Investors hold their breath

Amid ongoing political turmoil, EXECUTIVE lists the concerns of investors and their policy prescriptions for averting economic crises

Reading Time: 6 minutes

If the political confusion reigning at the end of March sent any kind of message as to what the agenda of a Lebanese government, or governments, would be in the next six months, it was that now is gambling season when it comes to predictions. The challenge to the Syrian-dominated order in Lebanon, which began after the assassination of former Prime Minister Rafik Hariri, has pushed most policy issues, particularly those related to the economy, to the backburner.

Investors, at least those interested in Lebanon’s future, are understandably worried. Any sensible agenda they would define for the coming months would have to address several certified headaches. Amid plausible delight in seeing the onset of a new era in Lebanon, those with the money must keep a wary eye on the political and economic challenges, not to mention security threats, gathering like a storm cloud. What might their imagined list of preferred policy options be?

In the first week of April, according to an agreement reached last month by the Syrian-Lebanese Higher Council, the Lebanese and Syrian governments must sign off on a final withdrawal timetable for Syrian forces. While there was much talk in March that Syrian President Bashar Assad had agreed to both a full withdrawal and one that would occur before scheduled Lebanese parliamentary elections in late May, he personally had made no public statements to that effect. The April meeting should clarify the situation, assuming that governmental gridlock does not encourage Syria and its Lebanese allies to indefinitely delay discussions on a withdrawal timetable.

Investors are most worried about delay. While some believe that a solution requires creating a government of national unity, others are less certain that that would do more than just divide the political class further. That’s why, arguably, the options most favored to break out of the deadlock are either the formation of a government similar to the last one, which could rapidly move ahead with elections (under the assumption that the Syrian withdrawal and the public mood would allow a fairly free voting process); or the formation of a neutral government. Anything preventing either option will only alarm investors further.

One potential problem, perhaps not obvious today, is what will constitute a full Syrian withdrawal? The Lebanese-Syrian border has never been demarcated, so, if there is Syrian bad faith on the border issue, there is also the potential for disagreement over Syria’s fulfillment of Resolution 1559, which calls on Damascus to pull its troops out of Lebanon. This situation would replicate that of May-June 2000, when Israel pulled out of south Lebanon. The business community would weather the tension, but also pop many Maalox tablets.

While some opposition figures, particularly Walid Jumblatt, focused on ousting President Emile Lahoud in mid-March, by the end of the month the mood had decisively changed in favor of carrying out parliamentary elections on schedule. Investors probably agreed, since the downfall of Lahoud might create a political void that could have negative repercussions on the economy. Indeed, this was one reason why Maronite Patriarch Nasrallah Sfeir urged delaying focusing on removing the president.

For the present or future government, the question is: Which election law? Parliament is sitting on a draft law that calls for elections at the level of the small circumscription, the qada. If all goes well, parliament must approve the law by the end of this month. But if for some reason there is further political stalemate, it might decide to go back to the election law of 2000, which is more advantageous to pro-government candidates.

Any government, whether the caretaker Karami government or a successor, will have to ensure that the election law is not divisive. Elections today would probably reflect widespread, though not complete, support for candidates critical of Syria; for the government to avoid this through gerrymandering would fail and do more harm than good in terms of political stability. In that context, the government’s first priority for investors must be to force elections on schedule and not allow a democratic vacuum. Despite its imperfections, the past government’s draft law is acceptable to all, a rare consensus that a new government must highlight in encouraging parliament to approve the legislation.

The United Nations report in late March cast serious doubt on the behavior of the Lebanese security services in the aftermath of the assassination of the former prime minister. From the outset, the official investigation of the crime has been intolerably mismanaged, with investigators not even able, or willing, to find the bodies of two individuals who died on the scene. This has greatly undermined public confidence in the Lebanese state

Any future government, to be trustworthy to investors, will have to hold senior security officials accountable. This must not only mean confirming the bona fides of officials accused of responsibility for the Hariri murder, but also those conducting the investigation afterwards. This goes to the heart of the rule of law, and will be a test case for those new investors wishing to enter the Lebanese market after a Syrian departure. A priority of any credible new government must be to clarify such questions and present a report on the killing of the former prime minister that is internationally relaible; or request an international investigation that will determine responsibilities.

