Castles made of sand

When future generations of Lebanese look back on 2011, they may remember it as a year when the economy, having driven up the growth graph since the 2006 war, simply ran out of road at the top and headed off a cliff into recession.

How far the economy has fallen and how much further it may dive is a question that will have no certain answers anytime soon. As Executive went to print 2010’s national accounts — the primary method used to calculate the size and relative growth of an economy — had not yet been released by the government, much less those for three first quarters of 2011.

“Every growth estimate is nothing more than a guestimate,” says Jad Chaaban, acting president of the Lebanese Economics Association. As such, in October the International Monetary Fund guesstimated that this year growth had fallen to 1.5 percent from 7.5 percent in 2010. What makes the outlook even more somber is that it was the second time this year the fund had revised growth downwards; previous to April the growth estimate was still hovering between 2.5 and 4 percent, depending on which international organization you chose to cite. By November the fund went even further.

“After four years of strong growth, Lebanon’s economy has lost momentum reflecting domestic political uncertainty and regional unrest,” said an IMF press release marking the end of their annual appraisal visit to Lebanon. “Latest indicators are pointing to some pick-up in activity, and the economy could grow at 1 to 2 percent in 2011, markedly below an average of 8 percent per year during 2007-10.”

Of course the government itself did no better in calculating growth. The previous finance minister’s budget proposal — which like all other budget proposals since 2004 have not made it past Parliament’s sticky gates — estimated growth at 5 percent.

“You are not walking into a certain environment… If the problem gets worse in Syria all of our exports will go down and we could even have the counter effect, with refugees coming into the country and a huge consumption problem,” said Chaaban. “With this uncertainty that is present today, you can’t just have one scenario. It’s more honest as an exercise to do different scenarios. I’ve never seen anyone give you a real plan for something with one scenario, unless they want to sell you the plan.”

This precipitous fall in economic activity was not only a byproduct of the country’s failing infrastructure or lack of official employment, inflation or economic policies. At the start of 2011 Lebanon got a new year’s shock as the cabinet collapsed over the issue of trying ‘false witnesses’ for misleading the Special Tribunal for Lebanon, set-up to investigate the assassination of former Prime Minster Rafiq Hariri and 22 others in a 2005 explosion. Since then, the issue has largely been ignored, but its repercussions are still being felt.

Almost immediately the readers of Lebanon’s economic crystal balls saw the dark clouds approaching. By the end of the year there was still little consensus over what the ultimate effect was. While the IMF posited a figure of 0.8 percent growth for the first six months of 2011, Finance Minister Mohamad Safadi joined the guessing game in October when he announced that the same period saw no growth and projected a 4 percent outlook for the second half.

“Neither the zero growth for the first half of the year nor the 4 percent for the second are precise or accurate,” says Elie Yachoui, dean of the School of Business Administration and Economics at Lebanon’s Notre Dame University, who agrees that all the indicators suggest that the gross domestic product (GDP) growth for this year will not exceed 2 percent. In an exclusive interview with Executive [see page 84] Safadi explained that the 4 percent projection was based on a “best-case scenario” playing out next year.

“This year [2011] clearly we wasted opportunities from the start, with changes taking place in the Arab world and the collapse of the  government,” said Nassib Ghobril, head of economic research and analysis at Byblos Bank. “If we had a government in place we could have been able to benefit and be on the radar, just like we did in 2008 and 2009 from the global financial crisis. All of this was before Syria. Once that started it affected confidence even more.”

Two months after the government collapsed the situation in Syria erupted, with widespread protests engulfing the nation, which constitutes Lebanon’s only open land border. The effects of the crisis on the economy were palpable, especially over the summer months when many tourists would usually arrive over land. Official figures show a 25 percent yearly contraction in visitors by the end of September — falling to 1.28 million compared to 2010’s year-on-year figure of 1.69 million. The turmoil in Syria was still ongoing as Executive went to print, a fact that Riad Salameh, governor of Banque du Liban (BDL, Lebanon’s central bank, finally admitted last month has hammered Lebanon’s economy.

“Since Lebanon’s economy is so closely intertwined with that of neighboring Syria, the unrest across the border has taken a huge toll on the Lebanese economy,” he said in a television interview in November.

As the terra firma shook under Lebanon’s economy, the structural indicators also gave in. For the first time in many years Lebanon’s balance of payments, a relative measure of money coming in and out of the economy, turned from a surplus to a deficit. A detailed breakdown had not been released by the time Executive went to press (something that used to happen during the days of the surplus) but consolidated figures show that by end-September the deficit had reached $302 million dollars, a far cry from the $186 million surplus posted in September 2010.

In the past the positive balance of payments was heralded as one of the shining beacons of Lebanon’s economic indicators because it overshadowed the balance of trade (the difference between the monetary value of exports and imports in an economy), which subjects Lebanon to a host of economic ailments. All throughout the year the balance of trade was setting record lows, and by the end of September 2011 had reached a five-year nadir of $11.18 billion — constituting a 10 percent increase in the trade deficit on 2010.

