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No way out?

The debt that consumed Lebanon

by Salim Taha

The Lebanese national debt, seen in relation to the country’s GDP, has been one of the highest in the world for many years. When the cost of servicing that debt became extreme and international investors lost faith in the country’s ability to manage its finances, it was inevitable for the whole financial system to crash. Generations of savings by Lebanese residents and non-residents evaporated through high exposure of banks and the BDL to the sovereign risk. Getting out of the debt trap requires drastic measures.

Sovereign debt defaults have been part of the modern world’s economy for centuries; some defaults are even traced back to the fourth century in Greece. Countries choose certain economic, fiscal and monetary policies that put them at risk, and when adverse events occur over a relatively short period of time, the system endures a distress that mostly ends in a financial and economic crisis. The risky policies usually involve overspending by a government, leading it to borrow more. The consequence of this is higher interest rates to compensate for the increased risk, which, if not reversed with economic growth in time, leads to a spiral of risk that threatens the government’s finances and the national currency.

Like a hell-broth boil and bubble

Lebanon treasury finances were always in deficit and mostly in Lebanese pounds. A large and constant inflow of dollars from remittances, personal capital flows, and – in some years – tourism, helped contain the risk of expansion in Lebanese pound debt.

However, Lebanon’s dollar borrowing to fund the deliberately failed electricity company, Electricité du LIban (EDL) and the interest on dollar debt, meant that every new dollar borrowed locally translated into a Lebanese depositor’s dollar wasted. By the end of 2019, the interest expense of the Lebanese government had reached 65 percent of its total revenues.

Lebanon’s last Eurobond market issuance was in 2017, which means no one wanted to hold Lebanese Eurobonds because it was clear to investors worldwide that the Lebanese debt had crossed its point of sustainability. Instead, only BDL had the appetite to buy those bonds, with depositors’ money, as one of the tools of its “financial engineering.” By the time the crisis reached its peak, out of the $120 billion in depositors’ money, $20 billion had been borrowed by the government and $80 billion had been borrowed by BDL under the appellation of “reserves.” The government policy of peg of the Lebanese pound to the dollar artificially overvalued the currency and depleted deposits.

The Lebanese national debt reached 174 percent of GDP towards the end of 2019 and two years later, at time of this writing, stands at 210 percent at market rates. The envisioned restructuring of the debt would now involve a haircut of 60 percent to make it sustainable, which would have been equivalent to a haircut of around 50 percent on depositors in 2020. This was considered the best case scenario by some in 2020 when the government issued its ill-fated recovery plan. However, the plan was never adopted, and the BDL monetary policy intervention continued, opting to inflate the system by printing trillions of Lebanese pounds, thereby rendering people’s deposits worthless, and inflicting an indirect haircut of 80 percent on them.

Any restructuring that would be imposed would still need to haircut depositors, but these depositors would be much poorer now, given the spiral of inflation and devaluation of the Lebanese pound.

Lifting the curse?

For the debt to be sustainable in the coming decade, its cost has to be contained. For the Treasury to afford the interest on the newly restructured debt, it needs to be able to collect taxes again from a functioning economy. For the central bank to be able to pay back its debt to the banks and hence to depositors, it needs to replenish the dollar reserves. Therefore, the solution to the debt is an economic, fiscal, and monetary one.

Unless there is a holistic approach to the Lebanese crisis, the country would risk being subject to multiple defaults over the next two to three decades, with increased poverty and no cumulative wealth, rendering the country one of the poorest in the world.

The restructuring of the dollar debt requires an international bailout. The restructuring of the Lebanese pound debt is important to keep the cost of debt low. It is nonsense that the large portion of the debt which is denominated in Lebanese lira is not a threat anymore because its value, it terms of dollars, has shrunken and is continuing to shrink. But lira-denominated debt is payable in lira, from lira revenues. Indeed, the only fiscal revenues that could be used to pay this debt, as all fiscal revenues of the finance ministry in Beirut, are lira revenues; hence the 3 trillion Lebanese Pounds in payable interest on this debt still hold.

In such a severe recession as currently experienced by the Lebanese economy, one cannot expect to collect more money from existing taxes or hike tax rates; the focus should be on increasing the productivity of the Lebanese economy and supporting export-oriented sectors. One time-honored idea for boosting productivity is to invest in needed infrastructures, and once the international community was standing by to inject those billions of dollars in infrastructure projects that would boost the economy and support the fiscal and monetary policies. But alas, we missed that opportunity and we now seem to be on our own – and we all know what that means.

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Salim Taha

Economist specialized in public finance.

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