Sovereign Analysis /

Lebanon restructuring on pause as we await a new government

  • Crisis will continue to worsen with restructuring and IMF talks on pause following government’s resignation

  • Formation of a credible government could revive the reform process, but infighting will likely cause delays

  • Speed is critical, but hastiness risks entrenching Lebanon’s broken political system; bonds likely to suffer either way

Lebanon restructuring on pause as we await a new government
Tellimer Research
13 August 2020
Published byTellimer Research

Following last week’s tragic explosion in Beirut (see here) and the government’s subsequent resignation this week (see here), we consolidate our thoughts on where Lebanon stands and where it is headed.

The impact of the blast has been significant, with at least 170 killed, 6,000 injured and 300,000 made homeless. President Michel Aoun says the damage amounts to US$15bn (28% of last year’s GDP), and the IIF now expects a 24% contraction this year (from -15% before).

Pressure mounted on the government as it became clear that it has received consistent safety warnings since 2,750 tons of ammonium nitrate (the cause of the blast) was seized in 2013 but chose to ignore them, prompting mass protests to breakout in Beirut.

In response, the government of Prime Minister Hassan Diab resigned on Monday, but continues to lead the country in a caretaker capacity until a new government can be formed.

We think the resignation has put both restructuring talks and IMF negotiations on hold. It is unclear who the counter-party would be for discussions with bondholders and the government is largely stripped of decision-making capacity so is unable to commit to any sort of formalised arrangement at this point.

While the argument could be made that the explosion would pressure the IMF to extend support without reform commitments, their statement on 9 August ( see here) makes it clear that IMF support is still conditional on reform implementation (which, again, is now held up without a government).

Donors committed US$298m of relief over the weekend, but took a similar tone (ie that reforms are a necessary precondition for more funding). It is certainly possible that some bilateral partner(s) could step up and give aid, but any additional funding is likely to be allocated directly to relief efforts (ie channelled through third-party organisations on the ground or subject to strict oversight) and will in any case pale in comparison to the estimated damages of US$15bn.

Beyond the relief efforts, the government’s restructuring plan in April estimated a financing gap of US$10bn that would need to be filled by the IMF and other multi/bilateral sources, which has almost certainly increased in light of the explosion and rapidly evolving economic crisis.

It is also unclear that the government plan is still relevant following its resignation, but we think the broad contours will likely remain unchanged since the IMF appeared to endorse the approach and figures used (though of course the latter is a moving target).

While government actions had, in the IMF’s words, "yet to yield results", it is possible that the appointment of a credible and technocratic government could give new life to the restructuring/reform process.

There have been whispers that former UN ambassador and current ICC judge Nawaf Salam is being considered to form a new government, which if swiftly constituted could potentially leave Lebanon in a significantly stronger position than before.

However, given the nature of sectarian divisions and likely resistance of Hezbollah to a candidate blatantly favoured by the West, this process could drag out. In addition, it is not clear that appointment of a technocratic government will be sufficient to unlock reforms if it remains constricted by Lebanon’s existing political system. Recall the government of PM Diab, a career academic, was seen as technocratic but failed to make any progress on reforms amid endemic infighting and corruption.

Over the long-term, what is required in Lebanon is the adoption of a radically different, non-sectarian political system. There is hence a balance that must be struck between quickly forming a government to deal with the crisis in a timely manner versus taking the time to hash out more holistic political reforms. The former risks dooming a well-intentioned government to failure and further solidifying Lebanon’s broken sectarian system, but the latter will face stiff resistance and will exacerbate the humanitarian crisis while negotiations drag out.

The coming weeks are really a litmus test for the willingness of Lebanon’s elite to finally make good faith efforts to implement reforms and adopt a new political status quo. Early indications, however, are not promising. The caretaker parliament convened today for the first time since the explosion, approving a 2-week state of emergency in Beirut, which grants the military sweeping powers. Critics think the move is designed to allow the military and police to suppress protests, which have continued with citizens demanding the resignation of President Aoun and broader reforms to dislodge the entrenched elite and embark on a non-sectarian political path.

While around 20 arrests have been made so far in relation to the explosion and Lebanon’s judiciary will reportedly question several current and former ministers, infighting has delayed the formation of a committee to investigate the incident as officials appear intent on continuing the blame game rather than accepting even an iota of accountability for the crisis.

So in short, Lebanon is yet again at a tipping point. Without a government, Lebanon will remain rudderless as the crisis worsens, with restructuring and IMF negotiations on pause. However, if the crisis finally jolts the elite into action and they form a new technocratic government that is willing to start IMF/creditor discussions in good faith (unlike before), then this could be a positive inflection point. However, while speed is necessary to limit the humanitarian costs of the crisis, it also risks consolidating Lebanon’s corrupt and broken political system and missing a major opportunity for real reform.

From the bondholder perspective, the impact is likely to be negative either way. If Lebanon continues without a government, the restructuring needed will be even more dramatic once the crisis is finally addressed. However, even if a credible new government resuscitates the restructuring process, the massive cost of the explosion will likely necessitate an even more punitive restructuring and bondholders will find it difficult to argue otherwise without risking reputational damage.

From the moral perspective, more importantly, reforms must go on one way or the other (and quickly). Humanitarian aid can only go so far towards alleviating the crisis, and a comprehensive and aggressive reform plan is required to unlock financing and begin to piece the moribund economy back together. For the third time in two weeks, we reiterate that we hope this crisis is inducement enough.