Some critics say that the country is already dysfunctional, fragile, and the government immobile. While the political chieftains dither over how to retain their prerogatives, international bodies, financial and political, are readying near-death announcements. This past week, Moody’s and S&P Global reflected on the demise of the financial engineering that had propped up the Lebanese pound and ranked the country and its banks to even lower levels of junk status. With payment coming due on about $1.5 billion worth of internationally-held bonds, the Central Bank, with no formal decree on capital controls, in fact allows private banks’ largest clients to continue to move their assets out of the country. So how long can Lebanon continue its financial fast shuffle that has now slowed to a geriatric hobble?
Moody’s Investor Services based its further downgrading into junk status on an increased likelihood that Lebanon’s external debt would have to be rescheduled or other measures such as a haircut in earnings or debt swap that are all defined as default, a word that the Central Bank refuses to utter. In addition, the country continues to be “under review” for additional potential downgrade. What this means is that Lebanon no longer can raise through bonds or other instruments the large amounts of financing needed to prop up its subsidization of the pound.
It said, "Widespread social protests, the resignation of the government, and loss of investor confidence have further undermined Lebanon's traditional funding model based on capital inflows and bank deposit growth, threatening the viability of the peg and macroeconomic stability." The next quarter is the critical assessment period measuring capital inflows, bank capital stability, and level of solvency of government institutions, that is, is it paying its bills?
Almost $3 billion has already left the country including $800 million since the demonstrations started a scant month ago. The resignation of Prime Minister Hariri and his rumored replacement by a former finance minister has not eased the pressures on the government as it continues to lack a program for implementing badly needed reforms that will reassure international funders.
The demonstrators are unsurprised by the lack of leadership to stop the hemorrhaging as the President and his allies in the government seem more intent on the survival of their prerogatives rather than that of the country. As Moody’s reflected, “In the absence of rapid and significant policy change, a rapidly deteriorating balance of payments, and deposit outflows will bring GDP growth to or below zero, further stoking social discontent, undermining debt sustainability and increasingly threatening the viability of [the Lebanese pound's peg to the US dollar]." Moody’s downgrade puts further pressure on Lebanon’s ability to borrow as it has to offer very high yields to attract investors to invest in the country given its continued deterioration.
On the issue of the debt servicing, Moody’s estimates that the country has about $5-10 billion available to redeem existing bonds. It opined, "In the absence of new net inflows, these $5bn to 10bn will likely be consumed by the government's forthcoming external debt service payments estimated at $6.5bn this year and next, including the $1.5bn November 28 maturity."
While the bulk of Lebanon's public debt is held by local banks and the financial system, a condition that enabled the country to attract large amounts of overseas capital inflows that sustained the currency peg, local institutions are facing challenges in balancing their books in light of the lack of continued investment to offset deficits.
S&P Global, in fact, has downgraded Bank Audi, Blom Bank, and BankMed to CCC from B-, reflecting their weak ledgers and capital reserves, and is maintaining a negative outlook on their prospects. The agency also maintained a negative outlook on the banks, stating that it will look for more clarity on deposit outflows and "reported restrictions on specific transfers and operations imposed by banks." IT said, "We understand that the deposit erosion that started in first-half 2019 has recently intensified. This has happened because of recent political developments, protracted social unrest, prolonged bank shutdowns, and individual banks reportedly placing some restrictions on specific transfers and operations."
S&P doesn’t believe that the banks will be able to meet their obligations to pay back investors who have been enjoying very high interest rates paid on their deposits. "We believe that large maturity mismatches on the banks' balance sheets limit their flexibility to respond to major deposit outflows in times of liquidity stress," was its comment. This attacks the core transaction in the Central Bank’s financial engineering in which “banks have typically used customers' short-term deposits to invest in longer-dated term deposits and certificates of deposits from the country's central bank, Banque du Liban.”
The Central Bank faces a dilemma. If it continues to provide liquidity to the banks to meet their depositors’ demands, it has less capital available to continue financing the operations and debt servicing of the government. There are no more simple solutions. As long as there are demonstrators in the street and the government has no credible program for economic reform, the financial system remains hobbled by this conundrum. As Capital Economics in London said, “We understand that at this stage banks have had limited recourse to this liquidity facility. [Global markets investors] are coming around to our long-held view that the government will have to resort to a restructuring of its large debt pile." It further predicted that there is an 84% chance that Lebanon will default on its debt within the next five years given the high rates it will have to pay to extend its bond obligations, referred to as “credit default swaps.”
Just to make sure the message is clear, Gallup, the global survey firm, released some statistics on what the Lebanese think of the government’s performance. Its latest results show that 93% of all Lebanese adults say corruption is widespread throughout the government, noting that this perception hasn’t fallen below 90% since 2012. Similarly, less than 20% of those surveyed before the current crisis said that this is a good time to find a job. For complete methodology and specific survey dates, please review Gallup's Country Data Set details.
For cogent and insightful assessments of understanding the ins and outs of the crisis, see the work of the Lebanese Center for Policy Studies, here and here.