Lebanon’s public debt has been accumulating rapidly over the past decade and a half, making Lebanon one of the most publicly indebted countries in the globe. Political imperatives and reconstruction needs led to large fiscal deficits and debt build up. Higher than anticipated costs combined with elusive assumptions on growth and aid kept the overall fiscal deficit at 22% of GDP by 2000, raising public debt to 151% of GDP.
Realizing that debt build up could generate solvency concerns, strong fiscal discipline was initiated in 2001 involving freezing expenditure and introducing value added tax (VAT), generating primary surpluses for the first time, and stabilizing the debt rate.
Nevertheless, Public debt by end 2006 reached $40 billion, 178% of GDP. The fundamental question remains: how much solvency risk does this level of debt impose on the Lebanese economy? The peculiarities of public debt as well as that of the Lebanese economy have enabled Lebanon to avert crises even under extreme political stress and turmoil. Large private transfers, limited external market exposure, lower rollover risk, and comfortable reserves have allowed Lebanon to sustain higher public debt than one would otherwise expect.
Lebanon is a very open economy with heavy dependence on transfers from the Lebanese diaspora. Annual private transfers are one of the highest in the world, estimated at over 20% of its GDP. Accounting for these transfers brings down the debt ratio to 140% of disposable income (GDP plus transfers). A rate deemed closer to a sustainable threshold.
External debt exposure
Lebanon’s exposure to external debt, at 15% of the total ($6 billion), by end 2006, is low by emerging market standards, and much lower than that of countries that faced financial crises. Further, nearly half of it is to official creditors with long term maturity. The large central bank reserve cushion of $13 billion (excluding gold) can certainly absorb a sudden reverse in sentiment in external private markets.
Another peculiar feature of Lebanon’ debt structure is the successive decline in its market debt ratio to 60% of total debt in 2006 from 82% in 2000. Market debt to GDP and as well to disposable income has declined to 110% and 88% respectively, perceived as more viable ratios. The central bank has increased its holding of public debt to 25%; official creditors’ share as well increased to 11%. The counterpart to increased central bank financing has been a rise in commercial banks claims on the central bank, notably in the form of long-term deposit certificates.
The increased intermediation role of the central bank (with a lower default risk) has pacified financial markets at a time of increased political uncertainty. However, this operation has it own cost, weakening the financial strength of the central bank. Shocks to the financial system, however, can still be absorbed by its reserve base and swap operations, albeit at a higher cost, as in the case following Hariri’s assassination.
High share of debt holdings for commercial banks
Commercial banks’ share of public debt holding, however, remains high at nearly 50% and is closely linked to the stability of the deposit base (banks’ liabilities) and the maturity of public debt. The rollover risk is low owing to the banks’ strong incentive not to jeopardize the financial viability of their main debtor, the government. Their inter-twined interest, limited exposure to foreign banking, and high liquidity has limited their alternatives.
Lebanese banks continue to experience high liquidity brought about by its ability to attract substantial flows from regional financial markets, making money supply to GDP (nearly 3 times) one of the highest in the world. Banks on their own can absorb sudden shocks of rapid deposit withdrawals; their foreign assets are twice non-resident deposits in foreign currencies.
The term structure of Lebanon’s debt maturity structure has improved in recent years. With Paris II (and looking forward to Paris III), long term debt has risen to three-fourths of total debt by 2006, reducing government exposure to interest rate risk. Nevertheless, compared to many emerging economies, Lebanon’s debt remains burdened by short maturity, $16 billion mature in 2007-08.
Finally, the debt overhang remains serious, raising solvency concerns and the possibility of transmission of shocks between the fiscal and the financial sectors. Serious fiscal adjustment as well as financial sector reform is urgently needed to reduce the debt burden, diversify debt holding, and reduce the sterilization burden on the central bank. Solvency risk, however, prompted by external shocks is low with foreign assets of the banking sector standing at $33 billion, 75% of total debt and 150% of debt denominated in foreign currencies.
Dr. Mounir Rached is a senior IMF economist, and a founding member of the Lebanese Economic Association. The views in this article are those of the author and don’t represent those of the IMF