That is not withstanding the level of remittances entering the country, which, as Executive went to print, had not yet been released by BDL or the World Bank. Some 45 percent of households have at least one person abroad sending home money, according to research conducted by economist Robert Kasparian, who heads the compilation of Lebanon’s National Accounts.

Last year remittances reached a level of around $8.2 billion, although that figure includes some dubious additions such as payment of salaries from abroad.

“Our economy is more an external economy than an internal economy,” says Notre Dame’s Yachoui. “The remittances of Lebanese workers amount to $8 billion or $9 billion; it’s as if we were exporting such an amount. As long as the global economy is recovering I don’t expect any new crisis in terms of Lebanese employment aboard… unless a new international crisis erupts.” As Executive went to print, the Greek and Italian sovereign debt crises were looming apocalyptically over global markets.

Pressure on the lira

As the rate of growth in the country’s economy nosedived, its currency has felt a downward drag, though, as has been the case since December 1997, the BDL maintained the exchange rate of the lira to the US dollar at 1507.5 through tapping its $30.6 billion war chest of foreign currency reserves. (By the end of September the total foreign assets of the BDL totaled some $32.2 billion, of which $16.2 billion was in gold.)

In the absence of an operational currency exchange market that could be used to value the Lebanese lira, the main indicator of currency pressure is the deposit dollarization rate, which rose during the first three quarters from 63.2 percent to 66.6 percent.

Adding to the weight on the lira and rattling the banking sector earlier this year was the debacle involving the United States Treasury Department and Lebanese Canadian Bank, when the treasury proposed banning US financial institutions from opening or maintaining certain accounts at the bank, in effect forbidding it from using the US dollar. At a time when government was at a standstill, this had reverberating effects on economic confidence due to the suggestion (still unproven) that the bank was working with Hezbollah — which the US has labeled as a terrorist organization — setting off speculation over possible banking sanctions. There are still widespread reports of investigations being carried out by the US treasury into a list of banks, although Lebanese authorities have refuted these. “We have no problems and no issues at all with the American treasury,” insisted Finance Minister Mohamad Safadi when questioned by Executive about his meetings with US officials.

“The dollarization rate is still high but there is no panic or rush to the dollar,” said Ghobril. “There was obviously in the first half of the year, especially during the first few months, but now that is not the case; it’s a stable market. As long as there is no outflow from deposits the [currency] situation will remain stable.” Commercial bank deposits stood at $115.7 billion after the first nine months of 2011, a 6 percent growth year-to-date and a 9.4 percent growth relative to the first nine months of last year.

Feeling the inflation

While exports fell during the first three months of the year, they experienced a relative turn-around over the next two quarters and managed to stay in the black. However, imports have been rising; even in a period of assumed recession when consumption usually falls, the value of imports rose 9 percent year-on-year in the first three quarters.

While on the surface this figure may not seem too much of a worry, it has to be taken into account that Lebanese consumption of imports increased far less than the price they paid for those imports. Fuel prices averaged $113 per barrel in the first nine months of 2011, compared to $77 per barrel in the respective period of 2010, causing fuel imports — which constituted 18.3 percent of all imports by end-September — to rise by 5 percent in value. “Excluding this item, imports that have increased in value are mainly those that are highly affected by the volatility of international prices,” an October trade report issued by the finance ministry said.

Thus, the problem of import inflation is intensifying. Official figures, which are widely discredited by economists, put the third quarter year-on-year consumer price index (CPI), the major indicator of inflation, at 4.8 percent, while the governor of the central bank estimated it will hit 6 percent by year’s end on the back of rising commodity costs.

There is currently no concrete indication of how much this inflation is due to higher import prices and how much is homegrown. According to a World Bank report issued in May regarding 2010, “imported inflation in Lebanon has a strong impact on the CPI because imports amount to… 50 percent of domestic consumption.”

Still, Chaaban, whose organization is carrying out a study to quantify the sources of inflation, deems that the common estimate thrown around — that import inflation constitutes around 70 percent of inflation — is inaccurate. He estimates the figure somewhere between 50 and 60 percent because of the prevalence of what is commonly referred to as “the cartels.”

“If you look at the structure now — what we call the syndicate of this, or the syndicate of that — it’s basically cartels of this or cartels of that,” said Finance Minister Safadi.

At the crux of the matter is the long-standing issue of exclusive agencies, basically monopolies, enjoyed by importers who can sell a given brand in the country. This is compounded by a lack of legal controls on price fixing and other non-competitive practices such as import bans on certain sectors. Politicians, rich families or religious establishments, whose constituents are usually the same people wearing different hats, often own and control these companies.

“The 500 to 600 families that run the country need to admit to themselves that in order to keep the country running they must open up and partner with new companies and open up their capital,” said Chaaban.

A quick fix would be to pass and implement a comprehensive competition law, something that has been drafted and proposed for years but never made it through parliament. Given the make-up of the Lebanese economy and political circles that may not be such a surprise. “With regards to exclusive agents, you have companies that market thousands and thousands of items and the politicians have connections and interests with the oligarchs,” said Yachoui.

