default ‘virtually certain’ after credit downgrades

Investors holding Lebanese bonds are expecting the worst, as years of financial mismanagement could well push the country into defaulting on its debt for the first time in its history.

International Monetary Fund officials have been called in to help find a solution to manage Lebanon’s crippling debt – around 160% of GDP, the highest ratio in the world – amid the worst financial crisis since Lebanon’s brutal civil war. 1975-1990 in the Mediterranean country and month of popular protests.

Lebanon was hit with a double downgrade over the weekend by two of the world’s biggest rating agencies, dragging its sovereign credit rating further into junk territory. Moody’s and S&P Global Ratings downgraded Lebanon’s long-term foreign currency rating to Ca and CC, respectively – both of which are ten levels below investment grade. The country is now rated lower than Argentina and the Democratic Republic of Congo.

“As a result of strong fiscal, external and political pressures, we believe a distressed exchange or unilateral default on Lebanon’s commercial debt is virtually certain at this stage,” an S&P analyst report said last week. Overall. The report follows Nabih Berri, speaker of Lebanon’s parliament, who said last week that debt restructuring would be the “best outcome”.

As the deadline for Lebanon’s $1.2 billion Eurobond, maturing on March 9, approaches, the price of the bond has risen from 90 cents to the dollar in early February to a record high of 53 cents last week, with the yield on these Eurobonds exceeding 1,000%. The pound, officially pegged to the dollar, has fallen 40% on the black market as local banks ration dollars needed to import food, medicine and other essentials.

“They will have to restructure; it’s inevitable,” Mohamad Faour, a Lebanese finance researcher at University College Dublin, told CNBC. “Right now they’re burning through their reserves to pay off their debt and that’s a classic sign of impending default. The question is more about ‘when’ rather than ‘if’.”

“You’re in the middle of a banking crisis, a currency crisis, a debt crisis, and all of that has led to an economic crisis,” said Nafez Zouk, Lebanon expert and emerging markets strategist at Oxford Economics, to CNBC by phone. . “It’s not every day that a country has to deal with all of these things at once.”

Lebanon has suffered for years from low growth, high unemployment and endemic corruption – it is ranked 137th out of 180 countries on Transparency International Corruption Perceptions Index 2019.

Many economists say the central bank’s “financial engineering” is also to blame, which involved luring in dollar deposits from local banks at high interest rates – often above 15% – to finance the government spending.

Lebanon “lived beyond its means” for years, Zouk explained, running twin deficits – in both the government’s fiscal balance and the current account balance – something that required some confidence from the public. investors to sustain themselves. But in recent years, that confidence has dried up, as have capital inflows.

“So now we’re at the point where we have a dollarized economy, and there are no more dollars in the system,” Zouk said. “More dollars in the system to pay off debt, more dollars in the system to import, more dollars to pay back people’s deposits.”

Critics of the central bank and its policies call it a Ponzi scheme: taking new money from new depositors to keep repaying old ones. “It’s like the housing bubble,” Zouk said. “You can keep going as long as prices stay high, but as soon as the deposits slow down or stop, you’re screwed. And now we’re screwed.”

Lebanese banks also have a staggering proportion of exposure to the country’s sovereign debt: around 70% of Lebanese banks’ assets are sovereign and central bank debt instruments. This means that “a default is likely to wipe out the capital of most local banks,” Faour said.

Of Lebanon’s $30 billion in international bonds, two-thirds are held by local banks and the central bank, while about a third is held by foreign investors. Moody’s predicted that a debt restructuring plan for Lebanon would likely include bond writedowns of 35% to 65% of face value.

“That $30 billion, you have to pay it back. And we’ve gotten to the point where it’s becoming very clear that we can’t pay that money back,” Zouk said.

Western and Gulf allies have made it clear that any potential aid to the country must be subject to a viable and convincing reform planand so far they are not convinced.

Some economists have argued for an immediate repayment of the March 9 Eurobond, which will be followed by further Eurobond payments due in April and June. But Lebanon is starting to deplete its reserves, which many in the country believe should be kept to fund its import needs rather than pay foreign creditors.

With Lebanon’s current $30 billion in foreign exchange reserves gradually depleting – and analysts estimate that $1-2 billion worth of foreign currency leaves the country each month – Zouk thinks a default must occur. produce now, with an IMF-backed reform plan, before things get worse.

“From a macro perspective, this debt should be restructured as soon as possible before we really have a knife to our throats. Before it’s too late and there are literally no reserves left to do whatever whatever,” he added.