Lebanon Economy

Effect of Downgrade on Lebanon's sovereign Debt

Effect of Downgrade on Lebanon's sovereign Debt

Answer 1

Sovereign credit ratings are the evaluations of the relative likelihood that borrower will default on its obligation. Governments usually require credit ratings to facilitate their access to worldwide capital markets. Sovereign debt is the debt issued by the government in the foreign currency to foster the issuing government growth. The stability of issuing government is an important factor to consider when evaluating the risk of investing in sovereign debt.

Impact of credit rating downgrade on Lebanese sovereign debt

A credit rating downgrade would adversely affect the sovereign debt position of Lebanese sovereign debt. After the downgrade the bonds of the Lebanese government may turn from investment grade to speculative grade and as most investors invest only in investment grade securities only, Lebanese government can have difficulty in raising additional foreign reserves. The consequences of a downgrade on Lebanon's economy could be an increase in its borrowing cost and an increase in credit spread which could result in a decline in the price of bonds issued by the government.

Impact of Lebanese credit rating downgrade on yield curve

The yield curve of Lebanese bond market will steepen as a result of this downgrade and as a result of which yield spreads will raise which will in turn increase the interest rate on bonds and lowering of bond prices. The yield curve shows the relation between interest rates or the cost of borrowing at different levels of maturity. The graphical depiction of the relationship between a bonds yield and its interest rate is called yield curve. As the length of investment increases interest rate or rate of return also increases. Yields tend to rise as ratings get downgraded. The relation between a credit rating downgrade and yield spreads is portrayed in the graph below. The increase in yield due to a rating downgrade could seriously cause the interest bill to rise and would also mean more losses to banks and pensions funds. The result is easy to comprehend as investors require more and more compensation now to invest in a risky investment after the downgrade (Cantor and Packer, 1996).

Answer 2

Impact of trade deficit

Lebanese government runs a fiscal deficit, which means expenditures are more than the revenues generated. A fiscal deficit that absorbs private domestic savings indicates reluctance in terms of will or ability of a govt. to tax ...