Fast Track to Growth

With winds of change sweeping the country, the time is now for a new government to kick-start the economy. Executive submits its blue-print for economy recovery

Until the assassination of Mr. Hariri and the subsequent uncertainty, Lebanon had, for the previous 18 months, enjoyed relatively robust economic activity, which allowed for the replenishment of reserves, better GDP growth in 2004, vigorous financial sector liquidity, and, through swaps, more efficient management of the country’s debt stock, which in turn allowed for the lengthening of Lebanon’s foreign debt’s maturity.

The fact that these positive gains were set back by one, albeit enormous, bomb blast, proves that no post-war government has yet been able to build the necessary foundations to reduce the vulnerability of the economy to unexpected trauma, nor for that matter set up a sound economic base to generate recurring revenues, diversify the economy or create jobs.

This situation has not been helped by the Lebanese government’s failure to implement administrative reforms – especially the privatization program demanded by the 2002 Paris II conference – and by shelving attempts to reverse the current political and social status quo, which has so far been characterized by corruption, waste and incompetence.


 

Palestinians would make an ideal blue-collar labor force in Lebanon, if allowed to work more freely

International donors, investors, lenders and rating agencies repeated time after time that Lebanon badly needs to implement structural reforms, meet Paris II objectives, and build a basis that would allow successive governments to comfortably service and repay debt.

Today, there is a consensus that any political impasse will lead to an erosion in international confidence that would precipitate a financial crisis. It is therefore time to act with maturity and vision and tackle problems head on.

A brave new world

Any post-election government should be bulging with technocrats and specialists, species that, with a few exceptions, have been overlooked by all post-war governments, who saw them as an obstacle to the self-interest, cronyism and corruption that has defined the Lebanese political system for the past 15 years. It is imperative that they now be given free reign to reform and restructure the country, in particular focusing on:
 

Political and geopolitical risks
Consolidating economic development and improving external liquidity
Maintaining long term growth rates
Implementing a serious policy of privatization
Debt and overall fiscal management

Sound politics are crucial for a sound economy

Political stability is crucial if the pillars of a healthy social and economic structure is to be created.

It is important that Lebanon recovers its full democratic character by allowing for consistent, regular and impartial elections. The extent of popular participation must be significant and clear for the world to see, as this is generally considered one way of building up international credibility and reassuring foreign investors, just as a country with a perceived Third World election process is certain to lose credibility with the international community.

Lebanon must have a consistent and high degree of consensus on economic policy objectives and global trade and financial organizations. There must be a strong will to carry out reforms and privatization, and political institutions must be unanimous on issues of that ilk.

Politicians and public institutions have to show, through meticulous marketing, a strong capacity to adapt to changes in political trends on an international, regional and domestic basis. Any stubbornness and inflexibility will be immediately be interpreted negatively.

Lebanon must show a degree of reform in leadership succession.

Lebanon must reduce to a minimum, internal and external security risks. This has partially been accomplished and the departure of Syrian forces should enhance the security aspect even further.

Public Sector bliss

The Lebanon of the future will have to ensure that the public administration become more of a meritocracy. In Western countries, particularly in Europe, the public sector is the major source of employment amongst the youth and specialized professionals. In Lebanon, the abysmal image of the public sector is fuelled by incompetence across the board and by the complete lack of accountability of civil servants, who have no concept of serving the interests of the people. An efficient, competent public administration, free of unnecessary bureaucracy, would be key in attracting foreign investments and restoring confidence in the local economy.

Regional obligations and political realities

Another priority for any new government is the Palestinian “problem.” Any Lebanese government must face up to the fact that the 400,000 Palestinians in Lebanon must be given a less constraining economic status and be allowed to work freely within the country. Lebanon must therefore seek financial aid to allow for the smooth integration of the Palestinians, whose would be re-injected into the domestic economy. A blue collar Palestinian workforce would also be more stable than any foreign workforce, as it would be born and bred in Lebanon. The integration of Palestinian workers would, in time, give Lebanon important economic links with neighboring countries in the Levant, namely Jordan, Palestine (the West Bank and Gaza), and, in the event of a peace treaty, Israel.

