A matter of inevitability

The case for Lebanon restructuring its debt

The case for restructuring Lebanon’s debt

Lebanon’s economic vulner

abilities are on full display. Investors and other stakeholders have lost confidence in the Lebanese financial system, triggering an existential economic crisis. In short, Lebanon’s future is jeopardized by three intertwined crises of sustainability with regard to the public debt, the current account deficit, and the financial sector. As such, resolving Lebanon’s crisis requires a full-blown multifaceted stabilization and reform plan initiated by restructuring the stock of public debt.

REQUIRING CREDIBILITY

Restructuring Lebanon’s stock of public debt is inevitable since it has exceeded the economy’s capacity to service it. Expected to be at around $90 billion—and assuming it can be refinanced at 7 percent over seven years—the stock of debt will demand roughly $19 billion in maturities and coupons annually, or around one third of 2018’s GDP. This high level of debt service is not a new phenomenon and governments have sustained it from borrowing from the market and building on top of the existing debt stock.

Over the years, these governments were repeatedly warned over the unsustainable nature of their stock of public debt and the need for fiscal adjustment to bring their finances back on track. These calls, however, were ignored, and repeated government deficits have led to today’s crisis. In 2016, when it was clear that kicking the can was no longer an option, there was no effort undertaken to curb down expenditure. Instead, the Ministry of Finance (MoF) started funding itself via off-market deals with Banque du Liban (BDL), Lebanon’s central bank. This process has greatly impacted BDL’s balance sheet and magnified the extent of Lebanon’s ongoing crisis. The sovereign’s debt is only half the story—BDL’s hidden debt is the other half.

As a result of the negative net foreign exchange position (the difference between the assets and liabilities held in foreign currency) at BDL, Lebanon’s financial situation has deteriorated greatly since 2016, and the long-lived tradition of debt rollover is no longer an option. Debt restructuring is needed to avoid a disorderly default. Economic literature proposes that for developing countries the stock of sovereign debt should be brought down to around 60 to 80 percent of GDP. Given that Lebanon’s institutional fragility hinders its ability to generate budget surpluses, the lower part of that range is the most advisable. To reach this target, a large restructuring effort is needed, which bondholders will only agree to if a credible medium-term expenditure framework is presented with the needed checks and balances. Given that the first eurobonds payments are due on March 9, this would necessitate a grace period to work out the plan to restructure.

Such a plan would need to be drafted by a credible government that would rely on the assistance and support of multilateral organizations to secure its financing gap. Once the plan is accepted by bondholders they would be offered a “menu” of options such as reducing principal and/or interest payments while keeping the same maturity dates, or extending maturities. A combination of these is also an option. The leading principal should be that all creditors are asked to give the same net present value reduction, meaning a reduction in the current value of their debt after discounting its opportunity cost over time. Once the negotiations are successfully concluded, the Lebanese government would exchange the existing stock of eurobonds with the newly negotiated ones. These new bonds could also include warrants that Lebanon would only pay if it reached its growth targets.

In short, restructuring Lebanon’s public debt is not a daunting task on the face of things, but nonetheless requires a massive shift in how the government conducts itself in order to secure a good deal for the country. The 2020 budget was a missed opportunity in this regard. It is now time for the government to roll up its sleeves and proceed immediately to negotiating a debt restructuring plan as part of a credible, fair, and comprehensive macroeconomic-fiscal-financialbanking plan, one that can garner the needed international support and financing and regain the confidence of the Lebanese people.

Lebanon’s public debt has exceeded the economy’s capacity to service it.