Oxford Business Group, April 30, 2002

The April down-grading from international rating agencies for Lebanon's sovereign rating and for three of the country's largest banks brought home again the harsh realities of the size of the national debt and its effect on Lebanon's creditworthiness. Around two-thirds of lending from Lebanon's commercial banks is in government Treasury bills, and conversely the majority of the government's T-bills are taken by domestic banks. Foreign observers believe that this ties the banks too closely into a potential national debt trap, as the government struggles to bring the debt under control. Although most Lebanese banks have said privately that they will no longer finance their government after 2002 the move into alternative sources of income- most often retail banking- has been hampered by economic sluggishness and profits are declining.

The ratings agency Standard & Poor's said on April 10th that its was reducing Lebanon's long-term credit rating from single-B to B-minus, six grades below investment grade, and was cutting the short-term credit rating to single-C from single-B. The outlook was negative with the agency blaming the lack of a "credible fiscal programme" from the government to control its debt in the short-term on its decision. In effect S&P believes that Lebanon will have trouble gaining access to international credit in the coming years and may face a painful restructuring of its debt. Another major player in the ratings game, Fitch, said a day later, on April 11th, that it believed Lebanon's public finances to be "unsustainable", although the government was not about to face a default. Again the agency warns the government that unless it acts soon it will face a financial crisis. This is likely to arise from the debt-deficit spiral the country finds itself in, coupled with slow privatisation and falling foreign exchange reserves, according to Fitch.

It is the domestic banks that absorb the majority of the government's T-bills, with over 60% of domestic bank loans going to the state, and domestic banks holding an estimated 56.3% of outstanding T-bills at the end of 2001. However margins are falling on government debt and commercial banks are less willing to continue financing it, and exposing themselves to a possible default. Bank deposits rose in 2001 over 2000, with private sector deposits rising by 7.7% to LL51.23tr by the end of December 2001. However, this is less than during 2000 - when private sector deposits rose almost 11% - worrying analysts. Despite the higher interest rates offered on Lebanese Lira accounts foreign currency deposits grew much faster - 19.6% higher than at the end of 2000 at $23.50bn - than did deposits in lira, which fell 12% during the year. By the end of 2001 dollar deposits in Lebanon stood at around 69.2% of total deposits. The total assets of the banking sector also rose in 2001 - by 5.8% to reach Ll71.86tr - but again the growth was lower than it had been in 2000.

So although the banks have more money to play with, they have been less willing to provide loans. By the end of December 2001 the claims of commercial banks on the private sector stood at Ll22.19tr, a decline of 0.2% on the previous year. Claims on the public sector had also stagnated, falling some 0.9% to Ll23.07tr over the period. The indication from this was that banks were less willing or able to lend their money, instead preferring to hold on to the deposits, largely out of concern at the country's economic situation. In such an economic climate businesses are also less willing to embark on new projects that may require financing. A further event to bring down the number of loans banks were willing to make, was the central bank decision in September 2001 that commercial banks should increase their reserves in lira time deposits at the central bank from 13% to 15%, and their reserves on demand deposits from 13% to 25%.

The concern amongst some analysts is that some of this money may be used to prop up the Lebanese Lira peg, which has come under increasing pressure as the country's debt has grown. The central bank only publishes gross foreign exchange reserves, which includes deposits from commercial banks, and even these have fallen to around $4.69bn by mid-April, well down from $5.75bn at the end of 2000. The Moody's Investors Service report for February indicated that the company believed Lebanon's net official reserves to be negative. It is just this policy of targeting the nominal exchange rate and nominal interest rates, while at the same time consuming more foreign exchange reserves as the government debt continues to rise that Fitch said on April 11th it believed to be "unsustainable".

The close involvement of the domestic banks in the country's debt was further highlighted by the down-grading for three of the country's largest banks in April. The rating agency Standard & Poor's, as well as down-grading Lebanon's sovereign rating, lowered long-term credit ratings on Banque Audi, Banque de la Mediterranee and Blom Bank. The agency brought all of these down to single-B-minus from single-B and for the first two banks brought their short-term ratings down to C from B. In all cases the outlook was negative.

Local bankers have defended their exposure to the government's debt, saying that the Lebanese government would not default on domestic debt and that the Lebanese Lira exposure to the state - at the end of 2001 around 64% of the government debt was in local currency - is backed by a lira customer deposit base. In any case, the chairman of the Lebanese Banking Control Commission Walid Alameddine pointed out to Oxford Business Group recently "ratings agencies do not rate local currency debt very favourably". The Lebanese government has gradually been shifting much of its domestic, local currency debt into longer-term foreign currency-denominated debt with lower interest rates, in an attempt to put off the inevitable. Although Alameddine believes the foreign currency debt level to be "manageable" he says that it will soon enter an area where it should be "better controlled".

Most analysts expect that the debt crunch will come soon with not much help from abroad and the government struggling to help itself at home. Prime Minister Rafik Hariri is hoping that the EU and the World Bank will look favourably on Lebanon and help it out of trouble, and he has implemented some of the requirements. A 10% VAT was introduced in February this year, with the government hoping to make some $500m per year from that, jobs have been cut at the loss-making Middle East Airline (MEA) and the 2002 budget sees the deficit reduced to 40% of spending from 48% in 2001. However, sceptics argue that with no sign so far in 2002 of the hoped-for privatisations of important sectors and little real belt-tightening at home, 2003 will really become a crunch year for Lebanon. Amortisation payments are set to more than double to around $1bn next year, with observers worried about capital flight.

Meanwhile, the country's banks are looking to expand their services and operations beyond just vehicles for government debt, with most moving towards retail banking. Byblos Bank had been at the forefront of this shift, which began in the 1990s, realising that although Treasury-bills were an easy source of income it should create a more balanced portfolio. Most Lebanese banks will now offer a range of fee-based services such as saving plans and car loans as well as greater options for private clients with credit cards becoming more widespread. As banking and insurance have grown closer together, through media such as Bancassurance, so has online banking. Most of Lebanon's largest banks are also looking to begin operations in neighbouring Syria, and a number have already applied for licences in this recently-opened market.

However, the continuing economic slowdown in Lebanon restricts the banks' ability to diversify quickly and expand their assets and deposits, as does their sizeable exposure to the public debt. For the foreseeable future Lebanon's banks will probably continue to support government borrowing, although trying to limit their exposure to it and maintain their profits through quality lending.