Repayment difficulties put Lebanese investors in a risk frenzy

BY Jeremy Weltman Published

Authorities are seeking to honour upcoming debt repayments, but more needs to be accomplished to restore market confidence, with the economy in a spin.

Lebanon stood out with one of the biggest falls of all among the countries downgraded by risk analysts in Euromoney’s global risk survey last year. The political and economic crisis saw it plunge a massive 25 places in the survey rankings between the third and fourth quarters, to 127th out of 174 countries, and fall in line with high-risk Mongolia, Nepal, Niger and Iraq. All of Lebanon’s economic and political risk scores worsened by year-end, along with its capital access rating, as economic indicators flashed red, public protests ignited and chunky debt repayments loomed.

The downgrade occurred amid a spike in the credit default swap market, highlighting the elevated cost of insuring sovereign debt as Lebanese authorities pondered the repayment of $1.2 billion-worth of borrowings due in March. Credit ratings similarly fell, with Standard & Poor’s lowering its ratings to CCC negative (from B-) in November, and Fitch from CCC to CC in December, though Moody’s Caa2 grade was kept under review.

Dilemma 

In January, the markets took the view the new administration would take the appropriate course of action to improve the economy and win over the trust of creditors, citing the fact it contains several experts likely to value economic over political prerogatives.

Recent days have seen confidence increase as the government will at least honour the first of its debt repayments to international creditors, while possibly enforcing a swap (selective default) on domestic bondholders.

Yet maintaining investor confidence requires devising and, crucially, implementing a credible economic recovery programme, which carries huge risk.

Doing so is complicated by political challenges in a coalition led by Hassan Diab, the former education minister with a background in academia and engineering, but not in economics or public policymaking, who is notably backed by Hezbollah. The influence of the Iran-backed military group is jeopardizing the support of Gulf partners, such as Saudi Arabia, amid threats also from the Trump administration it will slash aid if the government moves too close to Tehran. 

And then there is the economic crisis to contend with, which is stark to say the least. GDP growth has been crawling along at less than 1% per annum on average between 2014 and 2018. Last year saw little growth, if any at all – most likely a contraction will be revealed – and a similar outcome is expected for 2020,

given the electricity outages, reduced flows of government funding and limits on cash withdrawals, as intense pressure continues on the currency peg. The reliance on food, energy and other imports has created a persistently large and barely sustainable current-account deficit of around 25% of GDP. 

Meanwhile, the fiscal deficit is expected to widen to 11.5% of GDP this year from an already large 9.8% in 2019, according to the IMF, with total debt climbing to 162% of GDP, and to 185% of GDP by the end of the forecast horizon in 2024, with external debt – including non-resident deposits – a staggering 219% of GDP. In theory, the central bank has ample foreign currency reserves of more than $30 billion, providing adequate imports coverage of around 11 months, but the net position is much worse with a large shortfall of reserves to cover the central bank’s liabilities to commercial banks.

Pessimistic scenario None of Euromoney’s Lebanese risk experts was prepared to comment publicly on the crisis, though Byblos Bank – a contributor to the risk survey – signalled that all aspects of Lebanon’s risk profile have worsened. In a recent research note quoting analysis undertaken by the Institute for International Finance, it remarked:

“The current government could fail to take the necessary actions to restore macroeconomic stability, given the track record of previous governments.” In this pessimistic scenario, with limited reforms, little access to international financing and the depreciation of the parallel exchange rate, GDP is seen declining in real terms by 9% this year and by a further 7.4% in 2021, with inflation rising to 35%, the fiscal deficit-to-GDP ratio remaining in double digits and FX reserves continually dwindling.

That worse case will hopefully fail to materialize, but the government has little time to get on with the changes required to restore confidence.

Although a default in March now seems less likely, there are more payments due in April and June, and the markets are still factoring in an increased risk of default, or restructuring of longer-dated bonds, with IMF support now crucial – and almost inevitable.

The drop in Lebanon’s rating in Euromoney’s risk survey means investors had been warned.

EUROMONEY