Living on borrowed time

IFR IMF/World Bank 2020
10 min read

Lebanon faces a long road to recovery after decades of fiscal mismanagement and political chaos

It is hard to overstate the difficulties that Lebanon faces as it tries to avert a humanitarian disaster and an imminent economic collapse.

With more than US$90bn in debt and the country’s foreign exchange reserves dwindling fast, the economic situation is dire.

“In our scenario analysis, Lebanon may run out of FX reserves within the next 12 months, which will have insurmountable repercussions for the Lebanese economy,” said Ehsan Khoman, head of MENA research and strategy at MUFG.

But before it can formulate a plan to plug a hole in its finances, it must fill a political vacuum. On September 27, the country’s new prime minister designate, Mustapha Adib, stepped down less than a month after being appointed, admitting defeat in his attempt to form a government that was so crucial to its ability to secure support from the International Monetary Fund and the broader international community.

Adib was appointed on August 31, after the previous Lebanese administration resigned amid widespread anger following the huge explosion at a port in Beirut which killed 190 people and injured 6,000.

Adib pledged to form a government of technocrats with no affiliation to political forces and not defined along sectarian lines, so that he could begin urgent reforms and receive IMF support. But this attempt was undermined by powerful Shia groups Hezbollah and Amal, which insisted on controlling the finance ministry.

The resignation of Adib, who apologised to the Lebanese people for his "inability to realise its aspirations for a reformist team", leaves the country’s reform plans in tatters and scotches hopes of imminent talks with the IMF.

The IMF has struck a supportive stance in the wake of the explosion in Beirut, but the fund is balancing a willingness to help solve a humanitarian crisis with scepticism about Lebanon’s commitment to reform.

On September 24, a spokesperson for the fund said that it was “ready to engage with the new government in Lebanon after its formation is completed”. This followed an earlier move by the Lebanese finance minister to launch a forensic audit of the central bank at the request of the IMF.

“The audit will also help assess the central bank’s financing of government operations and the central bank’s financial engineering on its own net worth. This is an important part of assessing past losses that are a part of the central bank’s balance sheet,” said the spokesperson.

But it made it clear that any support would be contingent upon reform.

“There’s a need to embark on comprehensive reforms to restore confidence and address challenges in many areas so as to bring back stability and enhance investment prospects, and these will help with putting the economy back on a growth path,” the spokesperson said.

Lebanon has US$31bn of sovereign bonds outstanding and its international creditors including Fidelity and Ashmore, have no prospect of resolution – and no one to negotiate with.

The country’s problems began long before the devastating explosion that ripped through Beirut in the summer, but they have worsened as a result, with the World Bank estimated that the explosion caused as much as US$4.6bn in damage.

“This has been brewing for a while. Lebanon has suffered from fiscal mismanagement, falling FX reserves and a lack of a coherent, credible and coordinated structural reform agenda,” said Khoman.

Lebanon’s economic growth has stalled since the start of the Arab Spring in 2011, putting an increasing strain on government finances. Last October, an attempt by the state to raise funds through a tax on WhatsApp calls led to mass protects and deepened the malaise.

In March, the country defaulted on its sovereign debt for the first time, just as the coronavirus pandemic was starting to affect the region. The government then set out plans to address its problems, and initially received an encouraging response.


Following a summit in Paris, French president Emmanul Macron said he had pulled together an aid package worth US$11bn, including US$4bn in World Bank loans and a US$1bn credit line from Saudi Arabia, on the condition that then prime minister Saad al-Hariri would commit to long overdue reforms.

Macron has pledged support throughout but has been adamant that any assistance would be conditional on the formation of a government. He raised the prospect of reviving an international aid package on the condition that Adib formed a government within 30 days of taking power, but that deadline passed.

There were also ‘technical’ discussions with the IMF, but talks came to nothing as the government continued to resist reform.

Nick Eisinger, co-head of emerging markets active fixed income at Vanguard asset management, which holds a small but underweight position in Lebanese bonds, said that the resignation of Adib is a further demonstration of how difficult it is for Lebanon even to form a cohesive government.

“The first sign of progress will be for the government to make a determined move and get the IMF back on board. But I think we’re still some way off that. It’s going to prove to be one of the most complex sets of debt restructuring that we’ve seen for quite some time.”

Prior to the resignation of Adib, Lebanon’s short-dated bonds were quoted at around 20 cents in the dollar but eventual recovery rates are probably in a range of 10 to 20 right now, said Eisinger.

“Lebanon is an outlier. Ukraine’s bonds came out with a recovery rate somewhere in the region of 80 cents in the dollar, while in a worst case scenario for Angola the recovery rate would be around 50-60. The solution is to secure some type of medium-term funding from the IMF which can be used to service debt. But the IMF will likely insist on very large debt restructuring and that’s when that 20% number starts to move around,” he said.

The average recovery value from emerging markets sovereign defaults is at 69 cents. Lebanon’s mismanagement has cast it adrift, not just from the IMF, but from the overseas diaspora that previously supported the economy by sending money home - a source of funds that dried up last October, leaving the state facing a debt-to-GDP ratio of 176%.

Eisinger noted that number is based on the official exchange rate, and that with the collapse of the currency, the figure is closer to 300%. “It’s hard to get a real hold on what would be the sustained debt-to-GDP starting point for Lebanon,” he said.

In March 2020, the previous government put in place a blueprint of measures aimed at beginning to address the issue and said the starting point would be somewhere around 90% of debt to GDP.

That looks optimistic, but in theory if Lebanon can grow its economy and cut the interest rate it is paying on its bonds with concessional funding from the IMF, it can start to reduce its debt levels.

“If Lebanon can restore itself investors are looking at an exit yield of 10% or 12%, then it could be attractive. But there are many hurdles to overcome before that happens,” said Eisinger.

Investors are already drawing comparisons with the 2014 Argentine debt crisis under former president Cristina Fernandez, when the country’s long and painful restructuring was hampered by holdouts led by a group of bondholders which prevented the country from gaining access to IMF funding.

While creditor talks remain a long way off, documentation in Lebanon’s Eurobonds allows its foreign creditors to block any attempted restructuring. In April, when reports of initial talks with the IMF surfaced, Fidelity and Ashmore created a committee focused on Lebanon’s sovereign debt, and are understood to have White & Case as its legal adviser.

Lebanon is facing both a solvency and a liquidity problem. Its major creditors are its banks. However, the Lebanese pound has collapsed and bank deposits have effectively been frozen, with total losses in the banking system exceeding US$100bn.

This means the government will need to adopt an even-handed stance when it comes to distributing the losses of any debt restructuring. On the one hand, the country’s banks will face deposit writedowns, while, on the other, taking a hard line with international bond holders will undermine its ability to attract the foreign capital that has been so crucial to its economy.

But any restructuring will remain theoretical unless Lebanon can engage constructively with the IMF, with whom talks cannot come quickly enough.

“In the interim there’s enormous dislocation from a sociopolitical perspective. There is high unemployment and hyperinflation. You have an exchange rate that’s all over the place, you have people who can’t get money out of the banks, which have run out of working capital,” said Eisinger.

David Rothnie

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