Lebanese Debt Death Spiral

Christian Abou Tayeh / Linkedin

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.

Debt Situation


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.

Debt Accumulation

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.

Interest Expenditures

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.

Government Budget

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.

This is clearly not healthy or sustainable, which leads to the crux of the problem …

Debt Death Spiral

Let’s summarize the figures:

GDP = $52 billion (per World Bank), and growing at 1-2%

Debt = $83 billion

Interest Payments = ~$5 billion

Yearly Deficit = $7 billion

With debt ballooning, GDP growth anemic, infrastructure investment limited, and interest rates rising around the world, the inevitable consequence for Lebanese debt is a death spiral.

Larger Deficit, leads to more debt, leads to higher interest payments, leads to larger deficit, leads to more debt, etc etc etc etc

How do the markets think the country finances will hold up? If Credit Default Swaps (CDS) are the indicator to follow (which they are), then it’s a bleak picture:

Since September, the CDS spread has increased from around 400bps (= 4%) to 759bps (=7.6%) today. This means for every $100 in Lebanese Government bonds that an investor wants to protect, they have to pay $7.6 in insurance yearly. The ripple effect of the CDS rising will be felt in the economy: bank will have to hike up interest rates on Lebanese Lira loans to protect against currency risk, Government debt will become more expensive to finance, and eventually the credit rating agencies might want to reconsider their “stable” outlook.

For comparison, Argentina’s CDS spread is 640bps and Turkey’s CDS is at 400bps. Given the economic collapse those countries have suffered, it is somewhat logic-defying how the Lebanese has stocked up so far.

Unfortunately, this situation can be better described as paper over cracks, with every leak becoming larger and larger. At one point, the dam is going to explode.

Potential Solutions and Remedies

It would be typically Lebanese to go over a long list of issues, complain, then shrug and carry on, but we are trying to set a new approach to things and hopefully lay stronger foundations for our country. Hence, we considered several remedies to the current issues. More experienced, creative and knowledge people can add plenty more, but here are our suggestions:

Grow out of the Debt

The approach here would be to invest heavily in infrastructure, and stimulate investment in productive sectors of the economy. This can be built on the recommendations presented by McKinsey to the Ministry of Economy a few months ago. Stimulating the economy would unshackle GDP growth from its 1-2% growth, and lead to a lower debt-to-GDP rate and growing tax receipts.

The $11 billion raised in April have been earmarked for developmental projects, but donors are still awaiting plans from the Lebanese government. The country though has not had a functional government since May, and no concrete plans have been put together. In addition, with only 7% of government expenditures going towards capital projects, it is highly unlikely for any in-house financing to take place. In 2013, the oil & gas deposits found in the Eastern Mediterranean were hailed as a $200 billion opportunity to get out of the rot. 6 years on, the final bidding round has been pushed back yet again due to political bickering.

With the current political class showing remarkable incompetence for the past 30 years to grow the economy, why would it be capable of handling such programs going forward?

Trim the Deficit

The interest payments can, potentially, be reduced subject to a renegotiation of loan terms with donors and some sort of refinancing of treasury bonds. However, given the current dire situation, this is unlikely to take place precedent to an actual economic reform.

The more viable approach would be through some sort of austerity and a reduction in social benefits and entitlements. This topic requires a separate discussion, but the government’s current public servant benefits runs akin to a welfare-program for political gain. Current political leaders run on populist platforms and would hesitate to cut spending. On the other hand, grassroot parties and civil movements are left-leaning and if they are voted into parliament, would push for an expansion of the welfare state.

It would also be quite a slap-in-the-face if the population must suffer from austerity due to years of mismanagement and corruption by the political parties. This option would be unlikely.

Unpeg the Lebanese Lira from the US Dollar

Lebanese Lira has been pegged to the US Dollar since the 1990’s after wild volatility during and just after the Civil War ended in 1990. The peg is now considered the main indicator of financial health and has become the be-all end-all of the economy.

However, to maintain the peg given deteriorating conditions, the Central Bank has had to pull off riskier and riskier operations, costing the treasury substantial amounts of money.

In addition, the peg inflates the prices of Lebanese goods on the international markets as the US Dollar appreciates. With little exports to speak off in the first place, the peg has removed the incentive to develop local products and service to export, as imports have become cheaper.

Unpegging the currency would be messy. It will lead to wild inflation initially, and maybe even require a negotiated restructuring of the debt before it takes place. It is not unheard of however, as Egypt devalued its currency by 48% to meet IMF standards for a loan.

On the other hand, an unpegging might present a good opportunity to start off from a clean slate. Devalued currency would make Lebanon an attractive location for multinationals to relocate into, especially since the country has the most educated population in the region.

Other Solutions?

Plenty more low hanging fruit can sort out this mess…

In conclusion, this is where the country stands, right on the brink of a death spiral. News outlets (politically affiliated), politicians, and other public figures have been bullish on the situation. There’s no reason for them not to be, this is largely they’re own doing. We can hope that the country will avoid a crash, but financial markets don’t have a lot of sympathy for people’s hopes.

This might be an opportunity though, to restructure and rebuild.