Reflective of Lebanon’s shortage of foreign capital, the Lebanese government recently announced it will stop payment on all future maturing eurobonds. In parallel, government and financial circles have increasingly discussed the potential need for a package by the International Monetary Fund (IMF) to supply the majority of the needed capital. In this roundtable, co-produced by the Lebanese Center for Policy Studies (LCPS) and Jadaliyya, three analysts share their views of the amount of capital needed, the potential implications of IMF involvement, and what might need to be different this time around vis-à-vis international borrowing.
LCPS and Jadaliyya (LCPS&J): How much foreign capital does Lebanon need and for what purpose?
Mohamad Faour: Lebanon would require at least thirty billion US dollars of capital over the next three years to weather the current economic storm. These funds would be used for five purposes. First, provide much-needed foreign currency liquidity for its balance of payments, especially in light of a dire currency crisis and dwindling reserves in an environment in which little, if any, regular capital inflows are to be expected for the foreseeable future. Second, help recapitalize and restructure the banking sector, which is effectively insolvent. To put things in perspective, on a consolidated basis, the banking sector’s capital base stands at circa twenty billion US dollars. However, this is based on very optimistic and grossly overvalued estimates that do not take into account that the market values of these assets have significantly deteriorated. If banks were to revalue their assets based on their current market values, this capital will be fully wiped out. Therefore, full recapitalization is required, which would take the form of capital injections and/or depositor bail-ins. While a combination of both capital injections and bail-ins of big depositors is likely, larger capital injections would help minimize the damage that is expected to be incurred by depositors as a result of a bail-in. The third purpose of foreign funding is to help ease the pain associated with the adjustment period. Signaling credibility to creditors during Lebanon’s anticipated debt restructuring negotiations is a fourth purpose. With an interest bill that currently stands at around twelve percent of Lebanon’s annual GDP and forty-seven percent of annual government expenditure, a deep debt restructuring program is of utmost importance. This may only be possible with an IMF-backed program that signals Lebanon’s seriousness to creditors. The fifth and final purpose is to restore investor confidence to re-attract capital into the country, by providing much-needed financing of gradual economic adjustment and stabilization.
Alia Moubayed: Lebanon may need around thirty billion US dollars of external capital in the next three years. This will depend on the credibility of the planned fiscal and exchange rate adjustments, the depth of the public debt restructuring, and the successful recapitalization of the banking sector. The thirty billion covers three types of needs:
- First is the need to rebuild a positive net foreign exchange position at the central bank. Indeed, Lebanon has been running large current account (CA) deficits—averaging eighteen percent of annual GDP for 2002–2018 (or fourteen billion US dollars in 2018). These were financed by external borrowing, by attracting non-residents deposit inflows (including deposits of the Lebanese diaspora), and by depleting foreign currency reserves of the central bank. Although the current account deficit is narrowing as the economy contracts, it will likely remain large at thirteen percent of GDP (around five billion US dollars) annually in the coming few years (2020-2022). Given the sudden stop of capital flows, Lebanon will, thus, need to secure circa seven billion US dollars per year to finance this deficit, to replace the continued capital outflows (one to two billion US dollars during 2020-2022) as well as gradually rebuild the reserves buffer.
- Second is the need to recapitalize a smaller banking system after the restructuring. The requirement for banking sector recapitalization under a deep debt reduction scenario (sixty to seventy percent haircut on public debt) could be around twenty-seven to thirty billion US dollars, a large part of which could be funded locally through a bail-in program using large depositors’ money. The remaining part, about four to six billion US dollars, requires fresh external capital to minimize the impact of the losses on small depositors (i.e., those with less than one hundred thousand US dollars).
- Finally, there is the need to support growth and jobs. Given the contracting economy, two to three billion US dollars for investment are needed per year to support growth revival while attending to the acute shortage of infrastructure.
Nasser Saidi: The amount of foreign financing needs to be viewed within a comprehensive, multi-year adjustment and reform program that tackles macroeconomic, fiscal, banking, financial, monetary, and currency sectors of the economy. There are four components to such a program: macroeconomic and structural reform; banking sector restructuring; public debt restructuring (including central bank debt); and social welfare.
According to government estimates (revealed at a recent presentation to investors) public debt was 178 percent of GDP at end-2019. The cost of servicing the debt would be just over ten billion US dollars, which is equivalent to approximately twenty-two percent of GDP and more than sixty-five percent of government revenue. This was an unsustainable position even before the country fell prey to the COVID-19 outbreak. Separately, the central bank (BdL) owes 120 billion US dollars to the local banks. BdL foreign exchange holdings have come under high pressure, dropping to about twenty-nine billion US dollars in January 2020, of which twenty-two billion are liquid (eighteen billion of which is BdL-held mandatory banking sector reserves). It is evident that the banking system needs a comprehensive restructuring.
