An accelerating descent

Like baying sheep some continue to follow their leaders into the economic abyss (Photo: Sam Tarling)

The failure of a government to actually govern can be overlooked, and even ignored, when a country’s economy somehow manages to independently cook up growth, as Lebanon’s has, churning out annual increases of gross domestic product in the range of 7 percent for half a decade. During these years many seemed to regard the economy’s continued subscription to miraculous performance as assured by God while the fundamentals needed to sustain this growth, such as infrastructure, were rotting beneath their feet.

Today, however, the boardrooms’ belief that Lebanon’s soaring growth is immune to the laws of gravity that apply to the rest of the world has disappeared, as first quarter results for 2011 clearly show that the country is entering an economic downturn. And now — with the fiscal forecast inclement and a government necessary to navigate the storm — it becomes painfully apparent how the intransigence of the competing political camps has left the Lebanese on a quickly sinking ship. Lebanon’s sectarian political divisions and the grinding stalemates they produce are at the root of the vast majority of the nation’s tangled shortcomings.

Executive does not pretend to have the formula to resolve the impasse and get a government formed and functioning again. Instead, the following report examines the most critical issues facing the economy, and if those whose responsibility it is to govern do manage to form a government that is actually empowered to enact and follow through on policy and reforms, what some of these should be in order to cushion the current fall and restart growth.

Counting in the dark

Typically, the International Monetary Fund issues its annual forecasts for the Lebanese economy around October, but this year it waited an extra six months to come out with a figure of just 2.5 percent real growth for 2011, down from an estimated 7.5 percent last year, signaling the end of the country’s economic honeymoon. The finance ministry has also signed off on the 2.5 percent estimate.

At a press conference last month, IMF Resident Representative in Lebanon Eric Mottu explained to Executive that the estimate took into account that, even if a cabinet was formed by the second half of the year, it would not be enough to cover the losses incurred during the first half of the year. The IMF’s growth projection for Lebanon is much lower than the fund’s regional estimate of 4.1 percent. However, not everyone agrees with them.

Real GDP growth in Lebanon

“The IMF have been wrong a number of times in their predictions,” said Marwan Iskandar, economist and chairman of Banque de Crédit National, before predicting that growth would be between 4 and 5 percent. “They used to tell us five or six years ago to reduce the burden of public debt because otherwise we [would be] in dire straits, and then they changed their tune to reducing the debt-to-GDP ratio,” he said.

One reason for things being better than the predictions could be Lebanon’s sizeable informal economy, which is not factored into IMF statistics. Iskandar said that staff at the fund’s sister organization, the World Bank, told him that they estimate the ‘informal’ economy to be around 30 to 35 percent of the size of the formal economy, though World Bank officials have denied to Executive making such assertions.

“They don’t want to say it publicly because it would make what they are saying irrelevant,” said Iskandar. “It would make the public debt something close to the [size of the] economy.”  Currently Lebanon’s debt-to-GDP ratio is widely believed to be somewhere over 130 percent. Jad Chaaban, acting president of the Lebanese Economics Association and professor of economics at the American University of Beirut explained that developing countries usually have an informal economy at about 20 to 30 percent and Lebanon was “above average.”

“The problem is we are not [even] measuring the formal economy,” he said.

Indeed, to make an accurate forecast one would need to know the base from which that forecast is being made. As Executive went to print official GDP figures were only available for 2009, which saw 8.5 percent real GDP growth. Because economies naturally evolve between periods of positive and negative growth or contraction, until the end of last year Lebanon’s economy appeared to be experiencing what economists call a “soft landing”, a pseudonym for the graphical representation of cyclical economic slowdown resembling a plane coming into land; if the IMF and the finance ministry are now to be believed, it looks instead like the country is going into a nose-dive.

Main macroeconomic indicators

“The IMF uses official government figures and they don’t contest them,” said Nasib Ghobril, head of economic research at Byblos Bank. “It might be optimistic; we still don’t know.”

The level of uncertainty has fueled speculation and has understandably resulted in a lack of confidence in the system. Reforms purportedly underway include a program, aided by the European Union, at the Central Administration for Statistics (CAS) to transfer the job of comprising national accounts away from the prime minister’s office and to the CAS. Yet how long that will take is anyone’s guess. In the meantime “it’s all a walk in the dark,” said Chaaban.

Without accurate and timely statistics, especially during times of political transition, those with an interest in using the economic situation to their own advantage — and there are many — have the upper hand. “People who want to make the numbers look bad, lower GDP growth and those who want to make things look good, make the numbers high. GDP growth becomes a signal for confidence in government and the country; same goes for the banks and financial sector,” said Chaaban.

