Overcoming the debt trap in Lebanon: from a rent-based to a productive economy

Any proper understanding of the debt phenomenon in Lebanon requires a short historical review of how this huge amount of debt could have piled up. It is to be noted here that the Lebanese public debt stood at the equivalent amount of $2 billion at the end of 1992, representing approximately 50% of GDP at that time. By the end of 2006, this debt stood at the equivalent of $40.5 billion representing 200% of GDP. During this period of 14 years, the total fiscal deficit of the state and the public sector (without debt service, but including all reconstruction expenditures and expenses outside the budget) did not exceed the equivalent of $4.7 billion.

This means that the cumulated annual amount of debt service during the period 1993-2006 reached the astronomic figure of $31.4 billion, while the capital of the debt at the end of 1992 ($2 billion) plus the fiscal overall primary deficit ($4.7 billion) during this period did not exceed $6.7 billion (2 + 4.7). The cumulated amount of debt service was higher than the total of all other budget expenditures during the period and represented 87% of the cumulated overall Treasury fiscal deficit including debt service for the period 1993-2006 ($36.9 billion).

The main factor leading to such a staggering figure is the level of interest rates on the T-bills issued in domestic currency between 1993 and 1998. Rates have reached levels of more than 35% in 1995 and of more than 20% in certain years between 1993 and 1998. Real interest rates have been almost above 10% of the local CPI throughout the period from 1994 to 2002. Although the level of yields on domestic T-bills declined substantially in 1999 from 18.6% to 14.4%, it is only after 2002 that it was reduced again to below 10%. In fact, the average annual interest rate paid on the capital of the debt was 14.6% during the period 1993-2006, a very high average compared to the level of international interest rates and to the domestic CPI.

It will be very important to be explicit in the future why interest rates increased so dramatically in Lebanon during the 1990s. After all, during this decade interest rates were declining worldwide, domestic inflation was coming down substantially, there was a surplus in the balance of payments and the Central Bank was piling up foreign exchange reserves without being indebted to the domestic banking system, as is the case today. If the average annual interest rate on the public debt in Lebanon had been set at 5% above LIBOR during the period 1993-2006, the cumulated debt service would have reached only $16 billion, compared to the $31.4 billion effectively paid by the Treasury. In fact, in this case, we can estimate the overcharge of interest rates to the Treasury at $15 billion. A calculation of such overcharge, in case of an average interest rate on the public debt during the same period at the level of 3.5% above LIBOR, shows that the amount of debt service during the period would not have exceeded $11.2 billion; in this case the public debt today would be standing at $19.7 billion only, i.e. at less than 100% of GDP instead of 200% as is currently the case.

Resolving the debt trap

During the last few years, the government was able to continue to refinance its huge debt due to two positive factors. The first one is the decline in interest rates since 1999 which contained increases in the annual debt service. In addition, the Treasury receipts were substantially strengthened both by the implementation of VAT and the cancellation of the two cellular phone companies’ BOT allowing the Treasury to cash 100% of their profits. However, in spite of these positive developments, the vicious circle was not broken and the ever-increasing amount of debt is still the biggest obstacle to a return to full economic health.

In fact, to reduce the level of indebtedness, the rate of growth of government receipts should have surpassed the interest rate paid by the Treasury on the public debt. This is why what is needed to get Lebanon out of the debt trap is a combination of an extremely high rate of growth, more interest rate reduction and a well designed and properly timed privatization program.

It should be noted, however, that due to the present level of Treasury indebtedness ($41.5 billion), whatever privatization receipts could be generated, they will not be able to substantially reduce this level. One can anticipate at best an amount of $6 to $8 billion in case the Lebanese government nomenklatura could agree on implementing a privatization program. This amount could stop the debt increase for maybe two years, but no more. In addition, to be effective, this program should be properly planned and implemented. There should be an adequate timing whereby privatization receipts would be an additional element in creating a positive dynamic to get out at once of the debt trap.

