CDS market signals risk of a cash crunch looming for Lebanon

LEBANON CENTRAL BANKThe cost of insurance on Lebanese sovereign bonds has soared in recent weeks, reflecting concerns about the sustainability of the country’s debt burden as its economy slows and faces a potential cash crunch.

Like many emerging markets, rising global interest rates are swelling Lebanon’s external financing costs as the economy’s growth rate slows to 1.3 per cent this year. The country has the world’s third highest debt-to-GDP ratio at 150 per cent, a legacy of borrowing from public markets to rebuild after its devastating civil war.

That has spurred a sharp slide in bond prices and a rapid rise in the price of insuring one-year Lebanese government paper using credit default swaps.

The one-year CDS has jumped from around 620 basis points to a high of over 1,100 bps over the past two weeks. The one-year contract remains quoted above 1,000 bps and the risk premium of Lebanese sovereign bonds over US Treasuries has climbed to a record high of 848 basis points this week. JPMorgan’s Lebanon EMBI Index now has an 11 per cent yield, compared with around 4 per cent at the start of 2018.

Ehsan Khoman, head of MENA research and strategy at MUFG, said markets were reflecting concerns that lack of action to strengthen Lebanon’s fragile balance sheet could prompt a potential devaluation of the Lebanese pound. In this scenario, “the authorities would find it increasingly challenging to service their large foreign currency debts”.

The Banque du Liban, Lebanon’s central bank, has performed complex monetary policy operations since 2016 to protect the Lebanese pound. But the pressure on the country’s finances is illustrated by the cost of insurance for one year CDS rising above that of the five-year contract, which is the standard benchmark for the sovereign CDS market. Such an inversion between the one and five-year contracts is commonly seen when investors are worried about a near term cash crunch, as they rush to buy protection against a default within the next 12 months.

Marwan Barakat, head of economic research at Bank Audi, a Lebanese lender, cautioned that the widening CDS spread is “not related to any fundamental change,” but to “uncertainty related to the formation of the government.” The country’s politicians have not formed a new cabinet nearly five months after elections were held in May, in which Hezbollah and its allies won over half the parliamentary seats.

In turn, the pledge of some $11bn in soft loans and gifts to support Lebanon’s public investments in April by nations including Britain, France and Germany remains untapped.

“When we have a cabinet formed the markets will appease and we’ll see it return to normal levels,” predicted Mr Barakat.

Central bank governor Riad Salamé called the political hold-up “frustrating”, in a recent interview with CNBC.

FINANCIAL TIMES