Can Lebanon’s new PM save the economy?

Nominated with the support of Iran-backed Hezbollah and its allies, Prime Minister-designate Hassan Diab and the cabinet he has vowed to form quickly must win over investors and foreign donors.

What are the main concerns for investors as Lebanon grapples with a hard currency shortage, a huge public debt and a weakening currency?

HOW LIKELY IS A DEBT DEFAULT OR RESTRUCTURING?

Lebanon’s public debt burden, equivalent to around 150 per cent of GDP, and its twin current account and fiscal deficits looked unsustainable even before anti-government protesters took to the streets two months ago.

Lebanon will face a test of its ability to meet its obligations in 2020, with $10.9 billion of debt maturing across the year, including a $1.2 billion eurobond due in March, Refinitiv data shows.

The international sovereign bonds continue to trade at less than half their face value, while credit default swaps have rocketed, suggesting Lebanon may be drifting towards a default.

But that might not be a given.

“A combination of fiscal reforms and a restructuring of the domestic debt could be enough to put public finances on a sustainable footing without having to resort to an external default,” Farouk Soussa, senior economist at Goldman Sachs, said in a note this week.

And even if a default does occur, Lebanon might be able to cushion the fallout.

Central bank holdings of government securities implied that Lebanon had near-term debt management options that would limit losses borne by the private sector in the event of a default, Moody’s Investors Service said in a note.

IS A CURRENCY DEVALUATION A GIVEN?

Lebanon’s 22-year-old peg to the US dollar has been strained to near breaking point by the country’s political and banking crisis.

With the pound losing roughly a third of its official value on the black market, a devaluation has loomed increasingly large.

Central Bank Governor Riad Salameh governor has ruled out any such move, saying the government has the means to maintain it.

But without a revival in sagging capital flows and a recovery in Lebanon’s external balance sheet, the central bank’s ability to defend the peg will diminish.

Foreign exchange reserves have already dwindled to $28 billion, according to Goldman Sachs.

Economists say, at least in the short-term, a devaluation could be harmful as it would push up Lebanon’s already steep overseas liabilities - hastening the risk of a default. It would also likely stoke inflation, at 1.3 per cent year-on-year in October.

HOW CAN THE BANKING SYSTEM BE REVIVED?

Banks have long served as a vital cog in keeping Lebanon’s economy moving. By taking deposits from Lebanon’s millions of scattered diaspora and snapping up the government’s local debt, banks helped prop up the state’s finances. But that system has broken as foreign deposits dry up amid a collapse in confidence in the banking system.

Non-resident deposits in the banking sector fell by 5.2 per cent on an annual basis in October, while Lebanon faces a hard currency shortage - leaving Lebanese at home and abroad with restricted access to their bank funds.

“Restoring confidence in the financial system needs to include restoring confidence in the political management of the system. This is a ‘financial translation’ of what thousands in the streets of Lebanon have been demanding,” said Walid Alameddine, former chairman of Lebanon’s Banking Control Commission and a recent former candidate to be prime minister.

Depositor haircuts would be “counter-productive”, Alameddine warns. Instead, banking deposits should be guaranteed by the state to help restore confidence.

WHAT ABOUT SECURING FOREIGN FINANCIAL SUPPORT?

Lebanon is mired in recession and its recovery remains largely dependent on Diab’s ability to form a new government and make reforms needed to secure overseas financial support.

Lebanon won pledges of over $11 billion at an international conference last year conditional on reforms that it has so far failed to implement.

Further support appears uncertain given Diab’s support from Iran-backed Hezbollah and its allies.

Gulf states, which have provided financial aid to Lebanon in the past, have appeared more circumspect during the latest crisis and may be even less willing to stump up with Diab in power.

Instead, Lebanon may look to Qatar, accused by its Gulf neighbours of more closely aligning itself with Iran. Qatar will stand by Lebanon during its economic crisis, Qatari Finance Minister Ali Al Emadi said this week.

Lebanon’s now departed caretaker prime minister Sa’ad Hariri had been discussing the possibility of technical assistance from the International Monetary Fund and World Bank.

But it is unclear whether Diab will pursue such a path and some observers warn the United States, the largest financial backer of those institutions, could oppose any deal due to the role of Hezbollah and its allies in designating Diab. Washington regards Hezbollah as a terrorist group.