No Magic fix to the Lebanese Economy. Treat the cause.
After the end of the civil war in 1990, Lebanon required investments to fix its infrastructure mainly telecoms, roads, electricity, Rafic Hariri International Airport, Beirut port and other sectors. These were performed by the public sector and thus there were some inefficiencies in executing the process. Unfortunately, these capital expenditures have resulted in budget deficits that were financed by issuing Eurobonds. The key of success to this strategy was that the investment in the infrastructure of the country resulted in an elevated GDP growth of 6 to 7 percent. Luckily this has worked for the benefit of the country as the GDP growth outpaced debt growth.
A key hazard and crucial mistake that took place thereafter was the gradual shift from investment spending to government spending on recruitment which resulted in an increase in the workforce employed by the public sector to over 300,000. Many Lebanese call this political hiring, which lead to an inflated less productive public sector. Suddenly economic growth started to lose steam due to lower investment spending and an inflated public sector. This was a leading indicator that the public sector did not contribute to an increase in GDP productivity equivalent to the new workforce added to the sector. Now the deficit spending strategy worked against the economy as the public debt accumulated, but GDP growth declined to 1 or 2 percent and failed to keep up with the public debt growth. In 1990, Lebanon had approximately USD 3 billion of debt which was very minimal, and the sovereign rating of Lebanon was BBB equivalent to an investment grade rating. Remember the country had emerged from 15 years of civil war and did not have any proven oil reserves back then. The buildup in the public debt from 3 billion in 1990 to 90 billion in 2020, had put pressure on the Sovereign rating of the country which fell from BBB to RD (restricted default).
Lebanese debt to GDP ratio is estimated at 170 to 180 percent depending on the amount of GDP contraction that is expected in 2020. If GDP contracts to USD 50 billion, then the ratio is estimated at 180 percent. If the aim is to go back to BBB or BB rating then the targeted Debt to GDP is in the range of 100 to 110 percent of GDP. Poland had a BBB rating (investment grade) with a debt to GDP ratio of 120.6% in 2018. Hence the aim is to reduce debt to a manageable level of USD 60 billion (110%x55 billion). Some have the unrealistic idea of erasing the debt which is untrue.
The debt structure is estimated at 31 billion denominated in dollars and 55 to 59 billion denominated in Lebanese pounds. A suggestion would be to reduce the face value of the Eurobonds by 50 percent which would result in a savings of USD 15 billion. No clear statistics are available and the calculations that follow are estimates and educated guesses. Suppose the Lebanese banks held USD 18 billion of the Eurobonds at restructuring then the mark to mark loses to be absorbed by the banks is USD 9 billion. Assume that the Tier 1 banks have CAR of 14 to 16 percent. Moreover, consolidated shareholder’s equity of banks is estimated at USD 22 billion. Thus a hit of 9 billion will bring shareholders equity down to USD 13 billion and CAR down to an estimated value 9%. To maintain a minimum value of CAR of 12 percent a capital increase of USD 4.6 billion is required or 21 percent of current total shareholders equity. As such it is of paramount importance that the banks implement a minimum capital increase of 31 percent of capital (21 % to cover for mark to market losses of Eurobonds investments and an additional 10 percent to provide for the rise in nonperforming loans.)
It is my opinion that restructuring of the Central Bank Balance should be postponed after the Eurobonds restructuring is finalized. It is estimated that the Eurobonds restructuring can take 6 to 18 months. Restructuring of the Central Bank balance sheet will bring more pressure to the balance sheet of banks, and any attempt to do so at the current time would raise the capital requirement of the banks from 31 percent to 100 percent.
Suggested Solutions. (Seven steps)
1. Install 2 gas operated generators with a capacity of 500 Gigawatts from Siemens and General Electric. This should be done soonest and blindfolded without long periods of analysis which lead to paralysis. Pay in 20 years with a grace period of 3 years. Or build, operate, transfer mechanisms can be used coupled with price caps on tariffs.
2. Recapitalize the banks, increasing the capital requirements by 35 percent in the first stage and extended to 100% at later stages. This can be done by a rights issue selling shares at par value initially offered to the current owners and then are offered to the general public. The new shares can be sold at fair value but the valuation exercise will depend on the mark to market loses of the Investment securities and write offs to loans and advances. A rights issue is appealing to the general public and bridges the gap between the banks and their clients. New owners will never line up to withdraw their deposits and will fend off withdrawals. Moreover, in a rights issue the old owners are given the opportunity to subscribe to the new shares before they are offered to the public.
3. Deflate the size of the public sector. Decrease unproductive head count in addition to the review of remuneration packages and end of service indemnity. This will create lots of political resistance, but government should help in finding alternatives in private sector and international opportunities.
4. Work on developing the oil and gas reserves of Lebanon in hope of finding probable and proven reserves of 2 to 3 TCF in the coming 18 months. Drilling should commence on other blocks to shorten the exploration stage. Depending on luck the process can be slowed down by a couple of dry holes.
5. Work on restructuring the Eurobonds limiting the discount to less than or equal to 50% of principal. Avoid restructuring the balance sheet of the Central Bank at the same time of Eurobond restructuring. Postpone for a period of 3 to 4 years.
6. Establish a Lebanese Sovereign fund and transfer oil assets, real estate assets, telecom and electricity companies to the fund collectively or selectively together with the Lebanese sovereign debt and issue shares or debt against the fund assets.
7. Instate laws to fight corruption and ask European nations to place subsidized deposits with the Lebanese central bank.
Capital Controls and deposit haircuts should be avoided as these hit the Lebanese citizens and transform the country from a liberal banking system to communism and can lead to political and civil unrest. Constitutional and credit law protect individual ownership and depositors money. It is only fair to treat the cause of the problem. Depositors money have facilitated the growth of the banking sector and the Lebanese economy. These should be untouched.