Lebanese Debt Death Spiral
Christian Abou Tayeh / Linkedin
20 سبتمبر 2018
This article intends to provide a general, albeit concise, overview of the Lebanese Debt Crisis that’s (finally) made its way into the public conversation. All figures and facts quoted in the articles are sourced from documents made public by the Ministry of Finance and the Lebanese Central Bank. Lebanese Lira has been converted to US Dollars at 1507 LL/USD.
This article is the result of collaboration with Vincent Khoury, Marwan Matar, Christian Adib, Anthony Daou, Wadih Kassis, who have provided facts, ideas and arguments. We do not claim absolute knowledge of the details of the Lebanese government’s finances (made harder by a lack of transparency) so comments, corrections and feedback are welcome. We encourage a discussion of this topic and any other initiative that increases awareness of the dire financial situation of the country.
We hope that this will be the first of a series highlighting the economic and financial challenges in Lebanon.
It’s almost ironic that a decade after the financial crisis that crippled the world but provided a boon for the risk-averse Lebanese banking sector, the recovery from that crisis seems to be bringing the Lebanese economy to its knees. Capital inflows in 2008 and later during the European debt crisis provided the liquidity needed for the Central Bank to maintain the currency peg, and shore up reserves, while the public deficit was growing larger.
With an excessive reliance on remittances from the diaspora in the Arab Gulf, United States, Europe and Africa, no exports to speak off and an almost religious adherence to the currency peg to the US dollar, it was always a matter of when, rather than if, the situation will reverse. Today, as capital inflows are harder to come by, the Lebanese economy is waking up to the reality of a potential crash.
To understand the gravity of the situation, we should consider Lebanon’s debt comparatively to the size of its economy.
Lebanon’s Debt-to-GDP is 152% as of the end of 2017, third to Japan and Greece. This does not account for the $11+ billion that were raised in April from international donors. Accounting for that debt would raise Debt-to-GDP to 175% with GDP at the current $52 billion.
Years of mismanagement of public finances, corruption, lack of fiscal discipline, and spending for political gain have increased debt at an annualized 7%. As of June 2018, gross public debt stood at $83 billion.
Interestingly, in the past 6 months, USD debt increased by 15.5%, while historically foreign currency debt grew at 6.4% annually. This is due to an increased need to finance the increasing twin deficits (budget and current account) in foreign currencies.
An increasing local currency is a simpler problem than foreign, as the Central Bank can print money to pay it off. This will have repercussions on inflation and the sustainability of the currency peg, but it’s a realistic short-term fix.
Ballooning foreign-denominated debt presents several issues, with the main one being the fallout of the monetary tightening by the US Federal Reserve. Improving economy in the United States has led the Federal Reserve to increase interest rates thereby making borrowing in USD much more expensive (with two more 0.25% hikes expected in 2018). This means other countries looking to raise USD to pay off debt will have to pay higher and higher interest rates.
When a small country like Lebanon, suffering from anemic GDP growth and (again) a religious attachment to the currency peg, this puts the Central Bank in an impossible bind: how to spur the economy to grow, when the interest rates are being, effectively, set higher by another country?
Another explanation of the USD-debt is LL/USD swaps that the Central Bank is effecting to increase USD reserves, in order to defend the currency peg. The Central Bank cleverly calls these operations “Financial Engineering”, but they are standard swaps that cost heavily in transaction fees and issuance discounts.
As debt has grown so have interest payments, though at a lower rate than debt at 3.4%. The average interest rate has been around 6.2%.
Now, interest payments in isolation aren’t really very interesting, which leads to the next point: The Fiscal Deficit.
Successive Lebanese government have generally lacked transparency when it comes to the yearly budget. Due to political squabbling, amongst other things, the public never got a look at public finances. In 2018, pushing for transparency, the Ministry of Finance published a budget report. Main takeaways are that:
– Government expenditures are expected to amount to $19.1 billion in 2018
– Interest payments represent 29% of those
– Public salaries and benefits, which constitute large welfare programs, take up 35%
– The loss-making National Electricity Company sucks up 7%
– Capital Expenditures (i.e. on infrastructure and growth projects) is also 7%
On the other hand, the government only expects to take in $12 billion in revenue from taxation and State-Owned Enterprises.
Consequently, the deficit will be around $7 billion = 37% of the budget = 14% of GDP.