Hezbollah in Syrian War Drives Lebanon Risk Higher: Arab Credit

Lebanon’s investor risk surged to the highest level in 10 months amid concern that sectarian violence in the most indebted Arab country may escalate after Hezbollah openly joined the war in neighboring Syria.

The yield premium investors demand to hold Lebanon’s $34 billion of dollar debt over U.S. Treasuries climbed 33 basis points in the past four weeks to 464 on June 11, the highest since September, after the Shiite group sent fighters to support the Syrian government, JP Morgan Chase & Co. data show. The cost of insuring Lebanon’s debt against default rose 31 basis points this month to 471, compared with 305 basis points for Hungary, according to data compiled by Bloomberg.

Hezbollah’s military backing of President Bashar al-Assad against the mainly Sunni rebels risks turning sporadic clashes between Islam’s two main sects in Lebanon into a civil war as early as next year, according to research firm IHS. While violence has been largely confined to the north, rockets slammed into Hezbollah’s stronghold in southern Beirut last month for the first time since Syria’s uprising started in 2011.

“Hezbollah’s support for the Assad regime is the single biggest risk factor for Lebanese credit, the economy and social stability,” Raza Agha, London-based chief Middle East and Africa economist at VTB Capital Plc, said by e-mail June 11.

Yields Rising

The yield on Lebanon’s $2.1 billion bonds due April 2021 jumped 25 basis points, or 0.25 percentage point, last week, the biggest weekly increase since July last year, according to data compiled by Bloomberg. It fell two basis points today to 6.74 percent.

Hezbollah’s leader Sayyed Hassan Nasrallah has justified supporting pro-Assad forces as a necessary step “to protect the back” of the group, which fought a monthlong war with Israel in 2006 and receives weapons through Syrian territories.

In response, the Sunni-ruled Gulf Arab states, which include Saudi Arabia and Qatar labeled Hezbollah as a terrorist organization. The action followed a warning to their citizens, who account 60 percent of tourism revenue during peak summer months in Lebanon, against traveling to the Arab country.

Tourism Minister Fadi Abboud said May 29 that the industry, Lebanon’s main hard-currency earner, has already dropped 13 percent this year. Economic growth, which averaged 8 percent a year between 2007 and 2010, won’t exceed 2 percent this year, Finance Minister Mohammad Safadi said in an interview in Beirut June 5.

‘Political Uncertainty’

“There is a general wait-and-see approach by investors regarding the prevailing political uncertainty that has increased recently,” said Nassib Ghobril, chief economist at Beirut-based Byblos Bank SAL.

Lebanon’s credit default swaps have increased over the last four weeks, making them the second-riskiest credit in the region after Egypt, according to data compiled by Bloomberg. Lebanon is rated B at Standard & Poor’s, the fifth-highest junk grade and two levels above Egypt.

To be sure, not all reasons for Lebanon’s higher borrowing costs are political.

“There has been a significant supply of Eurobonds in the market recently” that helped drive yields up, Ghobril said. The government sold $600 million in bonds due 2023 and $500 million in securities maturing in 2027 in April. Lebanon has the equivalent of $18 billion in debt due this year and next, according to data compiled by Bloomberg.

Political Turmoil

The performance is also affected by concern among investors that the U.S. Federal Reserve may cut its bond purchases amid signs that the world’s biggest economy is recovering.

“Most of emerging-market yields, be it local or external, have gone up,” Jean-Dominique Butikofer, who helps manage over $2.5 billion of emerging-market debt at Union Bancaire Privee in Zurich, said by phone June 11. “The liquidity provided by banks in this risk-off environment is not that ample. Non-investment grades debt has for once also underperformed across the board.”

Add the region’s political turmoil, and holding Lebanese debt becomes less appealing, he said. “The big question mark for the entire region is whether there will be a spillover from the Syrian turmoil into neighboring countries and its impact on the performance of their external debt.”

Cabinet Delayed

Three people were injured on June 11 when nine rockets hit Lebanon’s mostly Shiite northeastern region of Hermel, according to the official National News Agency. After the attack, unidentified gunmen shot and killed a man from a mainly Sunni town. Earlier this month, Hezbollah’s fighters clashed with Syrian rebels in Lebanon’s eastern Bekaa Valley.

Political unrest has also delayed the formation of a new cabinet after the resignation of Prime Minister Najib Mikati in April, amid disputes between Western-backed political groups and a Hezbollah-led front over the mandate of the government and a new election law. The U.S. lists Hezbollah as a terrorist organization.

“The prospects of forming a cabinet have plummeted with the increasing spillover from the Syrian conflict,” said James Petretta, associate director for the Middle East and North Africa at Maplecroft, a U.K.-based global risk adviser. “Hezballah’s open support for the Assad government and growing violence inside Lebanon will make it virtually impossible for the formation of a neutral, or non-partisan, cabinet.”

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