Reaffirming a tradition

Since its independence, Lebanon has always been a market economy and, although this tradition is not in danger, it is still important for the country to emphasize its commitment to the concept. Lebanon has always been an example in terms of economic liberalization in the region, especially amongst other Levant countries and in North Africa, but has been lacking economic reforms and restructuring since the end of the war to genuinely play the free-market role. Living standards, income and wealth distribution have been erratic at best for the last fifteen years, and very little has been done to diversify both the economy and the revenues generated, mainly as a result of incompetence, corruption, waste and racketeering, leaving no room for resource endowment. The result is a complete reliance on free entrepreneurship and the private sector, and very little economic guidance and help from the government.

Any future government will have to risk investing in projects that will yield significant economic and social benefits in the medium to long term and cannot forego opportunities just for the sake of avoiding financial or political risk. The development of the water and transport sectors – arguably the most strategic at the moment – is crucial to the future diversification of the Lebanese economy and the creation of jobs. Although Lebanon is blessed with substantial water reserves, due to its favorable geographic layout and weather, nothing is being done to exploit them.

The creation of an efficient water distribution system would create significant revenues for the country and establish Lebanon as a strategic geopolitical nexus, ensuring its long-term protection by the international community from bellicose neighbors. Selling water to its neighbors, while being self-sufficient at home, is a scenario that many countries would have worked hard to realize decades ago. Likewise, a developed motorway and rail network, linking Lebanese ports and cities to neighboring countries would not only create important direct revenues, but also make Lebanon a regional hub in the modern sense. The development of water resources and their distribution, as well as transport links (mainly through toll roads and passenger and freight railways) would boost GDP exponentially, easily doubling the current GDP figure of US$19 billion.

Water, rail and toll roads must all be privatized, with the government maintaining a golden share in these newly privatized companies, and having a say in their strategies. Such projects must take a regional dimension, as the Lebanese market on its own is too small. Privileged relations with countries like Syria, Iraq and Jordan are crucial to the future economic prosperity of Lebanon, which as a country, must exploit its comparative advantage in terms of know-how, geopolitical positioning (on the Mediterranean coast and in between Europe and the rest of the Middle East), and wealth in water resources, to position itself as a regional intermediary and springboard.

Improving growth prospects

Lebanon will only achieve consistent economic growth through:

Economic diversification, such as creating new sectors (ecology-related, technology, capital markets, specialized finance houses, heavy industry, etc.), developing existing ones (light industry, tourism, banking and telecommunications), and using current subsidies spent on inefficient public sector companies such as EDL (which drains the public coffers with US$1 billion in subsidies on a yearly basis) to invest on economic diversification and job creation.

The restoration of confidence and trust in the domestic economy and economic infrastructure, through the eradication of bureaucracy and corruption, setting solid and realistic political objectives related to the economy, and updating the existing infrastructure.

The re-building of the middle class and their savings base. One way of facilitating this is to keep the taxation as light as possible to avoid impacting the country’s savings. It would also discourage capital flight and slow the “brain drain”.

The creation of tax incentives, especially to woo expatriate Lebanese.

The development of the country’s capital markets provide companies and banks with alternative sources of funding.

The consolidation of its position as the sole Arab bond issuer to develop as a regional capital markets hub, hopefully leading to an influx of regional companies, seeking to raise funds both in terms of debt and equity.

Other ways to ensure economic growth include the development and proper re-organization of a wide range of economic sectors such as :

Tourism: despite the mini-boom in 2004, the sector is still severely under-exploited, due to a lack of adequate marketing and communication. Major infrastructure investments and a committed, long term policy from the government are essential if Lebanon is to realize its full potential.

