Our daily bread

Lebanon, Lebanon making dough, but can’t catch up to what she owes

Prices of bread rose 4-fold in 2008 because of rapid inflation and increasing food costs (AFP)

Judging an economy solely by the numbers rarely reflects the situation on the ground, especially in Lebanon. In 2009, the country experienced an economic roller-coaster with gross domestic product growth estimates ranging from a pessimistic low of 2.4 percent at the beginning of the year — due to the perceived effects of the international financial meltdown — to the optimistic high-end estimate of 7 percent growth some were proffering by year’s end.
While growth of some sort was almost certain, the Lebanese economy is still vulnerable, especially when it comes to managing or reducing its gargantuan debt.

The greatest success story has been in the banking sector, which has seen a 21 percent rise in deposits from September 2008 to September 2009, reaching $92.2 billion, with total assets rising 16.6 percent to $109.9 billion in the first three quarters of 2009, according to the Association of Banks in Lebanon (ABL). Compare that figure to Lebanon’s GDP projection of $32.7 billion — according to the International Monetary Fund — and, considering that banks and governments around the world were reeling from a lack of liquidity, Lebanon’s situation at the end of 2009 is enviable.

Industrial devolution

But a banking sector alone does not an economy make. The high energy prices in 2008 had a knock-on effect for many in the industrial and manufacturing sectors, who finally threw in the towel in 2009. The most remarkable closure was arguably Uniceramic, one of Lebanon’s flagship manufacturers, which produced 82 percent of the ceramic tile market share in March 2006. The company went bankrupt in September after high energy costs, cheaper imports and being stripped of safeguard measures saw its margins plummet. One of the few companies listed on the Beirut Stock Exchange in its early days after the Civil War, Uniceramic was finally delisted once and for all in November 2009.
Another sector that has seen better days is the agricultural sector, not least because of the scandal that erupted late in the year when lax regulation led to poisoned fruit appearing on local market shelves. The issue prompted many agriculturalists to lambast the government for its lack of focus on a sector that is the main source of labor for much of Lebanon’s rural population.

While reliable figures are not readily available, the sector is estimated to be worth some $1.5 billion by those in the industry, and the Economist Intelligence Unit’s (EIU) latest figures, from 2007, put its share of GDP at some 5.2 percent. According to Bank Audi, Lebanon’s agricultural exports amounted to a meager $69 million in the first six months of 2009.

“The share of GDP that agriculture and industry hold is around 15 percent,” says Kamal Hamdan, economist and managing director of the Consultation and Research Institute. “It’s not at the heart of the club,” he adds, referring to the Lebanese government’s focus on other economic sectors such as banking, real estate and services.
The amalgamation of these two faltering sectors, industry and agriculture, may prove to be their salvation. The agro-industry sector has seen double digit growth in the past few years, as well as in 2009, according to Nabil Itani, chairman and general manager of the Investment Development Authority of Lebanon (IDAL), the governmental institution that promotes investment in the agro-industry sector and other “productive sectors.” Again, exact statistics are unavailable.

“We don’t have industrial, tourist or sectoral censuses. We don’t count the production in each sector,” laments Jad Chaaban, acting president of the Lebanese Economics Association (LEA) and associate professor of economics at the American University of Beirut.

Even without sector specific data, indicators show that the tourism sector has done exceedingly well and real estate held relatively stable in 2009 riding, respectively, the 2 million tourists expected to have visited Lebanon by year’s end and a constant flow of real estate investment from inside and outside the country. According to Byblos Bank, by October 2009, a total of more than 1.4 million tourists had arrived in Lebanon, an increase of 46.3 percent over the same period in 2008.

Real estate sales transactions over the year declined by only 3 percent to total 55,482 in the first three quarters of the year, according to the General Directorate of Land Registry and Cadastre (GDRLC). The figures are a marked decline from the 24 percent yearly growth in transactions from 2007 to 2008. The total value of transactions during the first nine months of the year reached $4.3 billion indicating a 6.4 percent drop over the same period in 2008. Be that as it may, the accuracy of these figures has been questioned by some who deem their source, the GDLRC, as susceptible to false declarations from real estate firms and other obfuscating elements.

Karim Makarem, director at Ramco, a Lebanese real estate advisory company, says that one reason for this is because many sales are made off-plan and don’t get registered until buildings are completed.
“Transactions may be done a long time before [they are registered],” he says. “So you might have a situation where the real estate market is very stagnant and the figures being released are ever increasing.”

