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Lebanon, fixed income

The view from Lebanon

  • 17Oct 17
  • Kevin Daly Senior Investment Manager, Fixed Income - EMEA

“Progress lies not in enhancing what is, but in advancing toward what will be.” – Khalil Gibran

The renowned Lebanese poet could very well be speaking for his home country. Lebanon has the potential to be as strong as its famed cedar trees, but first it needs to tend to its roots. So far this year, Lebanon has underperformed the JP Morgan EMBI Global Diversified Index of emerging-market debt. In the current environment, this is not a surprise.

Lebanon’s elevated macroeconomic and political risks, along with its high fiscal deficit and debt, may make investors wary. But two factors could create a backdrop for its debt that is altogether more supportive. The first is the technical position, as Lebanon benefits from a loyal domestic investor base, boosted by rising bank deposits from Lebanese people living abroad.

The second factor is the prospect of a re-rating by offshore investors as the impact from the Syrian reconstruction and the offshore gas fields materializes, although that may be a few years out.

If political stability is achieved, which may be a stretch considering Lebanon’s recent history, one can envisage a situation where the benefits of Syria and gas could have a material impact on growth, fiscal stability and debt levels. As the nation attempts to make progress in its government and economy, investors must weigh these positives against the challenges that the current situation presents.

Lebanon is a complex story.

Political challenges

Lebanon is a complex story. When walking down the street, you can see its diverse culture and religious life reflected in mosques and churches located in close proximity to one another. Security forces are also noticeable, a reminder that the threat from Daesh is still high even though they were driven beyond the northern border in August. The country’s political system, which is based on confessionalism, disperses political power equally among its large religious communities. In Lebanon, the president is always a Maronite Christian, the prime minister is always a Sunni Muslim and the Speaker of the Parliament is always a Shi’a Muslim.

Allowing a voice for each of its major religious affiliations hasn’t prevented the nation from experiencing a number of local and regional political shocks over the past decade or so. Yet Lebanon has remained resilient in the face of falling growth, high and arguably unsustainable debt, double-digit fiscal and current-account deficits, and a humanitarian crisis caused by the Syrian civil war.

But much stands in the way of Lebanon’s progress at this point. The absence of a functioning government for the better part of the last three years has resulted in a deteriorating outlook for the country’s bonds. Although a new law passed in June outlines plans for the first round of parliamentary elections since 2013, there is still much uncertainty over how to advance the political system beyond its sectarian split and include parties that have no religious affiliation.

Many Lebanese doubt whether any renewed political stability following the parliamentary elections in May 2018 could have a meaningful impact on governance, fiscal and structural challenges. For those who view the glass as half empty, the prospect of a new government does not look like a catalyst for change.

Still, Lebanon continues forward. Its central bank, Banque du Liban (BdL), which has broadened its mandate amid the lack of political leadership, should be credited with helping the nation weather its many storms. Many believe that BdL’s creativity has kept the economy afloat in the absence of a government for nearly three years. In addition to its policy actions, BdL has undertaken quasi-fiscal activities, injecting $6 billion in loans over the past five years into the industrial and housing sectors, and more recently providing support for the digital economy.

Drivers of economic growth

While economic growth has fallen sharply since onset of the Syrian crisis in 2011—to 1%-2% from 8%-10% in the preceding four years—it is poised to improve in the coming years on back of the Syrian reconstruction, which the World Bank has estimated at a cost of between $250 billion and $300 billion. The timing and scope of Lebanese involvement are unknown commodities at this point, but many believe it would have a meaningful impact on growth. There are plans to build a railroad to Syria and improve the roads, which should enhance land exports that have collapsed during the crisis.

The development of the offshore gas fields, estimated at 100 trillion cubic feet, will be another important driver for growth, although that may take time to develop given the long lead time from investment to production. Investment in the offshore gas fields is expected to commence by the end of the first quarter of 2018, with production expected in next five or six years. Finance officials estimated the revenues from the offshore gas at $300 billion, of which it is believed that up to one-third could be captured by the government. Gas revenues are likely to have a meaningful impact on government revenues and growth.

But the economy still has its fair share of struggles. The influx of refugees, estimated at over one million, or around a quarter of the Lebanese population, has clearly put a dent on the economy, particularly with respect to tourism. However, there are signs of a revival, with tourist arrivals up 30% year over year through the first half of 2017. Other traditional growth drivers, such as real estate and construction, remain soft, and improvements remain elusive at the moment. Another challenge is that Lebanon’s debt load ranks highest among emerging-market countries and the third-highest in the world behind Japan and Greece. Finally, renewed tensions between Hezbollah and Israel have had a negative impact in the past, and remain a key risk to the economic outlook should hostilities break out again.

What’s next?

Political, structural and regional tensions could continue to weigh on Lebanese risk premiums for some time. Nevertheless, we believe the country can avoid a crisis, given a responsive central bank, continued support from local investors and rising bank deposits from the diaspora. Further down the line, the Syrian reconstruction and the development of offshore gas should improve the picture significantly. If the roots continue to strengthen, the tree should thrive.

Editorial image credit: IgorGolovniov / Shutterstock.com