Lebanon: Debt dynamics

Despite the ongoing political stalemate, Lebanon’s economy looks set for continued expansion in 2011, albeit at a somewhat reduced pace, although continued uncertainty may result in higher costs for borrowing when the country seeks to finance its growing budget deficit.

A number of agencies forecast Lebanon’s economy to expand by 5.5% this year, down from the 7.5% GDP increase in 2010 and the average 8.5% from the past three years. However, these predictions generally carry with them a caveat, such as that from Standard Chartered Bank in a report issued in late March, which said that while the Lebanese economy was expected to exhibit its usual resilience, a slowdown was likely due to political volatility.

The prime minister designate, Najib Mikati, has been unable to form a cabinet, despite having been given the mandate to do so in late January, and further delays would stall much-needed fiscal reforms and measures to maintain or increase state revenue. This in turn could see the state deficit swell and necessitate raising more public debt, either through direct borrowings or the issuing of bonds on local or international capital markets.

The government issued a seven-year bond as recently as December 2010. Amounting to some L£1.5trn ($992.78m), the bond is part of an effort to shift public debt from foreign currencies to the Lebanese pound. Issued at a 7.9% coupon rate, the bonds will mature in 2017 and according to the finance minister, Raya Al Hassan, the issue was heavily subscribed, an indication of ongoing confidence in the economy.

However, figures released by the credit-default swap (CDS) and bond-pricing firm, CMA Datavision, showed that the spreads on five-year CDSs for Lebanon widened by 17% between the fourth quarter of 2010 and the first quarter of 2011. The five-year bonds ended the first quarter at 347.7 basis points, widening by 49.6 points over the previous quarter. Over the course of the previous year the spread widened by only 28.5 basis points. Nevertheless, Lebanon’s 17% rise was significantly less than those of other countries in the region over the same period, including Bahrain (74%), Saudi Arabia (66.4%) and Egypt (42.6%).

Still, there is ample money in the Lebanese economy, with domestic banks holding deposits equivalent to around 275% of GDP and the country boasting a proud record of having never defaulted on an international debt. However, the price for the lack of political stability may have to be paid, in part at least, with higher rates for bonds and local papers.

There are some indicators that Lebanon will have to find funds to finance state activities, despite the fact that some outlays, such as capital works projects, are expected to be put on hold until the new cabinet is formed. With the economy slowing, revenue from real estate taxes and tourism have eased, according to figures issued by the Ministry of Finance in early April, while the deficit as of the end of February stood at $555.5m, just under 31% of total government spending. This compares to the $195m deficit, equivalent to 12.02% of outlays, that the government was running one year before.

At present at least, Lebanon is not likely to experience any difficulties in servicing its existing debts, according to Nassib Ghobril, the head of the research and analysis division at Byblos Bank. “We will not face problems in terms of debt at the moment, because our liquidity levels are good,” Ghobril said in an interview with the Daily Star on April 6, though he warned that this situation could change if state spending rose at a time when the economy was sluggish. “The last thing we need is for our borrowing needs to grow,” he said.

Should those needs grow, it might cost the state more to borrow. At the end of March, Barclays Capital downgraded its recommendation in its emerging markets credit portfolio on the country’s external debt, lowering it from the neutral weighting it had assessed it at as of December 2010 to underweight. This revision put Lebanon’s external debt rating at the same level as Egypt and Tunisia.

An additional disincentive for investors looking to buy into debt papers, Barclays said Lebanon’s external debt posted the second-steepest decline in returns among five countries in the Middle East and North Africa region, ahead of Egypt but behind Tunisia, Qatar and Abu Dhabi over the three months ending March 31. Barclays cited a slowdown in economic growth and a declining primary surplus as major risks to Lebanon’s debt dynamics.

On April 8, the CMA issued its latest report setting out the 10 most risky sovereign debtors, with Lebanon joining Egypt and Bahrain as newcomers to the top ranking, a result of rising costs for debt insurance as confidence in their debt stocks fell.

“As the Middle East enters a turning point in its history, the cost of debt insurance widened out this quarter as bond investors move to the sidelines, waiting for the unrest to pass,” the CMA report said.

Thus, despite the expectations of continued growth and the abundant liquidity in the local banking system, outsiders are remaining cautious about the country’s prospects moving forward and it may take greater clarity in the situation, both domestically and regionally, before borrowing costs and CDS spreads ease.