Debt markets should pay attention to the Lebanese standoff

Over the past few months, a Lebanese debt default has seemed a matter of when, not if. The market seems to have decided that this moment will come sooner rather than later.

The price of the Lebanese March 2020 bond plunged to 57 cents to the dollar on Wednesday. That’s a huge discount for a bond that has to be repaid in just 19 days.

Debate over whether the government should repay the money is raging in financial circles in Beirut. On the one hand, Lebanese banks – themselves major holders of the bond – argue that the country’s impeccable record of meeting its obligations is worth defending. But opponents say there is no point handing over $1.2 billion on March 9 that could be used to import food or fuel, to deal with a similar crisis in April and June when more dollar debt expire.

Foreign bondholders are also divided. Ashmore, the London-based asset manager that holds $300 million of the March bond as part of a $1 billion bet on short-term Lebanese debt, has drawn criticism from other investors pushing for a full refund. These critics – including Pimco, the global investment house – say the March redemption would only delay the inevitable and lead to bigger losses for holders of longer-dated bonds.

Crucially, Ashmore has accumulated a stake of more than a quarter in bonds maturing in March, April and June – above the threshold required to block a debt restructuring.

The Lebanese government could still decide to reimburse Ashmore and Co next month. The price of the March bond has seen wild swings in recent weeks: it was trading above 90 cents just two weeks ago.

But moves this week suggest the anti-payment camp is gaining the upper hand, as IMF staff arrive in Beirut to advise on a possible restructuring of the country’s debts.

Buyers of the dollar bonds had hoped they could escape any restructuring in part because they collectively account for less than half of Lebanon’s government borrowing, which amounts to 160% of GDP. As one fund manager who was buying in November put it: “We think they’re going to muddle through and pay it back. There is no great point in defaulting. . . for a very small amount of debt relief.

Such arguments carry less weight now that the market has, in fact, priced in a default. The importance of a spotless repayment record has also been overstated, judging by markets’ willingness to lend to “serial defaults” such as Ecuador in recent years, according to Oxford Economics’ Nafez Zouk.

Ultimately, whether or not to repay next month is a political decision. A weeks-old government can bow to the pressures of a slowing economy, a gaping budget deficit and popular protests and choose to restructure its debt. But Ashmore and Co hopes that Beirut will last a few more months.

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