(Bloomberg) -- The market’s memory is so short when it comes to Lebanon that a few weeks of government inaction all but wiped out a bond rally fueled by Gulf aid pledges and the end of a nine-month political stalemate.
The brief morale boost is giving way to frustration among investors and creditors as a new cabinet formed in January fails to discuss, let alone act on, promised measures meant to shrink a yawning budget gap and jumpstart growth. The economy is creaking under the strain of public debt, which the World Bank has warned is on “an unsustainable path.”
The market backlash didn’t take long to materialize. Left out of a broader rally in emerging markets, Lebanon’s dollar bonds due 2028 have declined almost daily in the last three weeks, sending the yield to near its highest since Jan. 30, the day before the cabinet was formed.
Lebanon’s debt risk, measured by credit default swaps, has climbed by over 100 basis points since the end of February, staying above 700 basis points during the past two weeks.
“Lebanese bonds are only able to sustain rallies when the news flow continues to be positive,” said Richard Segal, senior analyst at Manulife Asset Management in London. “The trend is still negative, but a positive policy surprise will be taken well by investors.”
Yet politicians appear to be bogged down in bickering over missing public funds and the Syrian refugee crisis, inviting more skepticism about the government’s ability to deliver.
Talk of a possible debt restructuring earlier this year -- later denied by the government -- has already taken a toll on investor confidence in the country’s ability to repay what it owes. Calm returned after Qatar pledged to buy government bonds worth $500 million while Saudi Arabia vowed to lift a 2012 travel advisory and support the Lebanese economy “all the way.”
But donors who pledged $11 billion last year to improve Lebanon’s infrastructure need to be convinced of its commitment to implement reforms, French Ambassador Pierre Duquesne said this month. The new cabinet has vowed to trim the budget deficit, improve tax collection and fix Lebanon’s broken electricity network.
In one encouraging sign, the cabinet added a plan to overhaul the electricity sector to its agenda for Thursday, according to local media. Lebanon could save hundreds of millions of dollars a year by slashing costly subsidies to the state-owned electricity company and revamping its aging power plants. Fixing the industry was supposed to be the newly formed government’s first item of reform, a senior adviser to Prime Minister Saad Hariri said last month.
Diaspora Lifeline
To keep its banks stable and defend the dollar peg, Lebanon relies on bank deposits, mainly from the millions of Lebanese living abroad. The combination of slowing inflows, high rates on deposits and reported problems buying dollars and transferring money abroad has stirred speculation that lenders were imposing capital controls.
But Freddie Baz, vice chairman of Bank Audi, said any restrictions on the movement of capital would alarm diaspora investors, Lebanon’s lifeline.
“If we do anything wrong and it might stop these inflows, it would be like cutting out half a lung,” Baz, whose bank holds the largest dollar deposit base, said in an interview in Beirut.
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