“We believe that some form of government debt restructuring is probable, as reflected in our decision to downgrade the sovereign's rating to 'CC' in December 2019,” Fitch Ratings said in a report on Lebanon.
“We estimate Lebanon's gross external financing requirement in 2020 at around USD10 billion, moderating close to USD9 billion in 2021.”
“We assume that the main financing item will be the foreign currency (FC) assets of the central bank (Banque du Liban; BdL). BdL had around USD29 billion in gross FC reserves at its disposal as of end-January 2020, according to our calculations, with reserves continuing their decline in February. However, the overall net FC position of BdL is negative, according to Fitch's estimates”
The agency noted that the Central Bank’s idea of a debt exchange with Lebanese banks under which their holdings of Eurobonds maturing in March 2020 might be considered a Distressed Debt Exchange (DDE).
“If so, we would likely downgrade the rating to 'C'. When the exchange was complete, the rating would likely be downgraded to Restricted Default 'RD',” it warned.
“The prioritization of available FC for debt service implies an ongoing and severe recession, accompanied by higher rates of inflation and unemployment and prolonged crisis in the financial sector,” it indicated, questioning the move that would fail to achieve a more sustainable financial position.
Turning to external financial support as an agreement with the IMF is the most likely scenario, the report noted, as it would almost certainly require some restructuring of government debt.
“More than 60% of government debt is denominated in Lebanese pounds. Even if Eurobonds were restructured with a 60% nominal haircut, this would reduce government debt by only 33% of GDP (assuming the current official exchange rate),” the report mentioned.
“Restructuring of domestic debt, which is all held locally, would help to address this,” the report stated, outlining that this would only be part of the challenge.
“Fundamentally, debt sustainability will be contingent on a meaningful fiscal and structural reform process,” Fitch Ratings pointed out, adding that “to achieve economic stabilisation the authorities may also have to address the Central Bank's liabilities and the intertwined balance sheets.”