In the coming months, Lebanon is hoping to secure a rescue package at interest rates of less than 1.5% over periods ranging from 20 to 30 years. The country, caught between Saudi Arabia and Iran, which back opposite sides in the Syrian War, is key to securing what’s left of peace in the Middle East. Deputy Prime Minister Ghassan Hasbani calls for an intervention “the same way that Greece was salvaged, but before it’s too late.”
The World’s Third Most-Indebted Country
Tourism, real estate, and construction, the usual levers of GDP growth in Lebanon, have slowed. The IMF estimates growth to be at about 1% to 1.5% for 2017 and 2018, while The Institute of International Finance communicated slightly better figures with 2.2% in 2017 and 2.9% in 2018. Public debt is estimated to be above 150 percent of GDP at end-2017 and could balloon to the Greek ratio of 180 percent by 2023 if the government does not undertake reforms. With a net public debt of 234.7% of GDP, Japan is the only country with a bigger debt ratio, but it’s not at the mercy of external forces because, unlike dollar-pegged Lebanon, its currency trades freely.
To meet the funding needs of the economy, the Banque du Liban (BdL) will need to use its gross reserves or increase interest rates. In 2008, Lebanese banks were able to attract foreign deposit inflows at an average of about $1bn a month, with attractive interest rates of 7% to 8%, especially compared to plummeting rates everywhere else. The country was able to pull this off and bypass the crisis because the BdL had banned investing in subprime mortgages.
Since then, interest rates have dwindled down, and with them deposit inflows, a key source of financing for the large deficit. In 2017, private sector deposit growth was 3.8% —below the average 7% growth in previous years. The country also saw outflows of $2 billion after PM Hariri announced his resignation on Nov, 4. This, however, was a temporary setback, as retracting his resignation, a month later, brought back the money. Riad Salameh, the Governor of BdL, said in an interview: “We are back at $43 Billion. Money returned gradually with inflows exceeding outflows since Dec. 10.”
Panic in the Sovereign Credit Market
Given eroding competitiveness and low growth, investors have been dumping Lebanese bonds, sending the yield on Lebanon’s dollar-denominated bonds due 2037 up 59 bps last month. But investors might have jumped the gun. Goldman Sachs indicated that Lebanon’s Eurobonds are undervalued. The difference between the actual and the model-implied spreads is 90 bps, 109 bps, and 107 bps for bonds with a maturity of 3 to 7 years, 7 to 12 years, and 12 years or higher respectively. According to the investment bank, Lebanese and Tunisian sovereign credits are the only ones to be undervalued among 21 B-rated emerging market countries in Goldman Sachs’ universe.
High Hopes for a Bailout
Lebanon’s outlook is linked closely to developments in Syria. The country is dealing with hosting about 1m Syrian refugees, the highest number per capita worldwide. To alleviate the burden on both host communities and refugees, Lebanon plans to raise up to $16bn over the next decade in a new capital investment program (CIP) by tapping into funds from the World Bank and long-term concessional lending sources. In April, the Paris IV conference, renamed “La Conference du Cedre” by President Macron, will offer an opportunity to secure the funding. The CIP will increase public debt, and possibly the borrowing cost. Therefore, it becomes increasingly important for Lebanon to ground its future investments in a comprehensive reform framework that includes stabilising debt as a share of GDP, improving bank capital buffers, promoting sustainable growth, and fighting corruption.
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