Fitch: reserves sufficient
for external debt payments

Conditional on

maintaining capital controls

Fitch Ratings said that assets in foreign currencies at the Central Bank (BDL) are sufficient to cover Lebanon’s external debt payments in 2020 and 2021, provided the restrictions that the banks introduced in November 2019 on deposit withdrawals remain in place.

Fitch said that payments of debt obligations are unlikely because of political considerations.

It said that BDL has $29 billion in gross foreign currency reserves that it can tap to cover gross external financing requirements, which it estimates at $9.8 billion in 2020 and $9.3 billion in 2021. This would lead the reserves to drop to $20 billion at the end of 2020 and $10 billion at the end of 2021.

Fitch said that the country’s public debt is not sustainable without some debt restructuring. It considered that an agreement with the International Monetary Fund (IMF) is the most likely scenario for external financing support. It said that a financing package from the IMF would require some restructuring of the sovereign debt, as the Fund is unlikely to lend money without putting the debt on a sustainable path.

Fitch expressed concerns on differentiating between resident and non-resident bondholders, and on eventual litigation from lenders. It said that restructuring negotiations could be complicated by the absence of enhanced Collective Action Clauses (CACs) for Lebanese Eurobonds, which means that Lebanon will have to negotiate with the bondholders of each series.

As part of its efforts to limit the drain on its foreign currency 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). If so, Fitch said it is likely the country will be further downgraded. “The prioritization of available foreign currency for debt service implies an ongoing and severe recession, accompanied by higher rates of inflation and unemployment and prolonged crisis in the financial sector,” said Fitch. “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,” it said.

Government debt restructuring could take different forms and negotiations with bondholders could prove complicated. Some restructuring of foreign currency debt appears likely. More than 60 percent of government debt is denominated in lira. Even if Eurobonds were restructured with a 60 percent nominal haircut, this would reduce government debt by only 33 percent of GDP (assuming the current official exchange rate). This would leave total government debt at roughly 120 percent of GDP. 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 stabilization 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,” said the Fitch report.