An elusive formula
When all the figures are tallied, Lebanon’s real economy is expected to have recorded bumper growth in 2009, albeit less than the IMF’s figure of 8.5 percent seen in 2008. The real amount of growth, however, is a contentious topic in the country’s economic community. The latest figures from the IMF predict a total growth of 7 percent for 2009. However, according to Bank Audi’s  research department, the last GDP figures provided by the government are those from 2007.

“You have several problems with estimating GDP. Even the government accounts are not up to date because they run on arrears,” says Chaaban. He predicts that 5 percent GDP growth is a more accurate number considering that “too few companies report their accurate figures. Even when it comes to real estate registration, hardly anyone puts in the right figure. You end up with a system of estimation and not accurate measurement.”

Much of the debate over the country’s accurate GDP centers on methodology. According to Hamdan, the government is currently using the French National Institute for Statistics and Economic Studies’ (INSEE) methodology to calculate GDP. This method offers three different ways to calculate GDP (see box on next page) and uses several parameters that cannot be calculated if sectoral or income-based reporting does not exist or is indeed inaccurate.

“Unfortunately we have no surveys which confirm the situation at the level of the economic sector,” says Hamdan.
The difference in methodologies has prompted organizations such as the EIU to maintain an estimation of 5.1 percent real GDP growth in 2009 as of end-October.

Marwan Iskandar, economist and managing director of MI Associates, however, agrees with the 7 percent IMF estimate made in early October, saying that the figure is not  just down to a bumper tourist season and real estate investments.

“The financial crisis had a beneficiary effect on the Lebanese economy because many Lebanese felt that their money abroad was not that safe, brought it back and are now looking at possibilities,” he says.
Iskandar’s point is substantiated by the fact that recent remittance figures have allayed fears of a decline in non-resident inflows to the country. According to the IMF’s most recent projections, Lebanon will attract a total of $7 billion worth of remittances in 2009, registering a contraction of only 2.5 percent on the previous year. According to Hamdan, some of this is a result of assets being liquidated by non-resident Lebanese, which could result in this phenomena being a one off.

The prognosis of many experts however, is that remittance levels will remain relatively stable in 2010, as the global economy is expected to see some kind of recovery and Lebanon has not seen the massive influx of expats from the Gulf that were expected due to the global downturn.

“There was a presumption that there was going to be massive unemployment in the Gulf and the reality was that while growth was stunted, massive unemployment was not created,” says Rabea Ataya, chief executive officer of Bayt.com, one of the largest recruitment firms in the Middle East.

The increased non-resident interest in Lebanon is also reflected in the growing amount of foreign direct investment in the country. In 2008, FDI reached $3.61 billion, according to a statement made by the United Nations Conference on Trade and Development, and is expected to hit $4 billion this year, says IDAL’s Itani.

Certain elements of Lebanon’s investment climate helped as well, such as the number of procedures needed to start a new business, which remain at five, lower than the Middle East and North Africa’s average of 7.9, according to the World Bank’s “Doing Business Report.” The report also stated that the time needed to complete these procedures had decreased from 11 to nine days in 2009 compared to a regional average of 20.7 days.

Despite the increasingly friendly investment environment, legal recourse in the country remains an obstacle for investors, because of Lebanon’s infamously tedious litigation process and inefficient judiciary.
“For the last 10 years, investors have depended on arbitration [instead of judicial process]. This is a solution because time is money,” says Itani.

As Executive went to press, the Court of Accounts — the judicial body responsible for Lebanon’s Financial Court — had not yet submitted its annual reports for the years 2006 to 2008. Neither had it appointed a new president. The president’s post has been vacant since 2007.

Moreover, the special economic zone in Tripoli that was slated for construction at the end of 2008 was not created, although Itani expects it will be completed by the end of 2010.

Balance it out
One thing the Lebanese economy can also count on is a large and positive balance of payments (BOP) boosted by inflows of remittances, non-resident investment and a positive net increase in the foreign assets of the central bank.
According to the ABL, the first nine months of 2009 saw the BOP come in at a record $4.84 billion with the trade deficit narrowing to reach $952 million in September. Speaking at the Union of Arab Banks annual conference in November, Central Bank Governor Riad Salameh even stated that the balance of payments had reached $6 billion in October.