Thus it is hardly surprising that public officials and the media from across the political spectrum have been eager to comment on the economic situation without having any real indication of just how bad things are, or could become. Those on the side of the recently deposed March 14 coalition have been quick to point out that March 8’s stalled efforts to form a cabinet have destroyed the economy, while the latter camp has accused the former of over-reacting to make the situation look worse that it actually is.

In fact, both camps are relying on the same scattered indicators that economists have come to depend on when trying to gauge Lebanon’s performance, due to a lack of national accounts which are themselves “the best available estimates”, according the CAS’s document explaining the national accounts reform program.

Adding to the hodgepodge of numbers and forecasts, the International Institute of Finance (IIF) — a global association of financial institutions — estimated that growth in Lebanon would reach 4 percent at the unveiling of their Middle East regional overview forecast in Beirut on May 15. When questioned by Executive about why the estimate was so different from the IMF’s, Garbis Iradian, deputy director of the Africa Middle East Department of the IIF, said the forecast was “probably optimistic” and assumed there would be cabinet in place in “a few months.”

The debt: the elephant in the room

So while there are scant reliable means to measure the latter half of the debt-to-GDP ratio, there is ample documentation regarding the former, and it is soaring; currently the Lebanese public debt is pegged at $52.6 billion. In the first quarter alone the deficit rose almost $1.1 billion, nearly double that of the corresponding quarter in 2010, taking the primary balance from surplus to deficit. Revenues are also dropping, particularly in excise taxes on gasoline and property taxes, which are expected to fall by 57 and 17 percent, respectively, according the IIF’s forecasts, given a slowdown in construction and cuts to the gasoline excise tax this year.

This has caused jitters about the government’s ability to finance the debt, and if real fears caught on in the market then borrowing to continue funding public services would become more costly, which could in turn erode confidence to the point that the currency’s stability would be put in question, though Banque du Liban (BDL), Lebanon’s central bank, is currently well positioned to defend the lira, at least in the near-term.

Additionally, the previous government’s mantra — that the debt was sustainable due to a decreasing debt-to-GDP ratio — has now gone out the window.

“The economy is not growing as fast; when it was growing strong, we saw a big improvement in debt-to-GDP,” said Saad Azhari, chairman and general manager of BLOM Bank. “Now I don’t think we can see this improvement because of the situation. We hope that [it] does not last long and we can have again stronger growth.”

Freddie Baz, chief financial officer and strategy director at Bank Audi, remarked: “If at 185 [debt-to-GDP ratio] we were not really concerned about the ultimate outcomes, its not at 130 or 140 that we will start being concerned.”

The relationship between the banks and the debt has seen worse days and even with the current economic downturn, and the expected rise in debt-to-GDP, Lebanese government debt still appears marketable, though at a somewhat more costly rate.

Last month the government rolled over $1 billion in Eurobonds in two tranches: the first for $650 million expiring in 2019 with a yield of 6 percent, and the second valued at $350 million maturing in 2022 and carrying a yield of 6.475 percent. The last Eurobond rollover in November 2010 carried yields carrying a weighted coupon average of 5.44 percent and an average time-to-maturity of 9.21 years, the lowest ever, indicating new upward pressure on debt financing.

“It’s not us who decide the government will pay 6 or 7 or 8 percent, it’s the market,” said BLOM Bank’s Azhari.

Even if private demand for government debt dries up, it is likely that the BDL would itself step in as it has done in the past to buy up debt and keep the market stable. “Their goal is to ensure stability so they do what is needed. But this is something the IMF is totally opposed to and it’s a burden on the central bank’s income statement, which no one sees except the IMF,” said Ghobril.

“They will do it and of course this is not the best way,” added Iskandar. “It is the most inflationary way but under duress it is the one way to [keep] the government running.”

At present BDL does not release its total holdings of government debt but instead a number of different figures that include vague statements such as “claims on the public sector”, which do not represent the actual debt. According to the Association of Banks in Lebanon, treasury bill holdings of the central bank, which it also issues, stood at $9.67 billion or 18.4 percent of the total debt at the end of the first quarter. Using a crude method of subtracting the central bank’s foreign currency holdings from its foreign assets, one can get an idea of the bank’s Eurobond holdings, or debt in foreign currencies, which came to a further $1.9 billion, bringing the total to $11.57 billion by the first quarter of 2011.

The governor’s office of the central bank did not respond to requests to disclose the total holdings of the bank’s public debt.

