Lebanon gets a ‘stay of execution’ from investors, but now the real work begins

Beirut, Lebanon

Beirut, Lebanon

The cost of insuring Lebanese debt has hit its lowest level this year on the back of some reassuring news for investors: The country has finally formed its government after nine months of gridlock, and state officials revealed they are in talks over financial support for a floundering economy.

Lebanon’s five-year credit default swaps, or the price of insuring the country’s debt against a default, fell to $694 this week from a high of $900 in January, levels not seen since November last year.

But markets have yet to see the change that will unlock $11 billion in funds pledged by international donors to the small Levantine country at the Paris Cedre conference last April. The financial support rests on the condition of direly needed reform in the areas of corruption, subsidies and public-sector spending.

The new government will “most certainly” introduce austerity measures to shore up international and bond market confidence, according to political risk consultancy Eurasia Group — and that will not be easy.

Unpopular, yet urgent, reforms

“The issue of cost cutting will prove challenging, though some cuts are also likely,” said Ayham Kamel, Eurasia’s practice head for the Middle East and North Africa (MENA). “On balance, these positive reforms will not be overly ambitious and could slow over the long term.”

Many of the reforms are also unlikely to sit well with the Lebanese population. “If it’s taken nine months to form a government, it will be extremely difficult to agree on the details of an aggressive (and unpopular) fiscal tightening. The only other plausible option to deal with the public finances would be debt restructuring,” research consultancy Capital Economics said in a weekly report Thursday.

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One key area of reform is the electricity sector — Lebanon suffers daily power outages while the state power company, Electricite Du Liban, is awash in subsidies. Reforming this sector would cover a huge part of the fiscal consolidation promised to donors in April, but Kamel notes that this has thus far been prevented due to “vested interests.”

Overhauling the electricity sector, and the infrastructure upgrades that would come with that, is one of the new government’s first priorities, a top advisor to the Lebanese prime minister told media in an interview earlier this week.

A ‘stay of execution’

The numerous and drastically varied political interests comprising Lebanon’s government will continue to threaten the pace of reforms, but at least for now, a fully-formed government has allowed Lebanese bond holders a sigh of relief, said Daniel Marc Richards, a Dubai-based MENA economist at bank Emirates NBD.

“While easier said than done, especially in light of the disparate stakeholders represented within the government, the vocal commitment to it is encouraging, and will help stem the growth in Lebanon’s debt levels,” Richards said in a report this week. The bank forecasts Lebanon’s 2019 growth at just 0.9 percent.

While significant challenges to the Lebanese economy remain, “the risk of a crisis appears to have been averted for now,” he said, adding that the country still has reserves equaling roughly 11 months of cash to pay for imported goods. “Reforms are still essential, but Lebanon has been given a stay of execution for now.”

The recent bouts of good news have allayed fears of an economy facing meltdown. At more than 160 percent, Lebanon’s debt to gross domestic product (GDP) is the third-highest in the world, and ratings agency Moody’s in January downgraded its credit rating from “B3” to “Caa1,” on concerns it wouldn’t be able to pay its massive debts. Growth in the country of 6 million is stagnant, dragged down by the influx of some 1.5 million Syrian refugees and increasingly strained and insufficient infrastructure.

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Financial support – with strings attached?

Beirut got some much-needed breathing room following aQatari offer to buy $500 million worth of Lebanese bonds in January, and Saudi Arabia quickly followed suit, withholding details but pledging tosupport the country “all the way.”

Lebanon’s elections in May, held five years after they were originally scheduled, saw the Iran-backed political party and militant groupHezbollah make record gains. The nine months of haranguing among competing political factions, choking potential reform efforts and investor sentiment, was a reflection of the country’s complex sectarian divides and deeply entrenched patronage system.

There is likely to be “consternation in the Gulf” over Hezbollah’s more entrenched role in Lebanon’s cabinet, Capital Economics said. This “raises the risk that the likes of Saudi Arabia row back on previous commitments, potentially putting renewed pressure on the balance of payments position,” the firm warned, something that could trigger a fresh sell-off in local markets.

Saudi Arabia, traditionally an economic patron of Beirut and one of its top investors,withheld a $3 billion aid package in 2016 in response to the rising power of Hezbollah, with whom Lebanese Prime Minister Saad Hariri — himself a dual Saudi-Lebanese citizen — had brokered a power-sharing deal. Observers now question whether aid from various partner countries will come with strings attached, and whether the financial support Lebanon needs will come at a political cost.