Debt sustainability has become a focal point for Lebanon’s economy following comments made by its finance minister vis-a-vis its public debt. Beirut’s dollar dominated sovereign bonds also witnessed a sell-off midst a market turbulence following concerns that Lebanon could potentially restructure the debt.
The government has made it clear that it is “absolutely not” planning to restructure the debt; in fact it is committed to reducing the debt load by paying off debts as and when they mature, including interest payments at predetermined dates.
The development has added to the debate on Lebanon’s debt sustainability. The World Bank, the IMF as well as politicians have warned about the country’s worrying financial condition. Lebanon’s economy faces strong headwinds from a lack of political direction. Although eight months have passed since the results of an election, government formation has yet to take shape.
The issues at hand
In comparison to the size of its economy, Lebanon’s public debt is nearly 150% of its GDP. Debt sustainability is the elephant in the room that just cannot be wished away and ignored anymore. As per an estimate from the World Bank, financial transfers to the state-owned power producer for the period of 2008 to 2017 has averaged to 3.8% of Lebanon’s GDP. Further, in 2017, a public-sector wage increase has piled more pressure on the budget deficit.
Since Lebanon’s economy imports more than it exports, it has a current account deficit. In order to finance its budget deficit as well as the current account deficit, Lebanon has had to depend on financial transfers from its diaspora.
This model of debt financing has led to more questions than answers on the country’s debt sustainability.
“At the heart of concerns is the recent slowdown in remittance/deposit inflows, which have traditionally funded a large part (if not all) of Lebanon’s financing requirement,” said analysts at Goldman Sachs in a note on December 3, 2018.
Mirroring similar view, in a report, the World Bank also stated, Lebanon’s debt sustainability faces significant refinancing risks.
“Attracting sufficient capital, and in particular deposits, to finance significantly larger budgetary and current account deficits is proving challenging in light of slower deposit growth” reads the World Bank report.
One of the issues why the country’s debt sustainability has become an issue is lower prices. Economists see low oil prices as a major reason for the slowdown since many Lebanese work in oil-producing Gulf Arab states. Political instability and low economic growth have also been cited as other factors.
In the four year before Syria’s civil war in 2011, Lebanon’s economy grew between 8% and 10%; since then its economic growth has plumetted to just 1% and 2%.
Urgency of the matter
Last month, Riad Salameh, the central bank’s governor stated, Lebanon’s banking sector was capable of financing the state’s foreign and domestic debt in 2019, given the bank’s net foreign assets at around $40 billion. Despite this assurance of debt sustainability, despite the fact that its financial system has proven resilient through wars, assassinations and political crises, the fact of the matter is that all of these have been made possible due to the large deposits made by Lebanon’s dispora into its banks.
Since 2016, the country has witnessed a slowdown in non-resident inflows which prompted the central bank to embark on “financial engineering” in order to attract more dollars to its reserves. While the central bank’s critical role and deft maneuvering has drawn praise from the World Bank and the IMF, in a report made available in October 2018, the the World Bank noted that some of the bank’s tools were becoming less effective which was leading to a higher risk profile.
Confidence in Lebanon’s government is critical to encouraging more inflows from its diaspora. If government formation were to happen quickly, Lebanon’s central bank could reduce its debt profile and make debt sustainability less of an issue.
Much needed reforms in the power sector can unlock nearly $11 billion in pledged funding by foreign states and institutions.
Investors are depending on Prime Minister-designate Saad al-Hariri’s ability to form a working government. Despite the risks of politics coming in the way of reforms and once again weighing on Lebanon’s debt sustainability risk profile, investors are likely to look past that and instead focus on promises to reduce the budget deficit.
“Lebanese and international stakeholders agree that the budget deficit needs to narrow, but a credible, actionable plan for achieving this is still lacking and it remains unclear if political dynamics will allow for a concerted fiscal adjustment,” said Fitch Ratings.