Another method used by economists is to assume that the “securities portfolio” of the central bank is comprised of only Lebanese debt, which would mean they hold $10.3 billion of public dues.  “The whole way it is managed is ridiculous,” said Chaaban. “We are selling ourselves. The banks are over exposed so the central bank buys T-Bills from their own portfolio but where does the money come from? From the [commercial] banks’ 15 percent required deposits! You are buying from yourself and giving from one pocket to the other.”

Subsidies — popular but pricey

Compounding the debt problem has been the recent debacle over gasoline prices, which hit a historic high of 37,300 lira ($24.74) last month for one jerrycan (20 liters) of gasoline, even after a tax cut that will cost an estimated 1 percent of GDP, according to the IMF.

This tourist is as lost as Lebanon's economy (Photo: Sam Tarling)

Last month the finance minister announced that a “temporary solution” was found one day before public transport workers were planning a major nationwide strike over the price of gasoline. The agreement between the finance ministry and the drivers is set to cost the government a further $15 million each month, for which it will take out another loan to finance the subsidy.

Proposals to cap the price at a level more acceptable to all consumers were deemed too expensive by the finance ministry, something many economists and consumer rights groups dispute.

“In all cases it is having an effect on the fiscal revenue, so at least do something tangible. Now you are not winning on any side,” said Ghobril, adding that even though this would eventually increase the amount of public debt, that was somewhat “more long term.”

“If revenues are going to fall at least let the citizens benefit,” he said.

Inflation picks up steam

Realistically, there are no short-term solutions to the debt or the deficit, but these are not what impacts their day-to-day lives. Headed in the opposite direction of GDP figures, inflation rates are expected to rise from 4.8 percent last year to 6.5 percent this year, according to the finance ministry.

Even this may be an underestimate as the figures which go into determining the Consumer Price Index, the CAS’ major indicator of inflation, only go back to December 2007, meaning that it does not cover price fluctuations of even one full economic cycle. Then there is the difference between what people feel in terms of rising prices and what the actual overall inflation rate is.

“An index [shows] an average, which is not necessarily indicative,” said Chaaban.

Still, the CPI published by the private Consultation and Research Institute showed an increase in March alone of 1.33 percent, and increased 1.95 percent in the first quarter of the year, well on pace to surpass the 6.5 percent full-year estimate.

According to most estimates, some 70 percent of the price increases come from import inflation — the increase in the price of imported goods. What’s more, during the first three months of the year the trade deficit increased 8 percent to $3.6 billion, due to a drop in exports of 7 percent and a rise in imports of 4 percent to total $4.5 billion.

The bill for “mineral fuels and oil” was 8 percent higher due to an average oil price of $105 per barrel during the first quarter compared to $76 per barrel last year. Trying to bring the price of oil down internationally is impossible for Lebanon but what is possible is to address the cartel that imports oil into the country.

“If you are a retailer and the material price is increasing you cannot really reflect this change to the consumer unless you are a monopolist. That’s why the [price of] gasoline has been rising because there is a cartel of importers,” said Chaaban. “We call this asymmetric price transmission because if the prices of imports rise you throw it out on the consumer, but if prices fall you don’t necessarily do so because your margin decreases.” But dismantling the oil-importing cartel will be complicated, as political heavyweights own the energy companies that operate the port and distribution, according to Iskandar.

Another option to decrease real inflation would be to de-peg the lira from the dollar and re-peg to a basket of currencies in line with the composition of imports, instead of the current practice where the central bank buys and sells US dollars in the market to keep the currency steady.

“Because the central bank has so much in reserves they don’t want to change the model now because no one feels the heat to do so,” explained Chaaban.

During the first quarter, some 30 percent of imports came from countries using the Euro, 8 percent from China and only 12 percent from the United States. The exchange rate between the dollar and the euro also remained relatively high. “When the price of the euro goes up 40 percent and we import 30 percent of goods in that currency then the cost of business goes up 12 percent,” said Iskandar.

Instead of governance

So with the first quarter of 2011 summoning the horsemen of the apocalypse to ride down on Lebanon’s economy, how have the policymakers reacted? Well, last month Lebanon’s caretaker Finance Minister Raya Hassan, a member of the March 14 camp, made a comment that shook confidence in the country even further, saying that her ministry may be unable to pay public sector salaries due to the refusal of Telecom Minister Charbel Nahas, from the March 8 coalition, to transfer the remaining telecom revenues in his ministry’s account at the central bank to the treasury’s account.