With Rafik Hariri gone and the transitional period leading to a Syrian withdrawal over, a new government will have to navigate through the backlash of a business sector that no longer can rely on the former prime minister. Already, the Hariri camp is trying to play the continuity card, with Bahia Hariri perhaps angling to be a future prime minister, which could imply a return of the former finance minister, Fouad Sanioura. This should help stabilize the markets in the short term, particularly on the revenue front, as serious preparations take place for deeper economic reform.

The first priority in terms of finances will be to stabilize the pound. The currency has remained steady in the month since Hariri was assassinated, but in the first two weeks of March there were reports of a $667 million drop in foreign currency reserves at the central bank. Private demand for foreign currency has risen, but there are no signs of panic in terms of capital flight. While this trend is sustainable in the short term, in the medium and long term it is not, particularly if the security situation deteriorates with more bombs going off. In order to help reverse growing pessimism, a new government must urgently present a new budget (a process the political crisis has delayed) that sets stringent spending limits.

Even with Hariri alive, it was always doubtful that Lebanon would escape its debt trap unscathed. With him dead, a new government must initiate steps to ensure that a domestic and international safety net is prepared for what is likely to be very severe, if not uncontrollable, pressure on the pound. Cutting budgetary spending is a first step, but so too is seeing whether this can be leveraged to attract international loans allowing Lebanese banks to reschedule their domestic debt. Lebanon’s integrity is in tatters when it comes to implementing economic reforms justifying such assistance. However, France and the United States may try to help guarantee a smooth economic transition after a Syrian withdrawal, to buttress the view that peaceful democratic changeovers are possible in the Middle East. If the US Deputy Defense Secretary Paul Wolfowitz is appointed to head the World Bank, Beirut might have in him a helpful ally on debt relief.

Any serious Lebanese effort to reassure investors and earn international assistance must be accompanied by a reform package that includes hefty budget cuts, privatization, and reductions in the bloated and inefficient bureaucracy. It may also require advancing rapidly on a new tax law that can expand the revenue base of the government beyond the income it receives from customs duties, state services and the value-added tax. Economic reform is largely political, so this is all easier said than done.

Precisely where the government should start on privatization is not entirely clear. The fixed telephone network could be a start, but it is not easy to see who would want to pick up the black hole that is the heavily indebted Electricité du Liban before the government props it up. A little-discussed initiative in recent years may make a comeback if the opposition wins a majority in parliament: eliminating superfluous parallel security agencies and cutting back on the high defense bill. A Syrian departure may also ensure that less money from governmental or government-licensed institutions is distributed to Syrian officials. In the short to medium term, however, there could be an economic price to pay if Syrian depositors continue withdrawing their money from Lebanese accounts. The question is whether that is sustainable: Lebanon offers more advantages than Jordan to Syrians, and the Syrian banking sector is still embryonic.

A government will also have to adapt to a new financial climate worldwide, where accounts will be more closely scrutinized by foreign governments and international financial overseers. Times are changing and Lebanese banking secrecy will almost certainly become more of a target of the United States. Shaping a valid response to such pressures will be necessary, and investors will be keeping a close eye on how this reaction affects their business overseas.

Beyond the political implications of the future of Hizbullah specifically, economic stability will be closely linked to the party’s disarmament. Resolution 1559 specifically calls for such a measure, opening the door to retaliation if the party retains its weapons. And while the international community has shown willingness to allow the Lebanese to resolve the issue internally, this margin of maneuver will not be unlimited

Hizbullah’s disarmament puts investors in a dilemma. While the markets would react positively to the party’s decision to give up its weapons (since that would alleviate fear of Israeli retaliatory strikes against Lebanese infrastructure in the event of cross-border violence), investors are aware that the process leading up to that stage may be particularly divisive domestically. Hizbullah has repeatedly indicated that it has no intention of disarming, and not a few observers see in the party an entity that considers itself above the Lebanese consensus. This sends out vibes that make the business community uneasy.

Investors, like many Lebanese, would welcome closing the curtain on the war years by putting an end to an era when guns do the talking. Any future government will have to emphasize that with vigor. One thing money will not follow in a new era without the Syrian army is any reminder of that time.