Fiscal flood

Lebanon must prepare for higher interest rates

People may like to think otherwise, but the majority of catastrophes throw very visible shadows ahead. For example, most floods can be foretold by analyzing the human impact on terrain and studying long-term weather patterns. Prudent preparations can be made to help avert the worst outcomes.

In 2016, Lebanon will face a rising tide of devastating consequences. The deluge will not be one of rain — which we usually pray for more of in Lebanon — but instead a gradual flooding of global financial markets with higher interest rates.

This rise is announcing itself from the west, where most of our economic and financial weather is made. The possibility of a hike has recently been hinted at by Federal Reserve officials in Washington in various sibylline statements as likely to commence six months after the end of its quantitative easing program, presumably at the end of 2014. The expectations for a gradual hike got a further boost after the Fed in late May released the minutes of its April meeting.

Was it a coincidence that our central bank governor visited the finance minister at almost the same time and emphasized the importance of managing the public debt in ways that do not put pressure on borrowing rates?

As economists at Lebanese banks explained to Executive during our research for this issue’s banking special report, the Federal Reserve’s likely increase of interest rates in 2015 will influence our interest rate environment within a few months of the start of the expected hike.

“We currently have a fiscal deficit at 9.5 percent of GDP. If we stay at the same level of fiscal vulnerabilities with public sector financing gaps and increasing public debt — whether in nominal terms or as share of GDP — then you will see pressure to increase interest rates in Lebanon. This will increase debt servicing cost to borrowers here, whether they are corporate, households or individuals,” Byblos Bank’s chief economist Nassib Ghobril told us.

Higher debt servicing costs for anyone could flood the Lebanese economic terrain — which is already saturated with old debts as well as the new financial debris of the past two years — to the point of drowning us all.

We have seen public debt expand precipitously once before. In the 1990s and early 2000s, high interest rates, low economic growth, security problems and politicians’ failure to implement reforms inflated Lebanese debt to the point that the republic had to go begging, cap in hand. Those same problems are beginning to sound ominously familiar once again. 

A catastrophe is not inescapable, however. As Ghobril and the economists at the other top banks noted, the American tightening of interest rates is likely to be implemented in small steps and will not translate into one-to-one increases in domestic borrowing rates.

There will also be positive impacts of higher interest rates: banking sector earnings may increase while the pressure on the economy could be kept under control. However, benefitting from the upsides and keeping debt down will require swift action on political and administrative reform, with zero tolerance for procrastination.

The issues requiring reform have been outlined with great clarity and vigor in the recent debate over higher taxation of banks (see “Don’t kill the banks“). The country’s public sector economy needs to be reinvented and the private sector needs to be held to its fiscal responsibilities without exceptions. Broadly, this will require three steps.

Instead of muddling through from one emergency funding run to the next, the Cabinet and Parliament must first establish fiscal solvency by managing public finance and eliminating as much waste of public monies as possible.

To this end, the fight against corruption and cronyism in state-owned enterprises and our monstrous electricity utility must finally begin in earnest. Ministries have to be improved and made more efficient. Positions — from the highest to the lowest — should be allocated according to merit, and public servants must be incentivized to increase transparency.

Second, the tax base must be widened. Companies and professionals have to be motivated to register and fully integrate into the formal economy, first via measures that show that taxes are used properly and to the benefit of those paying them, and then through disincentives to tax evasion.

Finally, there must be political reforms that enhance the national cohesion and a political process for incepting a well-formulated national will that actually entails a sustainable strategy for the economy.

All these reforms and needs are well known, as the debates of recent weeks have shown. All of them deserve to be realized upon their own merit. But if they are not implemented between now and the time when the Fed raises interest rates, one must wonder if Lebanon’s debt to GDP ratio could not easily deteriorate beyond even the level of 180 percent in 2003 that the country has struggled ten years to get away from.

We may bet that the burden can be managed again, perhaps gambling that our neighboring country will start rebuilding in 2015 or 2016 and that this will grant the Lebanese economy with an unprecedented boost. But not only would such a wager be dangerous; it would leave us stuck with our systemic problems, problems that we know we can solve if we put our minds to the task.

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