That bloody debt
As for public finances, there has been little progress. Lebanon’s gross public debt, which is held in most part by local commercial banks, continues to mount and is expected to reach $50.46 billion by the end of 2009, according to Byblos Bank projections. The cost of interest payments on the debt is the heaviest burden the government carries. According to Lebanon’s finance ministry, debt servicing amounted to $2.91 billion in the first nine months of 2009 alone, well on its way to the 2009 budget’s target of $4 billion for the year. That budget, released in August 2009, is just a proposal, however, and has no legal bearing since no budget has been ratified since 2005 by the Lebanese Parliament.

Iskandar predicts that the final amount of debt for the year will come to around $4.4 billion, but he insists the situation is not “destitute” except when it comes to political decisions.

“The government can do something about it [the debt] but they don’t because the political system is based on clientelism and nepotism, not achievement or performance,” he says. Still, Iskandar believes that the situation is better than the numbers suggest, because 83 percent of the debt is held by both Lebanese individuals and institutions that have an interest in continuing to hold this debt, because “it pays rates that you don’t get anywhere else in the world.”

According to Byblos Bank’s estimates, return on Eurobonds ranged between 7.25 percent and 7.35 percent in November 2009. “As long as they are getting their interest and the principal is being paid by issuing [more instruments]…they don’t want to unload because they are earning,” says Iskandar.

Some even suggest that the real burden of the gross public debt is much less than the expected 154.3 percent of GDP projected by Byblos Bank at year’s end. The IMF says that if the government continues to enact “unchanged policies” the ratio could decrease to 151 percent by the end of the year.

Shortage and spending
Even if the country is not on the verge of financial collapse, the real problem of the debt is that servicing it does not allow the government to close the “black holes” that absorb so much of its current spending. The public electricity company, Electricité du Liban (EDL), is a case in point, as it is expected to drain some $1.5 billion from government coffers, according to Mohamad Chatah when he was finance minister in 2009. In the first three quarters of 2009, the government had already spent $1.16 billion on EDL, according to the finance ministry. The budgeted amount to be spent on EDL in 2009 was $1.23 billion, which will likely be overshot by the end of the year.

Most of EDL’s expenditure continues to be allocated to fuel oil imports that are shipped instead of piped, causing them to be even more costly. In September 2009, after repeated delays over issues relating to pricing and quantity, Lebanon began to receive cheaper and more environmentally friendly natural gas piped from Egypt via Syria to run its power plants. The agreement spans 15 years and stipulates that Egypt will supply Syria with 250 million cubic meters (mcm) of gas every year. In turn, Syria will pass on an equivalent amount to Lebanon whose total should eventually increase to 600 mcm per year. In total, the gas is expected to save Lebanon around $240 million based on an oil price of $75 per barrel, according to the investment bank EFG-Hermes, which also owns a minority stake in Bank Audi.

“It’s good to take gas from the Egyptians because the Syrians cannot interfere with it. This is a multilateral agreement and that is the only reason why we received the gas,” says Iskandar.

The agreement is renewable by mutual consent with pricing renegotiated every three years, meaning that the gas is seen as more of a non-stick band aid than a stitch-up for Lebanon’s electricity finances.
“If the Egyptians suddenly don’t like us, they will shut off the gas,” says Chaaban.

In the short to medium term, the government looks set to implement former energy minister Alain Tabourian’s plan of buying smaller generators, which will cost around the same as the amount the government saves from using Egyptian gas. The agreement comes after months of political quarreling over the issue between the ex-minister and former Prime Minister Fouad Siniora. The generators are expected to produce 300 megawatts of electricity, slated to begin operations in the summer of 2010 during the months of the year when electricity consumption peaks.

Gas in hand, the Lebanese government will have some room to maneuver on the electricity issue. However, to make up much of the lost ground, the government will have to enact reforms, such as remote meter reading to replace the “1,900 people who come to measure your meter,” says Iskandar.

Another option is to increase costs of electricity to consumers, given that 38 percent of electricity in Lebanon is generated by private generators, according to Iskandar, and are much more expensive than state-provided electricity.
The proposal seems to be a sound one, according to Hamdan, who says his firm conducted a survey of 2,500 households in Lebanon, the majority of which stated they would be willing to pay higher prices if they were guaranteed 24-hour a day electricity. According to Hamdan, the sector itself will take about five years to reform if the government is serious about undertaking the task. Time looks to be of essence since he also states that electricity consumption is rising at around 10 to 15 percent a year.

