Lebanon’s Delusional Default Designs

Lebanese stocks at the bottom of the MSCI frontier market pack last year continued to slide through March as the interim government prime minister, a former academic, declared the 150% of GDP public debt unsustainable and officially defaulted on a $1.2 billion Eurobond payment. The rest of the $30 billion outstanding, around half the domestic amount, will be restructured as he warned that the “delusion” of choosing between covering imports and reimbursement with thin foreign reserves had ended. Prior to the action the sovereign credit rating was downgraded to near bust “CC,” while index providers weighed expulsion from benchmarks on tightening capital controls with the informal exchange rate reflecting 25% depreciation in the longstanding 1500/dollar peg. The instrument price plummeted toward the 20-30 range and default swaps will soon be triggered as ISDA rules set the clearing auction level. Local commercial banks are the overwhelming holders after a series of central bank high-yield “financial engineering” maintained subscription in recent years. They lost $15 billion in deposits in 2019, and apply curbs on daily withdrawals and may now face balance-sheet write-downs.

 The IMF and World Bank have been contacted for precautionary facilities and technical advice, as a $10 billion previous international aid package remains in limbo pending fresh elections and structural reforms to close the chronic fiscal deficit. The regime set off large scale violent protests with a proposed internet use tax, following an extended failure to collect street garbage and provide reliably electricity through the state electricity company. The government named legal and financial advisers for negotiations, and UK-based Ashmore has a blocking stake in short term maturities with the 75% collection action clause voting threshold for new terms. The true reserve position will drive the process, with Fitch Ratings estimating that it may be $40 billion net negative with lines to domestic banks and other institutions, including satisfying correspondent relationships essential to diaspora business. Authorities had earlier floated a swap to lengthen tenors quickly exposed as unrealistic with interest payments already gobbling up 40% of shrinking budget revenue. The remittance scare with massive unrest also coincided with a Gulf tourism break amid economic worries in that region, and the prospect of another Syrian refugee wave as President Assad and Russia cleaned out the last civil war rebel pockets.

Neighboring Mideast markets were largely trading flat with their own fiscal and current account gaps and mixed IMF program record. Egypt as the sole core universe representative lost luster as last year’s favorite with privatization listings slow to materialize and a regime crackdown on political opponents, reinforced by austerity measures, heightening investor and tourist unease. Jordan has its own teeming Syrian refugee population alongside the legacy of the Palestinian one, with the long awaited Trump administration peace proposal with Israel complicating and narrowing the parameters for an eventual separate state. The King replaced the cabinet after subsidy cut and living cost demonstrations, but it has yet to inspire business and financial community confidence. Tunisia after months of wrangling agreed on ruling coalition formation but the party lineup is volatile as Fund policy items are delayed and missed, with economic “spring” readily cast as a delusion.

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