Safe from harm?

Will Lebanon

Is Lebanon a genuine emerging economy? If so, how has the country been able to escape unscathed through the domino-like collapse of new entrants into the global financial architecture. After the implosion of several Asian “tiger” economies and the more recent Russian debt crisis, it seemed that the Lebanese bubble would burst. The common reflections on Lebanon as a potential ground were driven by fears over the fiscal imbalance and the stagnating macro economy. The emerging economies are in a sense the periphery in the global financial structure, and as the “hot” money (mainly composed of hedge funds and short term punters) flowed from the center to the periphery, many of the emerging countries witnessed a period of over investment. The excess inflows within a weak regulatory environment exposed certain vulnerabilities that highlighted a divide between both monetary and real factors. Once the short-term money flows reversed, the countries were left to pick up the pieces of fickle foreign hot money. The once revered Asian tiger countries eventually trumped their ability to siphon in short-term money.

Why has Lebanon been unaffected by all these global crises? After all, the fall in emerging markets is a stark reminder that economic reality, however masked by monetary factors, do come back to bite. It is important to note that during the period of euphoria, there is usually almost blind optimism and confidence in the countries’ ability to embark on reforms and policies that woo investments. The boom in Russia and South East Asia illustrates the wide held belief, strengthened by extensive research, that the economies’ fortunes will follow – a sort of “if you build it they will come” approach.

Lebanon stayed immune during these crises – from the Tequila Hangover that characterized the Mexican Peso collapse in the early to mid 90s, to the Asian, Russian, Brazilian blow-ups of the 1997 to 2002 period. The pessimists felt that the Lebanese miracle would unwind, and FOREX stability at the very least, would be in jeopardy. In fact, because Lebanon lacked the international sponsorship from an investment flow perspective, it would experience a more severe downfall. Marwan Barakat, head of research at Banque Audi, described in a recent presentation the crises factors that tend to precipitate problems as economic fundamentals, market factors, financial characteristics, and contagion variables. In Lebanon’s case, one would think that with the economy in the doldrums, the wake up call would be sharp. It is, however, on the other three fronts that Lebanon’s resilience was most prominent. Despite a costly monetary policy geared toward exchange rate stability and illiquid markets, it seems that the social benefit from maintaining the pound outweighed the risks. It also appears that the illiquidity of markets, seen in Barakat’s presentation as an element of vulnerability in other economies’ boom period, was a redeeming factor in Lebanon’s case, especially as most of the financial market transactions focused on local holders of debt and equity. The hot money never bothered with Lebanon, and this illiquidity, though a hallmark of a closed economy, contained the damage and banks rushed into lucrative but short-term Lebanese sovereign bonds. It also appears that the strength of the banking system was a pillar in this resilience. How much longer this can last with Basle II on the way is another issue. Contagion (the collapse of a nation with a large trade position that impacts directly on its trading partners) was never an issue in Lebanon as its role in trade and finance remains limited. The lack of statistics often distorts proper analyses of the situation. For instance, who knows what the real unemployment rate is? How often can one count on reliable monetary aggregate numbers, and what is the real level of consumption? As opposed to typical emerging markets, Lebanon has relied more on consumption than on investment, and while this provides temporary relief, for the economy to grow, real investment is crucial. This resilience is a rear view image of how Lebanon fared in comparison to other emerging markets. Simply put, Lebanon has not blown up perhaps because it has remained insular and closed, and relied on Lebanese and “patient” Arab money for its capital markets. But the resilience raises an important concern: the underreporting of non-performing loans. As this issue pertains to risks in China, Japan, and some of the South American economies, one cannot help but wonder how it may affect Lebanon. Non-performing loans to total loans in Lebanon are at a staggering 20%, according to Audi research figures. The policy lesson, according to Barakat, is that “banks and regulatory authorities should monitor sovereign exposure and find alternative sources of uses so as to avoid a strong correlation between sovereign and banking risks.”

Lebanon has weathered several global crises through a mix of luck and ephemeral variables. The key to maintaining the delicate balance is building confidence, which can be built only through public sector and political reform. As long as the current caretakers continue to place political bickering, personal careers, and confessional issues ahead of the economic and fiscal imperatives, the resilience of Lebanon will be an underutilized element. It is hopeful that unlike its emerging markets counterparts, Lebanon will not need an economic implosion to trigger change in the political and institutional modus vivendi. If, as Barakat put it, “credible policy response is crucial in the emerging economies’ ability to withstand shocks,” one wonders how the investing world feels about the future of a country where no clear economic plan is discernible and where any calls for “economic planning” is met with disdain.