All eyes on Central Bank and Finance Ministry as Lebanon’s debt continues to balloon.

Lebanon is ear deep in debt.

The debt-ridden country has been tittering on the edge, with no immediate solution in sight. Suffering dramatically by the regions seemingly never ending chaos, and a lack of strong willed leadership, the country’s economy has been in a NOSEDIVE for several years. Add that to the fact its politicians have stalled on the formation of a government for almost a year now.

The biggest area of concern would be its financial sector, which is facing total and utter collapse smack-dab in its face. Big banks on Wall Street have been upping their rhetoric on the nations ballooning debt. The World Bank recently warned Lebanon faces impeding collapse (Azar 2018). Global Rating Agencies Fitch and Moody both downgraded Lebanon's rating to “Poor”(Azar 2018). Even the good people over at Goldman Sachs reported on Lebanon’s debt and the effect a possible restructuring could have (Azar 2018). All these statements occurred just in the last two months.

Its always been understood that Lebanon has been playing hot potato with its impeding bankruptcy. The Central Bank and its Governor Riad Salemeh can only pull so many rabbits out of a hat. Eventually the serious issues would need addressing. But the sudden spike in interest from Global players on Lebanon’s debt warrants concern. What would happen in the case of a default, or “restructure”? What’s stood to be gained from the country’s ensuing bankruptcy?

Government Bonds

In the world of finance and financial markets, the complexity of the instruments involved makes it extremely difficult to understand. Add to that the “jargon” used and the degree of numbers involved. Without going into detail how financial instruments work, just know that when a Government needs money to finance its expenditures, it can issue what are called “bonds”. Such is the case for any sort of debt financing, even corporate. Sometimes these bonds can be insured, and this where things get swampy.

Credit Default Swaps

Credit Default Swaps (CDS) are like insurance on the underlying bond. It makes sense that, if you purchase something, you’re going to want get it insured, incase of a tragedy. Like when you buy a house, you’d want to get fire insurance on it… incase said house goes up in flames. Similarly, CDS act as insurance in case of a default (fire) to the underlying Bonds (house). When CDS rates spike, what that spike represents is a volatile situation where the underlying asset has become increasingly risky to insure. There’s a reason why insurance companies aren’t keen on handing out policies to 60 year-old chain smokers.

The Greek Tragedy

When the world economy crashed in 2008, a lot of economies struggled to maintain their balance books. Those who had it worst were probably EU countries. Countries like Italy and Greece were tittering. Greece was neck deep, and it 2010 a spike in its CDS ratings saw a fits ability in insuring the its debt questioned. CDS on Greek sovereign debt actually served a positive role: it alerted everyone around the globe that Greece was in a credit death spiral. In 2012 when Greece was forced to restructure its debt; holders of Greek credit default swaps came to collect. In the end the payout was tolerable, a measly $2.5 billion, but many analysts admit that amount came down to pure luck and could have been much worse. Still the case with Greece put into context credit default swaps and Sovereign debt. Greece got lucky, that doesn’t mean other countries will. In the case of Lebanon, that may be the worry.

Lebanese Roulette

Concerns began inside banking circles from the decrease of inflows to the country. When inflows decrease so do the reserves; then so does the Banks ability to lend the Government money, maintain the currency, and finance the debt. Banks increased their interest rates on deposit accounts, in order to keep the diaspora outside of Lebanon attracted to its banking sector. However, this has not stopped financial inflows from declining (Daily Star, 2018). Rates on Lebanese CDS began to rise, which, similar to the Greek situation, set off alarms of the government’s ability to payback its obligations (Cornish, 2018). Investment bankers have confessed to the extreme complexity of the Central Banks engineering. Yet the ship remains afloat even with water flooding its cabins.

The debt has been outstanding since the civil war. To no ones surprise, it doesn’t seem likely that Lebanon will pay back its debt, given a lack of clear plan/strategy. Talks of “debt restructuring” have picked up pace. Similar to Greece, debt restructuring means the government takes a haircut on its debt and pays back cents on the dollar. The cards available on the table make a debt restructuring the best option. Finance Minister Ali Hassan Khalil has religiously denied a restructuring, and has claimed that he intends to pay back his creditors. An option to do that would be to dig into the gold reserves to pay back the debt. In which case the Central Bank would have to unpeg the Lira as it struggles to maintain the peg. In any case the Lira is most likely to be devalued which would probably not sit easy with a lot of people. A jumpstart to the whole system is needed, because frankly the current system is extremely flawed and unsustainable.

Swan Song

Riad Salameh, Governor in Chief at this point, has religiously called the current situation in Lebanon “frustrating”, and that’s putting it kindly (Cornish, 2018). Riad Salameh is very much like that student in a group project that does all work because the other members have no idea what the project is about. Finance Minister in LIMBO, Ali Hassan Khalil, attempted to “reassure” Lebanese, and put recent rumors of a restructuring to rest (Habib, 2019). Economic Minister extraordinaire Raed Khoury, also assured “there is no need to panic” (Habib, 2019). He guarantees that Lebanon is “committed to pay its debt FOREVER”, which, if you ask me, sounds like a pretty long time to pay off a debt. When Stand In Prime Minister Saad Hariri was asked about Lebanon’s financial engineering during an investment conference in London, here is what he had to say: (skip to minute 25:30)

Reassuring.

The Lebanese and the whole world will most certainly be watching along with his Excellency. Albeit it’s not looking like it’s going to be a happy ending.

References:

Vilis. “Lebanese CDS on the Rise Due to the Oversupply of Eurobonds.” BLOMINVEST, BLOMINVEST, 29 June 2018, blog.blominvestbank.com/26256/lebanese-cds-rise-due-oversupply-eurobonds/.

The Irish Times. “Investors to Receive $2.5bn Insurance Payout over Greek Default.” The Irish Times, The Irish Times, 16 Mar. 2012, www.irishtimes.com/business/markets/bonds/investors-to-receive-2-5bn-insurance-payout-over-greek-default-1.482574.

Star, Osama Habib| The Daily. “False Alarm! Khalil Denies Plans to Restructure Debt.” The Daily Star Newspaper - Lebanon, The Daily Star , 11 Jan. 19AD, www.dailystar.com.lb/Business/Local/2019/Jan-11/473771-false-alarm-khalil-denies-plans-to-restructure-debt.ashx.

“Financial Inflows to Lebanon Drop 11.6 Pct.” The Daily Star Newspaper - Lebanon, 27 Dec. 2018, www.dailystar.com.lb/Business/Local/2018/Dec-27/472711-financial-inflows-to-lebanon-drop-116-pct.ashx.

Cornish, Chloe. “CDS Market Signals Risk of a Cash Crunch Looming for Lebanon.” Financial Times, Financial Times, 21 Sept. 2018, www.ft.com/content/bc99d2d4-bcec-11e8-8274-55b72926558f

Azar, Georgi. “Investors to Take a Big Hit If Lebanon Restructures Its Debt - Georgi Azar.” An-Nahar, An-Nahar, 7 Jan. 2019, en.annahar.com/article/922358-investors-to-take-a-big-hit-if-lebanon-restructures-its-debt.

Azar, Georgi. “World Bank: Lebanon's Economic Prospects Look Bleak - Georgi Azar.” An-Nahar, 30 Oct. 2018, en.annahar.com/article/889837-world-bank-lebanons-economic-prospects-look-bleak.

Azar, Georgi. “Lebanon's Credit Rating Takes Another Hit - Georgi Azar.” An-Nahar, 19 Dec. 2018, en.annahar.com/article/916444-lebanons-credit-rating-takes-another-hit.