In the past, revenues from the telecom sector — one of the few cash cows of Lebanon’s public sector — were transferred every month, providing the finance ministry with a steady cash flow to make payments to its two top expenditure items: the local banks who hold the majority of the public debt and public sector salaries.

Consumer price index

Now, under the pretext that the money will be squandered and that the amount is in dollars, not lira, the telecom minister decided that he will not transfer the money to the treasury, which the finance ministry controls, citing the legal principle that a part of the money from cell phone revenues must go to the ‘Independent Municipal Fund’ to be distributed to different municipalities according to the amount of telephone calls made from their respective jurisdictions.

In any case, only the finance ministry can distribute these funds, so the money looks like it will be staying put until perhaps another finance minister closer to March 8 is in place. (In the first quarter transfers to municipalities decreased from $5 million to $4.5 million.)

The telecom revenues issue has highlighted the long-stated but yet unabated problem of not having a single account for the government at the central bank, which allows each ministry to work independently of central finances. This also creates a situation where municipalities rarely get the dues they are owed and public finances are left exposed to political debacles. So when Hassan said that if the situation continues the government would not be able to pay public sector salaries or retirement dues, panic ensued.

“The statement by the minister of finance was very unwarranted and inaccurate. This is absolute hogwash,” said Iskandar, a generally pro-March 14 economist. “Most of the public policy is political instead of being tied to objectives that serve the economy at large.”

Eventually, the central bank governor said he would pay the salaries and the finance minister clarified that the scenario would not come to pass.

“The central bank is not going to pay [the salaries] but [Governor Riad Salameh] said it to reassure people,” added Ghobril. “It would be the equivalent of the government defaulting.”

Nonetheless, this does not take away from the fact that, on paper at least, the economic downturn is hitting public finances hard.

According to the IIF’s Iradian, if the telecom revenues were transferred to the treasury then the deficit in 2010 would have fallen from 7.5 percent to 5.5 percent. In any case “from an accounting perspective [the money] is not lost,” said Chaaban.

Securing growth

Even while the deficit increases and public debt mounts, there are some alternatives to dealing with the debt while at the same time implementing key infrastructure projects in areas such as water, electricity, roads and telecommunications, to create a framework for economic growth.

On average Lebanon spent only 2 percent of its GDP on government investment between 2003 and 2009, a figure well below many other countries in the region, including Syria, which spent 10.1 percent during the same period, according to the IIF.

For starters long-awaited public-private partnership (PPP) projects could be implemented, but only after a law is passed in parliament, which requires the formation of a government.

That law will have to be good enough to define the risks and obligations of both the public and private sectors. Even then it might not be enough. “In the current political climate no one is going to be believe a PPP law or any other law,” said Ghobril.

Supposing enough confidence is built after a government is in place, banks will also have to be interested, and perhaps incentivized, to finance such schemes for them to work. But since banks in Lebanon are usually more interested in short term profits to stay safe, the idea has not rubbed off well on everyone.

“I don’t think it’s a function of the banks to really take part of those PPPs; it’s not our business,” said Azhari “Since our sources of funding are short-term deposits, we should really fund the working capital, because those types of project are usually very long-term lending and this is not a function for a commercial bank.”

But as the banking sector’s deposit-to-loan ratios have grown to rates that place them well out of the range of most reasonable risks, there are some in the industry who may take the plunge of dealing with the government directly.

“We are risk takers, our duty is to buy risk; this is what we do [as] bankers,” said Audi’s Baz in relation to PPP projects. “Provided those projects are economically viable we don’t have a negative position — but don’t ask us, please, to finance non-viable projects which you know as a government are not viable because you want us to do political lending.”

Another option is to securitize public infrastructure projects, which would also develop the currently minute capital markets in the country. A securitization law already exists for this purpose so in theory the process is already one step ahead of PPP. However, even the law itself is not clear according to Chaaban, who noted that there was still uncertainty regarding the policy on reselling such securities, and issues relating to timeframes have yet to be ironed out.

The need for government to govern

It is evident that if confidence is to return to Lebanon’s economy, reforms implemented or mitigation measures exercised, then a cabinet will need to be formed. As Executive went to print, the country had been four months without a government and still the different political parties appeared no closer to a resolution over how to divide the cabinet posts.

“It is time to do so many things different but this country, with its sectarian administrative structure and facilities, is not destined to be a modern country,” said Iskandar. “It can be a place where people dance, play musical events, a university destination or maybe even technological nation one day; but as a society, it cannot be an advanced one.”

First published on the cover of Executive Magazine’s June 2011 issue

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