Will Lebanon’s Eurobond default spur much-needed reform?

Lebanon is one of the most indebted countries in the world.
Sunday 15/03/2020
Lebanese President Michel Aoun (C) leads a cabinet meeting at Baabda Palace near Beirut, March 12. (DPA)
No immediate solution. Lebanese President Michel Aoun (C) leads a cabinet meeting at Baabda Palace near Beirut, March 12. (DPA)

TUNIS - Lebanon has defaulted on its international debts for the first time. Through civil war and social and political turmoil, Lebanon had always met its economic obligations.

However, convulsed by a long-foreshadowed currency crisis and battered by the spread of coronavirus, Lebanese Prime Minister Hassan Diab said in a televised address March 7 that he was placing the needs of Lebanon’s citizens ahead of its fiscal responsibilities.

Announcing the country would not be paying the $1.2 billion Eurobond due March 9 he said: “How can we pay the creditors while there are people in the streets without the money to buy a loaf of bread?”

Few were surprised by Diab’s decision. Lebanon’s economy has been in decline for several years. Reports by the Financial Times in 2011 suggested Lebanon’s reliance on domestic consumption and hard currency remittances from the diaspora placed its economy at risk.

Over the following years, corruption and mismanagement along with Lebanon’s confessional system of government produced an economic crisis with no immediate solution.

Lebanon is one of the most indebted countries in the world, owing more than $90 billion, approximately 170% of GDP.

Official estimates in January stated that inflation was running at a year-on-year rate of 10%. However, a leading consumer association told Bloomberg News that prices have risen 45% since October, affecting purchasing power at an “unprecedented rate” as companies slash both jobs and pay.

“Since around August of 2019 and the dollar shortage at the banks, we’ve seen price hikes, a decline in consumer confidence and difficulties in importing and pricing basic goods such as wheat and fuel,” said Kareem Chehayeb an investigative journalist at the Public Source, an independent Lebanese media organisation.

Banks that remained open throughout Lebanon’s 15-year civil war are now closing early, cutting credit card limits and dramatically curtailing the public’s access to the country’s diminishing dollar supply.

“As the conditions worsened, we saw mass layoffs and salary cuts,” Chehayeb said. “Couple that with an inflated black market exchange rate dominating the markets and people’s lives have clearly worsened significantly.”

Mona Yacoubian, a senior adviser at the United States Institute of Peace, said: “Estimates already indicate that as much as 50% of the population live below the poverty line. Many people have faced layoffs and inflation is rising as the Lebanese pound continues to lose value. Many people are taking a de facto ‘haircut’ as their dollar-denominated accounts are translated into lira at a devalued rate.

“Unfortunately, more pain lies ahead in the short to medium term as austerity measures eventually are put in place following the default.”

“The medium- and long-term implications of the Eurobond default will very much depend on what measures and reforms Lebanon undertakes following the default. Obviously, a default is never good and Lebanon will necessarily pay a price in the markets for having failed to repay its debt,” she added.

Yacoubian said there remained the possibility that the default may spur much-needed reform, which, while including austerity, should “include a shift towards greater transparency and accountability and measures to combat widespread corruption, then the long-term prognosis for Lebanon is far better as the economy will be on a far more solid footing.”

Under typical circumstances, a country experiencing similar conditions would look to the International Monetary Fund (IMF) for support. An IMF delegation made a technical visit to Lebanon in February that it described as “very informative and productive.”

However, in the absence of a credible economic plan, the IMF is unlikely to offer Lebanon the level of support required to see it either through its present difficulties or to fund the fiscal stabilisation fund — estimated by former Economy Minister Nasser Saidi to be around $20 billion — to underpin any reform programme.

Lebanon’s unique political circumstances may impede any IMF bailout. The Iran-backed Hezbollah, which wields strong influence in the country’s government, is unlikely to welcome what it would see as a surrender of sovereignty over any IMF bailout.

An analysis by the global risk consultancy HIS Markit after Lebanon’s default noted that Hezbollah “has repeatedly expressed its opposition to an International Monetary Fund bailout and the measures it would require.” These are said to include cutting bread subsidies, taxing fuel and raising the value added tax.

It is possible that the government may undertake reforms without IMF support, looking to cut spending and commence a longer-term plan of tax hikes without an internationally funded stabilisation programme.

Credit ratings agency Fitch has suggested that Beirut might raid deposits and savings held by the country’s banks, a possibility the government has yet to rule out.