Investors to take a big hit if Lebanon restructures its debt

As Lebanon continues to thread the path of unsustainability and economic collapse, Goldman Sachs undertook an analysis of the country's debt recovery values.
by Georgi Azar

7 January 2019 | 12:42

Source: by Annahar

  • by Georgi Azar
  • Source: Annahar
  • Last update: 7 January 2019 | 12:42

Southern outskirts of Beirut (AFP)

BEIRUT: In the bleak, yet unlikely scenario of Lebanon restructuring its debt, foreign investors would recover 35 cents on the dollar, senior Goldman Sachs economist Farouk Soussa notes in his report. 

As Lebanon continues to thread the path of unsustainability and economic collapse, Goldman Sachs undertook an analysis of the country's debt recovery values in the event of a restructuring of its sovereign debt, based on a case implying a haircut for Lebanese Eurobonds.

Given a current debt/GDP ratio of 150 percent, this implies a "haircut of around 65 percent of the debt, or a recovery value of 35 cents on the dollar," assuming a long-term growth rate of 2.6 percent YoY and a decrease in interest rates follow. 

In the case of a restructuring taking place in the context of a sharp devaluation in the Lira, the leading economist notes a sharper negative impact on the expected recovery value, lowering it from 35 cents to 27 cents on the dollar. 

Lebanon has found itself in hot water in recent years, amid the ongoing Syrian civil war and lawmakers' inability to implement wide-ranging reforms to curb government spending and the ever increasing sovereign debt. 

Reducing the requisite fiscal adjustment to more achievable levels remains unlikely, he says, maintaining that it would require either a sharp reduction in interest rates or a substantial pick-up in growth prospects, "both of which, may be possible but are largely outside the control of policy-makers", and are highly dependent on regional economic and political developments. 

"The exposure of Lebanese banks to the sovereign (local debt and Eurobonds), amounts to some LBP55trn, almost double the LBP30trn capital base of the banking system. If the government were to apply a haircut of 65%, this would render the banking system insolvent," he says.

To mitigate the harm to the banking sector, some have alluded to a haircut on deposits (similar to the Cyprus experience) and the application of capital controls, yet Soussa argues that this avenue remains far-fetched to conserve Lebanon's reputation as a safe banking haven, "crucial to its ability to continue to attract diaspora deposits."

Despite the Lebanese financial system holding enough FX liquidity to "finance its deficits under the current circumstances for the next couple of years," the regional political turmoil coupled with the threat of a Hezbollah-Israel flare-up has rattled investors' confidence in the economy. 

Last month, Lebanon's economic outlook took another hit after another global rating agency revised its standing from stable to negative amid the government's increasing twin deficit.

Fitch Ratings, one of the big three credit rating agencies alongside Moody's and Standard & Poor's, also reaffirmed Lebanon's B- appraisal, a sign of the "government deficit and debt dynamics."

The Central Bank has continuously undertaken drastic operations to weather fiscal challenges, with the latest being a swap of Treasury bills held by BDL with newly MoF-issued Eurobonds in the amount of $5.5 billion, around $3 billion of which were subsequently sold (along with enticements) to banks.

This was done to raise BDL's foreign exchange reserves, which reached around $44 billion by the end of June.

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