As part of its efforts to limit the drain on its FC reserves, BdL in January raised the idea of a debt exchange with Lebanese banks under which their holdings of Eurobonds maturing in March 2020 would be swapped for longer-dated Eurobonds in its portfolio. While the government suspended this idea, it may still be considering it.
Such a transaction might be considered a Distressed Debt Exchange (DDE), according to our published criteria. If so, we would likely downgrade the rating to 'C'. When the exchange was complete, the rating would likely be downgraded to Restricted Default 'RD'. We would make such a determination at the time of announcement of such a debt swap. In our view, to be considered a DDE there would need to be a material reduction in terms, which could include a maturity extension, and the exercise would be undertaken to avoid a default.
The prioritisation of available FC for debt service implies an ongoing and severe recession, accompanied by higher rates of inflation and unemployment and prolonged crisis in the financial sector. The difficulty of enacting fiscal and structural reforms against this background makes it unlikely that this strategy will ultimately lead to the government achieving a more sustainable financial position, or to a renewal of confidence in the financial and monetary system.
We regard the most likely scenario for external financial support as an agreement with the IMF, which would open up other sources of external finance, including from the World Bank and bilateral partners in the Gulf. An IMF deal would almost certainly require some restructuring of government debt.
Government debt restructuring could take different forms and negotiations with bondholders could prove complicated. Some restructuring of FC debt appears likely given Lebanon's unsustainable FC position. Nonetheless, more than 60% of government debt is denominated in Lebanese pounds. Even if Eurobonds were restructured with a 60% nominal haircut, this would reduce government debt by only 33% of GDP (assuming the current official exchange rate). This would leave total government debt at roughly 120% of GDP, still exceptionally high. Restructuring of domestic debt, which is all held locally, would help to address this.
Government debt restructuring will be only part of the challenge. To achieve economic stabilisation the authorities may also have to address the Central Bank's liabilities and the intertwined balance sheets of the BdL and the commercial banks, which could have implications for depositors. Fundamentally, debt sustainability will be contingent on a meaningful fiscal and structural reform process.
Our report, "Lebanon: Balance Sheet Analysis Points to Restructuring of Debt and Financial Sector", is available at or by clicking on the link above.
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