Lebanon Eyes Move to Flexible Exchange Rate in Economic Overhaul
Lebanon Plans Shift to Flexible Exchange Rate
(Bloomberg) -- Lebanon plans to shift to a flexible exchange rate once it secures external funding for an economic overhaul and will need $28 billion in the next five years to overcome its worst financial crisis in decades. Lebanese Eurobonds rose.
The central bank will maintain the fixed exchange rate for now, Finance Minister Ghazi Wazni said in a presentation to lawmakers at the presidential palace.
“Floating the currency before regaining confidence, bolstering the economic and financial environment and getting funding from the International Monetary Fund and donor countries will lead to complete chaos in prices of goods and a sharp deterioration in the exchange rate,” he said.
Lebanon defaulted on its debt for the first time in its history earlier this year and has initiated talks with the IMF with the aim of securing a loan worth at least $10 billion to support its plan to overhaul the economy. The government’s economic reform program, which was unveiled last week, includes spending cuts, better tax collection and a restructuring of the loss-making electricity sector as well as the banking sector.
Markets reacted positively to the news, which was seen as a sign that the government was more serious about taking the tough decisions required to restore confidence. Lebanon’s Eurobonds rallied, with the security that matured on March 9 jumping 2.24 cents to 18.10 cents on the dollar at 10:14 a.m. in London. The debt due in 2037 climbed 0.34 cent to 17.71 cents on the dollar.
Renewed Riots
The country’s crisis has been years in the making, but financial conditions deteriorated rapidly in 2019 as foreign currency reserves began to run low, forcing businesses to turn to money changers for dollars they need to pay for imports. The central bank is supporting the import of essential goods by supplying dollars at the official rate for fuel, wheat and pharmaceuticals.
But on the black market, the pound has been sliding for months, reaching 4,000 to the dollar compared to the official peg of 1,507.5 per dollar. The currency crash prompted the central bank to introduce a series of different rates to manage demand and purchasing power as inflation soars in a country that has long been dependent on imports of everything from food to luxury cars.
Authorities will only turn to a flexible regime once the country has a solid program with a funding component in place, otherwise, the central bank would lose its ability to finance imports of wheat, fuel and medicine, according to a person familiar with the government’s plan.
The currency crisis has reignited protests that abated earlier this year due to a nationwide lockdown imposed to contain the spread of coronavirus. Riots in the northern city of Tripoli, home to some of the country’s poorest neighborhoods, led to the death of one person as protesters angry over rising prices, joblessness and caps imposed on the withdrawal of dollars led to a spate of attacks on bank branches.
An uprising against a political class blamed for rampant corruption and mismanagement of public finances broke out on Oct. 17 after a minister suggested taxing calls made on free internet-based applications like WhatsApp, spreading across Lebanon and bringing down the previous government of Saad al-Hariri. However, many of the measures unveiled by the new government in its reform plan have been talked about in Lebanon for years but successive governments, hampered by the country’s deep political divisions and broader geopolitical tensions, have failed to implement them.
“Policy making in Lebanon continues to be impaired and largely unsuccessful in restoring confidence, internally and externally. The Lebanese pound is not pegged because the government and central bank cannot maintain a peg, let alone six different rates currently in place,” Mohieddine Kronfol, the chief investment officer for Middle Eastern and North African fixed income at Franklin Templeton, said. “None of the policy measures taken since Oct. 17 have been successful. They are continuously behind the curve and reacting to the realities of unfolding crises.”
Debt Talks
The new government, led by Hassan Diab, initiated talks with the country’s bondholders two weeks ago to restructure its $30 billion in foreign-denominated debt, Wazni said.
The government also seeks to restructure its local debt, which is mostly held by the central bank, as well as its financial sector. It estimates that the central bank and local banks have incurred billions of dollars worth of losses. Wazni said the government will work on protecting depositors’ money and explore its options to re-capitalize local lenders including an optional bail-in.
“The benefit of having the International Monetary Fund gives confidence, support for the treasury of $9 billion to $10 billion and opens the door to donor conferences, credit facilities from funds and facilitate negotiations with creditors,” the finance minister said.
Bank of America said in a research note on Wednesday that it understood the reform plan would include a nominal face-value cut of 75% on Eurobonds and 40% on domestic debt, reducing the losses to be incurred by the domestic banking sector but keeping the government debt level higher.
Last week, the premier said Lebanon started talks with the IMF in the hopes of obtaining a loan program that would potentially also unlock some $11 billion in donor funds that were pledged in 2018 but held back as Lebanon failed to carry out promised reforms.
“It has long been viewed as necessary for the IMF to be part of any debt restructuring negotiations with Lebanon, given both its expertise and financing capacity,” said Richard Segal, a senior analyst at Manulife Investment Management in London. “While it can’t dictate any particular currency regime for a country, it can impose realism if a country would like access to its financial resources.”
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