Lebanon: first sovereign debt default for Middle Eastern country

Monday 16th March 2020

The Lebanese government announced last week that it would not be making a Eurobond payment of $1.2bn due this month. [A Eurobond is a bond that is denominated in a currency that is not the native currency of the country where it is issued.]

Lebanon’s Prime Minister Hassan Diab said that the country’s reserves of foreign currency have fallen to a “dangerous level” which has led his government to suspend payment on the bond due March 2020 as the associated government funds were needed elsewhere. He also signalled the intention of his government to enter into debt restructuring agreements “in a manner consistent with the national interest, by entering into fair negotiations” with creditors.

It should also be noted that Lebanon has further sovereign bond payments due in April ($700m) and June ($600m) this year. The ability of the Lebanese government to make payments on these Eurobonds will now logically be called into question – with the willingness of creditors to lend to the country likely to deteriorate accordingly. Moreover, Lebanon is in the midst of a rapidly escalating financial crisis and has seen several months of protests in the streets against the incumbent government.

The situation in Lebanon’s own financial system is exacerbated by the fact that, as of the end of January 2020, $12.7bn of the Lebanese state’s outstanding $30bn in Eurobonds are held by Lebanese banks – according to Marwan Barakat, head of research at Beirut-based financial institution Bank Audi. Many of those local Lebanese banks had argued against the government defaulting on this month’s payment, citing the damage it would do to both the domestic banking sector as well as the confidence of international investors in Lebanon.

Additionally, the value of the Lebanese pound (which is formally pegged to the value of the dollar) has fallen sharply against the dollar over the last few months. As a result of the above difficulties faced by domestic banks, many of them have been reluctant to exchange their foreign currency reserves of dollars for Lebanese pounds – fuelling rising demand for dollars and thus exacerbating the exchange rate problem.

The problems have been amplified by anti-government protests which have escalated throughout Lebanon’s streets – including outside the country’s central bank – since October 2019. Many complain of the government’s handling of the situation, as well as falling living standards – with inflation making the cost of living soar, and electricity and water cut-outs alongside deteriorating public services becoming commonplace. The escalating mass protests have only further reduced investor confidence. Indeed, even Prime Minister Diab conceded that over 40% of his country’s population may fall below the poverty line as the economic crisis develops.

Lebanon’s debt stands at over 160% of gross domestic product (GDP). It is one of the largest of any country in the world – behind only Japan and Greece on the percentage of GDP metric.

Prime Minister Diab has already met with officials from the International Monetary Fund (IMF) to receive economic advice, but has not yet (at the time of writing) requested financial assistance from the lender.

Several economists have suggested that an emergency rescue package from the IMF is the only real way forward for Lebanon. It is a sentiment also put forward by Bank Audi’s Marwan Barakat, speaking to AFP.

However, in order to obtain such IMF assistance, Lebanon would likely have to sign-up to a structural adjustment programme (SAP) put forward by the Fund. Such SAPs require the borrowing country to implement certain policy reforms in order to access new funds. These reforms often entail the reduction of government spending – adopting a tight fiscal policy – and policies of ‘austerity’. In light of the current mass protests across Lebanon, much of these directed at issues of living standards, the government may be reluctant to adopt such reforms.

A number of foreign countries, including France, have expressed willingness to render financial assistance to Lebanon, but – much like the aforementioned IMF option – this is conditional upon the Lebanese administration implementing policies to resolve the economic problems at hand. Indeed, a package of $11bn (including loans and grants from France, Saudi Arabia and the World Bank, among others) committed to Lebanon at an April 2018 conference in Paris known as ‘CEDRE’ has not yet been unlocked to the country as conditions for reform have not yet been met.

It seems clear that the Lebanese government’s ability to balance public opinion with sensible policies to steer the country through this crisis will be the decisive factor as to the eventual economic outcome.