Given public debt and fiscal unsustainability, the prices of sovereign debt have plummeted by an average of about fifty percent since the end of 2019. With about seventy percent of total bank assets invested in sovereign and BdL debt, the write down of debt means that banks’ equity has been wiped out. Bank recapitalization and restructuring will require some twenty-five to thirty billion US dollars, of which I estimate some ten billion would be foreign financing. In addition, a foreign aid package of twenty-five to thirty billion US dollars will be needed for macroeconomic and fiscal reform, structural adjustment, central bank restructuring, and balance of payments support, along with the establishment of necessary social safety nets.
This will necessitate an IMF program and multilateral financing. For it, there should be a completely redesigned CEDRE II program. I call it a “Lebanon Stabilization and Liquidity” fund. It is important to note that the overall cost of adjustment and required financing is rising due to unwarranted delay in approaching the IMF for assistance and designing the financing.
Furthermore, the ongoing COVID-19 outbreak is adding more fuel to the fire. We can expect a GDP contraction of twenty percent, following a seven percent dip last year. The government has promised financial aid of four hundred thousand Lebanese liras (approximately 140 US dollars, at the parallel market rate of 2,900 liras/dollar) to the most vulnerable families (roughly estimated at 185,000 families combining those registered with the National Poverty Targeting Program, those drivers forced off the job by the lockdown, and frontline healthcare workers). But that will not be sufficient. The sharp drop in economic activity has led to growing layoffs and unemployment, business closures and bankruptcies, and overall falling incomes—all pushing more people into poverty. Social and economic conditions are rapidly deteriorating: Almost half of the population now lives below the poverty line; non-performing loans are likely to increase and many banks could become insolvent; the value of the Lebanese lira is now some forty to fifty percent less on parallel markets fueling inflation; and Human Rights Watch finds evidence of discretionary measures against refugees. The recipe for political and social unrest is boiling.
LCPS&J: What are some of the political and economic implications of securing such capital from the IMF? Could you identify other possible streams of foreign capital that could substitute for an IMF bailout program?
Alia Moubayed: Given the size of identified losses by the government (eighty-three billion US dollars), it is difficult to imagine a scenario without an IMF program. Other donors may in fact insist on one as a pre-requisite, before pledging any support on their part. Accordingly, Lebanon will need to nurture and consolidate its strategic relationship with key donors (i.e., the United States, the European Union, China, Japan, Arab states) to ensure their support at both the multilateral and bilateral levels. IMF financing will require the strict implementation of reforms necessary to regain fiscal and external sustainability. While those reforms will include fiscal consolidation, currency devaluation, a robust credible debt restructuring, and BdL/banking sector recapitalization plan, the sequencing matters. I do not believe that front-loaded austerity measures are socially and politically viable, especially that the economy will suffer a sharp contraction in GDP, along with higher inflation and unemployment, which will likely cause political and security tensions. In order to reduce those risks, the reform plan needs to be home grown, in other words led and prepared by the Lebanese government after public consultations, in a way to gather the buy-in and support from a wide range of stakeholders, including policymakers, parliamentarians, private sector organizations, civil society organizations, and more. An IMF program will require politicians to deliver on robust and credible policy frameworks, commitment to and timely implementation of reforms, as well as accountability toward domestic and external stakeholders. They have failed doing so in the past decades, will they do now?
Mohamad Faour: Unfortunately, we are not spoiled for choice when it comes to alternative sources of foreign capital. Given the country’s far from stellar track record in implementing much-needed reforms, most if not all potential donor countries have lost confidence in the Lebanese state’s willingness to implement economic and structural reforms. Multiple rounds of international financial aid, starting from Paris I, II, III and finally CEDRE, are testament to this mortifying failure. Furthermore, Lebanon’s creditors are unlikely to buy into a deep restructuring of the country’s debt if it is not frontloaded by an IMF program that puts the country back on the path of debt sustainability. Given these circumstances, we are now left with none other than the IMF to provide the umbrella that helps regain donor confidence, attract much-needed foreign aid, and signal credibility to creditors.
The political implications of an IMF program are largely dependent on the details and conditionalities of the program, which should be tailored to the specificities of Lebanon and its circumstances. A regressive program will come with adverse social and political consequences that would have negative feedback effects on economic stability and recovery. It is therefore necessary for the Lebanese government to propose a credible and viable economic plan that works for the country and protects the poor and middle class from the inevitable adjustment costs associated with the expected recession. This program can then be used as a basis for negotiations between a strong Lebanese negotiating team and the IMF.
