Moody s B3 / S&P B- / Fitch B 1 Economy: Agriculture 6%, Industry 21%, Services 73%

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1 Lebanon Summary Moody s B3 / S&P B- / Fitch B 1 Economy: Agriculture 6%, Industry 21%, Services 73% Lebanon s economy has proven resilient to shocks despite the combination of unstable domestic politics and regional conflicts. After more than two years of political deadlock, Lebanon elected a pro-hezbollah president in 2016 and arranged a power-sharing agreement with a Sunni Prime Minister. The ongoing Syrian conflict represents a major source of risk, exacerbating an already difficult political situation. Despite some of the highest levels of public and external debt in the emerging markets, Lebanon benefits from a large, captive local investor base, which owns a large majority of its debt. The financial system is among the largest in emerging markets and is funded by a reliable inflow of non-resident deposits from the Lebanese diaspora. On the external side, foreign currency reserves are among the highest in the world in GDP terms and partially mitigate risks from a double-digit current account deficit. The country s fiscal position is deteriorating largely due to a sharp growth slowdown, but for the first time in 12 years, the Parliament passed a budget in 2017, a positive step towards restoring public finances. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 10,399 10,810 11,177 11,296 11,685 12,081 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Haver Analytics, IMF 503

2 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency BB B+ B B- CCC+ Local Currency BB- BB+ BB BB- B+ B B- CCC+ CCC CCC Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Lebanon 2012 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 504

3 Lebanon Strengths Banking Sector Support Lebanon serves as a major financial center for the Middle East and the Lebanese diaspora, which is estimated at 15 to 20 million people, the equivalent of 3 to 4 times the population living in Lebanon. Because of this, the banking sector is one of the largest in emerging markets in terms of assets at 397% of 2016 GDP. Funding consists mostly of deposits, leaving the system with low levels of funding risk. A large proportion of deposits are from nonresidents, mostly the Lebanese diaspora. While in principle this could be a vulnerability, as non-resident deposits are typically more volatile, it has historically been a source of strength for Lebanon through various crises. Despite increasing regional uncertainties, non-resident deposits remain sizable at 66% of GDP. 2 The worst decline was at the height of the domestic political crisis in that included the assassination of former Prime Minister Hariri, the Israeli invasion and bombings. Even then, the decline was modest at 4% of GDP, and deposit flow returned not long afterward. The International Monetary Fund (IMF) highlights that the banking sector plays a key role in ensuring sustainable economic growth. 3 Low Rollover Risk Despite High Debt Level The IMF expects Lebanon s gross public debt to reach 151% of GDP in 2018, 4 of which 40% is denominated in foreign currency. The vast majority of that debt, including 80% of Eurobonds, is held by residents. Domestic debt is almost 100% owned by residents, and for the past several years, ownership by domestic banks and the central bank (BDL) combined has ranged between 80% and 85%. Lebanon demonstrated its ability to roll over debt in March 2017 when its $3 billion issuance was six times oversubscribed, with half of the proceeds used to pay maturing 2017 debt. 5 Links to Non-Arab Spring Countries Lebanon is an open economy, with trade exceeding 100% of GDP despite its status as a non-oil exporter. This is a strength because the country s financial links are primarily with countries that are more politically stable, with the exception of Syria. Over 90% of foreign direct investment (FDI) comes from Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates, while remittances come from the diaspora mostly living in the Middle East. Tourism, estimated at 20% of GDP, is mostly from Europe and the Middle East and North Africa (MENA) region, which traditionally accounted for approximately 65% of all tourists, 6 providing a stable and reliable source of external funding. Tight relations with Saudi Arabia have been key during times of crisis, including the 2006 pledge of $1.6 billion, about 7% of GDP, to the BDL during the Israeli attacks, followed in 2007 by another $1.1 billion, or 5% of GDP. However, the crowning of Saudi Arabia s King Salman bin Abdul-Aziz Al Saud in January 2015 may signal a shift in relations. For instance, he canceled a previous pledge for a $3.0 billion grant. While Lebanon s relationship with Saudi Arabia appears to have deteriorated further in light of the recent ascension of an Iran-backed president, the relationship is far more complex, and Saudi Arabia is expected to continue to be influential despite escalating tensions over Hezbollah

