Sovereign Analysis /
Lebanon

Hariri resigns as Lebanon descends further into crisis

  • PM-designate Saad Hariri resigned after failing to form a government, nearly a year since the last government collapsed

  • Economic crisis continues to deepen, with the currency plummeting by 35% in the past month and reserves running out

  • No end in sight, with little prospect for government formation and restructuring/reforms unable to proceed without one

Hariri resigns as Lebanon descends further into crisis
Tellimer Research
16 July 2021
Published byTellimer Research

Prime Minister-designate Saad Hariri stepped down yesterday after his latest cabinet proposal was once again rejected by President Aoun, saying, "I presented my apology for not being able to form a government and God help the country." His resignation marks the third of a PM or PM-designate since Hariri himself resigned as PM at the onset of the economic crisis in October 2019.

Lebanon has now been without a government for almost a year, with Hassan Diab resigning last August in the wake of the Beirut port explosion and PM-designate Mustapha Adib resigning in September after failing to form a government. Diab has been serving as caretaker PM since he resigned, but lacks a mandate to launch the reform and restructuring programme that Lebanon so badly needs to address its economic crisis.

Earlier this month, Diab said that "Lebanon is a few days away from social explosion" and that "the Lebanese are facing this dark fate alone." He called on the international community to save the country from "death and demise" and extend assistance despite the lack of a new government, asking "are the Lebanese people supposed to die at hospital's doors on the way to holding the corrupt accountable?"

Adib's failure to form a government, and Hariri's after him, came down to staunch opposition from President Aoun to the attempts of both men to form a non-partisan, technocratic government to steer Lebanon out of the crisis. Aoun, an ally of Hezbollah, continues to insist that he name Christian ministers to key positions under Lebanon's confessional system of allocating ministries by religious sect, and has refused to sign off on a cabinet in which his "March 8" alliance – comprising his party, the FPM (Christian), the Amal Movement (Shia), and Hezbollah (Shia) – do not hold veto power.

Aoun will now have to name a new candidate for PM after consulting with parliament, but it is unclear who, if anyone, will be able and willing to step into the breach to form a government with both sides –  Aoun's "March 8" Alliance and the opposing "March 14" alliance, comprising Hariri’s Future Movement (Sunni), the Lebanese Forces (Christian), and the Progressive Socialists (Druze) – seemingly unable to compromise even as the country goes up in flames.

France has threatened sanctions on key political figures, with Foreign Trade Minister Franck Riester saying in a recent visit to Beirut that "France respects its promises, unlike Lebanese authorities that did not implement reforms," and US Secretary of State Anthony Blinken said in a tweet this morning that "We're disheartened that political leaders have squandered the last nine months. All concerned parties need to work with urgency to put in place a government that's able to implement reforms immediately." But it is unclear how sanctions will unblock the government formation process, and there is little hope of an end to the political stalemate anytime soon.

Lebanese economy continues to crater

Against this backdrop, Lebanon’s economy has been in freefall. The complete absence of efforts by the government to address the crisis has prompted the World Bank to call it a “deliberate depression”, and it said in a report last month that Lebanon's crisis is one of the top 10, and potentially top 3, worst economic crises in the world since 1900 (the rank depends on the base year chosen, with real GDP per capita in continuous decline since the outbreak of the Syria war in 2011).

After contracting by 6.7% yoy in 2019, Lebanon’s real GDP dropped 20.3% in 2020 and is projected to contract another 9.5% in 2021. Its nominal GDP level in US$ plummeted from US$44bn in 2019 to just US$33bn in 2020, with GDP per capita falling by around 40% over that period. More than 50% of the population is now likely below the poverty line, and unemployment reached 40% by the end of last year.

Lebanon's currency has also cratered over the past few months, falling from LBP12,000/US$ on the parallel market in April to 23,000/US$ today, and is now down over 90% since the outbreak of the crisis in October 2019 (and relative to the official exchange rate of 1,507/US$) and 35% over the past month alone. Meanwhile, inflation has continued to spiral, reaching 120% yoy in May, with food inflation reaching an astronomical 226% yoy (albeit down from 158% and 395%, respectively in March).

LBP

Most Lebanese depositors have seen the value of their life savings plummet over the past year, with FX shortages preventing them from withdrawing their dollar deposits, which have been effectively "lirafied" at an increasingly depreciated exchange rate. The World Bank says that the ongoing adjustment has been regressive, with many wealthy Lebanese taking their dollars offshore before capital controls came into effect and pouring money into real estate once capital flight was no longer an option. Meanwhile, smaller depositors without alternative sources of savings and the domestic workforce paid in liras have borne the brunt of the adjustment.