A social insecurity
Another state-owned entity that is draining government finances is the highly politicized National Social Security Fund (NSSF). Iskandar, who previously consulted the government on how to reform the fund, says the NSSF is “cancerous and is not going to improve.” There are no reliable figures that detail the government’s liabilities to the fund. One chief executive officer of a Lebanese bank who spoke off the record stated that in the lead up to 2009, the NSSF’s records had not been audited for eight years.

“It is facing a crisis. They are spending money without accounting for it,” says Chaaban.

The 2009 budget proposal bluntly states, if only in small print, that, “NSSF dues have been paid by the Ministry of Finance in previous years but these amounts were not allocated in the national budget.”

Media reports have suggested that the fund is running a deficit of around $456 million and Chaaban states that only 35 percent of workers are registered in the fund because many employers and employees choose not to register. Another statistic that points to the fund’s inefficiency is that government spending on public health was estimated at 12 percent of total spending, or $820 per capita, while Syria spent only $110 per capita and Jordan $500 per capita in 2005, according to the 2009 UN Arab Human Development Report. Spending on health and the NSSF are accounted for separately in the 2009 budget proposal.

Spending without fixing
The central bank has been swapping short term debt for long term debt to maintain the semblance of financial stability. At present, the Banque du Liban has succeeded in “buying time,” as Hamdan puts it.

Time, however, does not seem to be a luxury the Lebanese government can afford, as it has to budget for an increase in expenditure of 42 percent, or $10.82 billion, even with a budgeted spike in revenues of 36 percent, or $7.55 billion. As Executive went to press, total budget deficit in the first three quarters of 2009 had reached $2.22 billion. As such, it seems highly likely that the budget deficit target of 10.6 percent of GDP set for the Lebanese government by the IMF, could well be met.

Notwithstanding the fact that the government has to bear the burden of interest payments on the debt, the NSSF, EDL and other expenditures, it still ran a primary surplus of $693 million in the first three quarters of 2009 and budgets for $746 million by the end of the year. The government is still using the budget of 2005 as a baseline, according to Chaaban, by allocating what is overspent to the next year; but without the interest payments on the debt, the government would in fact be profitable.

Promises, promises
The Lebanese government has few options to get out from under its mound of debt. It will have to make several political decisions, including those related to the Paris III commitments, the enactment of administrative reforms and privatization of key state-owned enterprises such as telecommunications and electricity, to garner enough revenue to pay off at least some of the debt in the hopes of having it reach a manageable level.
With new finance minister Raya Haffar stating that she will pursue Paris III commitments, there is renewed pressure to enact many of the initiatives proposed. According to the finance ministry, $5.7 billion worth of Paris III pledges have been signed as of end-September 2009, with disbursements increasing by $600 million from April to November 2009.
Paris III’s planned initiatives are expected to be opposed by many — from the parliamentary opposition to local commercial banks.

“The terms were negotiated in a different political atmosphere,” says Iskandar, in a reference to the former Rafiq Hariri government that drew up the initial program. “I don’t think there will be any progress because politically it is not feasible.”

Indeed, considering recent proposals, changes appear unlikely. Increasing the value added tax (VAT) to 12.5 percent is highly unpopular amongst the parliamentary opposition and will require a new law to be drafted and passed. Hamdan says that between 1998 and 2008 the average national wage has increased by only 20 percent, and cumulative inflation by 80 to 90 percent. Thus, he says, it is doubtful that an increase in VAT is possible in the near future.

“I know most of these ministers and I don’t think they will sign onto this approach,” he says.
With the threat of inflation looming because of a falling dollar and rising oil prices, this possibility seems even less likely to be popular with the wider public. Officially, the consumer price index registered at 106.7 in September 2009, according to official figures. Chaaban has little faith in official figures since, he says, a useful methodology was only recently adopted.

“They used to count only Beirut and the basket was not representative of the actual consumption pattern. At some point even housing was not included,” he says, warning that inflation, while steady in 2009, could rise by at least 5 percent in 2010.

While this figure is much less than the rates experienced during the oil boom of 2008, Chaaban says the phenomenon of asymmetric transmission, whereby prices go up but don’t come down, continues to affect Lebanon’s consumers. Even according to official figures, which use December 2007 as a baseline, CPI for the items with some of the highest weights such as housing, food, beverage and transportation have all risen by more than 10 points as of September 2009.

This may not bode well for those keen on implementing the global income tax, for which a draft law currently exists, making it more “possible that it might be implemented with some changes,” says Chaaban.
Increasing taxation rates from 5 to 7.5 percent on interest earned from banks also seems to be a highly unpopular move with many local banks that hold much of the public debt and thus have considerable political influence.

