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UPDATE 2-Moody's sees risk of Lebanon debt rescheduling despite budget

(Adds details from Fitch report)

BEIRUT, June 27 (Reuters) - Slowing capital inflows to Lebanon and weaker deposit growth increase the risk of a debt rescheduling or other steps that may constitute a default despite fiscal consolidation measures in the 2019 draft budget, Moody's Investors Service said.

The draft budget aims to cut the deficit to 7.6% of gross domestic product from 11.5% last year, with Lebanese leaders warning the country faces financial crisis without reform.

Asked about the Moody's credit analysis, Finance Minister Ali Hassan Khalil said on Thursday "matters are under control".

Lebanon's public debt is 150% of gross domestic product, among the largest in the world.

State finances are strained by a bloated public sector, debt-servicing costs and subsidising the loss making state-power producer. The state is riddled with corruption and waste.

The budget was approved by cabinet last month and is now being discussed in parliament.

"Despite the inclusion of fiscal consolidation measures in the draft 2019 budget, slowing capital inflows and weaker deposit growth increase the risk that the government's response will include a debt rescheduling or another liability management exercise that may constitute a default under our definition," the Moody's report said.

Lebanon has long relied on inflows into its banking sector from a large diaspora to finance its budget and current account deficits.

Deficit reduction measures include hiking the tax on interest to 10% from 7%, a cut to the debt servicing bill through the issuance of treasury bonds at concessionary interest rates, and a 2% import tax that is being challenged by MPs.

PUBLIC ANGER

Some of the measures have stirred public anger: on Thursday army veterans burned tyres and blocked highways to protest against a tax on their pensions and other cuts.

Fitch Ratings said on Wednesday that while the draft budget targets fiscal consolidation, it did not expect full implementation and additional fiscal and structural reforms would be needed to stabilise the debt-to-GDP ratio.

Fitch reduced its deficit forecast for 2019 by 1.5% points to 9% of GDP, saying revenues projected for tax measures "may be optimisitic given minimal economic growth and inefficient tax collection".

The finance minister aims to cut about 1 trillion Lebanese pounds ($660 million) in debt servicing through issuing low-rate treasury bonds in coordination with the Lebanese banking sector.

The central bank governor said on Tuesday he backed the bid to cut debt servicing costs, but an agreement had yet to be reached on how that would be done and nothing would be imposed on Lebanon's commercial banks.

"Details of how this will happen remain unclear, but it seems that (the central bank) will buy these bonds and will attempt to structure the transaction in a way that minimises the hit to its balance sheet," Fitch said.

It said total private sector commercial bank deposits had declined since the end of 2018 and that "April data suggests that net of reinvested interest earnings, the stock of deposits has fallen considerably, even in (year-on-year) terms". (Writing by Tom Perry; Editing by Alison Williams, William Maclean)