Lebanon announced its decision on Saturday to default on payment of the $1.2 billion Eurobond maturing on March 9, an unprecedented move for a country that has never before defaulted on debt.
A default on debt will have far-reaching and long-lasting effects on Lebanon, and with no decision in sight on how authorities will handle the debt liability, many have asked the question as to what will happen next.
In the event of a default, credit ratings agencies have already indicated there would be a further downgrade of the country.
“The downgrade and Negative Outlook reflect the very high risk that the Lebanese government will undertake some form of debt restructuring in the near term given the loss of access to capital markets, the ongoing crisis in the domestic banking sector, a weakening international reserve position, and heightened political risk,” Capital Intelligence Ratings wrote in a note on Friday in which it downgraded the country.
Another downgrade would further impact Lebanon’s ability to borrow money in the future as lenders would demand higher interest rates for loans to an organization that recently defaulted. This dynamic is comparable to an individual’s credit score affecting how likely it is for a bank to grant them a loan and for a country, it is a situation that can take decades to recover from.
Lebanon’s banking sector on the precipice
One of the biggest holders of Lebanon’s government debt are the country’s local banks. As it becomes clearer that authorities might default on the Eurobond, the banks have sought to offload the bonds to opportunistic foreign investors.
Local lenders sold around $500 million of the notes from the March Eurobond to emerging markets specialist Ashmore, a move now under judicial review.
Treasury bills also make up a significant portion of the overall assets of the banks, meaning that in the event of a default, the value of these assets would decrease. For consumers, this may mean an inability to withdraw their money from the financial system or further borrow from institutions with nothing left to lend.
These problems continue to stem from the years-long scheme that the local banking sector and authorities engaged in to maintain the financial system that led to the country’s economic crisis.
Some government officials have acknowledged the situation needs to change. During the announcement that Lebanon would not pay the Eurobond, Prime Minister Hassan Diab noted the country’s banking sector is bloated to four times the size it should be and in need of a total overhaul.
Officials are currently probing the possibility of a debt restructuring process for the Eurobond. It had been hinted at by authorities that a swap might be the restructuring solution. In this process, the $1.2 billion Eurobond notes would be swapped for new bond notes that would mature later with a higher interest rate.
In this event the total amount that Lebanon owes would only increase - a painful proposition for a country that is one of the world’s most indebted, with its loans totaling around 170 percent of GDP.