The Banque du Liban (BDL) has called on banks to allow each depositor to withdraw US$400 of FX monthly and another US$400 in LBP at the official exchange rate, which it claims will allow 70% of depositors to withdraw their money over the next 12 months, but it is unclear where this money will come from amid rampant FX shortages and the ongoing need to finance key imports like food and medicine. The IMF has also expressed concern that the withdrawals will increase the amount of money in circulation, which was already rising at a clip of 129% yoy in May, to unsustainable levels, fuelling further inflation and FX depreciation.

FX reserves have dropped to just US$15.7bn in May, or US$21.1bn once foreign securities are included, but net reserves are likely negative once you factor out US$5bn of eurobonds, an unpublished amount lent to banks since October 2019, and required reserves on banks' FX deposits (estimated by the World Bank at US$16.7bn). Even once you factor in the upcoming US$860mn SDR allocation, Lebanon has effectively run out of reserves to keep subsidising basic imports like food, fuel, and medicine.

Reserves

This prompted caretaker PM Diab to reduce the fuel subsidy last month by approving an exchange rate of 3,900/US$ for the import of fuel for a period of three months instead of the official rate of 1,507/US$ at which fuel had previously been subsidised. The government also raised the price of subsidised bread, raising the exchange rate in June from 2,750/US$ to 3,250/US$, the fifth such increase since June 2020. Meanwhile, the BDL continues to import other key goods, like food and medicine, at a subsidised rate of 3,900/US$.

The World Bank says that the subsidies are regressive and should be removed, with the overall subsidy regime costing an estimated US$6bn annually, over half of which goes to energy items for which the poorest 20% of the population receives only 6% of the benefit versus 55% for the richest 20%. Removing subsidies could result in an annual BOP improvement of US$1.7-3.2bn, according to the World Bank, extending the timeline to reserve exhaustion and preventing an even worse currency collapse. To offset the impact of the subsidies removed so far, parliament approved a law last month to distribute prepaid cards valued at US$556mn to poor families. While this is a commendable move towards more targeted transfers, it is unclear how the government will fund the programme given its severe cash constraints.

Meanwhile, state power producer EDL has reportedly run out of funds to purchase fuel, exacerbating endemic power shortages in the country. The EDL has asked for more transfers from the BDL's withering balance sheet, and has turned in desperation to Iraq for a US$200mn swap of fuel for in-kind services (largely medical expertise) to keep the lights on. EDL had to shutdown two of its key power plants this month due to lack of fuel, cutting 40% of Lebanon’s power supply, while mounting arrears to emergency power supplier Karpowership of Turkey has prompted it to intermittently cut off supply. FX shortages and smuggling (with many people purchasing subsidised fuel in Lebanon to sell at a profit in Syria) have also caused economy-wide fuel shortages, leading to long queues at gas stations throughout the country.

While Lebanon’s fiscal numbers are largely meaningless given the scale of the currency collapse, the World Bank estimates that the overall fiscal balance improved by 0.7pp to 4.9% of GDP in 2020. However, the improvement was driven by Lebanon’s decision to stop servicing its debt, with the primary balance deteriorating by 2.3pp to 2.8%, a rarity for a country without access to financing, with the BdL stepping up to finance the deficit despite spiraling inflation and currency depreciation. Meanwhile, public debt rose by just 3pp to 174% of GDP at end-2020, with the currency depreciation and inflation eroding the US$ value of domestic debt, which was more than offset by the GDP collapse lowering the denominator. However, the LBP value of Lebanon’s external debt stock would skyrocket if translated at the parallel exchange rate, highlighting the difficulty of fiscal accounting with the currency in freefall.

