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French Version

Ratings agencies warn political chaos could derail perennial stability of banks

Deposits at 235 percent of GDP trail only Luxembourg, Hong Kong

International financial ratings agencies urged Lebanon on Wednesday to implement immediate economic reforms in order to make better use of pledges from the January Paris III donor conference.

Three leading Lebanese banks were downgraded by Fitch Ratings and other agencies in late 2006 on fears that risks from political volatility and an increasing public debt threatened lending activity in the country.

Fitch on Wednesday affirmed that the Republic of Lebanon's foreign- and local-currency issuer default rating was 'B-' with a stable outlook. The short-term foreign currency rating was 'B' and the country ceiling was 'B-'.

"The stable outlook on what is a very low rating balances increasing political tensions and damage to public finances following last summer's war with Israel against the generous support once again demonstrated by donors," said Richard Fox, head of Middle East and Africa sovereign ratings at Fitch. "January's Paris III conference brought pledges of $7.6 billion in grants and concessional loans.

"Although no end is in sight to the political standoff between the government and opposition, key early-warning indicators of financial market stress, such as international reserves and bank deposit levels, have remained remarkably robust."

Support from official donors, expatriate Lebanese and Lebanon's large banking system remain crucial to understanding Lebanon's ability to support one of the world's highest gross public-debt ratios of 180 percent of GDP.

Bank deposits of 235 percent of GDP are second only to those of Luxembourg and Hong Kong relative to economic size. Consequently, with limited investment opportunities, banks hold over half of all government debt, including foreign currency Eurobonds, and yet this still amounts to a relatively low 75-80 percent of broad money.

This is lower than in many more highly rated sovereigns and significantly lower than its previous peak of almost 90 percent in 2002 on the eve of the Paris II donor conference. Gross foreign currency reserves of around $11 billion are also substantially higher than the $3 billion level of five years ago.

Although these levels are to a large extent the counterpart of banks' foreign currency liquidity deposits, they nevertheless are a reminder that the country's banks are highly liquid, with almost 50 percent of bank balance sheets in liquid foreign currency assets either at the Central Bank or abroad.

A sustained fall in non-resident deposits or broader capital flight would quickly be reflected in a slump in banking-system deposit growth. However, the latter seems unlikely in the aftermath of the major expression of confidence in the Lebanese government marked by the Paris III pledges.

Foreign currency reserves essentially support the integrity of the banking system and the peg to the dollar keeps the confidence of domestic investors in order to maintain their exposure to government debt.

In this regard, the government is working with donors on the details of a reform program to be monitored by the IMF.

Disbursement from money pledged at last year's Stockholm conference and bilaterally is also available to ease the financing of the large budget deficit, which rose to 14 percent of GDP last year as the economy contracted by an estimated 5 percent due to the war.

Bank deposit and loan dollarization are very high, but in times of stress, deposits are switched into foreign currency rather than leaving the banking system altogether. This acts as a crucial buffer.

The purchase of foreign currency Eurobonds by Lebanese banks is also supportive of the government's foreign currency financial management. Previous debt management operations have reduced Eurobond maturities to only $1.2 billion this year, $750 million of which is due at end-February.

In Fitch's view, recent political and economic turbulence and the current balance of risk scenarios is reflected in the 'B-' rating. But the current political stalemate and rising tensions are taking their toll, despite the resilience of the Lebanese financial system to date.

Beirut 15-02-2007
The Daily Star

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