At CCC+, Lebanon is the lowest-rated country monitored by Standard & Poors. It is two notches away from default and deemed more risky than Ecuador, Bolivia and Grenada, all rated B.
General government debt in Lebanon stands at 170% of GDP. The countrys banks hold about 75% of that debt, of which $20 billion is in local currency and $21 billion in foreign currency.
Over the past three years, the Lebanese pound has been remarkably resilient in the face of a series of political crises. But as political stalemate persists, Standard & Poors says the likelihood is increasing that depositors in local banks will take fright and prevent those banks propping up the pound.
So far, Lebanons financial sector has been the last remaining pillar of a faltering economy. Deposit growth in 2007 was about 8%, in part thanks to high levels of remittances and booming economies in other parts of the Middle East where Lebanese banks have branches. Ratios of dollar to local-currency deposits have also been stable.
It helps that the Lebanese pounds peg to the dollar has an implicit guarantee from oil-rich Gulf states. In 2006, Kuwait and Saudi Arabia deposited $1.5 billion in the central bank, bolstering faith in the local currency after the war.
Depositors in Lebanese banks are further attracted by the preferential rates of return given by the Lebanese pound compared with the dollar. And with recent interest rate cuts by the US Federal Reserve, that differential is widening in favour of the pound.
However, Lebanese banks have scant opportunity to invest their pounds within Lebanon and, thanks to the credit crisis, opportunities abroad are becoming scarcer too. With Lebanese treasury bills already comprising a large portion of their balance sheets, they have little to gain from an exodus from the governments debt.
The result is that every month these banks are rolling over an average of about 75% of government debt coming to maturity. Standard & Poors, however, is worried that political instability is pushing retail and corporate depositors faith closer to the precipice.
Descent of stability
"If confidence in the banking system or confidence in the currency were to diminish, then you would see a sharp reduction in Lebanese pound deposits, and therefore the liquidity with which the banks could buy the government debt would be much reduced," says Farouk Soussa, a credit analyst at Standard & Poors. "So long as the political situation remains manageable that wont happen. What were saying is that the risk has increased that stability will descend to such a degree it no longer remains manageable."
Over a three-year period, an average of around 40% of debt that is rated C defaults.
It is unfortunate, therefore, that as a result of the sovereigns re-rating, Standard & Poors has also downgraded to the same category three of the biggest banks in Lebanon: Bank Audi, Bankmed and Blom Bank.