Industry, which is suffering from high operational costs (electricity, fuel, social security on labor, etc.), unfair competition from neighboring countries and a lack of understanding from bankers, who generally penalize industrial companies heavily in terms of debtor interest rates. Lebanese industry desperately need private equity and venture capital funds, as well as specialized financial institutions that would cater to their financing and financial advisory needs.

Banking and finance, which is still desperately undiversified. New types of institutions need to be created and developed, mainly on housing finance, public works finance, financial engineering and securitization, industrial finance, etc. The current banking sector must also be restructured (even if it means changing the law) to resemble the Honk Kong model. The latter divides banks into three categories: savings banks, merchant banks and international universal banks. The central bank would decide on the classification of each bank.

Agriculture, which is currently in an abysmal state. Subsidies for that sector have been constantly diverted and dilapidated, and there has never been a state master plan for that sector. Lebanon’s weather is so appropriate that the country can ultimately become a net exporter of agricultural products, mainly in fruits (including exotic) and vegetables. Lebanon should seek to emulate the Chilean model, which has made Chile the most efficient agricultural country, deriving a large chunk of its revenues from this sector.

Real estate. Here it is essential that the political climate remains stable over a long period of time, that interest rates on deposits decrease and that legislation and fiscal stability be maintained over long periods of time. Real estate suffers significantly from constant changes in legislation and fiscal regime, which drive away investors.

ICT, with rock solid patent and copyright laws, and significant subsidies to develop research and development. The potential of the Lebanese in this sector is significant but under-exploited. Lebanon should also position itself, in a similar vein to India, as a major outsourcing of ICT services for Western countries.

Trade and transport. Here, laws must be fine tuned to allow everybody to trade freely. A climate of competition must be created and exclusive agencies must be become a bad memory. Trade barriers must also fall and Lebanon must join the WTO and the Euromed. As mentioned earlier, transport is crucial for the development of the economy, and Lebanon is ideally positioned to become a hub for at least the Levant region in the next decades, if an efficient motorway (with toll roads) and rail network system, linked to Beirut and other cities’ ports and Beirut airport, are built as soon as possible.

Health care. Lebanon has a comparative advantage in terms of the quality of its doctors and hospitals, and should develop a strategy to become, like Cuba, a regional centre. Subsidies must be diverted from inefficient state-controlled sectors into the health sector, which should become one of the best in the world.

General services, which will be efficient once efficiency is realized in the above sectors. Education, however, should become part of the new government’s priorities, as the country enjoys a considerable comparative advantage in this area. An education second to none would attract expatriates, foreign companies (their executives and families), and students from all over the Arab world. Job creation in this field is potentially significant too.

Privatization and a tight monetary policy are key

The development and diversification of the economy cannot be successful if they are not accompanied by privatization and a healthy monetary policy. The Banque du Liban (BDL) and the Ministry of Finance have done as much as they can given the past constraints, but today these areas are a priority.

Lost opportunities

The privatization program has been stalling since its inception by the Hoss government in the last quarter of 1998. Any privatization in an emerging market such as Lebanon has been very difficult to achieve, as international investors of equities are less keen on emerging market securities offered by institutions in countries such as Lebanon, especially in the wake of the Asian and Russian crises of 1997-98, which brought the emerging market trend to an end and the stock markets’ bear years of 2001-2004 rang the death knell for any emerging market initial public offering (IPO).

The current poor state of the Beirut Stock Exchange (BSE) is a reflection of the failure of the Lebanese privatization program and of the Lebanese government’s lack of judgment as to the timing of such a program. In short, Lebanon missed a major opportunity in terms of privatization. Were the government to have privatized in 1995-97, when emerging markets were so fashionable, more than US$10 billion would have flooded into the state’s coffers. EDL could easily have been sold for around $1 billion back in 1996, but can’t even attract one strategic investor for less than 10% of the 1996 price. In fact, today it is in such a mess that privatization for a symbolic $1 is the only option available.