Another concern regarding inflationary pressures in the last quarter of the year was a demand put forth in October by the country’s main labor union to increase the minimum wage. The issue was debated widely in the press and in cabinet until the latter decided to impose an increase on the eve of a general strike. Rather embarrassingly for the cabinet, a later decision by the Shura council, Lebanon’s highest court, threw out the measure shortly afterward because it was deemed contrary to labor law. As Executive went to print negotiations between the labor minister and the unions were ongoing and it was not clear when and if a new minimum wage measure would be passed.

A tool to help possibly ease inflationary pressure would be to de-peg the currency from the US dollar and instead peg it to a basket of currencies of countries where Lebanon sources its imports, such as a mixture of the Chinese yuan, the euro and the dollar. This would allow the exchange rate to ease some of the pressure on prices. The country’s main import currency is the euro with Italy, France, Germany, the Netherlands and Spain constituting 28 percent of all imports from 2006 to Q3 2011, followed by China and the United States with 8 percent, respectively. However, such a move would go against the longstanding policy of the central bank to annul the local currency market in the interests of “currency stability.”

“The banking sector has resistance to venturing into complex schemes even if they would probably be beneficial for us as a country,” said Chaaban in relation to such a proposal.

Add or subtract value?

Another further upward pressure on prices is expected to come in the form of an increased value added tax (VAT), as proposed in the 2012 provisional budget. Yet the budget, as well as its associated revenues, is based on growth, which is anything but assured. Minister Safadi told Executive that all items, including VAT, where up for discussion as long as the end result did not increase the proposed deficit figure of $4.14 billion, an 11.4 percent increase on the 2011 budget, which never reached a vote in Parliament.

In theory, the constitution states that the budget needs to be passed by the end of January at the latest. But if it is not, at least according to minister Safadi, “it’s not a catastrophe.” Lebanon has not managed to propose and pass a budget since 2004 and this year looks no more certain, with a host of new taxes on the banking and real estate sectors set to be debated by many of the very same proprietors of these institutions in both cabinet and Parliament.

What is perhaps nearing catastrophe in Lebanon is the state of its infrastructure, with its insufficient water supply and decrepit transmission network, almost nonexistent wastewater treatment, daily power outages, crumbling roads and insubstantial public transportation system. To amend this, vital infrastructure projects such as power plants and water storage facilities, among others, need to be built. The problem is that, with a widening deficit and a debt-to-GDP ratio of some 140 percent (depending on whose GDP figure you use) financing these projects from the government coffers has become nearly impossible, even if a budget is passed. The electricity sector is projected to need some $6.5 billion in investment and water some $8 billion, just in capital expenditure, according to the Ministry of Energy and Water.

“Very simply, our treasury is no longer able to solve any problem related to any public service — that’s it,” says Yachoui. “We are left with only one solution which is a very ‘light privatization’ where we sign investment and management contracts in all the public service sectors with the private sector without selling any of our public services.”

And that is precisely what has been proposed through a draft public-private partnership law that has been through several drafts, with the reasons for its delayed passing unbeknownst to many, including the finance minister.

Gloom on the horizon

The economy looks set to suffer in the year ahead as harbingers of a precipitous slide have been calling out ever more vociferously. The Beirut Stock Exchange, for instance, lost around 20 percent of its value in the first nine and a half months of 2011. A new listing of the national carrier was put on hold indefinitely by the central bank, which owns the airline, and a new capital markets law passed this summer is still to be implemented.

Unemployment is ostensibly on the rise. Few give credence to the official numbers, which have not been updated since 2007, when the figure was put at 9.2 percent. But, according to a leaked presentation about an unfinished project being conducted by the World Bank, unemployment rates amongst men and women are 10 and 18 percent, respectively, which, when added to those working in the informal sector, make up “close to half the labor force.”

Among the few silver linings is an expected increase in telecom penetration due to broadband infrastructure upgrades. The World Bank estimates that every 10 percent increase in broadband penetration accelerates economic growth by 1.3 percent.

“Any analysis of this sector gives you a stand-alone impact: it gives you the potential but not the real growth after impact,” says Chaaban. “If there are more jobs and profits from this sector and then there is inflationary pressure the net effect is zero.”

The telecom sector cannot save the economy on its own, however, and it should be taken into account that the new infrastructure will be owned and operated by the government, and thus it could quash already limited private sector participation [see page 98].

What’s more, as Executive went to print Prime Minister Najib Mikati had announced on a popular TV show that he would resign if funding for the special tribunal for Lebanon was not provided in some fashion by the end of the month.  If that occured it would result in the same scenario that caused the economy to plummet in 2011; the lack of a cabinet. This time, however, it will be more than just internal strains that the economy will have to bear.

“We are still subject to the problems in Syria and what happened in the first part of the year, from which we still haven’t recovered, so the outlook is tied to that,” says Ghobril. “As for the sources of growth, frankly, I can’t see them.”

First published in Executive Magazine’s December 2011 issue