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February 18, 2020
Should Lebanon Default? A Take by Amer Bisat

Restructuring Is Inevitable: The Sooner, the Better

As part of its effort to build constructive dialogue on important national issues, LCPS solicited the opinion of key experts who have varying perspectives on whether Lebanon should default. We invite you to read their different views in the next few days.
At 150% of GDP, Lebanon’s debt is unsustainable. Assuming 7% interest rate on the debt, the annual interest bill is 10% of GDP. Further, assuming the debt’s average maturity is 10 years, repaying the principal will absorb an additional 15% of GDP every year. As such, if not restructured, one out of every four units of Lebanon’s income will be used to service the debt. The IMF projected government revenues to be at 21-to-23% of GDP, meaning that the cost of servicing the debt will absorb the totality of government revenues, leaving literally nothing for all other public services. All these make restructuring inevitable.
Then why wait? Using valuable reserves to pay the March Eurobond, when an eventual restructuring is inevitable, is akin to “throwing good money after bad”.
Another argument for why a moratorium should be declared is that, according to banking sector data, commercial banks have more than $100 billion worth of people’s deposits parked at BDL. Those deposits are partially backed by BDL’s foreign exchange reserves, and therefore, using those reserves to service the debt will render the deposits less secure. By extension, if banks can’t withdraw their deposits from BDL, they will find it even harder to honor people’s deposits with them. Servicing the debt at this juncture increases the probability of a deposit haircut.
Will the restructuring ruin Lebanon’s reputation? It is not clear it will. Surveys of sovereign crises (including by the IMF), indicate that, over the past 30 years, 111 countries have restructured their debt, and the vast majority of them were eventually able to re-access capital markets. Investors will be open to lending to Lebanon once it reduces its debt stock and if, and this is crucial, it has put itself on an economic path that credibly promises future payment.
To be clear, this does not mean that the restructuring is painless. First, the formal recognition of a default is de facto an acknowledgement that the banking sector, which is heavily indebted to the public sector including BDL, is insolvent. While some would reasonably argue this is nothing more than an accounting acknowledgement of an economic reality, it will remove the past “luxury” of delaying the needed banks’ recapitalization. Second, given how the bond contracts have been written, restructuring will be legally very messy. The restructuring effort will surely be measured in years and will almost certainly be contaminated by creditors’ legal suits. Since restructuring is inevitable, the sooner we start the process—and more prepared we are for it—the better.
Others argue against restructuring, believing that we should instead push out obligations over the next few years rather than embark on a comprehensive restructuring. Advocates of this view contend that this would give the country the option of waiting for a better medium term situation, with oil and gas exploration and/or regional peace. I would not recommend this approach, which keeps the economy in a “zombie” state while waiting for an uncertain future. Also, it is worth noting that changing payment terms, required to get the cash flow relief, is a technical default, so nothing would be really solved with this tactic.
Likewise, a selective default—which is defaulting on Lebanese debt but remaining current on Eurobonds—is not a feasible option. If the default’s objective were to bring down the debt stock to a sustainable level, then treating some debt as “senior” would mean that the remaining “junior” part of the debt stack would have to be hit much harder. Put in starker terms, sparing foreign debt means pushing the burden onto Lebanese debt, which, of course, is both politically and morally a very tenuous proposition.

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