“If there is no reform, the banks will be reluctant to go in this direction,” says Hamdan. The only Paris III earmarked requirements that seem likely to continue are those associated with reforms in the public sector, from which Chaaban believes the government can only receive around $1 billion to reform EDL in 2010.

The only other option seemingly available to decrease the debt is to privatize the telecom and electricity industries. The former looks set to remain a contentious issue between the various national and international players who have diverging opinions on whether the sector should go private or stay public.

“I think that the minister of telecommunication will defend increasing the assets [of the telecom industry],” says Hamdan, in reference to the proposal to increase the assets of the telecom sector by improving its current infrastructure and selling it off at a higher price. That may well prove to be an arduous task if the telecom ministry’s operations continue to be politicized. “Selling it in this form amounts to giving the investor the current structure of prices and revenues, so you are essentially securing the flow of hidden taxes,” says Hamdan, who supports this proposal.

Others, however, disagree. “The sector is not going to move in the right direction without really having momentum from the private sector,” says Kamal Shehadi, chairman of the country’s Telecom Regulatory Authority. “By that I mean all of the economic associations will have to get on board.”

And given the track record of public ownership, his sentiments are echoed by many consumers who are tired of having some of the highest telecom costs in the world.

As Executive went to press, a ministerial policy statement had yet to be approved by the Council of Ministers. Expectations are that it will closely resemble the previous statements adopted by the past two governments.
There is still a sense of optimism that the new government ministers can overcome some of the economic hurdles, even if they will have to fight over details in the process.

“They are not politicians that are there just to oppose each other. Even if they oppose each other they will reach a compromise, as they are technical people who can discuss things,” says Chaaban. “Because the government took so much time to form I think now everybody is expecting it to deliver.”

First published in Executive Magazine’s December 2009 Lebanon issue

Sounding the alarm

Debt freeze leaves global markets howling

by Sami Halabi and Emma Cosgrove

Duabi's man-made islands were just one of the many projects that Duabi World borrowed a still unspecified amount to build (AFP)

Common sense is the currency of rational minds — in this respect Dubai may be short on change. On November 25, Dubai World, the wholly owned subsidiary of the Dubai government, announced that it would request a 6-month standstill on all payments and debt servicing of some $11 billion due to creditors in December — effectively giving notice that the further $49 billion the company has outstanding may also be beyond its means.

The announcement came after the markets closed for the four-day Eid al Adha holiday, during which time the company maintained complete silence while the news shook the financial world, prompting panicked investors to line up at the doors of Gulf markets to dump exposed portfolios when bourses reopened on November 30. As they waited in the Gulf, financial markets from London to Beijing shed share value in fear of their own exposure.

Dubai and Abu Dhabi markets dropped instantly at the opening bell, followed closely by other regional markets. The next day, Dubai World released a statement confirming it was in talks with United Arab Emirates banks to restructure $26 billion in debt. The company said restructuring could consist of “deleveraging options,” “asset sales,” and “formulation of restructuring proposals.”

“We would expect a decision to come out of [the discussions]  on what assets underlay the liabilities, and what the plan is for liquidizing those assets so that bondholders get some partial repayments,” said Raj Madha, director of equity research at EFG-Hermes.

As executives and Dubai authorities prioritize Dubai World’s obligations behind locked doors, the rest of the financial world can do nothing but wait and watch the markets.

The markets react
By the middle of November 2009, the financial world seemed optimistic — and with some justification. The Morgan Stanley Capital International (MSCI) index had recovered 48.9 percent of losses incurred during the downturn, while the MSCI Emerging Markets index had fared even better, recovering 58.13 percent. The MSCI Arabian Markets index — Gulf Cooperation Council, Egypt, Jordan, Morocco, Tunisia and Lebanon — also followed suit, albeit with a little less vigor, recovering 30.89 percent of their losses.

After the announcement that Dubai World could effectively not pay its debt on time, that recovery quickly went into regression. In just two days of trading the Dubai Financial Market (DFM) dropped 12.5 percent and the Abu Dhabi Stock Exchange fell by 11.6 percent. Dubai’s indices for real estate, as well as investment and finance, saw some of the worse losses, down 18.1 percent and 15.5 percent respectively.
The fallout from the Dubai World announcement is expected to send foreign investors’ capital looking for economies with lower risk factors. This will almost certainly have an adverse effect not only on public markets, but other financial institutions as well.

