NEW YORK  - Here’s a brainteaser for investment-banking job candidates. How can Lebanon – a country with debt running around 150% of its roughly $60 billion GDP, massive deficits and under $30 billion in foreign reserves – achieve financial stability Lazard, the country’s newly approved adviser, will earn its fees if it can solve this puzzle.

Lebanon has characteristics that make it especially hard to restructure debt without imperiling local banks or increasing political instability. The issue is coming to a head, too, with a $1.2 billion payment on foreign-currency debt due on March 9.

Restructuring Lebanon’s foreign-currency-denominated debt alone – which foreigners are more apt to hold – wouldn’t be enough. Only about 40% of the country’s nearly $90 billion debt stock is in hard currency. That means even if creditors took a 60% haircut, the debt-to-GDP ratio would still be around 120%, according to Fitch Ratings. That’s unsustainable.

And inflicting losses on all debt holders could threaten local banks. Their holdings of government paper represented about 12% of their assets as of December, and the banks’ overall exposure to the public sector is far higher. The balance sheets of private Lebanese banks are tightly woven with the central bank’s. Stiff haircuts could render them in need of their own bailout.

Forcing depositors to take losses is another possible avenue. However, Lebanon’s financial system has functioned by attracting deposits from the Lebanese diaspora and other wealthy foreigners. Siphoning off their cash would make it even tougher to access the hard currency the country needs to support the Lebanese pound’s artificially strong peg and pay for imports.

So a bailout from the International Monetary Fund would seem logical. But with public protests having recently brought down the government of Prime Minister Saad al-Hariri, it’s not a good time to introduce austerity measures like those the fund normally requires. And the multilateral lender may also be loath to dive into a country whose governing parliamentary coalition is now led by Hezbollah – designated as a terrorist organization by the United States – and its allies.

The stakes are rising as Beirut decides whether to delay the payment due early next month. It may keep draining reserves to buy time, but that would only postpone the inevitable. The Lazard bankers’ heads are probably already hurting.

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CONTEXT NEWS

- Lebanon is due to repay a $1.2 billion Eurobond on March 9. The government plans to use the prescribed seven-day grace period to enable advisers to draft a restructuring plan, according to a government source quoted by Reuters on Feb. 27. Lebanon has given approval for investment bank Lazard and law firm Cleary Gottlieb Steen & Hamilton to be its financial and legal advisers.

- S&P Global Ratings and Moody’s Investors Service both lowered Lebanon's sovereign credit rating deeper into junk territory on Feb. 21 due to the expected debt restructuring. Fitch Ratings said on Feb. 18 that the country’s financial circumstances indicate that a restructuring is likely.

- The International Monetary Fund met with Lebanon’s authorities from Feb. 20-24 to provide technical advice on handling the nation’s debt burden and economic crisis.

 

(Editing by Richard Beales and Amanda Gomez) ((anna.szymanski@thomsonreuters.com; Reuters Messaging: anna.szymanski.thomsonreuters.com@reuters.net))