Reform and restructuring programme still at square one

Putting all this together, it is clear that Lebanon is in desperate need of reform and restructuring to prevent a more complete impoverishment of its citizens and stave off a humanitarian crisis. The World Bank lays out six key pillars for reform, including:

  1. Debt restructuring to provide short-term fiscal space and medium-term debt sustainability;

  2. Financial sector restructuring to restore solvency of the banking sector;

  3. A new monetary policy framework and FX regime to restore confidence in the currency;

  4. A phased fiscal adjustment to regain confidence in fiscal policy;

  5. Growth enhancing reforms; and

  6. Enhanced social protection

Meanwhile, a presentation last month by a former advisor to the finance ministry, Henri Chaoul, outlines a detailed plan on how the banking sector restructuring can be accomplished while protecting 100% of FX deposits for the smallest 85-95% of depositors. Details of the plan include:

  • Preservation of c50% of total FX deposits (including 100% preservation for accounts up to a threshold of US$50-200k, depending on the path chosen);

  • 50% of the remaining amount “lirafied” at 1,500/US$ in equal increments over the course of five years to prevent runaway inflation and currency depreciation;

  • The remaining 50% of unprotected deposits converted to bank shares in a deposits-to-equity swap to recapitalise the banking sector;

  • For accounts with balances exceeding US$2mn, a perpetual US$ bond issued by the BdL will replace a portion of the protected amount to reduce the size of the banking sector; and

  • A 70% haircut on eurobonds (including arrears), an 85% reduction of local currency debt (due entirely to LBP devaluation), and full recovery on external debt owed to multilateral institutions.

While this plan protects 100% of FX deposits for accounts with deposits of $50-200k, it is very much based on moving targets and the longer it takes to implement, the greater the losses will have to be. Chaoul estimates that FX deposits at accounts of up to US$500k, or 99% of all accounts, could have been protected if his plan was implemented at the beginning of the crisis.

However, with no government in place and little prospect for one to be formed for the foreseeable future, the economic crisis in Lebanon is likely to get much worse before it gets better. Meanwhile, Lebanese banks continue to advocate for solutions involving the sale of state-owned assets, gold reserves, and public real estate to recapitalise the sector, which would effectively amount to a bailout of the sector at the expense of the national wealth belonging to all taxpayers and citizens while protecting shareholders that played a pivotal role, whether knowingly or not, in creating the imbalances that sparked the current crisis. 

Further, a paper published by AUB in February shows that the prerequisites for a sustainable and transparent privatisation process are not present. The paper estimates a value of US$12-22bn for publicly held assets, resulting in potential state revenue of US$6-13bn from a successful privatisation process. However, without the proper policy framework put in place, privatisation at this stage is likely only to benefit corrupt elites who are able to co-opt the process, much like Russia's privatisation drive in the 1990s that only benefited a handful of politically connected oligarchs with limited revenue generation for the state and efficiency improvements from the transition.

Reform process will remain stuck in the mud without a government in place

Regardless of which path Lebanon takes for restructuring and reform, it is high time that the process begins in earnest. Lebanon’s caretaker government does not have the mandate to launch the reform process and negotiate the restructuring of Lebanon’s debt and banking sector, and international donors will continue to withhold financing as long as there is not a government in place. Without fresh financing, Lebanon’s reserves will continue to dwindle, exacerbating shortages of food and medicine, keeping the country in the dark, and increasing the severity of the adjustment when it ultimately occurs.

Lebanon's ruling elites have continued to abdicate their responsibilities by failing to move past the political jockeying of the government formation process, leaving the country to float rudderless through an ever-worsening economic crisis without any prospect for reform. Hariri’s resignation this week puts Lebanon back to square one, and there is little to suggest that there will be a break from the status quo anytime soon.

Against this backdrop, the prospects for Lebanon are dim. Each day that passes without a government, more Lebanese are pushed into poverty, raising the spectre of starvation, and, as my colleague Hasnain Malik posited in April, civil war as anger over Lebanon’s broken confessional system reaches a boiling point and the populace is pitted against one another in an existential battle for increasingly scarce resources. 

We hope that the next PM-designate is up to the task of uniting Lebanon's fragmented groups into a government that is willing and able to put politics aside to work towards a solution to Lebanon's monumental crisis, but if technocratic outsiders like Diab and Adib were unable to rise above the political fray and a seasoned political insider like Hariri wasn't up to the task either, then it is difficult to see who will be.

An analysis of existing restructuring proposals last July put recovery value at 8-26 cents on the dollar, depending on which path was taken, and given the scale of the deterioration in the ensuing year these numbers have likely dropped even further (and will continue to do so the longer the crisis is left to fester). We reiterate our Hold recommendation on Lebanon's defaulted eurobonds at a mid-price of US$12.625 for the LEBAN 7.15% ‘21s as of cob on 15 July on Bloomberg. 

Eurobond

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Back to square one as prime minister resigns, September 2020

New premier faces uphill battle, August 2020

Lebanon restructuring on pause as we await a new government, August 2020

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