After months of crisis Lebanon now appears on the cusp of a debt restructuring. What should emerging market debt investors make of this?
Lebanon’s current crisis can be traced back decades. Significant and persistent fiscal and current account deficits financed through the banking sector have led to a colossal level of debt/GDP, and to an oversized banking sector exposed almost entirely to the sovereign.
These macroeconomic imbalances have been accompanied by political stagnation. Given the country’s sectarian divisions and the fragility of its post-civil war institutions, the political elite has stalled on reforms and overseen an ineffective state riven with corruption.
Last year, against a backdrop of political paralysis and worrying signs that the country’s increasingly fraught funding model was running out of steam, a proposed social media tax acted as a catalyst for widespread protests. This was the final straw for confidence which led to a run on the banks.
The ensuing informal capital controls, US dollar shortages and spike in the unofficial exchange rate point to an economic breakdown and led to a collapse in bond values as the market started to price in an ever-increasing probability of debt restructuring.
Given the severity of the economic crisis and macro imbalances, we believe that debt recovery values for investors will ultimately be low and that prices still have some way to fall before becoming attractive on a risk-adjusted basis.
We have never owned Lebanese bonds and remain on the side-lines. We are carefully monitoring the current conundrum, with the hope that Lebanon can find the means to forge a more sustainable future.
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Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
The value of investments, and any income generated from them, can fall as well as rise.