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Message: <blockquote data-quote="ibnanv" data-source="post: 23682992" data-attributes="member: 218596">Lebanon’s worst bond market shock in a decade has raised doubts about  whether the country’s banks are willing and able to continue to bankroll  the government, raising pressure on Beirut to step up reforms or risk a  destabilizing currency crisis.In September the cost of insuring Lebanese sovereign debt against  default LBGV5YUSAC=MG soared to its highest level since the global  financial crisis of 2008, implying a more than 40 percent chance of  default in the next five years. Many of the government’s  dollar-denominated bonds hit record lows, while yield spreads over U.S.  Treasury debt scaled historic peaks. The panic was triggered  partly by a wider selloff in global emerging market debt. But when  Lebanon’s international bonds have fallen in the past, local banks could  typically be relied upon to buy up the securities. Not so this time.  “When  foreign entities found out Lebanese banks were selling their portfolios  heavily, they started to dump theirs,” said Marwan Mikhael, chief  economist at BlomInvest Bank in Beirut.  Anthony Simond at Standard Aberdeen Asset Management, pointed to a shift in the bond holder structure.  “In  the past, local banks were the marginal buyers of the Eurobonds,  always. So Lebanon used to really outperform in down markets, because  you always had that bid as a backstop,” said Simond, a London-based  investment manager. Just over two years ago, Lebanese banks held  just under $20 billion of the country’s Eurobonds. By July, those  holdings stood at just over $16 billion, having fallen to $13 billion in  April while the overall debt burden has been rising. Changing profile of Lebanon eurobond holdings : tmsnrt.rs/2ImPY7X The  waning of local banks as reliable bond buyers shifted markets’  attention to Lebanon’s credit quality when pricing its debt, said  Simond. “And the story isn’t great.” Lebanon suffers from  persistent budget and current account deficits. Credit ratings agencies  have classified Lebanon as sub-investment grade - or junk - on a par  with Egypt or Angola. S&P Global Ratings warned in August that debt  levels would continue to rise from already high levels. In June,  the International Monetary Fund sounded the alarm, urging Beirut to make  “immediate and substantial” fiscal adjustment. SHORING UP With growth low and traditional sources of  foreign exchange - tourism, real estate and foreign investment -  undermined by years of regional tension and war in neighboring Syria,  Lebanon is now relying more on the billions of dollars expatriate  Lebanese deposit in local banks. The central bank has been  offering high returns to commercial banks depositing dollars, and since  mid-2016 has conducted a series of complex financial operations -  including debt exchanges with the Ministry of Finance and financial  swaps with banks - to obtain even more dollars, helping it to shore up  hard currency reserves. Yet this has reduced the amount of additional hard currency banks can plow into sovereign Eurobonds. “Do  they want to add another $20 million or $50 million (to their  holdings)? Probably not, and that makes a huge difference in this market  just now,” said Simond. Lebanon has prioritized high FX reserves  to defend its two-decade old currency peg, which came recently under  pressure following the shock resignation of Prime Minister Saad  al-Hariri in November.  Since  then, central bank foreign assets, excluding gold, recovered what they  had lost defending the pound to hit an all-time high of $45 billion at  the end of May, before tapering to $43 billion by mid-September.  Over  the past few days, the debt market has calmed down somewhat. Five-year  credit default swaps fell back to just over 700 basis points from a peak  of 803 bps in mid-September, though they ended August at 642 bps. Yet  foreign investors are trying to gauge the risks if Lebanese bonds face  more weakness, which could make it difficult for the government to tap  markets abroad at affordable rates. Research from MUFG Bank  showed that almost half of the government’s foreign currency debt is due  to mature over the next five years.  “The country’s balance  sheets are by far the worst in the MENA region and, arguably, the  emerging world,” Jason Turvey at Capital Economics wrote in a recent  note to clients, adding that government FX debts amounted to 50 percent  of the country’s GDP and a rush to the exit by foreign investors could  tip the small country into a deeper crisis.  “Sustained capital  flight would quickly drain foreign exchange reserves and ultimately  force the authorities to devalue the pound.”  TOO PESSIMISTIC? Many  Lebanese economists call that scenario too pessimistic, saying only  around 11 percent of Lebanon’s public debt is held by foreign investors.  “Nobody here is saying there are no challenges, but there’s a  big difference between having challenges and facing a forced devaluation  of the pound and heading toward a Greek or Turkish scenario,” said  Nassib Ghobril, chief economist at Lebanon’s Byblos Bank. Yet  prospects for solutions to Lebanon’s underlying problems look distant.  Prime Minister Saad al-Hariri pledged in April to cut the state budget  deficit, but fiscal reform cannot happen until a government is formed.  Politicians have been wrangling over that since elections in May. Simond  said the central bank’s financial engineering to support foreign  reserves had succeeded for now, but its reliance on inflows of FX  deposits from commercial banks meant the situation resembled a Ponzi  scheme.  “The central bank has created a system where they are  paying someone to pay someone else to bring money in, and it’s working,  but eventually it may not and that is why they have to reform, and very  quickly.”</blockquote>

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