The aim of any future government is to commit politically and unanimously on privatization, and announce to the world’s financial markets its intention to resume the privatization program, this time seriously. A privatization authority or ministry must be put into place, which task would be to monitor the entire privatization process and ensure transparency at all times, while road shows and presentations to international investors must be carried out on a regular basis at the same time that a serious restructuring of state enterprises is accelerated.

The privatization of any state company must carried out in such a way as to include:

A major strategic shareholder (an international company involved in the same field and whose role would be to actively manage the newly privatized company).

A diversified local and regional investor base that would include the state.

Finally, privatization must not be carried out just for the purpose of raising fresh money. It must be done to improve public services. EDL could easily be sold for nothing, on the condition that whoever buys it manages it properly and ensures a good service to end users. The state would benefit from such a privatization in the medium to long term, as electricity services become more efficient and less costly to the local industry while tax revenues (i.e. taxing the private electricity company) increase over time.

Other companies to be privatized and which could yield significant cash returns are the tobacco regie and the fixed line telecommunications company. The introduction of affordable broadband internet services is imperative for the development of the telecommunications sector and for the establishment of Lebanon as a regional hub. The state should also sort out the mess that had been created in the mobile phone operators’ case, and restore its credibility with international investors. The mobile phone saga was a shambles, never to be repeated and any new government must seek to actively make amends with investors in order to restore credibility.

Fiscal husbandry

Privatization must be done in parallel with a national debt restructuring, which would include swaps and debt consolidation. The later would only be possible within a favorable and less risky political environment, as it would imply the help of supranational institutions such as the World Bank. In the case of debt consolidation, the latter would lend Lebanon substantial sums amounts ($ billions) over a long period of, say, 20 years, at favorable interest rates. Such a loan would then be used to repay most or a large chunk of the existing public debt, which is due in the next five years, giving, as a result, enormous breathing space to the economy.

Such a debt structure would allow Lebanon to reach financial equilibrium within five to six years. Of course, interest rates will have to decrease across the board, as the country improves its credit rating and the general risk level (particularly the political risk) is reduced significantly. In particular, debtor rates will have to be dropped, as local corporates are currently using their entire cash flow to service debt and are left with spare cash to invest in their businesses. Interest rates on deposits will also have to be dropped accordingly.

Other immediate measures to be taken by a new government would be to :

Reform the pension system and social security. An adequate state pension plan ensures the renewal of the work force, particularly at public sector level, and allows for the creation of jobs for the younger generation. For the moment, civil servants work beyond their retirement age, as their pension is insufficient to sustain them in their old age. Therefore, younger people have fewer opportunities for work, as all possible positions are filled, and are forced to emigrate.

Develop a more effective institutional and legal infrastructure, emphasizing on company protection from bankruptcy and implementing practices that are conducive to the functioning of markets, including property rights legislation and bankruptcy, contract and collateral laws.

The government must also :

Monitor the local banks’ progress in implementing the Basel II regulations for banks, through the national supervisor or the Banking Control Commission (BCC). Basel II will focus more on risk and capital management and on a more efficient way of lending, which can only be beneficial to debtors.

Use gold reserves, amounting to around $4 billion at current prices, either as collateral for cheaper long-term debt or sold outright for cash that could be re-invested in a government development fund. The current law forbidding any government to use or sell gold reserves is obsolete and must be annulled, provided, of course, that the future government be held responsible and accountable in case of fund misappropriation.

Conclusion

Lebanon has had two wars within a period of 30 years: a military one that ended in 1991, and an economic and social one that is now almost over. Two generations of Lebanese were lost in this devastating period, which nevertheless must serve as a strong lesson for future generations. Lebanon must adapt to world trends and build strong political and economic pillars as well as use its abundance of capable technocrats who would make it their absolute priority to build a realistic and efficient political consensus and strategy, which would drive the economy forward for the coming decades.
 

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