The Lebanese government recently published its draft reform program which aims to tackle the dire economic & financial conditions, restore confidence, boost economic growth, promote a healthy financial system and achieve debt and financial sustainability. The program hinges on the following pillars: external support, fiscal consolidation, public debt restructuring, overhaul of the financial sector, structural reform agenda and foreign exchange regime adjustment.

The reform program is based on a medium-term macroeconomic framework geared towards funding Lebanon’s external financing needs estimated at $27.3 billion over a period of 5 years of which $15-18 billion will come from the Eurobond restructuring process and the remaining $10-15 billion will come from external support. The program assumes real GDP will contract by 12% in 2020 and by 7% in 2021 before growing by 2% in. These external funding needs are necessary to limit the size of the economic contraction and restore confidence in the economy. The fiscal consolidation plan aims to reduce government expenditures by reforming the electricity sector, reducing the wage bill, conducting pension reforms, among others while simultaneously increase government revenues by broadening the tax base (through improving collection and removing exemptions), introducing new taxes (raise VAT tax on luxury goods to 15%, increase tax on interest for deposits exceeding $1 million from 10% to 20%, increase corporate income tax from 17% to 20%, raise the personal income tax on the highest income bracket from 25% to 30%, raise capital gain tax from 10 to 15%), among other measures.

According to the government’s program, Lebanon’s public debt reached unsustainable levels by end of 2019, standing at $90.2 billion, broken down into local currency denominated debt ($56.8 billion), foreign currency denominated debt ($31.3 billion), and multilateral & bilateral debt ($2 billion). In details, the government projects debt-to-GDP ratio to drop from an estimated 176% in 2019 to 103.1% in 2024 and to 90.2% by the year 2027. To reach these debt-to-GDP thresholds, the government intends to withhold all Eurobond payments, rollover the domestic debt principal maturities and the ongoing payment of interest due until a solution is reached, and remain current on debt service payments for multilateral and bilateral partners. Ultimately, the plan calls for nominal reductions in FC and LC debt. Furthermore, the government’s orchestrated plan aims at reducing the interest bill and start accumulating a primary surplus starting the year 2024 (1.6% of GDP) and consequently trim down the budget deficit to GDP ratio from 11.3% in 2019 to 7.2% in 2020 and 1.3% in 2024.

From another angle, the draft reform program pinpoints a need to recapitalize the Central Bank and the banking sector. It specifically estimates BDL’s losses at $63.6 billion which include the impairment of liabilities of around $54.9 billion and a reduction in its equity base from $3.7 billion to a negative $5 billion. These losses stem from years of loss-making financial transactions operated by the Central Bank and from the sustained financial engineering operations. Consequently, the plan envisages a loss of $83.2 billion at the level of banking sector stemming from a partial impairment of the assets held at BDL, partial impairment of banks’ loan portfolio and a haircut on government securities portfolio. These losses will be covered by a full bail-in from existing shareholders estimated at $20.8 billion and the remaining $62.4 billion will be covered by transitory exceptional contribution from large depositors through a deposit recovery fund. The program also noted that the unification of the official and parallel exchange rates and the formal devaluation of the former are contingent upon the prior stabilization of the economy and the restructuring of the banking sector.

In a related context and in its capacity as financial adviser to the Association of Banks in Lebanon, Houlihan Lokey (HL) addressed a letter to the Lebanese government expressing its disappointment in the government’s reform program which blames the financial crisis onto the banking sector and imposes the burden on depositors. HL advised that a comprehensive plan should have been prepared jointly with major stakeholders to address the underlying issues behind the crisis. HL concluded its letter with a statement asserting that a more substantive document is in the process of being drafted and will be shared with the government soon in response to the leaked government reform program.