One Abu Dhabi-based private equity (PE) executive commented that the “huge interest we have seen from foreign investors in the region will subside considerably over the next few quarters.”

This is seen as a harbinger of public sector encroachment on the private sector’s lending space.
“Banks will be less keen to lend to the private sector, and governments will prefer to tap into local resources. What is left over for the private sector will be reduced significantly,” said the executive.

While the immediate impact of the Dubai World announcement was felt worldwide, expectations are that outside the region the negative repercussions are temporary, as many markets are already bouncing back from their initial fall.
“This crisis will not find roots on the international level. It will stay regional,” predicted Fadi Khalaf, secretary general of the Union of Arab Stock Exchanges and former chairman of the Beirut Stock Exchange. “No one has any interest in pushing Dubai too much to make it pay at any price. We have to wait until they liquidate some assets at a reasonable price, but I think we will find a solution. We will pass through a difficult period but it will not be as long and as deep as the international crisis.”

Khalaf’s only fear is that the latest announcement could imply that the curve of the financial recovery will be “W-shaped” rather than “V-shaped.”

“With a ‘W’ we will need more support and have to test the bottom before going up again, and that takes more time,” he said, citing the United States financial crisis of 1972 that took on a W-shape and lasted until 1982.

Were this limited to a local phenomenon, Dubai could merely pay for what it had done, literally and figuratively, and the issue would be somewhat resolved. However, given the nature of financial institutions, the shockwave that started on the artificial islands off Dubai is having drastic consequences for the region. Markets from Qatar to Egypt have been dragged down and further fallout is expected.

Save the banks!
Though the lack of transparency of UAE banks makes it difficult to say for sure, general sentiment holds that the rising rate of non-performing loans has led banks to slow lending. The banks remain well capitalized, however, and appear to have the support of the authorities. Dubai World, on the other hand, does not, as the government refuses to guarantee its debts.

“Mixing up between the Dubai World Group and the government of Dubai is wrong,” said Dubai ruler Sheikh Mohamad bin Rashid al-Maktoum on December 1. The statement, issued by the state-run WAM news agency, cited Maktoum as saying that citizens should “roll up their sleeves.”

Still, local banks have seen immediate effects in their insurance costs. As the first news coverage broke of the requested standstill, the price of insuring Dubai’s debt shot up almost 28 percent.

Between November 24 and November 25, the cost of insuring $10 million of debt from default over five years jumped from $360,000 per year to $460,000. Abu Dhabi saw a similar effect with its corresponding prices going from $100,000 on the Tuesday to $157,500 the next day.

Two days after the Dubai World announcement, Fitch Ratings announced that it had downgraded three banks that are partially owned by Sheikh Mohamad’s Dubai Holding, stating, “The outlooks on Dubai Bank and TAIB Bank are negative. Tamweel remains on rating evolving watch.”

On November 29, the UAE Central Bank announced that it would “stand behind” its banks, making additional liquidity available to both domestic and foreign banks at 50 basis points above the three-month  Emirates Interbank Offered Rate (EIBOR), which fell from 1.941 percent on November 30 to 1.905 percent on December 1.
In an attempt to quell depositor panic the emirates’ central bank also stated that: “The UAE banking system is more liquid than a year ago.”

Emirates National Bank of Dubai has taken the lead as Dubai World’s largest creditor, according to the Financial Times, with an estimated $3 billion in exposure. Abu Dhabi Commercial Bank is likely to come in second, with a senior executive telling Reuters they were owed up to $2.45 billion, while another senior official at First Gulf Bank told the news agency their exposure is $1.36 billion, though First Gulf Bank later refuted this statement.
What exactly is on Dubai World’s books is unclear, as the company is not in the habit of issuing complete and transparent disclosures, but most financial experts estimate it’s total tab at near $60 billion.

European banks are quickly tallying their own exposure to Dubai World, and reports thus far point to a number in the range of $40 billion, with approximately $5 billion owed to banks in the United Kingdom.
The Financial Times estimates that HSBC, Standard Chartered and Lloyd’s Banking Group hold around $1 billion in exposure each. Royal Bank of Scotland is expected to be the most exposed with estimates of between $1 billion and $2 billion. Other European Banks heavily affected include the ING Group, BNP Paribas, Societe General and Calyon, who saw their shares plummet in early trading after the scandal broke.

