The international investment bank J.P. Morgan issued on February 4, 2025 a report titled “Lebanon: Politics and stability before economics” discussing the latest developments related to Lebanon. According to the investment bank, the Lebanese parliament managed to elect Chief General Joseph Aoun as a new President in early January 2025 and designated diplomat and Judge Nawaf Salam as the new Prime Minister, citing the clearing of the political vacuum in the country as a first major step towards a potential economic stabilization. Furthermore, the report commented that recent events count as positive but are insufficient to reach normalization.

From another standpoint, J.P. Morgan mentioned that the Middle East conflict inflicted another shock to the Lebanese economy and led to massive displacements and severe destruction, which according to the World Bank’s Interim Damage and Loss Assessment report, is estimated at $8.5 billion. According to the report, Lebanon has been suffering from an economic crisis long before the conflict in the Middle East. More specifically, the report mentioned that Lebanon defaulted on its sovereign debt in March 2020, with the situation in the country further exacerbated by the COVID-19 pandemic, the Beirut port explosion, and the Russia-Ukraine war back in 2022.

According to the report, Lebanon’s Eurobond prices have recently rebounded back to their 2020 levels following the positive events that took place in January and reached around 16-17 cents to the Dollar, noting that this upside move placed Lebanon as the best performer in the EMBIGD in 2024. J.P. Morgan warned, however, that caution is still warranted given that the risks to political stability prevail.

From another perspective, the report noted that the deteriorating situation of the country especially after the Middle East conflict would likely imply more time to reach medium-term stability. In parallel, the investment bank assumed in its analysis of debt restructuring a package of bonds with a 10-year maturity extension (bonds maturing between 2030 and 2047) paying a 1% coupon until the year 2027 with a step-up to 2% in 2027 and to 7% starting 2028. By adopting an exit yield of 16%, J.P. Morgan estimated that markets are pricing close to a 70% notional haircut on bonds.

The report noted that Lebanon’s economy has become virtually dollarized, with Dollar banknotes making up around 95% of deposits and cash held outside the banking system. J.P. Morgan commented, however, that the elevated dollarization level and the pegged currency are not sustainable, especially given the low level of net FX reserves. According to the investment bank, Lebanon’s Central Bank would need to restore confidence by severely reducing money supply growth, restoring confidence in the banking sector by protecting small depositors, and rebuilding FX reserves.

Moving forward, J.P. Morgan stated that markets would be paying close attention to Lebanon’s politics over the near term especially concerning the formation of a credible and capable government that would establish state authority, noting that Lebanon would also require international support to carry out reforms. The country’s reform plan would need to start with reconstructing damages inflicted by the Middle East conflict with the help of international support. As per J.P. Morgan, once the reconstruction phase is up and running, the authorities should shift their focus towards the banking sector before moving to restructuring Eurobonds.

According to the report, since Eurobond holdings are significantly smaller than the overall assets of the banking sector, a larger haircut on Eurobonds will not have a sizeable impact on the banking sector’s balance sheet. Furthermore, the report noted that since it is likely that the recapitalization of the banking sector could involve additional concessional debt, the Lebanese government could seek a larger relief from existing creditors to reach debt sustainability. J.P. Morgan stated in this respect that the IMF’s scenario in 2022 suggested that debt sustainability could be achieved by reducing Lebanon’s debt to GDP ratio to around 80% by 2027 (down from around 200%), with gross annual financing needs averaging around 9% between 2024 and 2027 assuming a 75% notional haircut.

J.P. Morgan mentioned that losses in the financial system were estimated at more than $70 billion according to the IMF’s article IV consultation report, implying a net equity position at BDL of negative $60 billion. It also cited the IMF’s report highlighting that around 80% of commercial banks’ assets are with BDL and that in order to reach an equity position of at least zero over time, BDL would have to write-down most of its liabilities to banks which will result in wiping out 60-70% of commercial banks’ balance sheets. In addition, the report noted that losses to the banking sector are even larger when taking into consideration the rise in non-performing loans since the onset of the crisis. Furthermore, the report stated that since around 60% of banks’ liabilities pertain to resident customer deposits, there is a risk that some deposits may be lost.