monetary policy front, BDL’s initiative further supported the currency peg replenishing its foreign assets. Despite the negative developments on the Balance of Payments front, BDL managed toreplenish its foreign assets which stood at $37B (excluding gold) by June 2019, constituting a coverage of 22 months of imports of goods and around 75% of LBP deposits at commercial banks. Moreover, BDL’s foreign assets recorded a monthly 4.3% uptick (equivalent to $1.6B) to $38.7B by August 2019, with the $1.6B increase largely attributed to BDL’s re-incentivizing commercial banks to attract fresh dollars as deposits into the country. The central bank enabled banks to offer attractive yields close to 14% on their fresh USD deposits and it offered them 2% loans in LBP in return for their dollars, which will be placed at the central bank at a rate close to 10.5%.
Therefore commercial banks’ total assets added 3.89% year-to-date (YTD), to $259.18B by July 2019. This increase is due to a 13.52% YTD growth in Deposits with BDL to $147.8B, while total outstanding loans to the private sector retreated by 6.82% YTD to $54.89B by July 2019. In turn, total private sector deposits increased by 1.12% YTD to reach $172.35B by July 2019, such that the dollarization ratio of Private sector deposits grew from 70.62% in December 2018 to 71.73% in July 2019.
Overall, Fitch’s August rating report said the downgrade reflects intensifying pressure on Lebanon’s financing model, increasing risks to the government’s debt-servicing capacity. Fitch highlighted that downward pressure on banking sector deposits and central bank foreign reserves and measures by the central bank to attract inflows illustrate increased stress on financing the economy. The government is largely relying on financing from the central bank, both in domestic debt markets and for repayment of Eurobonds.
Standard & Poor’s said the negative outlook reflects that, “We could lower our ratings on Lebanon in the next six-12 months if banking system deposits and the central bank foreign exchange reserves continue to fall.” However, the agency rating remained the same since the central bank’s FX reserves are sufficient to fund the government’s borrowing requirements and country’s external deficit over the next 12 months. Moreover, S&P could revise the outlook to stable if the Lebanese government is able to significantly improve foreign investor confidence by taking credible steps to implement its fiscal consolidation and medium-term electricity sector reform plans.