1.         Having spiraled out of control, Lebanon’s public debt needs to be drastically reduced both as a share of GDP and in absolute amount given the stalled economic growth and, worse, contraction. At the current level of indebtedness compared to economic output, the debt cannot be put on a sustainable path without major policy adjustments, in parallel with a massive, if at all bearable, fiscal effort to generate substantial primary surpluses of some 5% of GDP annually over the next twenty years.

2.         A general consensus has now formed that a restructuring program is inevitable to address the huge debt overhang. (Restructuring entails: rescheduling, i.e. postponing instalments; lowering interest payments; and most distressingly, reducing principal amounts due.) In legal terms, failure to make timely repayment of principal or interest is construed as a default. A default on a single debt issue may trigger cross default clauses on other, or all debts outstanding. Default will ineluctably translate into a sovereign rating downgrade to the lowest category, and impede for a long time Lebanon’s ability to access international debt markets other than at forbidding costs, if at all.

3.         Debt restructuring is no benign process. Yet Lebanon’s specific case may call for a tailored approach, taking into account two factors:

• Only 1/3^rd of Lebanon’s US$90 billion equivalent total government debt is denominated in foreign currency, and only 12% of the total debt is owned to foreign creditors, while the bulk of 88% is held by domestic entities – central bank, commercial banks, national social security fund, and bank deposit guarantee agency. This configuration warrants a differential treatment between foreign and domestic currency and holders, as the resolution of the Lebanese pound (LBP) denominated debt, major as it is, ranks second in priority, especially in a depreciating currency environment, and can be addressed separately.

• The large concentration of deposits in the banking system, where 50% of all deposits, or US$86 billion equivalent are owned by 1% of the accounts. Let’s call it the “prime group”. It is acknowledged, furthermore, that reducing the debt overhang would inevitably affect bank balance sheets through a write-off on shareholders’ equity, as well as deposits (“haircut”).

4.         These two factors combined argue for a two-track approach that would address, in a first step, the US$32 billion foreign currency debt, half of which (US$16 billion) is held by domestic commercial banks. For any resolution measure to be socially fair and acceptable, it should target, first, the more affluent, i.e. the larger accounts. The Lebanese authorities may thus want to redeem immediately US$16 billion of Eurobonds in writing-off, on the liabilities side of the commercial banks’ aggregate balance sheet, an equal amount from the US$86 billion “prime group” deposits. The “appropriation” by the state of US$16 billion in depositors’ money would be in the legal form of a 20%, “one-time national solidarity tax” levied on the “prime group”; the measure could also provide for future compensation of affected depositors, for instance in the form of bank shares. A change in tax policy, even in the context of a debt resolution program, is not construed as a default, fiscal policy being the undisputed domain of sovereign states which can alter their tax code at will. In implementing, up-front, such a bold quasi-fiscal measure as part of a debt restructuring package, the Lebanese authorities would demonstrate their determination to tackle the debt problem, and strengthen their stance in the restructuring negotiations with external debt holders.

5.         One may justifiably argue that the fiscal approach is hurried and inequitable as it starts by penalizing depositors while exonerating, and keeping whole, bank owners whose equity shares, to the contrary, are meant to take the first loss in a debt resolution scheme.  The answer is that, although the proposed fiscal levy on deposits might temporarily spare capital-depleted banks a further erosion of their equity base when measured against their hollowed assets base, it will not, and must not preclude a full restitution by shareholders, especially as the debt restructuring process will also bear on the LBP-denominated debt held by banks.

6.         It is important that the proposed solidarity tax not be designed, nor viewed as a retaliatory act against the wealthy, as this has irreversible long-term costs in driving them out of the domestic economy. To this end, the real wealth effect of the proposed tax on the “prime group” should be measured, and one way to do so is to compare, over a relevant period of time, the returns on bank deposits in Lebanon against those that would have accrued in external markets. The following comparison demonstrates in a way that the “prime group” real economic loss from the one-time levy is largely mitigated by the attractive returns they have reaped on their high interest-paying holdings in Lebanese banks.

7.         Consider the four-year period starting in 2016 when the central bank launched its financial engineering schemes, bidding up interest rates, signaling and building up stress in the domestic financial market. Large depositors and savvy investors who choose to keep their funds in Lebanese banks – and had done so, it is assumed, in light of their intrinsic risk/reward profile – would have, over the period, accrued on their bank deposits a return of 31% (assuming a compounded average interest rate of 7% p.a.). This would mean that the “prime group” present holding of US$86 billion stood at (86 divided by 1.31) or US$66 billion in 2016 – a total gain of US$20 billion. At the other end of the spectrum, risk averse investors would have transferred their holdings to safer (US/European) markets, settling for a return of 1.5% p.a., for a total gain of US$4 billion on the US$66 billion original principal. “Capturing” thus US$16 billion out of the 20 billion earned by the “prime group” over the period would leave the latter with a US$4 billion gain – at par with what prudent investors have reaped and whose aversion to risk was in retrospect fully borne out. Add to this that the “prime group” deposits, like all deposits in the nation’s banking system, are in any case impounded sine die. Seizing thus “notional” gains accrued on “virtual” accounts can be hardly viewed as a punishing, real capture of wealth.

S.El Daher

March 5, 2020