Day of Reckoning Approaches for Lebanon's Economy

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Day of Reckoning Approaches for Lebanon's Economy

The future of Lebanon’s economy could be hanging in the balance. Years of apparent mismanagement by a series of politicians who have failed to pursue reforms are taking their toll. Today, sizeable fiscal and current account deficits loom large at a time when deposit inflows from the diaspora, which fund these deficits, are beginning to stall.

Levels of public debt, unemployment and poverty are elevated, while critical national infrastructure is in desperate need of investment. And although Lebanon has been promised billions in foreign support, much of it depends on the introduction of painful and politically unpopular reforms.

“We have definitely witnessed a slight deterioration in Lebanon’s risk profile as measured by the macro-economic distortions and debt profile of the country,” says Freddie Baz, vice-chairman of the board and group strategy director of Bank Audi, Lebanon’s largest bank by total assets.

The collective pressure being generated by these problems is only increasing. Foreign investors are growing nervous at a time when the government is looking to tap the international debt markets, in part to finance the country’s maturing foreign currency debt for 2019.

Most analysts expect Lebanon to issue $2.5bn in Eurobonds in 2019, but the timing of any transaction is unclear. This is because the global investment community, alongside the Lebanese people, is still awaiting the government’s draft 2019 budget, which is expected to detail a strict programme of fiscal consolidation. Only then will the billions promised to the country by global creditors be released. But securing agreement on this programme is proving elusive.

The fiscal challenge

All of this is happening just months after hopes were raised following the formation of a national unity government in January, in the wake of nine months of political wrangling. Since then, optimism has faded as the country’s political machine has brought progress on the delivery of a budget to an apparent halt. Herein lies a fundamental problem that Lebanon is facing: the authorities are tasked with pursuing fiscal consolidation at a time when the economy is almost stagnant.

According to the World Bank, Lebanon’s gross domestic product (GDP) expanded by just 0.6% in 2017 and 0.2% in 2018.

“We expect the new Lebanese government to implement some fiscal consolidation measures in order to unlock the $11bn five-year investment package committed by international donors during the Paris IV conference in April 2018,” says Elisa Parisi-Capone, vice-president and senior analyst at ratings agency Moody’s. “However, in the context of very weak growth, fiscal consolidation will remain very challenging for the government.

Moreover, as long as deposit growth remains weak, potentially because of lingering uncertainty about the capacity of the government to shore up macro-economic stability, Lebanon’s fiscal and external positions will remain among the weakest across the sovereigns that we rate.”

To secure the external support it needs, Lebanon is facing a host of daunting political challenges. In May, retired soldiers picketed the central bank over fears the budget may curtail their pensions and benefits. Meanwhile, central bank staff themselves were briefly on strike over proposed cuts to their wage bill, which in turn forced a suspension of trading on the Beirut Stock Exchange due to a lack of clearing and settlement capability. Staff at other state institutions have also gone on strike in 2019.

Backlash risk

Concerns of this kind reflect the bloated state of Lebanon’s public sector wage bill, which eats up about half of the country’s total expenditure. The remainder is largely allocated to servicing its debt, which stands at 150% of GDP, and data from 2018 points to the fact that these costs have gone up, rather than down, in recent times.

“Figures issued by the ministry of finance show that the compensation of public sector personnel totalled $5.9bn in the first 11 months of 2018, constituting an increase of 22.1% from the $4.8bn in the same period of 2017,” says Nassib Ghobril, chief economist at Byblos Bank, Lebanon’s third largest lender by total assets.

“The double-digit rise is due to the across-the-board increase in the wages and salaries of public sector employees and retirees that was enacted by the Lebanese parliament in July 2017.”

As a result, if the Lebanese government is to meet its fiscal reform targets, the chances of a political backlash are high. Prime minister Saad Hariri warned in April that the economy faced a ‘disaster’ unless these reforms were enacted and claimed that the budget would be the most austere in the country’s history. But the gap between the prime minister’s rhetoric and political reality appears, at this stage, to be large. Indeed, when global consultancy McKinsey authored a 1274-page report on the Lebanese economy (commissioned by the government) in January 2019, it noted that the country was stuck in a ‘vicious economic cycle’.

This highlighted a host of impediments that are holding back the economy, including high levels of corruption, stalled reforms and legislative improvements to the business environment, as well as Lebanon’s dependence on diaspora inflows, among other challenges.

Overcoming these problems will not be easy. To begin with, some segments of the country’s political elite are widely seen to benefit from the status quo.

“Urgent economic reforms are needed, but how can we expect the ruling class that is responsible for this dire state of affairs to enact them?” asks Jad Chaaban, associate professor of economics at the American University of Beirut, writing for Diwan, an online service from the Carnegie Endowment for International Peace’s Middle East Program and the Carnegie Middle East Center. “The ruling cartel – a coalition of sectarian, business and military leaders – has survived by sustaining a rentier economy, distributing income and services to its networks of supporters.”

Power surge

There is little doubt that Lebanon’s economy is facing a severe set of challenges, but some scope for optimism remains. In the short term, the country’s maturing foreign currency debt is likely to be serviced through a financial engineering arrangement involving the Banque du Liban and Lebanon’s commercial banks. Meanwhile, in April 2019 Lebanon’s energy minister announced the second licensing round for offshore oil and gas exploration in five blocks. In the same month, the new cabinet approved a groundbreaking plan to reform the country’s ailing electricity sector, a move that, if executed properly, could result in 24-hour electricity across Lebanon and contribute to a significant reduction in government subsidies to the sector.

In addition, a number of high-profile judicial and security officials are facing disciplinary or court procedures for various infractions that have undermined the public good. These examples suggest a more positive direction of travel for Lebanon in niche but significant domains of the country’s economic and political development.

“Though Lebanon’s risk profile has worsened, we are seeing an improvement in political governance and the collective awareness of policy decisions to implement reforms and fight corruption. For these reasons I am cautiously optimistic about the country’s prospects,” says Mr Baz.

Lebanon’s economic potential is abundant. The country’s political class could be forced to make painful long-term decisions to unlock this potential in the coming years. This will require moving beyond the short-term ‘clientelism’ that has characterised some segments of Lebanese political life.

This system has only worked because Lebanon’s banks, and its central bank, have essentially anchored the country as its political leaders have bickered, while seeming to squander opportunity after opportunity for reform.

But as the eyes of the global market watch events in Beirut, against a backdrop of a deteriorating macro-economic profile, time could be running out for Lebanon’s politicians. The next 12 months will decisive for the country’s long-term future.

Source: The Banker

Author: James King