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Beware the black swan

The dangers of depending on growth to keep the debt at bay

by Natacha Tannous

Forecast to reach an altitude of $55.4 billion by year’s end, the precarious flight of Lebanon’s arrears is ruffling far too few feathers among our policy makers. Instead, they’re counting on economic growth to dilute the debt by reducing the debt-to-GDP ratio, which differing sources currently place around 150 percent. In the words of Finance Minister Raya el-Hassan: “Don’t use economic textbooks to understand the Lebanese model.”

Is Lebanon somehow serendipitously always right on the money? Is the country some sort of economic maverick with a secret recipe for success?

True, Lebanon has never defaulted on its debt, but staking so much on our economic exceptionality to see us through can only help hasten the arrival of our ‘black swan’ — that unpredictable and improbable high-impact event left unaccounted for in the economic models, which could sink us into a debt deathtrap.

Prudence therefore calls for effectively managing the surging debt burden; we need to reduce the debt inventory and avoid renewing bonds at maturity while containing inflation amid excessive liquidity.  Our archaic infrastructure cannot maintain current growth rates indefinitely and only the gullible would believe the cyclical reduction in Lebanese bond yields are sustainable.

Financing long-term growth requires structural reforms. We must improve infrastructure and promptly implement, among other things, an energy policy to tackle the national power company’s $1.4 billion yearly losses; we must realize the potential of our natural resources and human capital, and create new initiatives in education. The government must quit beating around the cedar tree and properly address these issues to build a healthy economy.

In a modern country it is unacceptable that the 2010 budget, if endorsed by Parliament, will be the first budget passed in five years. And as it stands, this budget projects a $4 billion deficit, meaning debt issuance is unlikely to slow anytime soon. Central Bank Governor Riad Salameh admits he is “concerned about the growing deficit and we are incessantly calling for reforms to decrease [it].”

How though, is not clear-cut; in terms of expenditure, the quality and transparency of public spending must improve and the chronic leakages that plague the system need to be stemmed. On the revenue side, wages in Lebanon total approximately $20 billion; with direct income tax rate of 10 percent, government should be collecting some $2 billion annually, not the current $780 million. Closing the loopholes on tax dodgers will take time to implement; in the meantime, additional revenues could be mobilized through a 2 percent increase in value added tax, though this would likely spur social upheaval. Government officials have sung about privatization, public-private partnership (PPP) and securitization answering our debt woes, but none of these options can fully fix the problem.

In regard to privatization, between the telecom operators and the low value of the national airline, utilities companies, ports and airports, the government would be lucky to collect $10 billion and not sell at distressed prices, while it would also lose the revenue of telecom tariffs – currently a de facto form of taxation that earned government $1.36 billion last year. Privatization could help pay down the volatile part of the Lebanese debt — Eurobonds held by non-Lebanese — but it is no long-term solution. PPPs could help improve infrastructure without increasing the public debt, but require an autonomous capacity for the private sector to finance itself, and this is not self-evident. Such partnerships are complex, and potentially unsustainable. Ultimately, PPPs will not solve Lebanon’s debt bind.

Securitization is not the answer either, as future revenue streams from such a scheme must be proven viable before implementation. The fact is, the Lebanese market isn’t mature enough for it and the International Monetary Fund does not consider securitization proceeds as debt reduction, but rather an alternative type of debt. So as the government toys with wishful thinking on ways to balance the books and stalls on progress in substantive structural reform, our debt continues to take flight.

As long as the economic forecast stays bright and shiny, the country should be able to glide through debt refinancing by issuing more sovereign paper. The problem is the improbable — that black-winged bird which swoops down on us from above while we were gazing at how high we’d climbed. When our economic model begins its plummet toward reality, we will only have ourselves to blame.

NATACHA TANNOUS is EXECUTIVE’s financial correspondent

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