4 Lazard Emerging Markets Debt Large External Buffers The three main sources of external funding have traditionally been: 1) FDI, which tends to total approximately 4% 5% GDP and finances one-third of the current account deficit; 2) nonresident deposits, with an average annual flow of 3% of GDP; and 3) external debt issuance. Years of this funding mix have resulted in significant FX reserves accumulation, and Lebanon has among the highest reserves to GDP ratios in emerging markets at approximately 85% of GDP as of October 2017, which fully covers outstanding Eurobonds. 8 Unblemished Debt Servicing Track Record Lebanon s government has never failed to service its debt in a timely manner, despite regular political and economic shocks. The quality of the country s financial sector management and regulation, overseen by the BDL, is also high, as evidenced by its ability to navigate through frequent and, at times, severe crises. The central bank s personnel tend to have low turnover, and appointments tend to be less politicized than in other institutions. For example, the current governor of the central bank, Riad Salameh, has been in place since Governor Salameh was re-appointed unanimously in May 2017 for another six-year term. 9 Weaknesses Unstable Region and Complex Internal Politics Lebanon shares borders with Israel and Syria, both of which have invaded and occupied the country since its independence from France in Additionally, the country s history under democracy is relatively short and the country experienced a 16-year civil war that ended in Lebanon has undergone several government changes, with power alternating between Sunni and Christian pro-western coalitions and more militant, pro-syrian figures backed by Hezbollah and funded by Syria and Iran. Recently, the heightened level of violence in Syria has had notable repercussions for Lebanon s economy and political stability. For instance, it contributed to the deadlock in electing a president for more than two years, during which legislation could only be enacted when agreed on by all 24 ministers. 10 While it is encouraging that Lebanon finally elected Michel Aoun as president in 2016, the powersharing arrangement involves the appointment of Hezbollah critic Rafic Hariri as prime minister, 11 and the effectiveness of this arrangement is both complicated and untested. Syria Crisis The UN Refugee Agency reports that Syria continues to be the largest source of refugees in Lebanon, with an estimated 1 million registered Syrian refugees in a country of 4.6 million people. 12 This large influx of refugees has stressed local infrastructure and imposed higher fiscal costs as the government spends on healthcare, education, etc., which the UN Refugee Agency estimates will require $2 billion in funding for With the presidential deadlock solved, concerns are rising that the government may implement an anti-refugee agenda, such as returning refugees to safe zones in Syria, a stance the UN is likely to oppose

5 Lebanon High Debt Levels and Deteriorating Debt Dynamics Lebanon s public finances are among the weakest in the emerging markets. The bulk of its public debt was accumulated in the 1990s as a means of financing reconstruction following a 16-year civil war. Public debt is estimated to end 2017 at almost 150% of GDP, with interest payments alone consuming half of the government s total revenues. Fiscal deficits are structurally wide, between 8% 10% of GDP, because of high interest rates and sizable transfers to Électricité Du Liban (EDL), which cost 4% 5% of GDP annually. The current economic crisis has considerably worsened Lebanon s fiscal position. The IMF projects GDP growth of 2% 2.5% in the short term while the fiscal deficit is likely to be close to 10% of GDP in 2018, brought on by increased expenditures. 15 As a result, the public debt-to-gdp ratio continues to rise from already high levels, and this is unlikely to reverse, in our view. Given negative debt dynamics, Lebanon faces significant risk to its debt sustainability, and decisive policy actions are required to restore fiscal sustainability. 16 The government took a positive step toward reforming public finances in October 2017 by passing the 2017 budget, the first time it has managed to do so in 12 years

