Complex Made Simple

Lebanon: Everything you need to know about how to solve the debt crisis

Lebanon in a sink or swim situation, just got a dose of temporary relief, but could there be a practical 2-step solution out of the crisis?

Some think that if Lebanon announces bankruptcy, it will wipe out its debt obligations and relieve the country form $85bn it owes and $6bn in debt servicing Default will lead to downgrades, deposit outflows, loss of confidence, economic contraction and it will take many many years to recover from it The solution starts by cutting expenditures by $2bn in the 2019 budget and increasing revenues by $1bn

Lebanese central bank employees went on strike on Monday in protest to state budget proposals that would trim their benefits, but have now decided to suspend their strike for 3 days until Friday.

That by itself meant Lebanon could have a functional stock market, banks could breathe a sigh of relief and have more cash at their disposal and stem the tide of protests and strikes that spread around the country.

But that by itself will not make Lebanon’s economic problems go away.

As the Lebanese government debated a draft budget for 2019, dubbed the most austere in the country's history, the strikes could come back, compounding an already dangerous situation.

Pound in crisis?

Dan Azzi is a regular contributor to Annahar says failure to clear checks and receive transfers during a Central Bank (CB) staff strike, creates a cash shortage for people and a panicky rush to withdraw whatever banks have in their inventories, which banks would limit as a precaution.

That’s exactly what happened. If the strike from CB staff returns a worse scenario plays out. 


“When ATMs run out of both dollars and Lira, It could also cause a black market to develop for dollars, making the Lira jump outside the peg band, quite probably north of 1,600.”

Nassib Ghobril, Chief Economist, Head of the Economic Research & Analysis Department, Byblos Bank Group, told AMEinfo that the Lebanese Pound was in no danger.

"CB staff strikes have nothing to do with the stability of the pound, but the rumour mill is so fast and the imagination is so wild with some people and eventually led some currency exchanges to take advantage of the panic but these are isolated cases and the CB will not let this happen," Ghobril said.

According to ArabWeekly, Marwan Barakat, chief economist at Banque Audi, identified two “defence lines” to avoid a run on the pound and the transfer abroad of bank deposits.

“The first is that foreign exchange reserves at the Central Bank stand at about $38 billion, the equivalent of 76% of the Lebanese pound money supply. For the second defence line, the primary liquidity of banks in foreign exchange represents circa 39% of their foreign exchange deposits. So, we need to have 39% of depositors leaving Lebanon to have a liquidity issue.”

Is bankruptcy on the table?

Some think that if Lebanon announces bankruptcy, it will wipe out its debt obligations and relieve the country form $85bn it owes and $6bn in debt servicing. 

 "Bankruptcy is not a solution and not on the cards," declared Ghobril. 

"Lebanon has a major strength, never having defaulted on any of its obligations, even in the worst of times and this unblemished record should stay." 

The banking system continues to finance the government and that’s why Lebanon has been able to pay its obligations on time. 

He said if the government, wilfully or not, defaulted on its obligations, it will lead to a real disaster. 

"Default will lead to downgrades, deposit outflows, loss of confidence, economic contraction and it will take many many years to recover from it," says Ghobril.

He added that Lebanon does not compare to Greece, which In 2010 said it might default on its debt, threatening the viability of the eurozone itself.

"Greece does not have its own currency. It’s part of the Euro Zone. The monetary policy is decided by the European Central Bank. In Lebanon, we have our own sovereign currency, an autonomous central bank proven to be very capable of implementing monetary policy and preserving the stability of the Lebanese pound. Our debt is 60% in Lebanese pounds, and 89% of debt is held locally, The Pounds components are held by local institutions and ¾ of foreign currency is held locally, but in Greece the debt was held by global investment banks and asset and fund managers," Explains Ghobril.

Prime Minister Saad Hariri assured Lebanese and anyone willing to listen on Monday that Lebanon and bankruptcy are distances apart, however reminding that failure to pass a "realistic" budget that eats into a deficit would be "economic suicide ".

