Lebanon looks to avoid step from political to financial crisis

investment insights

Lebanon looks to avoid step from political to financial crisis

Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

Stéphane Monier

Chief Investment Officer
Lombard Odier Private Bank

Key takeaways

  • Lebanon has so-far failed to allocate roles in a ‘confessional’ government after the May 2018 parliamentary election, bringing the country’s economic and financial landscape under scrutiny
  • Lebanon’s gross domestic product has stagnated, the current account deficit is widening and gross public debt is the third-highest in the world with interest payments expected to account for almost half of government spending this year
  • The country’s demographics are challenging with one-fifth of the population made up of refugees from Syria or Palestine
  • Last month Moody’s and Fitch ratings agencies both cut their outlook rating on Lebanon’s sovereign debt
  • Despite Lebanon’s historic resilience, we caution investors exposed to the country to look for ways to diversify their exposure until the political situation is clarified.

Lebanon is trying to avoid adding a financial crisis to its political and economic woes. After the optimism of May 2018’s parliamentary election, its first since 2009, talks to form a balanced government along religious lines stalled, delaying reforms to address the world’s third-highest government debt-to-gross domestic product ratio.

International investors and the country’s extensive diaspora are questioning how long the economy can survive the continuing political crisis. Lebanon’s politics, driven by a “confessional” power-sharing arrangement, reflect the Shi’a and Sunni tensions in the region, from Iran-backed Hezbollah and Saudi Arabia. In the meantime, rivalries and haggling over government posts are hindering any progress in addressing the nation’s worsening finances.

Lebanon spends more servicing its debt than on public services. Interest payments may reach 49% of government spending this year

With gross public debt at 177% of GDP at the end of September, Lebanon spends more servicing its debt than on public services. Interest payments may reach 49% of government spending this year, Fitch ratings agency forecast, while its pegged currency and import-dependent economy are increasingly vulnerable to rising US rates. Only Japan and Greece have higher debt-to-GDP ratios.

With an agreement on a new government reported to be close for the past few weeks, a succession of officials have hinted at reforms, conscious that the continued political crisis, coming on top of the country’s economic problems, may spill over. Historically, Foreign Direct Investment, supported by Lebanese nationals abroad, averaged USD248 million from 2002 until 2017 while the Central Bank, Banque du Liban (BdL), has offered high interest rates in order to support the Lebanese pound, pegged to the USD for more than 20 years. The BdL also boasts a healthy USD44.4 billion in reserves, excluding gold.

Yet on paper investors have plenty of macro-economic concerns. Inflation is running at more than 5% and GDP growth forecasts point to a consensus of 1.7% for 2019. Growth has been persistently sluggish since collapsing from more than 8% in 2010 before Syria’s civil war. Lebanon’s current account deficit was USD3 billion at the end of the first quarter of 2018, and may widen to more than 20% of GDP as the government covers electricity subsidies and interest payments and overspends on salaries. The country also has balance of trade deficit with USD18 billion of imports compared with just USD2 billion of exports.

‘No need for panic’

“Public debt cannot continue in this way,” Ali Hassan Khalil, Lebanon’s Finance Minister, told al-Akhbar newspaper on 10 January, according to Reuters. Khalil’s ministry is preparing a “financial correction” plan to restructure public debt and avoid “dramatic developments”, he added.

“There’s definitely no restructuring for debt,” Raed Khoury, Lebanon’s Minister of Economy and Trade said on 10 January according to Bloomberg, contradicting Mr Khalil’s comments (and last year’s reports that investors may receive just 35 cents on the dollar should the government default on its debts). "There is no need for panic,” added Mr. Khoury. “The government is committed to pay its debt forever and not only for this year. It has the means to do that.”

Mr Khoury told Asharq Al-Awsat newspaper on 4 January that a series of proposals “will mainly increase production and create an atmosphere suitable for investors.” Saad Hariri, the Prime Minister designate, has suggested in recent weeks that a future government will cut fuel subsidies and the number of public sector jobs as well as salaries. The measures, he has also said, may include higher import duties.

Lebanon’s economy is further complicated by its demographics. With a population of 6.1 million, Lebanon also had around one million registered Syrian refugees at the end of 2018, giving the country the world’s highest ratio of refugees per capita. Numbers of Palestinian refugees in the country have fallen, according to the United Nations, to an estimated 260,000 from 280,000 in 2016, with precarious living conditions and labour rights.

Lebanon is nothing if not resilient. A civil war from 1975 to 1990, outright conflict and still simmering tensions with Israel as well as the neighbouring Syrian war that has left Lebanon with no workable land border for its exports, have all failed to trigger a sovereign default.

‘More intractable’ risks

Lebanese government bonds maturing in 2028 are currently yielding 10.98% while credit default swap spreads (CDS) which measure investor confidence that a country will repay its debts, have narrowed slightly to 780 basis points, from a high of 808 at the start of this year. Moody’s rating agency cut the outlook rating on Lebanon’s sovereign debt from stable to negative on 13 December, citing “domestic and geopolitical risks that have become more intractable” while on 18 December Fitch Ratings revised its outlook for the economy from ‘stable’ to ‘negative’ citing the country’s government current account deficit and debt profile as well as falling deposits.

The formation of a government followed by reforms are prerequisites for a 2017 international investment package of loans and grants worth USD11 billion.

All this said, Lebanon is nothing if not resilient. A civil war from 1975 to 1990, outright conflict and still simmering tensions with Israel as well as the neighbouring Syrian war that has left Lebanon with no workable land border for its exports, have all failed to trigger a sovereign default.

On balance, the political situation in Lebanon remains complex and unresolved since the election nine months ago. With the increased attention paid to the risk associated with the country’s sovereign debt, we would caution investors exposed to Lebanese assets to diversify until a political plan is in place to address the macro-economic challenges.

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