The authors are CEO and analyst at the consulting firm Complex
Sometimes the capital markets are the first to recognize positive economic changes out of difficult circumstances. At the beginning of 1942, at the height of World War II, when Germany won victories in Europe and the Japanese beat the US at Pearl Harbor, the world’s capital markets actually began to rise consistently. This, in anticipation of the US entering the war, which would lead to the defeat of Germany, as happened three years later.
In our estimation, it is possible that a similar move is currently taking place in Lebanon’s government bonds, which are deeply insolvent, and bodes well for Israel as well.
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What made investors in Lebanon change direction?
Lebanon’s dollar bonds have increased in value by 40% in the last two weeks, immediately after the severe blows inflicted on Hezbollah and the ground entry of the IDF into the country. The turn in the price, in fact, began on September 25, the day when the shooting from Lebanon expanded to the center of the country.
In our estimation, investors are looking beyond the destruction created by the fighting, and for the first time are pricing in hope for a dramatic weakening of the destructive grip of Hezbollah and Iran in Lebanon, in anticipation of new conditions that will allow an exit from the world’s biggest economic crisis in about 150 years.
On the other hand, it is appropriate to take things in proportion. The increase in bond prices is done in low trading cycles, and even after that the bonds trade at a ratio of only 9 cents to the dollar. This is a price that reflects the lack of chance for the bond to be repaid, but an expectation of a debt settlement in which new bonds will be received that will be repaid in the distant future, the economic value of which could be about 20 cents to the dollar. This, as part of the economic arrangement and the flow of funds from aid programs on behalf of international entities, such as the International Monetary Fund and investments for the reconstruction of the country.
Lebanon’s collapsing economy reflects failed political and economic management by extremists who are divided into different sects. The processes of deterioration matured slowly in the previous decade, in which the budget deficit and the trade balance deteriorated, while Lebanon had difficulty carrying out economic reforms, reducing deficits and even electing a stable and functioning government in the shadow of political disputes, until the outbreak Severe economic crisis in 2019.
In the past, one of the country’s most reliable sources of dollar funding came from millions of Lebanese who worked abroad and sent money home. However, these transfers have declined sharply since 2011 due to Iranian influence, increasing sectarian divisions, and the strengthening of Hezbollah’s power in Lebanon.
At the same time, foreign donors did not provide the promised aid and the few remaining liquid dollars fled Lebanon. As a result, the banks froze tens of billions of dollars of foreign currency deposits, which led to the bankruptcy of the government and the banks, and the collapse of many businesses and households.
From 2019, an unprecedented economic decline began in the country, manifested in unimaginable data: the Lebanese pound lost about 97% of its value against the dollar, while inflation jumped by 6,000%. The gross domestic product per capita was cut in half between 2019 and 2021 and more than 80% of the population was pushed below the poverty line.
The combination of these things dramatically strengthened the power of Hezbollah, which enjoyed Iranian funding and the ability to offer services and wages that the state could not compete with. Hence his interest – to leave the country in a political and economic limbo. The debt-to-GDP ratio in Lebanon reached a record rate of almost 300% as of the end of 2022. Such a high debt-to-GDP ratio means that it is impossible to repay the debt, and that an aggressive settlement will be required to erase the vast majority of it. For comparison, Israel entered the “Iron Swords” war with a GDP debt ratio of less than 60% and even today, after a massive increase in debt to finance the war, the ratio is about 68%. Therefore, it is not surprising that Lebanon defaulted in March 2020, when it defaulted on its debt repayments, and the state’s bonds amounting to approximately 30 billion dollars went into default.
Lebanon has stopped publishing official economic data since 2023 while the economic deterioration continues, so it is likely that today the debt-to-GDP ratio is much higher. The rating company Fitch even stopped rating the country in July of this year, in the absence of current fiscal information, which reflects the collapse of the country’s institutions.
Starting an exit from the crisis involves choosing a new government, without Hezbollah’s control, which will open negotiations with creditors and the International Monetary Fund to formulate the economic and political reforms required to consolidate a debt settlement and to inject billions of dollars required for aid and investments for reconstruction.
Ofek is also optimistic for investors in Israel
Investing in Lebanese bonds is not possible for Israeli investors since it is an enemy country, and in any case involves a huge risk suitable only for expert “junk bond” investors. However, the prices of Lebanese government bonds may be for Israeli investors another indication of how the war will be conducted and its end.
why? Because, surprisingly, the economic interest of the State of Israel and Lebanon is the same: a dramatic reduction in the power of Hezbollah and the influence of Iran.
To a large extent, Israel is currently going, militarily, “all the way” against Iran and Hezbollah, in order to change the face of the region politically and economically. Such a move will not only dramatically reduce a significant military threat to the country, but in our estimation will create unprecedented economic opportunities as a result of a historical political change of peace agreements with the axis of moderate Sunni policies, led by Saudi Arabia, who are interested in weakening the radical Shiite axis that threatens them as well. This may be an economic effect of the “Abraham agreements” in the square.
To the extent that this is realized in the long term, and to the extent that the government is able to formulate a necessary budgetary convergence and a solution to structural economic and social problems that the war necessitates dealing with, a huge economic leap may occur in Israel, combined with a force multiplier of the influence of new trade and development opportunities. In our estimation, these may overshadow the recent rating downgrades and allow the country to dramatically increase the GDP, in a way that will allow the debt accumulated during the war to be lowered in a gradual manner while restraining the debt-to-product ratio and rating increases.
In our opinion, investors in Israel still do not sufficiently recognize the enormous economic potential of the political and military hour. This optimistic scenario is not currently embodied in the prices of government bonds and stocks on the Tel Aviv Stock Exchange, but may begin to materialize as the signs of the weakening of Hezbollah and Iran multiply.
*** The above does not constitute investment advice or marketing that takes into account the data and the special needs of each person