Fitch: Lebanon faces post-election political, fiscal challenges

Istanbul, May 17 (DHA) - Lebanon faces geopolitical and fiscal challenges following its recent election, which has not fundamentally shifted the political status quo, Fitch Ratings says.
"The result underscores that policymaking will remain constrained by Lebanon's sectarian-based political system and highlights that Lebanon could be dragged further into Iran-related tensions" the rating agency added:
"The parliamentary elections held on 6 May were Lebanon's first in nearly a decade, reflecting the gradual improvement in the functioning of the political system since 2016.
"Incumbent Prime Minister Saad Hariri's position has been weakened. Nevertheless, he is still the most likely candidate to form a new government as his FM party remains the largest Sunni party, although it is no longer the largest party in the 128-seat parliament after losing 12 seats.
"Hizbollah and its closest allies, including Amal, hold more than a third of seats. The Christian FPM (founded by President Michel Aoun), aligned with Hizbollah since 2006, now holds the most seats in parliament (28). Lebanese Forces, a Christian party that opposes Hizbollah, made gains and holds 15 seats.
"Overall, the result is consistent with our view that the election would not fundamentally alter the political status quo, despite last year's adoption of a new electoral law.
"The immediate challenge is to form a new coalition government within a reasonable timeframe. We do not anticipate a return to the political paralysis of 2014-2016, but a repeat of the five months of negotiations that followed the 2009 election would prevent effective policymaking for much of 2018. The quicker the process, the more supportive it will be for financial inflows.
"A new government will face challenges managing geopolitical risks. Lebanon has proved fairly resilient to recent political shocks, but the fact that Hizbollah has entrenched its political position at the same time as the US, Israel and Saudi Arabia are moving to counter Iran highlights Lebanon's vulnerability to spillovers, for example via potential sanctions or damage to remittance or deposit inflows.
"The other major challenge is to improve fiscal sustainability, especially given large infrastructure spending plans. The outgoing parliament approved the 2018 budget in late March, targeting a deficit of 8.5% of forecast GDP. This would be smaller than the budgeted 2017 deficit, but 0.8pp larger than the actual 2017 deficit, and would not reverse the rise in government debt/GDP, which is already among the highest of all Fitch-rated sovereigns, at close to 150%.
"Plans for much-needed infrastructure investment were boosted in April when multilateral lenders and donors pledged around USD11 billion. This funding is mostly concessional and will reduce the financing cost of the Capital Investment Plan (CIP). The conditionality attached may boost fiscal reform. For example, Lebanon has pledged to enact fiscal consolidation worth 5 percent of GDP over five years through boosting tax collection and reducing transfers to the state electricity company.
"However, these two fiscal measures are both long-standing aims on which little progress has been made, and it is still unclear how they will be delivered. Similarly, slow and partial execution of CIP projects may limit the fiscal impact of capital investment but would also constrain the economic benefits (annual growth averaged less than 2 percent in 2011-2016).
"Without fiscal reform that lowers government borrowing needs, Banque du Liban (BdL) will undertake further unconventional financial operations to maintain deposit inflows into the banking system, FX reserves, and confidence in the currency's dollar peg. BdL last week confirmed it would sell USD2 billion of Eurobonds within the next 12 months as part of a debt swap with the Ministry of Finance similar to the first stage of the financial engineering operation in 2016.
"Lebanon's 'B-'/Stable sovereign rating reflects weak public finances and economic growth, high political and security risks, but also its resilient banking system and external liquidity and other structural strengths, and an unblemished track record of public debt repayment."