|20 May, 2019

Indebted Lebanon may struggle to refinance as austerity budget makes slow progress

Outright default can likely be averted in the short-term by a government financing manoeuvre involving the central bank and local banks

Image used for illustrative purpose. A Lebanese trader monitors the market at the Byblos bank dealing room in Beirut October 13, 2008.

Image used for illustrative purpose. A Lebanese trader monitors the market at the Byblos bank dealing room in Beirut October 13, 2008.

REUTERS/ Jamal Saidi

LONDON  - Lebanon's impasse in agreeing a credible fiscal reform plan and deteriorating global market conditions means it may struggle to refinance key foreign currency debts coming due this year, unnerving overseas investors.

Outright default can likely be averted in the short-term by a government financing manoeuvre involving the central bank and local banks, the main holders of its debt.

But this is only likely to be a stopgap and many foreign funds contacted said they would be reluctant to delve into new Lebanese Eurobonds until they assess reforms.

Lebanon's cabinet talks will convene again on Monday after about a dozen sessions so far without a deal, against a backdrop of protests by public sector workers and retired soldiers over concerns about wage and pension cuts.

The government in February promised “difficult and painful” reforms to control spending. Prime Minister Saad al-Hariri has said this may be the most austere budget in Lebanon's history.

At stake is investor support for new debt sales needed to help meet maturing Eurobonds this week and again in November. Access to international markets has been compounded by fresh turbulence on emerging markets as the trade row between the United States and China blew up again and geopolitical tensions involving Iran heightened.

Lebanon, with one of the world's highest public debt burdens, has been buffeted by political paralysis and fallout from conflict in Syria and Iraq, which has weighed on regional trade, investment and travel. A small, open economy, it has also been hit by a fall in money flowing in from its scattered diaspora, which traditionally helped fund a large chunk of its financing needs.

"The government is not even able to get its act together to deliver a comprehensible transparent budget. Nor did it present or formulate a credible medium term fiscal adjustment plan that strikes the right balance between the imperative of growth and fiscal consolidation," said Alia Moubayed, managing director at Jefferies, an international finance firm.

"Without a clear medium-term economic and fiscal policy framework that addresses large external imbalances, and given high levels of corruption and state capture, investors will not be convinced to buy Lebanon risk, as donors will look with extra scrutiny before committing further funding."

The protracted budget process has pushed up the cost of insuring Lebanon's debt in recent days to its highest level since Jan. 22, when it was struggling to form a government. 

Lebanon should be able to muddle through to find a solution to its most immediate debt headache, a $650 million Eurobond maturing on May 20.

Lebanon can pay back investors in this bond drawing on a foreign exchange transaction with the central bank, a source familiar with the matter said.

The government has used the same unconventional approach to financing its deficit in the past.

The central bank would likely discount dollar denominated certificates of deposits for the banks to subscribe to in return for them buying long-term domestic bonds, said one banker familiar with the situation. In parallel, the central bank would do a swap with the finance ministry, the issuer of the international debt.

The finance minister had previously said the government aimed to issue Eurobonds in the range of $2.5 bln to $3 bln on May 20 to cover this maturity and Lebanon's other maturing principle for 2019, a $1.5 billion issue due in November.

A source familiar with the matter told Reuters on Tuesday that Lebanon might wait until emerging market investors have more appetite and the government has approved its budget. The government is targeting international investors for around 20 percent of the new issue. 

The government says it is committed to pay all maturing debt and interest payments on predetermined dates.

"Eurobond maturities this year would be met by issuing further eurobonds," said Garbis Iradian, chief MENA economist at Institute of International Finance (IIF).

"First they have to send a strong signal to the market by approving strong fiscal measures."

Nassib Ghobrial, chief economist at Lebanon's Byblos Bank, said there was no risk to Lebanon's foreign currency financing for this year because the central bank was committed to covering the hard currency needs.

But Lebanon's economic challenges remain hefty.

Its fiscal deficit ballooned to 11.2 percent of gross domestic product (GDP) last year from 6.1 percent the year before and its international reserves fell to $39.7 billion, enough for 13 months of import coverage.

Lebanon's cabinet made "important" progress on Sunday in its debate over the draft budget which will have a deficit of 8.3% of GDP or less, Lebanon's Finance Minister Ali Hassan Khalil said.

Still, that rebalancing could be tricky to achieve with anaemic economic growth - JPMorgan forecasts recently revised its growth forecast down to 1.3 percent in 2019, warning of "significant downside risks" surrounding fiscal reforms.

"While cabinet formation has supported sentiment, delays in the execution of much needed reforms could dent confidence against the background of large fiscal and external deficits and high debt," Giyas Gokkent of JPMorgan Securities, wrote in a note.

Deep-seated fiscal reforms, including improving the business climate and fighting corruption, could help accelerate growth and unlock the $11 billion in funding pledged by the international community at a special conference in April 2018, according to the IIF. That money hinges on such reforms.

Qatar also said in January it will invest $500 million in Lebanese government dollar bonds. It is unclear whether that support has materialised.

Still, some prospective investors remain unconvinced.

"We are underweight Lebanon," said Sergey Dergachev, senior portfolio manager at Germany-based Union Investment. "There's very few items that make us feel confident about increasing our position as the problems haven't been solved on the ground and the long-term plan remains quite weak."

Dergachev said it would be tough for Lebanon to issue at the moment given uncertainty over the U.S.-China trade spat.

(Additional reporting by Tom Perry in Beirut; Editing by Toby Chopra) ((Tom.Arnold@thomsonreuters.com; +442075428510; Reuters Messaging: tom.arnold.thomsonreuters.com@reuters.net))

More From Levant