Can Lebanon Sustain Reconstruction and Relief Operations?

As Israel-Lebanon War enters its second year it is time to ask how efficient are relief efforts as well as how to bear the exorbitant price of reconstruction amidst the government plan to sustain displacement costs. Financing needs are expected to remain high, at 21.08% of GDP in 2025 and 27.49% in 2026, indicating a growing reliance on domestic debt to cover the government’s funding gaps , a report recently released by the United Nations Development Program (UNDP) said. Before the significant escalation in September 2024, real GDP was projected to contract by 1 percent, the World Bank (WB) said. However, this escalation, which has resulted in a severe human toll, further mass displacement, and substantial physical damage, is likely to drive a significantly steeper contraction that remains difficult to assess. As more components of the CPI basket become increasingly dollarized, and assuming exchange rate stability is maintained for the remainder of 2024, inflation is projected to decline to double digits, with an expected yearly average of 45 percent.

Can Lebanon rely again on the generosity of international donors or does it need to tap international markets; in this token, what would be the options of Lebanon Eurobonds Price Fluctuations?

The cost of the crisis

Already through to the end of 2021, the costs of recovery and reconstruction were expected to total US$1.8 to US$2.2 billion according to the WB. 

The assessment found the value of damage was in the range of US$3.8 to US$4.6 billion, with losses to financial flows of US$2.9 to US$3.5 billion. The impact has been particularly severe in key sectors vital for growth, including finance, housing, tourism, and commerce, the WB report said. As of mid-October 2024, over 3,600 buildings in Lebanon have been damaged or destroyed due to Israeli airstrikes, accounting for approximately 54%of total destruction since hostilities resumed last year. The Lebanese Health Ministry reports at least 2,350 fatalities and over 10,000 injuries from these strikes, with many casualties among civilians. Additionally, the UN estimates that around 90,000 people have been displaced due to the ongoing conflict 

As of early November 2024, approximately 5,868 buildings in southern Lebanon have been damaged or destroyed due to Israeli airstrikes. This represents nearly 25% of the total buildings in the affected border municipalities. The destruction has been particularly severe in villages like Aita ash-Shab and Kfar Kila, where up to 50% of structures have been impacted. The ongoing conflict has led to extensive devastation, with satellite imagery revealing widespread damage across multiple communities near the Israeli border

In a recent appraisal the UNDP said even if the hostilities were to cease by the end of 2024, the economy is likely to further contract by an additional 2.3 percent in 2025 and 2.4 percent in 2026. The medium term negative economic outlook is attributed to an expected sharp slowdown in economic activity, the anticipated slow pick-up of recovery and reconstruction efforts due to due to institutional weakness, in addition to significant losses in capital across all sectors, including infrastructure, buildings, factories, equipment, and utilities. The UNDP said also that unemployment could rise by 1.3 basis points in 2025 and 1.4 basis points in 2026,reflecting increased job losses and limited opportunities for employment recovery.

In the same predictions private consumption is expected to decline by 3.6% in 2025 and 2.8% in 2026, as households continue to experience reduced incomes and heightened economic uncertainty. Total investment could drop sharply by 6.3% in both 2025 and 2026, with private investment facing similar declines of 6.6% in 2025 and 6.7% in 2026, reflecting low investor confidence. Exports are projected to decrease by 1.25% in 2025 and 1.39% in 2026, while imports could fall by 3.07% in 2025 and 2.74% in 2026, as economic activity slows and trade continues to be disrupted, the report quoted.

The conflict’s population displacement will exacerbate weaknesses in the country’s already stressed health and social conditions. Also, a degradation of infrastructure and public services further undermines any prospect of economic recovery in the near term.

Efforts to rebuild damaged areas in southern Lebanon were primarily spearheaded following the 2006 war by Hezbollah through its Jihad al-Bina Foundation, which has begun assessing the damage and providing compensation to affected residents. Residents had two options: receive cash payments to manage their own repairs or allow Hezbollah to oversee reconstruction efforts directly. Additionally, Hezbollah’s initiatives included support for agricultural development and training p programs. The organization aims to quickly reassure the local population by facilitating rapid recovery efforts, similar to those seen after previous conflicts. Is this realistic? It is highly doubtful that Jihad-al-bina’a can resume its operations following the destruction of a majority of Hezbollah infrastructure.

Can Lebanon still revert to tap foreign markets?

