On 31 January, the three main political parties, which had been in deadlock since the May 2018 election, struck a deal to establish a new national unity government. Details are still emerging, but it is clear that incumbent Prime Minister Saad al-Hariri will remain in power, albeit likely in a weakened position that will see him make cabinet concessions to opposition parties, including the FPM and Hezbollah (the latter of which is likely to receive ministerial posts in health, youth and state, as reported on Bloomberg).
Early reports, though, indicate that Finance Minister Ali Hassan Khalil is likely to remain in his post. If this proves to the case, it is likely to be viewed with mixed emotions by investors. The latter would favour continuity, especially on the technocratic front, but will likely weigh that against Khalil’s comments in early January that threw markets into turmoil when he suggested the country was looking to restructure its external obligations; he later clarified that a restructuring of Lebanon’s external obligations was not under consideration.
Although the news comes as a slight surprise in terms of timing, we had anticipated a new government in the next few months. Ultimately, today’s events should be seen as very welcome news for a country that is facing considerable macroeconomic challenges, including a debt/GDP ratio that stands second only to that of Japan (if we exclude Sudan, Venezuela and Greece, who are either in distress or have recently been restructured) and a fiscal deficit nearing double digits.
The government’s formation should also release US$11bn in financing that the country was able to secure at the CEDRE conference last April, which has been frozen until the advent of a new administration. Although this additional source of external financing will reduce the country’s external financing gap, it will not be sufficient to put Lebanon’s debt on a sustainable trajectory, which will require massive structural adjustments – the possibility of a future restructuring cannot be ruled out. This is the sad reality for a country that has managed never to miss a single payment on external liabilities, even during its prolonged civil war.
Implications for our market views
Initial market reactions are very positive, Lebanon 8.25% 2021s are already trading up c2.4%, Lebanon 6.85% 2027s are up 3.8% and Lebanon 5.45% 2019s are up c0.5% to US$98.4, their highest level since July 2018. Although today’s news is obviously a positive directional move for debt sustainability, the reality of Lebanon’s macroeconomic challenges are simply too large for us to take a constructive view on the medium-to-long-dated bonds and, thus, we maintain our Hold on these issues. We, however, reiterate our Buy recommendation on the Lebanon 5.45% 2019s, which we had already believed to be money-good on the back of a US$5.5bn swap operation conducted between the Banque du Lebanon (BdL)/Ministry of Finance (MoF) that has effectively prepaid the country’s debt obligations through 2019. Today’s news will only go towards further reducing any credit risk on this issue.
On equities, meanwhile, for those prepared for very low liquidity, Lebanon stocks (AUDI, BLOM, SOLA) offer compelling value, particularly with the formation of the new government.