Lebanon's credit risk may be up but the government is unlikely to default on its illiquid and closely held sovereign debt because of a combination of established investor patience and regional financial support.
Investors have grown used to Lebanon's 180 per cent of public debt to gross domestic product ratio. The $36 billion in public sector debt is split roughly between local and foreign currency issues.
For a start, Saudi Arabia pledged $1.5 billion earlier this week to support the economy and fund rebuilding efforts, giving investors another reason not to bail out of the country.
It is the illiquidity of the market, the buy and hold mentality of many investors in the region who are flush with petro-dollars, that makes the widening of Lebanon's credit default swap (CDS) spreads since the conflict began misleading.
Investors buy CDS, which act as an insurance policy against credit defaults or restructurings, either to hedge against other investments or gamble on the question of default itself.
"I think the issue is no one really knows what the effect on the credit will be, but you have this situation in Lebanon where they have had a huge amount of debt, relative to its GDP, for so long that no one really wants to bet against it," said Angus Halkett, emerging market strategist at Deutsche Bank in London.
Traders note that Lebanese CDS probably trade as little as every other day, if that, and since the conflict between Israel and Iranian and Syrian-backed Hizbollah exploded July 12, spreads have widened by 100 basis points to a bid price of 450 basis points.
"My feeling with Lebanon is that even in the best of times it doesn't really trade that much on CDS. I think it has been trading a little bit, but you cannot really read too much into prices," Mr Halkett said.
Lebanon's long-dated US bond due 2021, was last bid on Wednesday with a price of 92 and a yield of 9.251 per cent, according to Reuters data..
The bond, issued in April of this year has seen its yield spread over benchmark US Treasuries widen by as much as 105 basis points since the start of the conflict but has since narrowed to a spread of 95 basis points.
"More than 60 per cent of Lebanese cash debt is owned by Lebanese investors... and in general over time it reacts really slowly to good or bad news because it is a captive market," said Luis Costa, emerging debt strategist at ING in London.
"They don't sell. They buy the bonds and sit on them and don't react like hedge funds do to either to good or bad news," he added.
Lebanon's CDS spread is difficult to compare given its illiquidity but it is currently running similar to Iraq's CDS spread which shows an ask price of 495 bps.
On Tuesday Saudi Arabia's King Abdullah ordered the transfer of $1 billion to Lebanon's central bank to help support the economy and secure against a run on the currency.
King Abdullah ordered a separate $500 million donation to be used to help rebuild war damage.
Credit ratings agency Standard & Poor's said Saudi Arabia's pledge is helpful for the country's near-term rating prospects although they remain on negative credit watch.