Major banks across Europe saw share prices drop  following the announcement of the debt standstill, with HSBC Holdings down by 4.8 percent, BNP Paribas down 5.1 percent and Deutsche Bank shares down 6.4 percent.
Asian banks are also sharing in the woe. According to Reuters, Japanese banks have $1.16 billion in exposure to Dubai World, while South Korea’s Financial Supervisory Service stated that the country’s banks were exposed to approximately $32 million.

Despite the fact that Moody’s global credit rating agency maintains the current crisis would not alter the UAE’s sovereign credit rating, the debt problems of Dubai World have many looking farther up the food chain, and worrying about the solvency of the emirate itself. The Wall Street Journal estimates that the total exposure of European Banks to Dubai is $83.7 billion.

The Bank for International Settlements (BIS), a Swiss international organization for cooperation between central banks, estimates that as of June 2009, UK banks had claims of $50.2 billion across the entire UAE, followed by French institutions at $11.3 billion, and German banks with $10.64 billion on their books.
The US appears to have less at stake, with the BIS reporting that American banks held $10.62 billion in exposure (as of June 2009). Southeast Asia’s biggest bank, DBS Group Holdings, said it had $1.3 billion of exposure in Dubai, calling the situation was “manageable.”

Family feud
As Executive went to print, Dubai’s big brother, Abu Dhabi, had yet to signal a willingness to help its smaller headline-grabbing sibling pay off its debt, which Moody’s estimated at $100 billion. For the moment, it seems Abu Dhabi is more concerned with propping up the country’s banking sector, evidenced by its most recent acquisition of $5 billion of Dubai-government issued bonds to two Abu Dhabi banks in which the larger emirate holds stakes.

“There was a decision taken a year ago that Abu Dhabi would not let Dubai fall but if they intervened they would do so only in terms of buying assets that actually have value,” said the head of a regional financial association that spoke on condition of anonymity. “They are not going to throw money on the streets, because they are responsible in the eyes of their population, so they won’t buy up too many of the distressed assets.”

The possibility is that Abu Dhabi will want stakes in flagship companies that are doing well, such as Emirates Airlines, which economists from French bank Societe Generale described as potential “collateral” for a bailout.
Abu Dhabi’s most significant means of asset acquisition is through its giant sovereign wealth fund (SWF), the Abu Dhabi Investment Authority (ADIA). Sven Behrendt, visiting scholar at the Carnegie Middle East Center and a specialist on SWFs and political risk management, said he didn’t believe that injecting massive amounts of cash into Dubai’s firms would fit ADIA’s core strategy.

“The idea is to spread your risk and then you come up with a certain formula,” he said. “If you have to bail out your friends from Dubai then this will have an impact on your investment portfolio.”

How much Abu Dhabi can afford to spend picking up Dubai’s assets — ostensibly protecting its own sovereign risk factor and the economy of the UAE — is not certain. Although the ADIA is purported to be the largest in the world, there is little transparency; estimates as to how much it holds in cash reserves — or its losses sustained during the global financial crisis — vary wildly, with assets estimated anywhere between $330 billion to $900 billion.
“Should we just think that Abu Dhabi has ‘a lot’ and that is sufficient?” quips Behrendt. “We don’t know their holdings, how much they have, or their asset allocations. We don’t know anything about them.”

The bloom is off the rose
Dubai World has said its debt restructuring will include the liabilities held by its property development subsidiaries Nakheel and Limitless, but not other companies it owns which are “on a stable financial footing.”
Arbitration procedures look set to be the next step as auditing firm KPMG has been selected to represent Dubai’s creditors. “They have to negotiate, to sit together and find a solution. If they don’t do this they won’t get a cent,” said Khalaf.

Dubai took hits, this year and last, as the global financial downturn struck home, but now it seems the gloves have come off. “The global markets are going to punish Dubai in the long term, and they are going to have to pay for the risks,” said Behrendt. “Perhaps that will lead them to a point where they reform their system… It probably didn’t work well as a model for others when it went well, and it doesn’t work as a model when it falls.”
Marred by a lack of transparency, where investors can only guess at how much has been borrowed, Dubai’s track record regarding risk management leaves much room for improvement.

“If you have a government that is going to default on its debt, you [normally] also have the parliament, media, banks and all sorts of stakeholders that are going to push the government to get its house in order. Normally these would be the checks and balances, but in Dubai this doesn’t exist,” says Behrendt. “You can build the biggest building, bridge or airport but at some point you have to keep your clients. Who is going to put money into Dubai now? I certainly wouldn’t.”