Reconstruction cost would have to be carried out by the government. In this token the figures of the budget 2025 presented last month to the parliament are meaningless. After former Prime Minister Hassan Diab announced that Lebanon would default on its Eurobond debt for the first time, the Lebanese currency began to plummet in valuation, leading to hyperinflation. In April 2023, Lebanese inflation hit a high at almost 270 percent reducing to 254 percent in June 2023. Despite being pegged to the United States Dollar at a rate of £L1507.5 per dollar since 1997, the Lebanese pound reached an an all-time low of more than £L100,000 per dollar in March 2023. As prices regain some momentum in the market the probability of institutional investors successfully suing the Lebanese state for defaulting on its Eurobonds is complex and depends on several factors. While the legal basis for such a claim is relatively straightforward, the practical challenges of enforcing a judgment against a sovereign nation are significant. 

A notable development was the increase in prices in early 2024, which was attributed to various factors, including potential legal actions by foreign investment funds and the government’s consideration of repurchasing Eurobonds at a discount. However, these positive trends were short-lived, and prices have since declined due to persistent economic challenges and political uncertainty. 

To note Lebanon’s handling of the financial crisis since 2019 has most likely been the worst on record. More than four years have lapsed and tens of billions of dollars of depositors’ funds have been wasted without any meaningful progress in Lebanon while, for instance, Greece (2020) has been able to exit its crisis in less than three years.

The unfolding conflict within Lebanon’s own territory compounds an already very bleak credit picture and undermines the Lebanese government’s efforts to stabilize the economy through increased dollarization. 

That FATF has now placed Lebanon on its “grey list” is another blow to any hopes of its financial system returning to health any time soon. But bond traders appear to be more optimistic. The new price of 9c suggests that at least some have bought off on the scenario that the possible elimination or severe castration of Hezbollah will cause a measurable improvement in the country’s governance, its willingness to implement long-overdue reforms and sign an IMF agreement, and ultimately its ability to restructure its external debts.

The conditions of the Eurobonds provide for a statute of limitations (prescription) of 10 years for the payment of principal and five years for interest. It is therefore highly likely that suits will be brought against the state before 9 March 2025 as the holders of Eurobonds will start losing their claims to interest on that date, unless a restructuring is completed by then.

If and when judgments are obtained by holders of Eurobonds, their claims will be converted from debt claims to judgement creditor claims. Judgements will not be subject to the “collective action clauses” included in the Eurobonds which provide Lebanon with the ability to force minority holders to accept a restructuring, if it is able to obtain approval of holders of 75 percent of the Eurobonds in each series (voting on a series-by-series basis). Lebanon would then have to negotiate separately with the judgement holders. 

These judgement holders would then be able to enforce against any assets of the state overseas (if any), except those assets protected by immunity. Recent months have witnessed significant fluctuations in the prices of Lebanese Eurobonds. While there have been periods of stability and even slight increases, the overall trend remains bearish, reflecting the ongoing economic and political turmoil in Lebanon.

Investor Sentiment and Market Volatility:

The war has created a volatile market environment for Lebanese Eurobonds. Investor sentiment has shifted dramatically, with many opting to sell their holdings to reduce exposure to the risks associated with the conflict. This selling pressure has contributed to significant price fluctuations.

Lebanon, even in the midst of a devastating economic collapse, total political paralysis and an actual war boasts meaningfully higher living standards than those countries, particularly when its gigantic unofficial economy, and the unregistered portion of overseas remittances, are properly accounted for. Simplifying enormously, one can think of the price of Usd 0.06 as the probability-weighted average of two outcomes: one in which the country stays a dysfunctional, near-failed state — in which case the debt would eventually become virtually worthless — and another in which at least some hint of prosperity and stability returns, and some kind of debt workout is eventually achieved, which might cause the debt to trade at about 20c (but realistically probably not much higher). 

Under this analysis the probability of the first outcome would be close to 70 per cent, while that of the second outcome would be the residual 30 per cent. If this model is broadly correct, the more recent price of almost 9c would be consistent with a reduction in the first outcome’s probability to 55 per cent and an increase in the second outcome’s probability to 45 per cent. In other words, the market is now implying a 15 per cent higher probability (in absolute terms) and a 50 per cent higher probability (in relative terms) to the scenario that Lebanon will become a semi-prosperous, semi-peaceful state — even while the Israeli ground operation continues unabated, the country’s economy is paralyzed and civilian casualties mount. Is this increased optimism consistent in any way with the most recent political developments in the country? 

