Duel: Dual figures Bust or boost

A battle has ignited after the government announced a Financial Recovery Plan. The plan has been mostly met by disapproval and was widely criticized by private sector stakeholders and most think tanks. A battle of proposals ensued between two highly polarized camps. The first one, consisting of the government and some of its political supporters, champions as the way out of the crisis an immediate recognition of what it deems ‘losses’ in the balance sheets of the Central Bank (BDL) and banks which would wipe out their equity and almost certainly necessitates a haircut on public debt and depositors in banks. The second camp, made up of BDL, banks, Economic Organizations, the Parliamentary Budget and Finance Committee and many others, proposes a path to recovery that focuses on a phased approach to debt recognition and restructuring, as well as taking measures to create economic growth. The most adamant response came from the banks which are highly exposed to sovereign risk. They firmly opposed any default on debt owed to domestic parties. The Association of Banks (ABL) said that the required debt restructuring must minimize the damaging consequences to the three million domestic bank depositors and to the economy at large. At the same time the Plan ought to prime “the economy for a faster recovery and higher medium-term potential growth,” the ABL said. The Parliamentary Finance and Budget Committee (FBC) went on a fact-finding mission, and was unofficially mediating between the government and its opponents. While avoiding declaring so, it has obviously sided with the opponents to the government plan. It said that it is the duty of lawmakers to discuss the government’s Plan because of its financial and economic impact on the future. It warned of dire consequences of haircuts on depositors and on domestic debt in lira and criticized the government for inflating losses. InfoPro, the publisher of Lebanon Opportunities, has issued a critique of the government plan and proposed an alternative plan. In its ‘Government of Lebanon’s Financial Recovery Plan-A Critique’ InfoPro said: “Our review of the government plan shows that it has failed to come up with a correct diagnosis of the crisis and that it has made proposals that would deepen it further.” It said that the government’s Plan has overlooked many crucial alternative solutions that are considered in Lebanon as immune to reform. InfoPro said its alternative plan aims to create a revival of the real economy as an alternative to defaulting on State obligations. (see page 48 for the full critique)

Excerpts from government plan

• The decades-old dollar peg is impossible to restore and must be revamped
• Move to a more flexible exchange rate
• Restructuring public debt is necessary because the fiscal adjustment is too large
• Public debt interest payment represents more than ten percent of GDP, rendering a near zero budget deficit too burdensome on people especially in time of recession
• Discounting domestic debt principal to restore sustaibnability of public debt
• Public debt to GDP ratio will remain fairly stable over the period 2020-2024
• Very large financial imbalances rarely seen in other countries
• A tight fiscal policy will improve the budgetary situation and the external position
• Limiting domestic demand through cutting public spending and reducing the wage bill will impact consumption and investment and will reduce imports
• The fiscal component aims to reach a primary budget surplus of 1.6 percent in 2024
• Inflation expected to drop from a 53 percent (2020) to seven percent in 2021 and further to six percent by 2024
• A scenario of no or very limited external support would lead to a complete collapse
• Escaping from an IMF program does not bode well for the future of a country
• Net external financing needs over the next five years are at $10 billion under an optimistic economic scenario of gradual economic recovery and the successful restructuring of the government foreign currency debt
• External support will be complemented with contributions from bondholders and by returning to the international capital markets in the medium run
• A full bail-out of the financial sector is not an option
• The Central Bank’s losses result from years of loss-making financial transactions aimed at accumulating foreign exchange reserves to defend the peg and cover the balance of payment funding gap
• BDL’s downsized balance sheet would remain sizeable post-restructuring.

Comparison of Government Plan-ABL Proposals

General outline of the government plan

The government announced a moratorium on payment on all outstanding Eurobonds in March 2020 before releasing the final version of the recovery plan at the end of the following month. It said in the plan that suspending principal and interest payments on Eurobonds aims to prevent further depletion of foreign exchange reserves. It also announced in the plan that it will impose a haircut on creditors. The plan said: “Foreign holders are expected to face significant losses on their holdings of Eurobonds.” It also said that a principal discount on domestic debt is a prerequisite for restoring public debt to a sustainable level. In addition to that, a rollover of the maturities of domestic debt principal and interest payments will be carried out. This does not apply to debt owed to BDL. The post-restructuring debt-to-GDP target for 2020 was set at around 103 percent.

Central Bank’s losses

The banks will have to contribute through a bail-in of assets they hold at BDL, namely deposits and certificates of deposit (CDs), in order to cover losses of the Central Bank that cannot be absorbed by its existing capital base. The remaining bank deposits at BDL will be re-profiled to help bridge the liquidity gap. Out of the LL177 trillion aggregated losses in BDL balance sheet, LL56 trillion can be covered, the net remaining losses will be LL121 trillion, according to the government plan. A Public Asset Management Company (PAMC) will be created to hold key government assets (excluding oil and gas). The profits of the PAMC will be used to fund BDL’s capital increases to help it face its remaining obligations to the banks

Restructuring of banks

Instead of a bail-out, the government intends to resort to a bail-in that will include writing off the banks’ capital and other liabilities excluding deposits. The banks will see their current capital base of LL31 trillion completely wiped put to cover part of their direct aggregated losses, which are estimated by the government at LL64 trillion. Thus their net remaining losses will be LL33 trillion. The government said it will claw back sums that had unlawfully escaped the country and apply those sums against the remaining losses of the banks. “Illegally obtained funds and assets, in all fields, and in particular from Politically Exposed Persons (PEPs), will be used to compensate for the losses,” the plan said. Bank owners will be required to re-inject an amount equivalent to the dividends received over the period 2016-2020. The plan also envisages mergers between banks or acquisitions by