Should Lebanon Default? A Take by Nisreen Salti

February 18, 2020
Should Lebanon Default? A Take by Nisreen Salti

Debt Restructuring Is Risky and Complex, but Should Happen

As part of its effort to build constructive dialogue on important national issues, LCPS solicited the opinion of key experts who have varying perspectives on whether Lebanon should default. We invite you to read their different views in the next few days.

Paying Lebanon’s $1.2 billion in Eurobonds in March involves tapping into the Central Bank’s rapidly dwindling dollar reserves, to pay bondholders that are increasingly foreign. The stated advantage of honoring the Eurobond contracts is to save the country’s reputation on the international borrowing market in order to preserve its ability to borrow again. This perceived gain holds if the decision is not just to pay the dues in March, but also all those in the near future, which amount to another $3.73 billion by April 2021. Proponents of repayment believe that doling out another $5 billion of our reserves over 14 months is a worthwhile cost just to avoid the stigma of restructuring. Unless they know of an upcoming windfall in the next 14 months, or an expected reversal in our now-chronic balance of payments deficit, this would set our reserves back by 16%, by the Central Bank’s own account.

Yet experience suggests that countries that have restructured their debt have suffered only a short-lived drop in credit ratings. The world is replete with examples of past defaulters who are borrowing again, and at reasonable rates. The past few months have also shown that reputation (as measured by credit ratings and interest rates on public borrowing) is just as sensitive to measures that have resulted from resistance to any debt restructuring thus far: Using reserves to repay debt, barring depositors from accessing their money, discretionary capital controls, and dual exchange rates.

There are, of course, alternative uses of the country’s foreign reserves. Importing essential needs (fossil fuels, foods, medicines, and medical equipment) remains a more pressing use of our limited foreign reserves, and one with a far wider beneficiary base. Another more progressive use of dollars is slowing down, to the extent possible, the depreciation of the Lebanese Lira. This would amortize the currency shock on salaried workers, retirees, and the largely un-pegged lower and middle classes.

Having said that, reticence to debt restructuring is not pure folly. Negotiating a debt restructuring requires expert legal, financial, monetary, and economic planning. The bind the Lebanese economy currently finds itself in is not simply a crisis of debt sustainability. So without addressing the concurrent balance of payment, monetary, and banking crises, no negotiation will bring us large enough concessions from our creditors to put the economy on a path to sustainable debt. The goal should be to negotiate repayment schedules, coupons, and principals that create fiscal space in the short and medium runs to manage the comprehensive reforms needed.

The openness of many foreign Eurobond holders to debt restructuring is a reassuring sign. Understandably, local banks, which still hold a substantial share of the maturing bonds, are less inclined to support it. It is therefore essential that the right set of incentives and constraints be implemented so that the costs of restructuring on creditors are neither prohibitive for the local banking sector, nor passed onto depositors. Another challenge for the government will therefore be to push for a workout that distributes the costs of restructuring equitably.

A debt restructuring plan is risky, delicate and, with Lebanon’s web of inter-connected crises, complex. The more practical question then becomes: Why should people trust a system as corrupt, short-sighted, and inefficient as the one we have to embark on an uncertain and collectively arduous reform path? After all, the risks involved are the reason that governments consistently wait too long before they decide to restructure debt. Incumbency is, in such an instance, a disadvantage. The recent change in government could have been an opportunity to form a cabinet free from that specter of blame. In embarking on reforms that constitute real departures from past policies, the government now stands to show if it is indeed, as it claims, “new.”