6 Lazard Emerging Markets Debt Country Background Size Capital Population 10,400 KM 2 (169th) Beirut 6.2 Million Religion Muslim 54.0%, Christian 40.5%, Other 5.5% Median Age 30.5 Years Literacy Rate 93.9% Independence 22 November 1943 Political System Government Leadership Next Election 2022 Legislative Branch Parliamentary Republic President Michel Aoun; Prime Minister Saad Al-Hariri Unicameral National Assembly Economy Agriculture 5.7%, Industry 21.0%, Services 73.3% Merchandise Exports Jewelry, Base Metals, Chemicals, Consumer Goods, Fruit and Vegetables, Tobacco, Construction Minerals, Electric Power Machinery, Textile Fibers, Paper Export Partners South Africa 21.1%, Saudi Arabia 9%, UAE 8%, Syria 6.7%, Iraq 5.4% Currency Lebanese pound (LBP) As of November 2017 Source: CIA 508

7 Lebanon Country Timeline 1990 The Syrian air force attacks the Presidential Palace at Baabda and Aoun flees. This formally ends the civil war The National Assembly orders the dissolution of all militias, except for the powerful Shia group Hezbollah. The South Lebanon Army (SLA) refuses to disband. The Lebanese army defeats the PLO and takes over the southern port of Sidon After elections in August and September, the first since 1972, wealthy businessman Rafik Hariri becomes prime minister After the collapse of the SLA and the rapid advance of Hezbollah forces, Israel withdraws its troops from southern Lebanon more than six weeks ahead of its July deadline UN Security Council resolution aimed at Syria demands that foreign troops leave Lebanon. Syria dismisses the move. Parliament extends President Emile Lahoud's term 2005 Rafik Hariri is killed by a car bomb in Beirut. The attack sparks anti-syrian rallies and the resignation of Prime Minister Omar Karami's cabinet. Calls for Syria to withdraw its troops intensify until its forces leave in April. Assassinations of anti-syrian figures become a feature of political life Israel attacks after Hezbollah kidnaps two Israeli soldiers. Civilian casualties are high and the damage to civilian infrastructure wide-ranging in 34-day war. UN peacekeeping force deploys along the southern border, followed by Lebanese army troops for first time in decades Lebanon establishes diplomatic relations with Syria for first time since both countries gained independence in the 1940s The pro-western March 14 alliance wins parliamentary elections, and Saad Hariri forms unity government Syrian warplanes and helicopters fire rockets into northern Lebanon, days after Damascus warns Beirut to stop militants crossing the border to fight Syrian government forces. Najib Mikati's government resigns amid tensions over upcoming elections UN announces that number of Syrian refugees registered in Lebanon has surpassed one million. The accelerating influx means that one in every four people living in Lebanon is now a refugee from the Syrian conflict. President Suleiman ends his term of office, leaving a power vacuum. Several attempts are made in parliament over subsequent months to choose a successor Israel launches air strikes on Syrian side of the Golan, killing Hezbollah fighters and an Iranian general. Several clashes ensue across Israeli-Lebanese border. New restrictions on Syrians entering Lebanon come into effect, further slowing the flow of people trying to escape the war New electoral law approved by Parliament after much delay. Source: BBC 509

8 Lazard Emerging Markets Debt Notes 1 As of December Lazard estimates based on Haver Analytics data, October IMF Article IV Country Report 15/ Lebanon, International Monetary Fund, World Economic Outlook, October 2016, external/pubs/ft/weo/2016/02/weodata/index.aspx 5 accessed 31 October Lebanon Economic Report: 3Q 2015, Bank Audi Lebanon, 12 November Hezbollah-DS _dsart / accessed 31 October Based on Bloomberg data of August 2017 FX Reserves of $43.88 bln as of October accessed 31 October Lebanon: 2015 Article IV Consultation, International Monetary Fund, IMF Country Report No. 15/190, July 2015, accessed 11 November accessed October accessed October accessed 11 November IMF WEO Outlook, October Lebanon: 2015 Article IV Consultation, International Monetary Fund, IMF Country Report No. 15/190, July 2015, 17 Lebanon s parliament approves country s first budget since accessed 31 October

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