UPDATE 4-Lebanon set to get new government in days - politicians
* Lebanon held general election in May
* Economic challenges loom for heavily indebted state
* Fitch Ratings revises outlook to negative from stable (Adds Fitch)
BEIRUT, Dec 18 (Reuters) - Lebanon is on track to form a new national government in the next few days, politicians said on Tuesday, raising hopes for an end to more than seven months of wrangling that has darkened the outlook for its struggling economy.
Efforts to form the new government, led by Prime Minister-designate Saad al-Hariri, have been obstructed by conflicting demands for cabinet seats that must be parceled out in line with a finely balanced, sectarian political system.
Heavily indebted and suffering from a stagnant economy, Lebanon is in dire need of an administration that can set about long-stalled reforms to put public debt on a sustainable footing.
"We are in the last phase and it is probable that the government will be formed before the Christmas holiday," Finance Minister Ali Hassan Khalil told Reuters. "This will leave a positive impact on the financial and economic situation and open the way for a start to dealing this file," he added.
Fitch Ratings on Tuesday changed Lebanon's outlook to negative from stable, citing a further deterioration in government deficits and debt dynamics and signs of rising pressures on Lebanon's financing model.
The May 6 national election, Lebanon's first in nine years, produced a parliament tilted in favor of the heavily armed, Iran-backed Shi'ite Muslim group Hezbollah, which together with its political allies won more than 70 of the 128 seats.
Hariri, who enjoys Western backing, lost more than one third of his lawmakers, though he remained Lebanon's biggest Sunni Muslim leader and as such was nominated again as prime minister.
Efforts to form the government have faced a series of obstacles, the last of which surrounded Sunni representation, with Hezbollah demanding a cabinet seat for one of its Sunni allies to reflect their election gains.
Hariri has resisted the demand.
But under a compromise that has taken shape, the Hezbollah-linked Sunnis are expected to put forward names of ministerial candidates acceptable to them for inclusion in the government rather than insisting that they themselves should get the seat.
In exchange, they say they want Hariri to acknowledge their political standing as a group of Sunnis independent of his Future Movement by meeting them. The Hariri family has dominated Lebanese Sunni politics for decades.
"Within two or three days - God willing - you will hear the news that the Lebanese masses were waiting for," Abdel Rahim Mrad, one of the pro-Hezbollah Sunni MPs, said after a meeting with a top security official involved in mediation efforts.
"All the problems have been solved," he said, standing alongside Major General Abbas Ibrahim, the security official.
"Matters are moving quickly and if things stay like this without obstacles - and I don't expect obstacles - the government will soon see the light," Ibrahim said in a televised news conference.
A source close to Hariri told Reuters there was "reasonable cause for optimism."
The Sunni minister is expected to be named among a group of ministers allotted to President Michel Aoun, representing a compromise on the part of his Free Patriotic Movement which had been trying to secure control of 11 ministerial portfolios - more than one third of the new cabinet. (Additional reporting by Dahlia Nehme; Editing by Andrew Heavens)
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