Can the Economic Upswing out-survive Another Political Crisis?
September was one of the most turbulent months in recent years. Not only was the ministry of finance managing the swap of the 2005 Eurobonds, the country also entered into a period of political tension that resulted in an amendment of the constitution and a three year extension of the presidential term. Joey Ghaleb looks at what is at stake for the country. In late August, a mission from the International Monetary Fund (IMF) visited Lebanon as part of its annual Article 4 Consultations and produced probably the most positive report since the early 1990s. The IMF not only estimated 5% real GDP growth (or an 8% nominal growth) but also stated “a significant reduction in the debt-to-GDP ratio – the first time since the civil war – is within reach in 2004.” The IMF’s positive outlook, which is based upon an upward economic trend that began around mid 2003, did not overlook the fact that “vulnerabilities remain … and the country continues to be vulnerable to adverse domestic and external shocks.” It is quite clear from reading the July and more recent IMF reports, that a lot of emphasis was being placed on what will happen in 2005, after totally discounting 2004 – a year that witnessed political deadlock and a highly questionable fiscal budget. Neither the IMF, which constantly refers to measures or reforms expected in 2005, nor the Economic Intelligence Unit (EIU) were party to the political debate in the country but they both considered that 2004 would not be a year in which the seeds of economic reform were sowed. Instead, they looked to the presidential and parliamentary elections as a turning point, which would lead to a more suitable environment to encourage economic growth. The economic indicators were positive throughout the first half of 2004 and the outlook is even more promising. Tourism boomed with a 45% increase in tourists, exports increased by 30%, the fiscal deficit stood at only 25% of total expenditures, and interest rates were continuing their welcoming decline. Three main factors are behind the 5% real GDP growth expected for 2004 and they are: exports, in principal to Iraq (via Syria); tourism; and real estate. These three factors stand to be weakened if international political pressure mounts on Lebanon, hence threatening the growth pattern, which is now still in its infancy. Stepping back and examining the immediate impact of the constitutional amendment on the economy, it is hard to ignore the fact that the politicking, which rocked the financial operation midway through the last week of August, overshadowed the bond swap. The ministry of finance was able to exchange only 55% of maturing Eurobonds ($1.186 billion) into two new instruments with 7.125 and 7.75 yields, saving about 200 basis points. A question that analysts might raise is what would have happened if the swap operation were conducted a week earlier or a week after? The straightforward answer to the first part is probably a more successful ratio of exchange (more than 55%) and thus additional fiscal savings might have been achieved. Now, if the swap were to be conducted post UN resolution 1559, the savings in percentage points would be lower than 200 basis points and some might argue that the swap would not have been recommended by the international investment banks managing the swap at the Bourse of Luxembourg. The next major fiscal milestone will be the much-anticipated 2005 fiscal budget, expected in a matter of weeks. If the environment in 2004 was not, according to finance minister, Fouad Siniora, suitable for a reformist budget, will a 2005 budget proposed by an outgoing minister during a period of political uncertainty include the necessary measures expected to put the country back on the Paris II tracks? Painful measures such as a VAT hike to 12% or 16% require a consensus, popular support and understanding. Will the government succeed in restructuring its administration by laying off redundant employees or increasing the working hours – two measures that previous governments failed to defend in past budget proposals during a period of more political cohesion than today? The constitutional amendment and the ensuing political tension has made it harder to introduce and execute the reform expected in the 2005 budget, improvements which are also eagerly awaited by the IMF, international rating agencies, Paris II member states, and all parties with a stake in the Lebanese economy. The savings in the debt service gained following the Paris II will be partially or fully wiped out and the debt dynamic reversal, referred to in the IMF July 2004 report, will not be sustained if Lebanon is downgraded and the economic momentum is lost. And then there is privatization. This pillar of Paris II has been delayed in 2004 but is promised in 2005, according to the IMF, the only institution that can make or break any Paris III gathering. Past experience now coupled with a bruised political climate does not bode well. The Telecom mishap and the ongoing lack of a consensus among Lebanon’s politicians cannot be overlooked. A successful and wide reaching privatization process requires transparency, a competitive economy, a suitable climate, a lucrative deal, but more importantly a stable and consistent environment, one that will not scare off investors, who are, by nature, twitchy to political rumblings. They need to be sure that their investments are protected and their contracts honored, and their rights preserved by an efficient and credible judicial system. Lebanon has failed to provide this in the past (e.g., telecom, electricity management contracts, Sukleen, etc.) and a last minute constitutional amendment will have done little to shore up confidence. Lebanon has continuously, and quite rightfully, highlighted the strategic importance of its European Union (EU) partnership agreement, signed in 2002. Key to this are the tenets of the 1995 Barcelona Process, which aim to create economic prosperity and political stability based upon shared values and mutual interests. EU Ambassador Patrick Renauld raised these values, when he recently met Prime Minister Hariri and hinted that the presidential extension might threaten the essential spirit of the partnership.
