Beirut — Lebanon is about to enter the crucial first phase of talks aimed at renegotiating its $30bn in Eurobonds after saying at the weekend it won’t pay dollar debt coming due on Monday.

The government’s declaration on Saturday that it won’t repay the $1.2bn Eurobond puts the country on course for the first default in its history as it copes with dwindling foreign-currency reserves and inflation running in double digits. Talks will be complicated by high foreign ownership of some of the bonds and political divisions that have left the economy on the ropes.

“We are entering uncharted territory and the crisis is set to become increasingly more complex,” said Ehsan Khoman, head of Middle East and North Africa research and strategy at MUFG Bank n Dubai. “The market’s attention will now turn to complicated deliberations with bondholders on overhauling the entire debt profile. This is no easy task and there is no quick fix.”

Once boasting an unblemished record of bond repayment through war and political strife, Lebanon came undone after months of protests fed its worst financial crisis in decades just as remittances from abroad — the main source of hard-currency revenue — slowed to a trickle. Led by a new government backed by Hezbollah and its allies, one of the world’s most indebted nations will be taking on creditors at a time the global economy is reeling from the coronavirus outbreak and the start of an oil-price war.

Prime Minister Hassan Diab said in a televised address over the weekend that his government would seek to restructure its debt through negotiations with bondholders. Formal talks are expected to start in about two weeks’ time, sources said.

“Creditors have begun the efforts to open the appropriate lines of communication with Lebanon and its advisers,” said Hans Humes, CEO of New York-based distressed-debt investor Greylock Capital Management, which had formed a group to talk to the government about its options.

IMF, Hezbollah

It isn’t clear if Lebanon will seek an International Monetary Fund bailout. Though IMF experts recently held meetings in Beirut, the issue of securing financing from the fund has become entangled in politics.

Hezbollah, an Iran-backed group that has a major say in government and parliament, has rejected the possibility of seeking a financial aid programme from the IMF, fearing it could hurt the poor and be used by the US as a political lever. That deprives Lebanon of a potential lifeline and could undermine the confidence in economic reform that creditors need when forgiving debt.

Iran and the US came to the brink of war earlier in 2020, with the Trump administration imposing punishing sanctions on the Islamic Republic after abandoning the 2015 nuclear deal.

“The IMF involvement will be tricky given the current US policies,” said Humes at Greylock Capital. “There is no question that the heightened tension between US and Iran has complicated the situation in this and many other ways.”

Locals vs foreigners

One question is whether the government will make a distinction between local and foreign bondholders, Fitch Ratings said in a report in February. Local lenders, which hold almost $14bn of the notes, had lobbied against a disorderly default that would force hefty losses on creditors, warning it could also inflict irreparable harm on the reputation of the country’s banks and their capital.

The central bank, which itself owns about $5.5bn of the debt, has proposed swapping the March bond for longer-dated instruments.

Bond investors are more sceptical about the prospects for an easy fix. Lebanon’s notes have mostly traded below 30c on the dollar, suggesting the market expects losses of roughly 70% in their value.

There is also concern over litigation risk, including the probability that some foreign investors could file a lawsuit asking the authorities in the US to impound Lebanon’s physical gold assets there, according to Fitch.

Lazard and law firm Cleary Gottlieb Steen & Hamilton are advising Lebanon.

Ashmore factor

Lebanon’s looming default is a blow for Ashmore Group, which was attracted to the bonds’ valuations as they tumbled in 2019 and had bet the government would pay out.

The London-based firm has amassed large positions in the $1.2bn March bond, as well as $1.3bn of notes maturing in April and June, that it can reject potential restructuring proposals backed by other creditors.