On Jan. 21, the Qatari government announced it would buy $500 million worth of Lebanese government bonds. The news briefly reassured markets that have been negatively affected over the past eight months as Lebanese politicians have failed to form a new government. But several hours after the Qatari announcement, Moody’s, one of the three main American credit rating firms, downgraded Lebanon’s credit rating, making it riskier to hold by investors. The move heightened concerns about Lebanon’s financial health and injected fresh uncertainty into financial markets.
The following is L’Orient-Le Jour’s guide to understanding different aspects of the debate on Lebanon’s uncertain financial climate.
The heart of the issue: a growing public deficit
The current economic slowdown began in 2011 following the start of the conflict in Syria and as wealthy foreigners from the Gulf left Lebanon. The Lebanese government found it increasingly difficult to make ends meet due to a downturn in the private sector that negatively affected the amount of tax revenue it has been able to collect. In 2011, the state brought in $8.8 billion in tax income, compared to $8 billion by end of September 2018. Meanwhile, the state’s spending rose from $11.6 billion in 2011 to $13.2 billion by the end of September 2018.
The increase in the state budget is primarily due to spending in three areas: the payment of Lebanon’s debt, salaries and wages for public administration and transfers from the treasury to Electricité du Liban to bridge its deficit. As a result, the public deficit, which was $2.3 billion in 2011, rose to $4.5 billion by the end of September 2018 and, according to several experts, will likely exceed $6 billion when the data comes in for the end of 2018.
Why are banks directly affected?
To cover the growing deficit, the state has needed to borrow more and more money. As a result, the public debt grew from $54 billion in 2011 to $83.6 at the end of October 2018. In Lebanon, local banks lend money to the state either directly by buying treasury bills in Lebanese Pounds or Eurobonds in US dollars. They can also lend money indirectly by making deposits to Lebanon’s central bank, the BDL, that will then be used to buy government bonds.
To continue to finance the state, banks rely on a continuous inflow of deposits. But deposits have been slowing down as the need to finance the debt has increased. The inflow of deposits mainly comes from remittances sent by Lebanese living in the diaspora, but these are slowing down for two reasons: the Gulf crisis and a lack of trust by expatriates in the sustainability of Lebanon’s financial system because of political tensions and geopolitical instability. Between 2008 and 2011, bank deposits grew by an average of 17 percent per year. Since then, the growth has slowed. In the first eight months of 2018, bank deposits only grew by 3 percent.
What is the link between the formation of a government and CEDRE?
A government needs to be formed to stop the growing public deficit and restrain the demands of financing the state’s debt. State spending will need to be lowered and its revenue increased. Lebanon committed to making these reforms during the CEDRE conference in Paris last April, and they were put forward in reports by several international organizations as the only way out of the crisis.
To increase its revenue, the state will need to combat tax evasion and improve tax collection or raise taxes once again. To lower its spending, the state will have to introduce reforms in the three main areas of expense mentioned above. The public sector will need to be reformed by cutting useless jobs that were created in the service of political clientelism; new power stations will need to be constructed and rates increased; and the amount of money spent on servicing the public debt will need to be decreased.
The last reform appears to be the most feasible in the short-term because it will allow the state to buy time to implement other reforms and delay the possibility of payment default. Payment default would negatively impact the state’s main lender, the Lebanese banking sector, and the banking sector’s depositors, the Lebanese citizens.
What are the main options to reduce debt servicing?
There are different options available to reduce the burden of servicing Lebanon’s debt. The newspaper Al-Akhbar published an article quoting outgoing Finance Minister Ali Hassan Khalil as raising the possibility of an imminent restructuring of Lebanon’s debt, which heightened tensions in the market. The minister quickly denied the report and explained the he was talking about rescheduling the debt not restructuring it. What’s the difference?
• Debt rescheduling means that the State renegotiates the terms of its debt with banks by lowering interest rates and postponing the maturities (paying them in ten years instead of five, for example).
• A debt restructuring means that the State negotiates with banks to scale down the principal (also known as haircut), which means the amount of loaned capital, not only the interest. In this case, banks will deal with huge losses that will directly impact account holders. The State might accept to reschedule the debt to prevent this scenario.
• The state could also choose to devalue the Lebanese Pound in relation to the US Dollar to lower the size of its debt in pounds and increase the State’s income. Despite speculation about this move, BDL governor Riad Salamé has firmly ruled it out as a possibility. “We hear talks about devaluation, but as the economy is dollarized, we have no interest in abandoning the stability of the exchange rate because it will harm our productivity and purchasing power without it helping our competitivity,” he said in December.
• High economic growth would also pave the way for increased state tax revenues, but financial forecasts rule out this possibility. The BDL expects a growth rate of between 1 and 1.5 percent for 2018, and the World Bank and IMF project a growth rate of around 1 percent.
As stated by many experts, the rapid formation of a government would help avert the most pessimistic scenarios.
(This article was originally published in French in L'Orient-Le Jour the 23rd of January)
On Jan. 21, the Qatari government announced it would buy $500 million worth of Lebanese government bonds. The news briefly reassured markets that have been negatively affected over the past eight months as Lebanese politicians have failed to form a new government. But several hours after the Qatari announcement, Moody’s, one of the three main American credit rating firms, downgraded...