Growing debt issues

Lebanon is one of the world's most indebted countries, with public debt at $85 billion means a 153% debt to GDP, 3rd largest after Japan and Greece.

The country pays a yearly servicing debt fee around $6bn, or a third of the state budget estimated at $19 billion in 2018. IMF economists say this servicing mount could reach to 60% of the State budget by 2021.

The Financial times says just paying interest on outstanding bonds is set to consume well over half the government’s revenues this year, while in credit markets “the price of protecting five-year debt against default has leapt more than 50% over the past 12 months.”

Lebanon McKinsey report

That makes Lebanon the third-worst performing sovereign in the world over that period, according to Bloomberg data.

Solutions in the works

The budget is based on an economic growth forecast of 1.5% in 2019, according to Finance Minister Ali Hassan Khalil.

Khalil expects deficit reduction measures in the 2019, 2020 and 2021 budgets.

The draft budget under discussion by Prime Minister Saad al-Hariri's government aims to bring down the deficit to less than 9% of GDP in 2019 from 11.2% in 2018, Khalil told Reuters. 

“The Lebanese government insists on raising the tax rate on interest payments to 10% from the 7% (introduced last year for the first time),” Khalil said on Monday.

Ghobril believes this to be a very poor idea.

"We are seeing the impact of the 2017 decision to raise the tax to 7% from 5% and now to 10%. It’s a 100% increase in less than 2 years," he says.. 

"This is income that depositors pay to the treasury. It’s interest on the deposits. It’s going to lead depositors to come to the bank and ask them to compensate for this tax increase by asking to further increase interest rate returns on their deposits,"

Ghobril further explained that the tax proposal will first increase the cost of financing for banks because banks use deposits to finance projects. Lebanese banks don’t issue bonds on international markets and 76% of the financing of bank operations is from deposits.

"The second impact is increasing the interest rate on lending so this will increase the cost on existing borrowers and discourage new ones, which will lead to economic contraction."

The government hopes to get about $1.1bn in 2019 from the entire 10% tax. 

Reuters reports that other measures include a 50% reduction in the salaries and allowances of MPs, ministers, and the President, as well as a reduction in the salaries of their retired colleagues.

“A three-year civil service hiring-suspension is also on the books, with employment to resume at a rate of half the number of those who retired during that period,” said Reuters.

An immediate 2-step solution 

Ghobril says the solution is first to reduce the borrowing needs of the government and then stimulate growth.

"We reduce expenditures by shrinking the fiscal deficit, by cutting expenditures significantly and not through cosmetic reforms, and a practical threshold is to shrink expenditures by $2bn in the 2019 budget and increasing revenues by $1bn and both are realistic figures," says Ghobril.

"We do this not by increasing taxes, but by fighting tax evasion, improving fee collection, controlling borders, stopping smuggling, implanting laws fully and not partially.

Ghobril continues to say that the public sector has employed an army of "cost" employees.

"According to the Economy and Trade parliamentary committee, 86 public agencies parallel to the central administration have no real work to do and can be shut down or merged," Ghobril reveals. 

"Public expenditures have increased by 147% between 2005 and 2018. In the past 4 years, the public sector has recruited 31,000 people, more than the number of employees in the entire financial sector in Lebanon.  

Ghobril says public expenditure on wages, salaries and pension payments and benefits of the public sector are much higher than debt servicing. 

"It accounts for 38% of spending in 2018 compared to 30% for debt servicing," he says.

"When you reduce expenditures and improve revenues, and take measure to stimulate growth you will create positive shocks that will reduce the fiscal deficit to GDP ratio, and stop the growth of debt to GDP ratio, which will reduce the borrowing needs of the gov and interest rate on debt servicing."

Meanwhile, what could also provide some temporary relief is a pledge worth $11bn from a Paris conference dubbed CEDRE in April 2018, but they stipulate commitments such as reducing its deficit-to-GDP ratio by at least 1% per year over five years and reforming Lebanon's ailing electricity sector.