BALANCING ACT

Lebanon 2014 | ECONOMY | REVIEW: ECONOMY

Lebanon's premier FDI-to-GDP ratio and an impressive surplus in the balance of payments in 2014 are good medicine to dispel fears of fiscal instability and public debt crises looming on the horizon.

After a positive first six months of 2014, by July Lebanon's prudent GDP growth targets of 2.5% announced by Banque du Liban's (BDL) Governor at the BDL Regional Outlook conference in June, as high as some estimates of 4%, looked highly unlikely to be met. Following 1% GDP growth in 2013, down 1.5% on 2012 and 2% on 2011, Bank Med's Lebanon Economic Outlook report published in line with the IMF's forecasting projected that growth would continue at a flat 1%. The World Bank report released in June forecast 1.5%, the lowest in the MENA region.

According to Bank Audi's 1Q2014 report, Lebanon was shaken by a dramatic 35.1% drop in exports following the previous year's astronomical increase. This, combined with a 2.1% increase in imports, resulted in a cumulative increase in the trade deficit by 7.1% on the same period in 2013, up to a total of $4.6 billion. Such a sharp decline in exports is explained by heightened levels of anxiousness and insurance premiums to traverse Syria. Whether by land or sea, overall exports to Syria fell by 15%, with a likely continued fall in exports at the time of TBY going to print, given the Syrian conflict permeating other regions on its periphery, notably Iraq, following the escalation of violence in the second half of 2014.

Such a trade balance left Lebanon's aggregate balance of payments (BOP) standing at a $301 million surplus by April 2014, compared to a deficit of $62 million during the same period of time in 2013. By May 2014, this figure was standing at an impressive $776 million. On the current account side, the BOP is weighed down with a raising trade deficit, slowing tourism, and the gradually worsening indications in Byblos Bank's Consumer Confidence Index, whereas on the capital account side Lebanon's lifeline continues to come through significant financial inflows, of which in the first quarter there was a 15.8% rise on the same period in 2013.

Figures released by the Institute of International Finance show that FDI decreased to $2.8 billion in 2013, down 22.4% from the $3.8 billion recorded at the end of 2012, accounting for 7.5% of aggregate flows to MENA countries recorded in 2013. The FDI flows into Lebanon were equivalent to 6.4% of GDP in 2013, the highest among the 30 emerging markets, in comparison with an aggregate of 2.1%.

The real sector changes displayed a balance of positive and negative indicators, following a general increase and more favorable macroeconomic conditions following the election of a new cabinet. Lebanon's traditional industries look strong, the country is enjoying a significant surplus in capital inflows, port activity, and volumes are up. Retail and wholesaling are still relatively low and bearing the brunt of high inflation and the cost of living being squeezed.

Financing for SMEs operating in the industrial sector through Kafalat guaranteed loans registered an increase of 17.2%, a sure fire indication that Lebanon's industrial sector has no shortage of labor and innovation, even if they are struggling to reach high-value export markets. Cumulatively, Kafalat loan guarantees were up by 6% in the first five months of 2014 to $45 million.

With Lebanon marginally meeting the BDL-imposed growth targets set in 2013, it miraculously pulled through thanks to exceptionally skilled navigation by the BDL. The central bank's stimulus plan, or support package as Governor Riad Salameh refers to it, has had a significant effect on the economy's growth over the last year.

In 2013, BDL's $1.4 billion support package of low interest loans to Lebanon's banks facilitated credit packages for low-cost housing, renewable energy schemes, and industry, and this had a significant knock-on effect on nationwide employment. Speaking at the BDL biannual regional outlook conference in June 2014, the Governor of the central bank, Riad Salameh, said “this package provided 50% of the growth that we saw in 2013, which in total was about 2.5%; we did the same for 2014 and we are pleased to see that the credit enhancement we did was successful and the funds have been used almost completely, which is why we are looking at increasing that package."

Although the injection targeted several sectors, it was mainly used to prop up the real estate sector. “We have low rates if you benchmark them with the region and our surroundings. Lebanon offers a great return on investment at that level," says Minister of Economy and Trade Alain Hakim, which is partly the reason why the vast majority of Lebanon's FDI inflows go into real estate and construction projects.

Indeed there are other priorities for the central bank's stimulus package, Salameh added that “The BDL with its strong balance sheet also has a role to play in employment, so investing in start-ups in the knowledge economy will provide a sector in Lebanon that will encourage competitiveness." Such initiatives on the part of the central bank only complement the strategy shared by the Ministry of Economy and Trade of supporting SMEs. “I imagine the main subject of this foreign investment on that level [SMEs] is not just about what the EU is doing, because we also have many funds helping on that level. The Ministry is preparing a national charter for SMEs to achieve this goal," said Minister Hakim.

A general view of the expansion in the real economy is best comprehended by the BDL's cross sector coincident indicator, which represents a weighted average number of indices, reaching 27.4 in the first couple of months of 2014, growing by 3.4% relative to the same period of time in 2013. This index was recently developed under the BDL in an attempt to better measure productivity in a country where important statistics are unavailable, and, thus, effective policy decisions cannot be made.

However, negative indicators are still a concern. The $65 billion in public debt stock is still growing, and the economy is as vulnerable as ever to shocks. Historically, Lebanon's public debt level declined from 180% of GDP in 2006 to 134% of GDP in 2011, but then started to increase again in 2012, and is now expected to reach 145% of GDP at the end of 2014, according to studies undertaken by Byblos Bank Research.

The servicing costs to this debt are, of course, increasing and marginalizing room for local infrastructural spending on health and other social services. Indeed, yearly servicing payments on the debt are around $4 billion, and rapidly increasing. The Association of Banks in Lebanon (ABL) were less concerned about the prospect of sudden international interest rate increases, likely imposed by the US Federal Reserve in the months to follow its quantitative easing program, which by August appeared a question of “when, not if."

A commentary from the ABL maintained that the banks are currently in a safe position. “We are doing the necessary stress tests to assess possible implications. I believe the interest rate risk [and associated maturity risk] is low and manageable as interest rates applied on loans to the private sector are periodically reviewed in line to a large extent with the period of revision of interest rates on deposits," Secretary General of the ABL, Makram Sader, explained to TBY.

In the meantime, it would seem the reduction of Lebanese public debt ought to be a greater priority by remedying the structural deficiencies in the Lebanese economy that will enable the state to close the gap. According to Byblos Bank's Chief Economist Nassib Ghobril, “The reversal of the debt dynamics was caused by the increase in government spending in conjunction with the slowdown in economic growth and the stagnation in revenues, which has widened the fiscal deficit from 6% of GDP in 2011 to an expected 11% of GDP in 2014." Ghobril also acknowledges how measures to reduce the fiscal deficit must occur on the expenditure and on the revenue sides.

For a long time, it has been down to the effective leakages on the expenditures side, top priorities include: restructuring the electricity sector, reforming the social security and pension system, reducing wasteful spending in government, and addressing overstaffing and nepotism in the public administration. “On the revenues side, the reforms consist of fighting tax evasion, improving tax and fee collection, involving the private sector in the financing and management of public projects, privatization, in addition to reducing the operating costs of the private sector so that companies operating in the informal sector have an incentive to join the formal sector and start paying taxes," Ghobril explained.

Such high operating costs were sustainable during periods of high economic growth, but now they are effectively barriers to entry. Ghobril adds “one of the most important measures to improve public revenues would be to stimulate growth through improving the investment climate and the business environment, which would raise the economy's competitiveness and allow it to grow even in periods of political uncertainties. In turn, increased economic activity would result in higher tax receipts."