First published in Executive Magazine’s December 2009 Middle East issue

Lebanon’s elephant in the room

As the public debt looms, many prefer to look away

Lebanon's new cabinet has $50 billion of debt weighing on its shoulders (AFP)

by Sami Halabi

Lebanon’s relationship with debt closely resembles an addiction to alcohol. For starters, it’s quite evident that the country wasn’t thinking straight when it took out loans with interest rates of more than 35 percent to fund its post-war reconstruction. Then, instead of accepting the inevitable fiscal hangover and reforming its institutions, the country continued to borrow money (mostly from its own banks) and spend it on those same institutions that never shaped-up. In order to remedy this situation, it may be wise to refer to the American Psychological Association’s summary of the ‘12 Step Program’, which has helped many overcome alcoholism. The first step states that recovery requires one to “admit that one cannot control one’s addiction or compulsion.”

Lebanon has yet to truly admit that it has a problem. At nearly $50 billion and 154 percent of Lebanon’s gross domestic product, the debt is mounting and the only policy the Lebanese government has enacted is to swap the short-term debt for long-term debt, in an attempt to keep its head above water just that little bit longer.
Now that Lebanon has a new government, a line is again being drawn in the sand between those who believe reducing the debt is the single largest economic problem the government must deal with, and those who consider it to be “perfectly sustainable,” as does Lebanon’s Central Bank Governor, Riad Salameh.

The “sustainable” theory goes that, given the high liquidity levels in Lebanese banks, they have the cash on hand to continue lending to the government to fund its spending; given Lebanon’s high GDP growth rate, government revenues in the form of taxes will grow, bringing down the yearly deficit and, given that the American dollar is forecast to drop in value and most of Lebanon’s debt is priced in dollars, the value of the debt will fall all by itself anyway. If Lebanon is attracting billions of dollars of investment inflows and registering record growth numbers, then why rock the boat? In time, the debt will reach a manageable ratio relative to GDP and the problem will solve itself.

That’s the rosy version, and a line put forward by prominent members of Lebanon’s banking sector, though such optimism may be easier when they hold around $110 billion in assets and are profiting from much of the debt anyway. The rest of Lebanon, however, hasn’t the luxury to be so cheerful while the country runs a deficit of 10.5 percent of GDP and has spent 20 percent more in the first three quarters of 2009 than it did in 2008. Even though these figures may be within global norms today, one must remember that elsewhere in the world government expenditures have skyrocketed to bailout their economies.

There are only two countries in the world that are in a worse state than Lebanon in terms of their burden of debt — one of them is Zimbabwe, where the local currency value has all but evaporated, and the other is Japan, the world’s second largest economy.

Japan already has some of the best infrastructure in the world; Lebanon doesn’t.

With the debt looming overhead, not only is the Lebanese government less able to provide or upgrade their antiquated public services, they also have less ability to fledge many sectors that people depend on such as agriculture or industry, not to mention protect their strategic and military interests. Lest we also forget that another conflict with Israel would completely wipe out Lebanon’s new-found investor confidence, or the fact that our politicians can hardly be trusted not to start another political debacle, putting us back in a situation of low, no or negative growth.
Those who believe Lebanon’s debt is sustainable because of the country’s economic growth tend to gloss over the fact that growth has not been uniform across all sectors, and that this is resulting in an economy that lacks diversification — the Lebanese are placing all their eggs in just a few very large baskets. To make matters worse, other untapped potential markets for development — such as water resources, refining and hydrocarbon development — are still taboo for Lebanon’s economic policy makers.

Basic economic theory, and history for that matter, dictates that for every boom there is a corresponding trough, which means that at some point in the near future the debt will not seem as manageable as some view it during this current growth cycle. Hence, as one European Commission economist stated last October, Lebanon’s fiscal situation is, and will likely remain, “unsustainable.”

Even the likely privatization of telecoms and electricity, from which the proceeds will go to reducing the principal on the debt, will not prove to be a panacea. At present valuations, Lebanon will not get much in return for these national industries due to their dismal state.

A focus on growth should always be a priority for an economy, but the kind of growth currently on the table boxes the economy in and tries to shield it from the inevitable reality of having to deal with the debt. An economy’s sustainability comes from its versitility and ability to grow on many levels — not just its ability to pay the interest on the debt it hopes will go away.

First published in Executive Magazine’s December 2009 Middle East issue

As the public debt looms many prefer to look away