Lebanon Warned on Default and Recession as Its Reserves Decline

(Bloomberg) --

Lebanon received some of the starkest warnings yet that a default and a deeper recession are increasingly a possibility as protests rock the nation.

Moody’s Investors Service on Tuesday downgraded Lebanon deeper into junk for a second time this year, reflecting “the increased likelihood” of what may constitute a default under its definition. The World Bank, which earlier projected a small recession in 2019, now expects it “to be even more significant due to increasing economic and financial pressures.”

Lebanon is in dire financial straits just as it succumbs to political paralysis and protests grip the country for a third week. The outcry already prompted the resignation last month of Prime Minister Saad Hariri. But the president has yet to set a date for the start of binding parliamentary consultations to name a new premier, raising concerns the country will be unable to implement measures urgently needed to avert economic meltdown.

Read more: How Lebanon’s Crisis Is Both New and More of the Same

“The politics has the most attention, but economy has the most risks,” Saroj Kumar Jha, the World Bank’s regional director, said after a meeting with Lebanese President Michel Aoun on Wednesday. “With every passing day, the situation is becoming more acute and this would make recovery extremely challenging.”

Lebanon has never defaulted on its obligations despite straining under one of the world’s biggest debt burdens, but the country has seen its credit risk soar as confidence crumbles in the government’s ability to cope with distress.

Investors have turned away from Lebanon’s debt despite a package of emergency measures rolled out in October. Its Eurobonds are the world’s worst performers this year after those of Argentina. Their average yield has doubled to 21% since the start of 2019, according to a Bloomberg Barclays index.

The nation’s currency peg, in place for more than two decades, is also coming under pressure as local businesses struggle to access dollars from banks at the official rate. After reopening last Friday following two weeks of closures, banks tightened informal restrictions on money transfers that were in place prior to the unrest, in an effort to curtail capital flight.

Moody’s lowered Lebanon’s credit rating one level to Caa2 -- the fourth-lowest junk grade -- and said it remains on review for downgrade. Lebanon’s central bank retains a “usable foreign exchange buffer” of only about $5 billion to $10 billion, according to Moody’s. Just over a month ago, the rating company said its usable holdings were no less than $6 billion.

Without new net inflows, the stockpile is now likely to be depleted by the government’s looming payments on external debt, estimated at $6.5 billion this year and next, Moody’s said.

Read more: Lebanon Banks Told to Boost Capital to Ease Growing Pressure

In an effort to boost liquidity and stave off possible downgrades, Lebanon’s central bank this week instructed local lenders to raise their capital by 20% by next June.

Earlier, it also agreed to slash $2.9 billion in interest payments on its holdings of local currency-denominated government debt by waiving coupon payments. The proposal was part of a sweeping package of reforms that aimed to lower the budget deficit to 0.6% of gross domestic product

Protesters are meanwhile keeping up the pressure on government officials as students led the demonstrations Wednesday, especially in the capital and outside state entities including the Education Ministry, the Judicial Palace and the electricity company. Thousands have been on the streets, demanding the resignation of a political class that they say has left the country on the verge of bankruptcy.

The World Bank warned of the steep cost the crisis could inflict, saying poverty could rise to 50% should there be no immediate solution and if the economic predicament worsens. A third of the Lebanese were estimated to have been in poverty in 2018.

“In the absence of rapid and significant policy change, a rapidly deteriorating balance of payments and deposit outflows will bring GDP growth to or below zero, further stoking social discontent, undermining debt sustainability and increasingly threatening the viability of the peg,” Moody’s analyst Elisa Parisi-Capone said.

--With assistance from Paul Wallace and Dana El Baltaji.

To contact the reporters on this story: Justin Villamil in Mexico City at jvillamil18@bloomberg.net;Dana Khraiche in Beirut at dkhraiche@bloomberg.net

To contact the editors responsible for this story: Carolina Wilson at cwilson166@bloomberg.net, Paul Abelsky, Amy Teibel

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