An economic framework for debt restructuring : the case of Lebanon

Abstract

Purpose: The purpose of this thesis is to find the best restructuring scenario for Lebanon through simulating what if analysis for local and external debts by taking an assumption of haircut percentages. These scenarios are taken at different estimates of the exchange rates. Additionally, this thesis will put in place reforms and recommendations aiming at promoting the neutralized sectors hoping to resolve the falling economy. Design/methodology/approach: To reach our purpose, we designed a unique regression model for USD/LBP exchange rate estimates since the official, pegged rate of 1,507.5 USD/LBP has become obsolete due to the deteriorated fundamental economic and financial situation. The customized regression analysis incorporates the difference in Gross Domestic Product (GDP), Real Interest Rates (IR) and National Income (NI) between the United States and Lebanon as the explanatory variables and the exchange rate as the dependent variable. The GDP and NI are statistically significant unlike the IR. We opted to choose the cutoff date of August 20, 2021, since we were unable to constantly follow the exchange rate fluctuations that started at USD/LBP 8,450 beginning of January 2021, reached USD/LBP 32,000 in December 2021 then decreased to USD/LBP 21,000 by end of February 2022. Therefore, we generated USD/LBP exchange rates ranging between USD/LBP 4,000 and USD/LBP 47,000. Thereafter, using these rates alongside assumptions of haircut %, we get restructuring scenarios ranging between soft restructuring and aggressive restructuring. Under each scenario, we calculated Debt to GDP, revenues, expenses, and financing needs to choose the most suitable scenario. Findings: We based our analysis on the debt to GDP ratio since the haircut application aims to lower Lebanon’s hardship. As such, at USD/LBP 11,657.19 excluding financing needs, in Scenario 1, the ratio is 480% as of Nov-22 and will reach 271% by Nov-25 (dropping by 17% year on year). In Scenario 2, the ratio is 377% as of Nov-22 and will reach 179% by Nov-25. In Scenario 3, the ratio is 229% as of Nov-22 and will reach 96% by Nov-25. At USD/LBP 20,366.29 excluding financing needs, in Scenario 1, the ratio is 775% as of Nov-22 and will reach 438% by Nov-25. In Scenario 2, the ratio is 598% as of Nov-22 and will reach 303% by Nov-25. In Scenario 3, the ratio is 339% as of Nov-22 and will reach 158% by Nov-25. USD/LBP 46,817.29 excluding financing needs, in Scenario 1, the ratio is 1670% as of Nov-22 and will reach 945% by Nov-25. In Scenario 2, the ratio is 1,269% as of Nov-22 and will reach 679% by Nov-25. In Scenario 3, the ratio is 675% as of Nov-22 and will reach 345% by Nov-25. Therefore, if the rate drops to levels close to USD/LBP 11,657.19, Scenario 2 with a 50% haircut on external debt is recommended. If the rate remains at levels close to USD/LBP 20,366.29, we recommend Scenario 3. Finally, if the rate reaches the pessimistic rate of USD/LBP 46,817.29, we recommend Scenario 3 and an increase in GDP growth rate higher than 25% yearly since the country will witness even higher inflation rates. Consequently, it is necessary for the country to take legal and administrative actions though the presence of few limitations. The government officials should work to provide a credible, resilient, and sustainable framework that will be quick and easy to implement in addition to an abrupt change in policies and domestic regimes. Research limitations/implications: During the past 3 decades, all financial data predicted a collapse for Lebanon, not to mention, warned about the inevitable crisis weare currently in. Corruption, mismanagement, and a lack in economic vision are a few of the factors that led to this dramatic outcome. For this reason, our limitations consist of the fact that very few researchers tackle the case of Lebanon and consider all facets the country encounters. Not to mention, the network of patronage where the political elites have long exploited the country’s resources at their own convenience and are not putting in place any initiatives to find solutions. Also, debt restructuring has a huge impact on the domestic economy especially through the disruptions of the financial system which imposes negative effects on the banking sector. Needless to mention, the severe deterioration in exchange rate levels which hurts recovery measures and jeopardizes creditor negotiations. All these limitations along with the complexity of sovereign debt defaults which requires complicated decisions causes several uncertainties. However, this thesis and its outcomes will help ruling parties and future researchers to make informative decisions. Originality/value: Through this thesis, we tailored a model to predict the closest estimates of the exchange rate. Thus, the added value of this thesis resides in devising and implementing a comprehensive model considered to be the first one to be suggested after the economic downfall. This unique regression model helped in estimating whether the current official level or the black-market level reflects reality. Therefore, the outcome of this thesis is novel and innovative.