Lebanon - A fiscal solution to the problem of the public debt – A one-time “National Solidarity Weal
Although Lebanon was able to meet its November $1.5 billion Eurobond payment, there is a general consensus that Lebanon’s public debt has spiraled out of control. It needs to be reduced both as a share of GDP and in absolute amount. There is a great deal of apprehension that Lebanon may not be able to meet the next bond payment of $1.2 billion due in March 2020. It is evident that the public debt cannot be put on a sustainable path without a major policy adjustment in parallel with a massive, if at all bearable, fiscal effort.
Several experts have mentioned the inevitability of “Debt restructuring,” the conventional approach advocated to address the debt overhang. Restructuring entails: rescheduling, i.e. postponing, debt payment installments; lowering interest payments; and most distressingly, reducing the due principal amounts. In legal terms, failure to make timely repayment (compared to the original contractual terms) of principal and interest is construed as a default. A default on a specific debt issue, or a specific borrower, may trigger cross default clauses on all debts outstanding.
As has become increasingly clear, in Lebanon, the main creditor of the Lebanese state is the banking sector – commercial banks and Central Bank of Lebanon (CdL). A public debt restructuring would thus affect bank balance sheets through a write-off of shareholder equity and, if insufficient, through a “haircut” on some, or all of the deposits.
Whichever option or options are exercised, a debt restructuring will dent Lebanon’s once stellar image as a creditworthy, resilient country that never failed its financial obligations, even at its darkest hours. It will ineluctably translate into a sovereign rating downgrade to the lowest rung, and impede the country’s future ability to access international and domestic debt markets other than at forbidding costs, if at all.
An alternative solution to debt restructuring. Just as there is a debate in the US over the so-called “wealth tax” as a tool to address fiscal needs, a similar concept for putting Lebanon’s finances on the right path is using fiscal policy initiatives. Fiscal policy is the undisputed domain of the sovereign state that can adjust its tax code at will. Altering the tax policy is not construed as a default even if the change is enacted in the context of debt resolution. The fiscal approach to the debt problem will have the same parties – bank depositors and the commercial banks in this instance – shouldering the cost of adjustment.
The proposed fiscal approach will seek to buy back the US$34 billion foreign currency denominated debt, or a substantial part thereof, by levying a one-time “national solidarity” tax, in the form of a wealth tax. For that purpose, wealth will be narrowly defined as foreign currency deposits in Lebanese banks at the exclusion of all other assets. To ensure fairness between depositors who kept their funds in Lebanese banks and those (notably insiders) who transferred them overseas, the measure could bear retroactively on the value of deposits present in Lebanon on a certain date, say January 1st, 2019. Were it to be applied, this tax will have the same effect of a haircut without triggering a default on the debt with a subsequent sovereign downgrade.
One may argue, correctly, that this approach would exonerate and keep whole the bank shareholders whose equity, to the contrary, is meant to take the first loss under any debt resolution program. Yet, given the deleterious condition of the banking system, this proposed fiscal solution might spare banks, for the time being, the further loss of scarce capital when measured against their hollowed assets base, although this doesn’t preclude that some measures of restitution be later applied to shareholders.
A number of scenarios could be envisaged taking into account the distribution and size of bank accounts. Were this tax to be levied on all US$120 billion foreign currency deposits, it would yield: US$12 billion for a 10% tax rate; US$24 billion for a 20% tax rate; and US$30 billion for a 25% tax rate.
For the measure to be socially fair and acceptable, it should rather target larger accounts, i.e. those of the more affluent. Here too, various scenarios may also be considered. For instance, applying a 20%, 25%, or 30% tax rate on the 1% of the largest accounts (about US$80 billion in total) would yield respectively US$16 billion, US$20 billion, or US$24 billion. The same analysis can be done in applying various tax rates on the largest 10%, 20%, or 30% of the accounts. Measuring comparative yields across specific timelines will both enable Lebanon the time to develop a more comprehensive strategic approach of reforms and help reduce anxiety among international investors.
NOTE. This proposed one-time national solidarity wealth tax should not be viewed as retaliatory against the wealthy. Antagonizing and demonizing the affluent has deleterious, irreversible long-term economic costs such as driving investors, entrepreneurs, job and wealth creators out of the domestic economy. In this consideration, it would be useful that the real wealth effect on those affected by this tax be assessed by comparing, over relevant periods, the after-wealth tax returns on bank deposits in Lebanon against such benchmarks as: the return on US dollar-denominated treasury instruments of comparable maturities; or the returns that would have accrued to bank depositors in other markets where interest rates are markedly lower.
The problem of the Lebanese pound denominated debt, major as it is, can be addressed separately, as in terms of priority it is less critical than the external debt, especially in the context of a depreciating national currency.