The plausible(s) scenarios

Experts believe that there are five potential pathways for Lebanon and Lebanese debt, of which only the first two are positive.

• Israel achieves continued operations against Hezbollah and in effect amputates the organization so badly that it ceases to dominate Lebanese politics and loses its ability to obstruct necessary reforms. Lebanon proceeds to implement those reforms, signs an IMF agreement and successfully restructures its external debt. 
• Hezbollah recovers from its initial setbacks and fights Israel to a standstill inside Lebanon, similar to what it achieved in 2006. This enhances Hezbollah’s standing within Lebanon and leaves the party stronger than before. Nonetheless, Hezbollah becomes more integrated in the Lebanese body politic and begins to co-operate with the movement to implement reforms, sign an IMF agreement and ultimately restructure the external debt. 
• Same as (2) with Hezbollah stronger even than before the ground offensive. But this leads to no reforms, no IMF agreement, and no restructuring of the external debt.  
• Israel achieves continued success against Hezbollah and ends its dominance of Lebanese politics; but the remaining Lebanese factions turn out to be incapable of national reconciliation and unable to sign an IMF agreement, so no debt restructuring is forthcoming. 
• Israel damages Hezbollah severely, but the organization remains the most powerful political group within Lebanon and is able to continue impeding reforms, obstructing an IMF agreement and thus stymie any debt restructuring. Anyone who’s lived in the Middle East will know to discount the optimistic scenarios, and therefore be understandably skeptical that the Lebanese bond rally can be sustained. .

Whereabouts:

In light of the above, experts suggested that the following actions be taken as soon as possible.

The state should take advantage of the current price for the Eurobonds to make purchases on the secondary market, subject to compliance with applicable law. Any restructuring of Eurobonds will likely be at a higher price than the current market price, ( currently at Usd0.07), given that the consent of 75 percent of the holders of each series is required in connection with any restructuring. In addition, there will likely be some amount to be paid for accrued interest in any restructuring (while accrued interest is included in the secondary market price). Finally, if Eurobonds are purchased from foreign holders, this will decrease the proportion of those holders, which should facilitate the restructuring.

 Lebanon cannot continue to postpone implementation of the pre-actions required under the IMF program. Enough dithering and populism. Even if it may not be possible or advisable to pass the required laws prior to the election of a president, getting them into an agreed form with the IMF would help restore some credibility to Lebanon and hopefully permit it to improve some of the terms of the IMF program. This in no way is a substitute for proper accountability and recovery of misappropriated funds, as well as funds transferred overseas after October 2019.

 Lebanon must commence immediate negotiations with the holders of Eurobonds, who are likely to insist on the completion of an IMF program, as they must have confidence that Lebanon will be able to service its restructured debt. Lebanon can also use the limits on indebtedness set under an IMF program to negotiate a better deal with the holders of Eurobonds.

 In parallel, it is critical to enhance BDL’s independence vis-à-vis the government and maintain and develop the recent measures taken by the interim governor in this respect.

Reconstructing Lebanon amid closed foreign markets requires a multifaceted approach focused on structural reforms and economic diversification. Key strategies which were asked by the IMF and international community highlighted that implementing a Financial Recovery Plan (FRP) is key. This involves comprehensive reforms to restore macroeconomic stability, improve tax collection, and restructure public debt to regain solvency. These parties will also want to see more transparency and accountability to improve the business environment and attracting domestic and international investments. 

One might infer that several factors continue to weigh on the performance of Lebanese Eurobonds, including the country’s high debt burden, the ongoing banking crisis, and the lack of progress in implementing much-needed economic reforms. Additionally, the global economic environment, marked by rising interest rates and geopolitical tensions, has added to the downward pressure on bond prices.

As a result of these factors, the outlook for Lebanese Eurobonds remains bleak. Investors are likely to remain cautious and may seek to reduce their exposure to this risky asset class. The future trajectory of bond prices will depend on a combination of domestic and external factors, including the resolution of the political crisis, progress on economic reforms, and global market conditions.

Maan Barazy is an economist and founder and president of the National Council of Entrepreneurship and Innovation. He tweets @maanbarazy.

The views in this story reflect those of the author alone and do not necessarily reflect the beliefs of NOW