Lebanese Ministry of Information
A new report by Citigroup said that the amount of U.S. dollars at Lebanese banks has dropped by at least $2.5 billion due to the recent purchase of government eurobonds by the local lenders.
“Bank U.S. dollar liquidity has fallen as a result of the cash purchase of eurobonds by local banks, in addition to that of certificates of deposit. We estimate the total amount of dollar liquidity drained by the operations could be as high as $2.5 billion, assuming that half of the purchases were funded through [Central Bank] repos. This represents around three months of deposit inflows into the banking system,” Citi Research said in its latest report on Lebanon.
The Central Bank requested in August that Lebanese commercial banks use surplus funds, which they generate by selling local-currency government bonds from their portfolio and buying eurobonds simultaneously, as provisions in Lebanese liras to be included in their Tier 2 capital.
The request was aimed at boosting the foreign currency reserves of the Central Bank, which have exceeded $40 billion.
According to the Central Bank circular, the provisions would prepare banks to meet the IFRS 9 requirements that will come into force in January 2018.
IFRS 9 is a financial-accounting standard issued by the International Accounting Standards Board.
Citi said the debt swap between the Central Bank and Finance Ministry has given a temporary breathing space to the Lebanese government.
“The debt swap between the [Central Bank] and [Finance Ministry] has potentially helped the government term out its debt at reduced yields through the retirement of domestic debt and the issuance of new eurobonds,” the report said.
It repeated that this financial engineering has also beefed up the Central Bank foreign currency reserves.
“By selling Eurobonds and issuing CDs, we estimate reserves have been bolstered by the amount of ‘fresh’ inflows (roughly half the total transaction size). We expect anywhere between a $1.5 billion and $2.5 billion increase in [Central Bank] reserves (all else equal) between May and July,” the report said.
It noted that the Central Bank’s possession of Lebanese currency has risen from this swap.
“The [Central Bank’s] purchase of local government debt from the banks as per above translates into quantitative easing and has injected significant amounts of Lebanese lira liquidity into the system in our view. Given the dearth of local lending opportunities, we expect this liquidity to be mopped up with Lebanese lira issuance by the government in the coming weeks,” Citi said.
However, Citi warned that this swap could cause higher yields on Lebanese sovereign bonds in the future. “To be sure, the macro picture in Lebanon is not encouraging and arguably justifies higher Lebanese yields in our view. Indeed, as we have highlighted in previous research, fiscal slippage has accelerated at a time when the capacity of the banking sector to finance the government is coming under pressure from a decline in deposit growth rates. Economic growth remains low (1 percent region), and the political backdrop is dire,” Citi said.
The report stressed that the debt swap will not encourage investors to invest in Lebanese sovereign bonds.
“Despite the potential for positive catalysts and support, we do not see Lebanese debt as a great opportunity for capital gain for investors. Rather, we believe that the relatively low volatility of Lebanese bonds makes them interesting generators of alpha in more defensive markets, given the superior Sharpe Ratio, especially when compared to other ratings and (regional) sovereign credit peers. In our view, Lebanese bonds should be seen as ‘carry opportunities’ in an environment where higher beta sovereign credits do not trade well,” Citi argued.
