Lebanon’s Illiquid Bond Market Takes a Hit as Credit Risk Mounts

(Bloomberg) -- The banks are closed. The protests that brought the country to a standstill have turned violent. The prime minister has resigned.

And now, trading in Lebanon’s government bond market has all but dried up, sending borrowing costs into orbit.

The yield on Lebanon’s dollar debt due 2021 has jumped to a record 39%, with the bid-ask spread widening to almost 2 percentage points this week, the most in more than a decade, according to data collected by Bloomberg. That’s an indication the bonds are barely changing hands.

Lebanon, one of the world’s most indebted countries, has seen its credit risk soar as confidence in the government’s ability to address the nation’s economic woes diminishes. The cost of insuring its debt against default has jumped about 75% this year, the most in the world after Argentina, amid political squabbles and delays in the 2019 budget.

Prime Minister Saad Hariri’s resignation has created a political vacuum that exacerbates risks to the nation’s economy. He stepped down about a week after presenting an emergency package to rescue the country’s finances. The plan was rejected by protesters, who demanded the ouster of the government and key officials.

Meanwhile, local banks, the biggest holders of Lebanese debt, have remained closed for more than a week. Calls are mounting for Lebanon to impose formal restrictions on the movement of money to defend the dollar peg and prevent a run on the lenders when they open their doors on Friday.

If capital controls are imposed, even temporarily, they risk discouraging the wealthy Lebanese diaspora from repatriating their dollars, a key source of funding for the financial sector.

The average yield on Lebanon’s Eurobonds has jumped to a record 21%, according to a Bloomberg Barclays index, up more than 5 percentage points since the end of last month, when Lebanon was said to have sent requests to banks for proposals for a potential international bond sale.

It’s unclear if those plans are off the table, although the nation’s borrowing costs may have become prohibitive. Governor Riad Salameh said in August that the central bank had already set aside cash to cover the $1.5 billion Eurobond due Nov. 28. There have been no public updates on government plans to raise the cash since.

Aside from next month’s debt, there’s about $12 billion of principal and interest payments coming due through 2022. That’s more than the government’s 2018 revenue and roughly a fifth of gross domestic product, according to International Monetary Fund data.

Given Hariri’s resignation, “the least disruptive way this could play out is an orderly restructuring with an IMF deal in hand,” said William Jackson, the London-based chief emerging markets economists for Capital Economics. “Although this would still entail bond prices falling from current levels.”

“The bigger risk is that events unfold in a disorderly way in which the dollar peg comes under pressure and strains spread to the banking sector,” Jackson said.

©2019 Bloomberg L.P.