A government debt restructuring in Lebanon involving write-downs of its bonds could trigger a “sovereign doom loop” that would prove costly to the Lebanese banks holding these assets, S&P Global Ratings warned.
Although the true extent of banks’ losses will only materialise once the government restructures its liabilities, the cost of a default could surpass 100 per cent of the country’s gross domestic product, the ratings agency warned in a report titled Calculating The Cost of Lebanon’s Bank-Sovereign Doom-Loop.
Under its most pessimistic scenario, lenders face asset write-downs equating to 134 per cent of the country’s GDP.
“Without a resolution, Lebanese banks could find it difficult to sustain their operations as deposit outflows continue and foreign correspondent banks sever relationships,” S&P Global Ratings credit analyst Zahabia Gupta, said. “Failure to restructure the financial system could leave Lebanon with banks unfit to support an economic recovery.”
Lebanon is in the grip of the worst economic crisis in three decades. The government defaulted on $1.2bn of eurobonds that were due on March 9 last year. It owes about $31bn in dollar-denominated eurobonds, which are currently trading at between 11 cents-15 cents on the dollar, the ratings agency said, meaning investors are pricing in an 85-89 per cent write-down in the face value of the debt.
A restructuring plan was first proposed in April last year by former Prime Minister Hasan Diab, which included a write-down of government debt and a discount of banks’ deposits held with the central bank, Banque du Liban.
However, the country has endured more than a year of political infighting ever since, leaving markets in the dark about a potential resolution.
“Resolving the political deadlock in Lebanon is critical to starting the restructuring process, and delays could complicate a recovery,” Ms Gupta said. “The main stumbling block to restructuring appears to be that Lebanon is currently functioning with a caretaker government without authority to agree terms with creditors.”
The prime minister-designate since October 2020, Saad Hariri, has been unable to form a government because of disagreements with the president and other political parties over the filling of cabinet positions. There is also discord among key political institutions over both the causes of and the solutions to the country’s debt restructuring, including the treatment of depositors.
The Banque du Liban has been servicing its local currency debts by printing money, which led to inflation soaring to 158 per cent in March, increasingly pushing more of the country’s population below the poverty line.
Although the Lebanese pound is still officially pegged to the US dollar at a rate of 1,507.50, it has lost more than 80 per cent of its value on the black market and is currently trading at just below 13,000 per dollar, according to the lirarate.org website.
“We don’t think restructuring foreign currency debt alone would put the government’s finances back on a more stable footing, since that debt comprised only 38 per cent of total sovereign debt at year-end 2020,” the ratings agency, said.
“Even a write-off of all Eurobonds and official debt would leave the government with debt amounting to 107 per cent of GDP, based on year-end 2020 figures. We therefore believe local currency government debt will likely be part of any debt restructuring programme.”
Under its most optimistic scenario, the Lebanese government would repay 50 per cent of its eurobonds and 50 per cent of local currency debt, as well as writing down 10 per cent of its placements with the Banque du Liban. This would lead to banks’ losses equating to 30 per cent of GDP. Under its most severe scenario, the government would only repay 10 per cent of eurobonds and 30 per cent of local currency debt and BdL placements.
Restructuring costs “could be even higher in the event of a currency devaluation”, the ratings agency said.
“The BdL’s governor has said the Lebanese pound will be devalued and that Lebanon is planning to launch a new foreign exchange platform to curb currency swings in the meantime. However, it is difficult to predict where the local currency’s value will find its medium-term anchor if the peg to the US dollar is removed,” it said.
External support from donors and multilateral lenders may still be an option for Lebanon to overcome its current crisis but “the formation of a credible recovery plan and political commitment to reforms” is needed to unlock any help, such as the $11bn that international partners pledged at the Cedre conference in 2018.
The Lebanese banking system is also overbanked, with 47 commercial banks serving only 7 million people, the ratings agency said.
“Thus far, we have not seen any merger or closures of Lebanon’s banks, although we expect this may change in 2021-2022.”