Dubai: Saudi Arabia’s recent decision to halt military grants of $4 billion to Lebanon followed by other GCC states to issue advisories for their citizens travelling to Lebanon is expected to adversely impact fund flows into Lebanon, adversely impacting bank deposits and government’s external balances, according to analysts.

Although the immediate impact of the travel restrictions on the fiscal and external position is insignificant, further escalation of tensions could lead to a slowdown in remittances from the Gulf Cooperation Council (GCC), a reduction in foreign-exchange reserves and disruptions in trade flows, which would be credit negative for Lebanon.

“These developments suggest potential negative sovereign credit implications for Lebanon of the growing polarisation between Saudi Arabia and Iran,” said Zahabia S Gupta said an Analyst at Moody’s.

Standard & Poor’s Ratings Services recently affirmed its ‘B-/B’ long-and short-term foreign and local currency sovereign credit ratings on the Republic of Lebanon with a negative outlook.

The negative outlook, according to the rating agency reflects the view that the protracted political deadlock and increasing regional tensions could further impair the functioning of the Lebanese government and result in a further slowdown in banking sector deposit growth over the next 12 months.

“We could lower our ratings on Lebanon if, over the next 12 months, deposit inflows significantly slowed or foreign-exchange reserves declined much further than we currently expect. If the domestic political gridlock escalated to something more destabilising, we could also lower the ratings,”

S&P’s affirmation of ratings assumes that Lebanese bank deposits will grow by at least 4 per cent in 2016, or about 12 per cent of GDP. Approximately two-thirds of Lebanese bank deposits are in foreign currency and nearly one-fourth is externally sourced. These flows of funds are critical sources of funding for the government’s 2016 gross borrowing requirement of about 26 per cent of GDP.

Political divisions within Lebanon cloud foreign policy outlook given Lebanon’s economic dependence on the GCC.

Thus an escalation in tensions with the GCC could negatively impact the Lebanese diaspora in the GCC through a freeze on new work visas for Lebanese nationals according to Moody’s. The Lebanese diaspora is a broad, wealthy and loyal depositor base, and the growing level of deposits supports the ability of Lebanon’s banks to continue financing the high and increasing government debt burden.

According to a recent study by Université Saint-Joseph and Byblos Bank, remittance flows from Arab countries (and mostly the Gulf countries) made up around 43 per cent of the total remittances of $6.2 billion in 2014, or approximately 5 per cent of GDP. A freeze in new visas would hence slow growth in remittances and deposit inflows.

Lower GCC support is seen eroding Lebanon’s still robust external payments position. GCC governments could withdraw their deposits from the Lebanese central bank, Banque du Liban, which are estimated at around $860 million. Although relatively small compared to the $33 billion in foreign-currency deposits held by Banque du Liban, such a withdrawal would signal lower backing from GCC countries in the event of a liquidity crisis. The GCC government deposits were injected in 2006, following the war with Israel, in order to shore up confidence in the currency peg.

Finally, a disruption in trade flows between Lebanon and Gulf countries would hurt an already weak trade position. Lebanese exports to the GCC (excluding Oman) have been relatively stable over the years and comprised around 27% of total exports. However, additional border closings with Syria and weaker regional demand have strongly impacted export earnings in 2015. “Trade disruption is unlikely to take the form of direct sanctions, but could include non-tariff barriers,” said Gupta.