Lebanon’s bond holders may have to write off 70% of their investments and the value of the country’s currency might be cut in half in an International Monetary Fund rescue, analysts crunching the numbers on its debt woes estimate.
Lebanon formally requested the IMF’s technical help on Wednesday as it tries to avoid a full-blown economic collapse. Whether that turns into a formal bailout remains to be seen, but analysts have started to evaluate possibilities.
“Past experience suggests that this will involve haircuts of up to 70%,” Capital Economics’ Jason Tuvey wrote in a note, referring to debt write-offs.
That would wipe out banks’ capital, and the cost of re-capitalising them would come to around 25% of Lebanon’s gross domestic product, though IMF technical assistance could help limit the strains.
A cut in government spending of 3% to 4% of GDP will also be needed to prevent the debt burden from growing. Austerity will focus on reining in public-sector wages and overhauling the state electricity company.
As in Egypt in 2016, the IMF would be likely to insist that – as a pre-condition to a deal – authorities devalue the Lebanese pound, Tuvey said.
Black-market exchange rates are now around 30% below the country’s official rate, but the IMF’s most recent review of Lebanon estimated the currency was over-valued by 50%.
“We think the currency could fall by 50% against the dollar,” Tuvey said. “And in the meantime, the economy is likely to fall into an even deeper recession. Overall, we expect GDP to contract by 5% this year. Our forecast lies right at the bottom of the consensus range.”
Mikhail Volodchenko, an emerging markets portfolio manager at AXA Investment Managers, also thinks a 50% currency devaluation is needed. AXA sold their Lebanon holdings last year.
“Lebanon has all the makings of a full blown banking, economic, liquidity, solvency crisis all in one,” he said, highlighting how the country currently spends around half of its revenues just paying the interest on its huge debt load.
“With every year you essentially accumulate more and more debt, so it is a slow-moving car crash… If the IMF has to come in and clean up Lebanon, the recovery (for bond holders), just based on pure maths, is much less than say Argentina.”
Apart from its next-to-pay-out debt in March and April, Lebanon bonds are currently trading at between 32 and 36 cents on the dollar.
However, BlueBay Asset Management’s emerging market veteran Timothy Ash said it was difficult to put firm numbers on how much of a debt writedown or how much of a cash injection Lebanon would ultimately need.
He said there was little clarity on the true state of the country’s currency reserves, its economic prospects or how its super-sized banking sector would hold up where assets are roughly four times the size of its economy.
“It is not only about the debt ratios, in the end you have to ask why Lebanon got into the situation it is in. It was years of bad policies,” Ash said. “The IMF will want to see that there is a willingness to reform.”