A government debt-restructuring exercise in Lebanon involving bond write-downs could trigger a “sovereign doom loop” that would prove costly to local banks holding these assets, S&P Global Ratings said.
Although the true extent of banks' losses will only materialise once the government restructures its liabilities, the cost of such action could exceed 100 per cent of the country's gross domestic product, the credit rating agency said in a report titled Calculating the cost of Lebanon's bank-sovereign doom loop.
Under its most pessimistic scenario, lenders face asset write-downs equal to 134 per cent of the country’s GDP.
“Without a resolution, Lebanese banks could find it difficult to sustain their operations as deposit outflows continue and foreign correspondent banks sever relationships,” said Zahabia Gupta, a credit analyst at S&P Global Ratings.
“Failure to restructure the financial system could leave Lebanon with banks unfit to support an economic recovery.”
Lebanon is in the grip of its worst economic crisis in three decades. The government defaulted on eurobonds worth $1.2bn that were due on March 9 last year.
It owes about $31bn in dollar-denominated eurobonds that currently trade at between 11 cents and 15 cents on the dollar.
This means investors are pricing in a write-down that is between 85 per cent and 89 per cent of the face value of the debt, the credit rating agency said.
A restructuring plan was first proposed in April last year by former prime minister Hasan Diab. It included a write-down of government debt and a discount of bank deposits held with the central bank, Banque du Liban.
However, the country has endured more than a year of political infighting since then, leaving markets in the dark about a potential resolution.
“Resolving the political deadlock in Lebanon is critical to starting the restructuring process and delays could complicate a recovery,” said Ms Gupta.
“The main stumbling block to restructuring appears to be that Lebanon is currently functioning with a caretaker government without authority to agree terms with creditors.”
Saad Hariri, prime minister-designate since October, has been unable to form a government because of disagreements with the president and other political parties over cabinet positions.
There is also discord among key political institutions over the causes of and the solutions to the country’s debt-restructuring process, including the treatment of depositors.
The central bank has printed money to service local currency debt, causing inflation to hit 158 per cent in March. The economic deterioration has pushed more people below the poverty line.
Although the Lebanese pound is still officially pegged to the US dollar at a rate of 1,507.50, it has lost more than 80 per cent of its value on the black market and is currently trading at about 13,000 per dollar, according to the lirarate.org website.
“We do not think restructuring foreign currency debt alone would put the government’s finances back on a more stable footing, since that debt comprised only 38 per cent of total sovereign debt at the end of 2020,” the rating agency said.
“Even a write-off of all eurobonds and official debt would leave the government with debt amounting to 107 per cent of GDP, based on figures [at the end of 2020]. We therefore believe local currency government debt will likely be part of any debt restructuring programme.”
Under S&P Global Ratings’ most optimistic scenario, the Lebanese government would repay 50 per cent of its eurobonds, 50 per cent of local currency debt and write down 10 per cent of its placements with the central bank.
This would lead to bank losses equal to 30 per cent of GDP.
Under its most severe scenario, the government would only repay 10 per cent of eurobonds and 30 per cent of local currency debt and central bank placements.
Restructuring costs “could be even higher in the event of a currency devaluation”, it said.
“The [central bank] governor has said the Lebanese pound will be devalued and that Lebanon is planning to launch a new foreign exchange platform to curb currency swings in the meantime. However, it is difficult to predict where the local currency’s value will find its medium-term anchor if the peg to the US dollar is removed.”
External support from donors and multilateral lenders may still be an option for Lebanon to overcome its current crisis but “the formation of a credible recovery plan and political commitment to reforms” is needed to unlock any help, such as the $11bn that international partners pledged at the Cedre conference in 2018.
The Lebanese banking system is also overbanked, with 47 commercial banks serving only 7 million people, the rating agency said.
“Thus far, we have not seen any merger or closures of Lebanon’s banks, although we expect this may change in 2021 and 2022.”