Could Lebanon jeopardize its strategic relationship with the EU, its natural and primary trading and economic partner? Fortunately for us, unless international political developments make a sharp turn to the worse, we cannot expect the EU to freeze the partnership with Lebanon, but we can expect a more lukewarm and cautious relationship, one that might delay or a number of EU-funded projects. The 2002-2004 National Indicative Program alone allocated €80 million, while EU had been planning to increase Lebanon’s budget. Can we afford to lose much needed technical assistance aimed at modernizing our economy? Moreover, and in addition to the Association Agreement, the EU is embarking on a new, wider European "Neighborhood Policy” to complement and build upon the existing Euro-med partnership. The EU, following its enlargement, now has borders from Russia to Lebanon, and all the way to Morocco. The new initiative aims to deepen economic and political integration between the EU and its neighbors by developing bilateral action plans whereby specific activities would be implemented to meet target objectives. Such an ambitious initiative requires a more generous budget and the EU is ready to increase financial and technical assistance to ensure stability and prosperity along its borders. Jordan, Tunisia, and Morocco have already negotiated bilateral action plans and large amounts have been allocated to properly implement them. Lebanon has already welcomed this initiative (an official letter was sent by Prime Minister Rafik Hariri to EU Commission President Romano Prodi in this regard) and is expecting to launch the process of developing the Lebanese-EU action plan once the new EU commission is in office next month. It would be disappointing if the constitutional amendment were to jeopardize not just the existing Association Agreement but also the more promising Neighborhood Policy and deprive Lebanon – like Libya for a decade – from the fruits of a Wider Europe. If Lebanon escapes censuring by the EU, it still has to get past the US barrier at the door of the World Trade Organization (WTO). In the last round of the WTO negotiations in July 2004, Lebanon scored many points towards acceding to the world’s most important trade (and probably soon multilateral investment) institution. Prior to accession, candidate countries negotiate on a bilateral and a multilateral level. The US, which has provided technical assistance to help Lebanon accede to the WTO, can, like any other member, also block, delay, or veto Lebanon’s accession. It can start by halting its technical assistance to Lebanon if relations between the two countries worsen; and even if Lebanon meets the minimum accession requirements – such as introducing new laws or adopting WTO principles (National treatment, most favored nation, etc.) – the US can shower Lebanon with requests and demands that would delay the process of accession for years. Lebanon must pray that this process does not encounter any political obstacles now that its “sister” organization, the UN has passed a new resolution.
Regionally, despite the escalation of violence in Iraq, the Iraqi market has been a major factor behind the recent upsurge in economic activity in Lebanon. Lebanese investment in Iraq covers a wide array of sectors and the Iraqi market has quickly become the primary destination of Lebanese exports with about a 17% share for the first seven months of 2004. The average monthly level of exports to Iraq in 2004 is 250% higher than 2002 while transit trade has also boomed creating backward and forward linkages benefiting a variety of sectors, such as the transport sector, the port of Tripoli, the cement industry, generator production, professional services and the export of expertise. That said, an American blacklisting of Lebanese firms (usually in the form of “indirect” blacklisting by not short-listing Lebanese tenders for contracts) and entrepreneurs could be detrimental to the economy especially that Lebanon fought hard to break into the Iraqi market and win contracts. Obviously any form of economic sanctions against Lebanon or Syria can lead to reversal in the economic trend but a blacklisting approach can also carry further negative implications at this early stage of the economic recovery process. The “loss” of the Iraqi market would fall under what the IMF called the vulnerability of Lebanon to external shocks (a small and open economy by definition cannot grow and develop within a small circle, especially one that is in debt to its eyeballs and which has a lack of natural resources). Any sanctions or blacklisting is not expected in the near horizon but, given the experiences of Libya, Iraq, Iran, Afghanistan, and to a smaller extent Syria, it cannot be disregarded.
Another engine of economic growth, which is also greatly affected by external shocks, is tourism. This sector had probably single-handedly lifted the Lebanese economy, creating activity in numerous service sectors and attracting the bulk of foreign direct investment into Lebanon. By September, the number of tourists exceeded 1 million, the same amount reached for all of 2003. Meanwhile, the yearlong campaign on CNN funded by the Lebanese government is now bearing fruit, while there are increasingly positive reviews in the European and American press.
However, one negative news bite on CNN can easily counterweight the hard work put into improving Lebanon’s image a safe and peaceful country. Figures from 2003 indeed show that tourist arrivals to Lebanon declined by 32% and 23% in March and April respectively due to the war in Iraq. Faint-hearted investors can disappear in a heartbeat. A couple weeks after the extension of the presidential term Lebanon seems to have its back against the wall but the picture is not as bleak as some may portray it, especially given that the Lebanese market has learned to foresee and thus discount “political crisis” as long as these crises remain contained and temporary. At any rate, it is a too early to determine where Lebanon is heading on the geopolitical map and hence it is premature to properly assess the full economic implications of what has happened on the Lebanese political scene. At this early stage though, the general observation is that the constitutional amendment and the debate that ensued has shaken the climate and will not improve the economic situation, at least in the short term. Lebanon must not let the positive upward momentum it has enjoyed in the past 12 months evaporate.
Dr. Joey Ghaleb is chief economist at the ministry of economy and trade and head of the Economic Research Center. The views expressed by the author do not necessarily represent those of the ministry.