Geopolitical crises are masking the hard decisions that must be made for Lebanon to embark on a restructuring journey. By David Rothnie.
When Riad Salameh, the former head of Lebanon’s central bank was arrested in September on charges of embezzling up to US$42m of public funds, demonstrators took to the streets in celebration.
Salameh, the former head of the Banque de Liban, is accused of concealing massive misappropriation of funds from the central bank through creative accounting and by offering interest rates up to 20%, which consistently attracted new capital. In 2019, a run on the county's banks brought the years-long scheme to an abrupt halt.
Millions of people lost their life savings in the resulting financial crisis and the country’s currency depreciated by more than 95%. Lebanon’s state news agency said the charges were in relation to alleged misconduct involving the brokerage firm Optimum Invest, which Salameh is accused of using to enrich himself by more than US$110m. Optimum has said that all of its transactions with the central bank were lawful.
But, while depositors heralded the arrest of Salameh, and a group of depositors staged a protest in front of Lebanon’s Palace of Justice, chanting “thief!” as Salameh arrived for his court hearing, the response from investors was more muted. “It’s hard to tell whether this helps move things forward or not,” said one asset manager.
The reason for investor ambivalence is that it is more than four and half years since Lebanon defaulted on its debt (it has not paid any principal on its Eurobond debt since March 2020), and any path to a restructuring plan appears impassable, blocked by war in the Middle East, and Lebanon’s political elite, which is ducking the necessary reforms needed to secure a package from the International Monetary Fund.
The IMF visited Lebanon in May but is no nearer to granting a potential US$3bn extended fund arrangement that could be used to help the country emerge from what the World Bank has described as one of the worst ever financial collapses.
Following the visit, Ernesto Ramirez Rigo, the head of the IMF mission, said in a statement: “While there has been some progress in lowering inflation and stabilising the exchange rate, supported by the BdL’s decision to end monetary financing and foreign exchange subsidies, as well as the elimination of the fiscal deficit, these reforms are insufficient for recovery.
"Most notably, the absence of a credible and financially viable strategy for the banking system continues to hamper economic growth and deposit recovery, while giving rise to an increasingly cash-based and informal economy and larger risks of illicit activities."
Unloved bonds
Lebanese government bonds trade in the region of US$6 cents in the dollar, by far the cheapest bonds in the emerging market sovereign universe – around half of where Venezuela trades, for example. That alone suggests a debt restructuring is a distant prospect, and the intensification of the conflict in the Middle East has placed reform lower down the list of priorities.
SorinPirau, a portfolio manager at Janus Henderson Investors, said: “We have reduced incentives to follow small details of the Lebanese economy on a day-by-day basis because these are not the things that will drive bond prices. The top priorities are to solve the banking crisis and to navigate the current geopolitical risks without ending [up] involved in a wider regional war with potentially dramatic consequences for its economy and people."
He said that, and given the unrest in neighbouring Israel, it is unlikely to embark on a debt restructuring process anytime soon.
Prior to the IMF’s visit in May, it had sounded a more conciliatory note. In 2021, it allocated US$860m of special drawing rights to Lebanon and a year later reached a staff-level agreement for the extended funding arrangement based on pre-conditions.
These included calls to strengthen governance with the formation of an anti-corruption framework, implement a fiscal strategy that combined “deep debt restructuring” with an expanded social safety net, the establishment of a credible monetary and exchange system and finally, and perhaps most importantly, a comprehensive restructuring of the financial sector, which, according to the IMF would be capable of “recognising upfront the losses at private banks and the central bank, but doing so in a way that protects smaller depositors”.
Modest signs of progress
Two years later, and there are modest signs of progress towards two of these four demands. Last July, Lebanon appointed Wassim Mansouri as the new governor of the Banque du Liban, replacing the discredited Salameh. Seen as a technocrat with no links to the political elite, since taking over, Mansouri has taken positive steps by unifying the lira exchange rate against the US dollar rates and stopping funding the government through quasi-fiscal operations.
Then, in February, the Lebanese Ministry of Finance presented its first financial restructuring plan to international investors including proposals on how it hopes to recapitalise the banking system – a crucial pillar that could form the basis of a restructuring.
Since the collapse of the Lebanese economy in late 2019, all of the country’s big banks have been insolvent. The complex proposal from the government makes a distinction between deposits that are protected and those which are not.
But a law that means depositors will not get their money back seems hard to implement in a country at the centre of ongoing conflict and where, according to the World Bank, 80% of the country is already living in poverty.
Since then, progress has stalled amid the intensifying conflict, while the absence of a permanent government has made any reforms unlikely in the short term.
On July 23, Fitch withdrew its ratings coverage for the country, giving Lebanon an ESG governance score of five, a ranking that according to Fitch reflects “the absence of a recent track record of peaceful political transitions, relatively weak rights for participation in the political process, weak institutional capacity, uneven application of the rule of law and a high level of corruption".
The agency said it no longer had "sufficient information to maintain the ratings due to the unavailability of certain key data”.
No way forward?
With such competing problems, it is hard to see a way forward for Lebanon, and the longer the war goes on, the further away a restructuring plan appears.
And some argue that by stabilising the economy, Mansouri’s measures have generated a false sense of security.
“Because the economy is no longer in a tailspin, the pressure to make the hard decisions has alleviated," said Janus Henderson's Pirau.
"It’s hard to square the circle in Lebanon. The IMF wants to see tough decisions on reform before granting a debt programme, while any financial support from bilaterals or multilaterals will be conditional on the IMF programme.”
In the view of one long-only investor, “the one reform that is definitely needed and without which you cannot move forward – either with a debt restructuring or with an IMF programme – is how to allocate the losses of the banking sector generated in the crisis”.
When pushed to suggest what a possible recovery might look like, one banker with experience of sovereign restructurings pointed to the recent resolution in Suriname: the African state brokered a solution based on its future recovery and cashflows coming in from its growing oil potential.
“Lebanon has oil deposits that are being considered in the Mediterranean which are shared with Cyprus and Israel. That’s the only source of credible revenue because tax collection in Lebanon is not credible," he said.
"If you want to restructure your debt, including the official sector debt, you need an IMF programme. To get an IMF programme, you need a government that is ready to negotiate an IMF programme with the IMF. So far, that’s not been the case since Lebanon defaulted.”
It promises to be a long road ahead.
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