The assassination of former prime minister Rafik Hariri on Valentine’s Day 2005, highlighted Lebanon’s economic vulnerability to sudden political and security events, as reflected in the significant slow down in economic activity; the massive decrease in GDP growth; and the rise of the proportion of public debt to government revenues. In the last quarter of 2005, after Syria’s withdrawal of its troops, relatively successful legislative elections and the naming of a “national unity” government – the country’s economy was still characterized by an extremely high level of public debt, wide fiscal and external current account deficits, a narrow economic base, and a fragile, arguably explosive, political environment.
At the end of 2004, the international community, as well as all the Lebanese were hopeful that a steady increase in government revenues and a substantial growth in the GDP would gradually reduce the debt burden and help the country outgrow its debt problem with new- found tourism revenues and foreign investment mainly from the Gulf. However, and perhaps with a degree of hindsight, those reading the runes should have predicted the unfolding of a different scenario, one based on the fallout of UN Resolution 1559, the extension of President Emile Lahoud’s mandate and a tightening of Syrian authority in the country.
Growth figures disappoint
Real GDP growth fell from a very positive 5% in 2004, a level unseen since the early 1990s, to an expected 1% at best for 2005 as the country’s GDP of the last few years (an average of 2% to 3% for 2001, 2002 and 2003, and 5% in 2004), was almost wiped out. This yo-yoing of growth figures should constitute a message to the Lebanese government that it is now time to genuinely tackle the debt and the economy. For the moment, the debt burden is still one of the largest among rated countries, with the debt to GDP ratio being estimated to exceed 170% by the end of 2005, and interest payments consuming around 55% of fiscal revenues (in both 2004 and 2005). The country’s overall fiscal deficit has remained very high at almost 10% at the end of 2004, and 11.7% estimated at the end of 2005, despite significant efforts to improve the primary fiscal balance of the last decade.
Moreover, the country’s economic base is still narrow and government revenues undiversified. The country still lacks primary resources and its export base is limited, with economic activity concentrated in services, namely banking, trade and tourism. The activities in the service sector account for around 60% of GDP, reflecting a high level of concentration on a handful of economic activities. This concentration coupled with a high dollarization of the economy and bank deposits increase Lebanon’s vulnerability to political and regional shocks. The current account deficit (or the current account balance to GDP ratio), after a period of decline between 2001 and 2004 (especially after Paris II), moved up again to an estimated 19.7% for 2005, compared to 13.1% in 2002, 12.4% in 2003 and 15.0% in 2004, approaching 2001 levels of 20.4%, which were then considered disastrous and a first sign of a country collapse.
More pressure from politics
The political environment remains precarious, with tension with Syria growing as the days pass by. The encouraging “free” elections of June 2005 produced a government of national unity, which is still unproven as regards to urgent economic reforms, although the resilience of this government is proving solid so far, as disputes and tensions between pro and anti-Syrian political factions take place on a daily basis. The government is keen to carry out long-overdue economic and administrative reforms, including privatization, as well as start planning for a debt restructuring program, which will be based on a successful donor conference planned in Beirut towards the end of 2005. However, it is clear that the deterioration of Lebanese/Syrian relations, which have been further exacerbated by the recent UN resolutions forcing Syria to cooperate in the investigation of Hariri’s assassination, should hamper the government’s efforts to initiate such reforms for the time being.
There is also the more delicate internal problem of Hizbullah, which still refuses to give up its arsenal of weapons and integrate into the Lebanese domestic political set up, in line with both the Taif Accord and UN Resolution 1559. This multiplies Lebanon’s political problems and opens two fronts, one external with both Syria and Israel and one domestic with the Hizbollah-Amal coalition. Although it is clear that such problems emanate from decades of civil conflict and its consequences, the country is still facing significant political problems that have been affecting the economy substantially during 2005. It would therefore be worth noting that the longer these problems persist, the more likely economic recovery will become unreachable.
All these risks remain more or less mitigated by a high level of external liquidity, a large and relatively sophisticated banking sector, and resilient confidence among the Lebanese, which has been reflected in a continuously strong and stable deposit base within the country’s banking sector. Another positive factor is the return of Gulf Arab tourism towards the end of the summer and the resumption of Gulf investment in the country, despite the turbulent political scene.
The high liquidity, estimated to stand at around $9 billion in terms of official foreign currency reserves and $11.4 billion in terms of commercial bank foreign assets reflected the country’s prudent approach within an unstable domestic and regional political context. The foreign currency reserves approached $15 billion prior to Hariri’s assassination, and were instrumental in restoring confidence among depositors of the banking sector and in preventing a devaluation of the Lebanese pound. The current official foreign currency reserves cover more that eight months of imports and exclude around $1.8 billion in Lebanese government eurobonds held by the central bank, which are not considered to be liquid. Although foreign currency reserves declined in the aftermath of Hariri’s death, they partially recovered due to the issuance of several government eurobonds, an easing in the dollarization rate due to regained confidence, and to a resurgence of non-resident deposits in Lebanese commercial banks.
Another strong sign of liquidity is the strength and stability of commercial bank deposits, which amounted to a little less than $60 billion in October 2005. The country’s banking sector has been capable of solidly financing itself through customer deposits and has not had to rely on market funds, which are more costly. Such customer deposits have been mainly used in the past decade by the banks to subscribe to government debt securities (including Treasury Bills in Lebanese pounds) and have provided the government with a source of steady financing. These customer deposits have historically shown a high degree of resilience to external political shocks and have been supported by a committed Lebanese Diaspora. On that note, Lebanon is traditionally regarded as one of the most important countries in the world in terms of remittances, which is a mitigating factor against potential risks.
Although the economic situation appears to be at risk in the short term due to internal and external political problems, the economic upside in the long term could be significant. Indeed, were the government to succeed in sorting out the political mess and resuming an efficient economic reform program that would include serious privatization and a long-term debt restructuring program, then economic prosperity would be regarded as a real possibility. For the moment, the country’s rating is still one of the lowest in the world at B- (S&P) and B3 (Moody’s), with the government required to undertake a massive effort in reducing debt and improving government finances, as well as for the political environment to ease considerably, if this rating is to reach more acceptable levels.