Nasser Saidi: The political and economic implications of an IMF program are all positive, as this would include the development and implementation of a social safety net to shield the more vulnerable segments of the population. IMF program conditionality will force an irresponsible and corrupt political class and its subservient policymakers—who are responsible for Lebanon’s catastrophic demise—to undertake needed reforms (e.g., electricity, fiscal, monetary, and exchange sectors) that should have been undertaken years ago. The policy conditionality would be based on the national program the government should prepare beforehand. An IMF program will add credibility to the reforms included in the proposed Lebanon Stabilization and Liquidity fund.
It is bitter medicine, but the alternative would be lost decades, growing misery and poverty, and the destruction of Lebanon’s economic base. The IMF itself would only be providing part of the funding (some four to five billion US dollars) with the balance coming from other international financial institutions (IFIs), the European Bank for Reconstruction and Development, and the European Investment Bank, and CEDRE participants, including the European Union, the Gulf Cooperation Council (GCC) countries, Japan, and China. It is important to note that non-IMF funding will only be available if there is an agreed IMF program. None of the countries and IFIs, including the GCC and European Union will provide aid and funding without it. The same is true for private sector investment and finance (e.g., for public-private partnerships), restoration of Lebanon’s access to capital market, or for a sustainable restructuring of Lebanon’s debt. There are no substitutes to an IMF bail-out program and conditionality. Lebanon desperately needs external funding. It cannot rely on purely domestic funding for the restructuring of its public debt and its banking sector (including BdL), investing in infrastructure, reforming public finances and rekindling and supporting the private sector, as well as provide balance of payments support.
LCPS&J: Given the Lebanese government's poor track record in effectively managing foreign aid, what measures should it take to ensure that such funds are put to meaningful financial recovery?
Nasser Saidi: The government must introduce an anti-corruption and stolen asset recovery program. Transparency International ranks Lebanon forty-third-most corrupt out of total of 180 countries. Protestors have, justifiably, focused on rampant high-level corruption, bribery, and rife nepotism.
The current government must prioritize combating corruption at all levels. This should include: (1) Appointing and empowering a special anti-corruption prosecutor and unit; (2) implementing an anti-corruption program with respect to taxation and revenue collection; (3) reforming government procurement law and procedures; (d) establishing strong and independent regulators in sectors such as banking, financial, telecoms, oil and gas, electricity, among others. And the posts should be filled making sure that the process is completely transparent and that appointees are shielded from political and sectarian influence.
Last, but not least, the state must recover assets that politicians, policymakers, and their associates illicitly and criminally appropriated. Recovering stolen assets can be a wealth-regenerating strategy if implemented properly with complete transparency. Lebanon should immediately participate in The Stolen Asset Recovery Initiative (StAR), a partnership between the World Bank Group and the United Nations Office on Drugs and Crime (UNODC). StAR works with “developing countries and financial centers to prevent the laundering of the proceeds of corruption and to facilitate more systematic and timely return of stolen assets.”
Mohamad Faour: The crisis is primarily one of poor governance and a sectarian political system that has outlived its usefulness (if any). Credible reform at the institutional level should therefore be part and parcel of any economic rescue plan, which would, by extension be incorporated into an IMF program’s conditionalities. Such measures include, among many others, an independent and empowered procurement and tendering agency to subject all state contracts to scrutiny, empowering the Audit Bureau, a fully-dedicated anti-trust authority with far-reaching powers, regulators for the electricity and telecom sector, abolishing banking secrecy in full, the implementation of a serious procedure to investigate and track questionable spending (popularly known as stolen funds), preventing the central bank from funding wasteful state deficit as was the case for decades, etc.. A full-fledged IMF program with such conditionalities can help anchoring the implementation of such measures. The absence of institutional reforms that help tackle the inherent corruption risks wasting any forthcoming foreign aid.
Alia Moubayed: Weak fiscal institutions, fragmentation of the budget process between current and capital expenditure planning and execution, and the absence of a modern and competitive procurement framework have all contributed to a poor track record in managing foreign funding. Lebanon needs to address these weaknesses in order to regain the trust of international donors and deliver on a series of critical public financial management and public investment management reforms necessary to secure value for money, improve the efficiency of spending, and support fiscal consolidation efforts. Some key measures include:
- Restoring the credibility of the budget and developing a medium-term expenditure framework, by ensuring the budget is realistic, comprehensive, transparent, consistent with government policy, and implemented as intended in an orderly and predictable manner.
- Ensuring efficient investment planning, allocation, and implementation: Through a unified, medium-term planning, and the adoption of objective criteria for appraising and selecting projects. In this respect, the government should implement the recommendations of the IMF’s Public Investment Management Assessment.
- Strengthening the procurement system building on the extensive work done by the Ministry of Finance (Institute of Finance) to modernize the public procurement law and framework.
[This roundtable was coproduced by the Lebanese Center for Policy Studies (LCPS) and Jadaliyya.]