The dangers of stimulus

Banque du Liban’s support for the real estate sector could go terribly wrong

Greg Demarque | Executive

Subsidies are always tricky and generally dangerous. Benefits are impossible to predict with certainty and unintended consequences range from valuation bubbles and boosts of inflation to loss of competitiveness. Governments are well advised to use subsidies sparingly.

Beyond the usual and long standing subsidies that aim at serving the disenfranchised and the needy (such as those on bread, certain social and medical services, and tobacco), subsidies are currently being used in Lebanon for propping up the economy. They are targeted, provided and supervised by the central bank. Known as ‘the stimulus package’, they are focused on the housing sector more than anything else.

[pullquote]Subsidies are always tricky and generally dangerous[/pullquote]

Some did raise questions about the wisdom of the initiative. After the first year of this stimulus when a nominal value of $1.47 billion in 2013 was extended into an $800 million second round for 2014, Executive opined that it was still not possible to see whether and how much exactly the first package had contributed to GDP growth in 2013. Specifically, the package’s 56 percent funding allocation to real estate financing was questionable, we thought, due to low multiplier effects.

Contrary to the doubts, including those voiced by Executive, the subsidies that the central bank extended to the real estate sector via lower interest rates on home loans for the third year running have, by numerous indicators, boosted the flow of property transactions and helped the economy.

Out of real GDP growth in the past two years, perhaps as much as 50 percent was due to the central bank stimulus package. In June 2014, central bank Governor Riad Salameh spoke to that effect about the growth that was achieved in 2013. More recently, the International Institute of Finance said in a paper published in March that 2014 GDP growth was helped by the central bank’s stimulus package boosting bank credit and paper projects, which the economy will continue to depend on in 2015. “Our baseline scenario expects a small pickup in growth to 2.2% in 2015, supported by a third BDL stimulus package and modest recovery in exports of goods and services.”

Notably, the IIF assessed Lebanon’s real GDP growth to have been 1.4 percent in 2013 and 1.7 percent in 2014. For comparison, the International Monetary Fund took a rosier view on both years, speaking last month of a 2014 growth estimate of “around 2 percent.” In its economic database for the World Economic Outlook, the IMF moreover assumed, as did BDL, that 2013 growth at constant prices was 2.5 percent.

Whatever estimate of national growth rates one considers most realistic, there is no arguing that recent years’ expansions of the economy were not enough. A quick jump in Lebanon’s economic pace is also nobody’s expectation and it is only fools or very deceptive property marketers who would today claim that demand for real estate will break out of its current sluggish mode anytime soon. As the IMF said last month, “Lebanon’s traditional growth drivers — tourism, real estate and construction — have all received a significant blow [from an exceptionally challenging environment], and a strong rebound is unlikely soon.”

During research for this year’s special report on real estate, no one in the industry played the fool and told Executive that they expect a near term boom in the sector. But what developers and leaders of the two sector organizations talked of in unison was the importance of the central bank stimulus. The most subdued assessment was that it was a “nice infusion of oxygen” into the market. The bluntest comment was that the sector would be “in deep shit” if not for the stimulus money.

This is concerning. Their conversations with Executive suggest that developers are not just evaluating the impact of the stimulus package — which this year is set at $1 billion according to an undated monetary overview page on the BDL website — on the real estate market. Rather, they are also including the stimulus directly into their expectations, speaking of new projects and ventures that would specifically target buyers who can tap into BDL subsidized housing loans.

This is the upper middle segment of the property market, meaning pricier and more profitable projects than those that benefit from PCH loans targeted at lower to average incomes, but not the over the top luxury projects whose developers angled for the investment cash of high net worth individuals and above. Even if there were zero new luxury projects where the asking price for a square meter of the average flat ranged from 50 to 200 percent of Lebanon’s per capita GDP, the question arises of whether there is genuine high demand for units in the market range of up to $500,000 per residence, or whether developers are not just treating central bank housing loan subsidies as deciding elements when initiating new projects in this category.

Such a distortion of the market cannot be excluded as per the numerically skimpy but visually compelling evidence. Although market participants have for the past three years been talking about negative demand signals, stagnant prices and shrinking profit margins, construction fences are still sprouting around sites in exactly those areas of Beirut where newly built units would have to retail in the quarter to half million dollar range and, by cost considerations, would be incredibly difficult to market.

Possible implications of developers’ self chosen dependency on the central bank’s housing loan stimulus extend from an artificial inflationary push in the Beirut real estate market, which after the extreme property price boom of 2005–2011 is something that the Lebanese economy would do better without, to formation of a not large but potentially very volatile layer of developers whose businesses would be in ever increasing danger of implosion once the artificial infusion of money via subsidized loans comes to a stop.

What exacerbates either concern is the forecast of no autochthonous economic upswing in the Lebanese property market or the economy at large. This means it could be several more years before improved regional circumstances — better banish that hope — or any decisive change in the political processes would provide a rationale for ending the stimulus package.

Thus developers who two years ago paid scant attention to the stimulus package and who are today totally enthused about it, two years from now might find themselves being so dependent on the subsidies that they will falter upon withdrawal of the stimulus. The central bank has clearly expressed its caution of inflation risks that the stimulus tool entails and has tightened some requirements in order to keep those pressures at bay. Yet Murphy never sleeps and repercussions of withdrawal-shocked developer bankruptcies could be grave, tearing down jobs, suppliers, and investor and consumer confidence.

[pullquote]Fiscal stimuli cannot be substituted by central bank initiatives, however smart[/pullquote]

A second vital consideration is that the off kilter real estate development of Lebanon shows no sign of balancing. As Executive commented on the stimulus package in January 2014, and has said in more reports and stories than we ourselves care to count, measures such as a holistic infrastructure development program are desperately needed to improve our productivity and justify real estate development. We are not getting such measures. This is maddening. Policymaking cannot be postponed ad infinitum. Fiscal stimuli cannot be substituted by central bank initiatives, however smart.

Yes, real estate and construction is one of our ‘traditional growth drivers’. In the past two years, a lot of money has been pumped into bank lending for home buyers. This has helped the economy more than we anticipated. What we need today is a convincing legal framework for housing, including provisions for the hitherto neglected parts of the current population, alongside political facilitation of a national infrastructure program, and convincing and sustainable urban and rural development legislation.

But what the Lebanese have seen in the past year alone were only deferrals of decisions, rendering measures such as the law on rental properties ineffective, and as far as property and urban development needs, absolute non delivery of a national framework. From all that we know, we cannot demand macroeconomic wisdom from our property developers. The question is, what reason might we find for having confidence that our elected policymakers will?