To this effect, what is important for Lebanon is to change its economic mentality and for its public and private sector decision makers to realize how much the economic and human potential of the country is remaining untapped. This, in my view, is largely due to the rigidity that has affected the economic vision of Lebanon as being able to grow and develop exclusively through the banking and the real estate sector, in addition to tourism. In fact, reconstruction policies in the 1990s have reproduced and aggravated the vision of Lebanon being ideally and exclusively suited to be a financial and commercial entrepôt for the region. It contributed to strengthen the wrong belief that the economy could only prosper if based on intermediation between supposedly underdeveloped Arab economies and Western or other more developed economies.

Keeping the brains here

In this respect, it should be noted that the reconstruction planners did not take into account all the changes that have affected not only the Arab region, but also the international economy. They also did not realize that the old regional role of Lebanon was over and that globalization and the electronic revolution were rendering intermediaries irrelevant. They did not realize that globalization requires a shift to high value added products and services in high demand in the world economy. Neither did they grasp the fact that the success in exporting such products and services requires any country to keep its best human resources at home instead of exporting them to other countries. Although many successful economic models could have inspired the Lebanese economic policy, like Malta, Ireland, Cyprus, Singapore and other larger economies like Taiwan or South Korea, the weight of the past seems to have been a fundamental obstacle to understand the urgent need for a change.

Creating artificial rent revenues in the country by increasing interest rates to the levels mentioned above was a high cost substitute to the lack of job creation and local economic dynamism outside the real estate sector. The traditional Lebanese wisdom about human resources is still based on the belief that it is more beneficial to the Lebanese economy to export brains than to devote efforts to keep them at home by creating locally new high value added activities securing enough employment opportunities for these brains. The regular remittance flow is viewed as an essential element of poverty alleviation and balance of payment equilibrium. It is not considered to be an economic waste, given the fact that the local economy supports the costs of educating and training these dynamic human resources, while countries receiving this educated manpower are getting the full economic benefits. The “brain exporting country” receives only a residual part of the revenues produced by these brains abroad through the flow of remittances.

This is why the quality and sophistication of economic thinking in Lebanon should be seriously addressed to get out of the debt trap. Now that the era of “crazy” interest rates is over, it is high time to look seriously at the comparative advantages that Lebanon enjoys in many fields. If properly used, these advantages will allow the country to compete successfully in the global market for high value added activities. Lebanon could become a very dynamic exporter of biological agricultural products, high-quality seeds, and plant-based medicine given its famous biodiversity and the existence of many plants with medicinal value. It could also much more develop its software productive capacities; it could attract sub-contracting of off-shored services activities in accounting, financial analysis, medical and biological research. It could also go into producing solar energy equipment in high demand worldwide, as well as into producing equipment for used-water recycling or solid waste treatment. It is only through sustained continuous high growth generated by a substantial increase in Lebanese exports of high value added goods and services that the country could break the vicious circle of ever increasing indebtedness.

There are, however, other actions to be taken simultaneously to get out of the debt trap, mainly reforming our dual monetary system whereby the US dollar and Lebanese pound coexist as legal means of payment. Reforming the tax system, as well as the public debt management, are two other key issues to get out of the debt trap. The part of the public debt, in the hand of Lebanese institutional holders, should also be progressively rescheduled through voluntary agreements between the state, the Association of Banks and the Bank of Lebanon. In fact, to be sustainable, the annual debt service burden should not exceed the level of 25% or 30% of public expenditures against more than 50% on average during 1993-2006.

But all this suppose a change of economic mentality and the adoption of a different reform program than the one developed with the help of international financial institutions. In the mean time, one should hope that the political situation will remain in control and will not spoil any chance of future reform of the Lebanese economy in a new direction.

George Corm

Georges Corm is an economist and served as Lebanon’s Minister of Finance from 1998 - 2000.