Lebanon’s bankers and the government are a close-knit family, and like any family they have a love-hate relationship. In this particular homestead, the kindred glue that binds them together is the colossal national debt.
Of late, however, this has started to come unstuck. Banque du Liban (BDL), Lebanon’s central bank, has made efforts that may offer some respite in the short term, but the long-term fix will have to encompass a much more fundamental rearrangement — if, that is, any one is daring to look that far down the line.
From a paltry $1 billion at the end of the civil war in the early 1990s, the state’s debt has skyrocketed to around $58 billion today and the main proprietor of this liability has been the nation’s prodigal sons, the banks. For many years, this relationship served the bankers well by providing them with a safe asset in which to park their extraordinary liquidity. As such, the commercial banks’ current exposure to the public debt is equivalent to 21 percent of their consolidated balance sheets.
The problem for the banks in Lebanon is that they are too big for a very small market, with assets surpassing 350 percent the size of the economy. So even if the private sector is growing well, the demand for credit does not suck up the banks’ liquidity, and hence, the attractiveness of the government’s ‘IOUs’. This is especially true considering the highly favorable interest rates on which the banks were reaping handsome profits for much of the peacetime period.
“Our banks are probably the only ones in the world who can continue to fund a particularly high public debt, fund the private sector with loans amounting to around 103 percent of gross domestic product (GDP) and at the same time remain very liquid with a loans-to-deposit ratio of 30 percent,” explains Mazen Soueid, chief economist at BankMed.
This anomalous arrangement is enabled because the banks are continually attracting huge inflows of capital to fill their vaults. From the four corners of the Earth, a successful diaspora send much of their fortunes home, enticed by high domestic interest rates, while from the east flow petro-dollars and from the west come those seeking sanctuary from the chaos bedeviling the European and American banks.
So that is the love part. But threads of discord have found their way into the home, and the banks are warning that the pillow talk is over until there is a serious shake up of affairs. “The banks have reduced their exposure to Lebanese pound denominated treasury bills and while we continue to exchange Eurobonds I don’t think we will continue to indefinitely subscribe if there are no concrete reforms,” warns Nassib Ghobril, head of economic research at Byblos Bank.
The music stops
The banks have reason to be concerned. The fiscal deficit rose from $2.3 billion in 2011 to nearly $4 billion in 2012, a year in which the primary balance recorded a deficit for the first time since 2006. Economic growth plateaued at an average of 1.2 percent over 2011 and 2012, foreign direct investment is plummeting and consumer confidence is rapidly following course. As Ghobril succinctly observes, “it is not a rosy picture.”
During the boom years from 2006 to 2011, the debt-to-GDP ratio fell as robust growth outstripped the growth of the debt. However, the unhealthy confluence of a hemorrhaging public purse and a crippled private sector reversed this trend, and since early 2012 the ratio has started to creep back up again.
The banks have previously been happy to snap up the government’s papers as politicians paid lip service to much-needed reforms. However, the ominous economic malaise throughout 2012 and into 2013 — compounded by threats to the balance sheet they now see from an inflated exposure to the sovereign — has compelled their toughening stance.
“In the end, the Lebanese debt dynamics — unless you go back to a growth rate of over 5 percent — are unsustainable in the medium term because you have a very high debt to GDP and therefore need a higher GDP to pay back the debt and to sustain it,” reasons BankMed’s Soueid. What is more, the yields on the papers that the government is reissuing are not as high as the originals that they are replacing, so understandably the bankers’ appetite for them has waned.
The debt-to-GDP ratio had declined from around 172 percent in 2006 to 126 percent in 2011. This welcome trend however was only precipitated off the back of a particularly robust period of economic growth, while in reality the fundamental problems persisted below the surface. When the economy started to falter, the ratio started to creep back up, indicating that any perceived gains in the past had been merely superficial. “The only reason the debt-to-GDP ratio had been falling was because of strong growth in the economy and not due to any decrease in the nominal size of the debt,” explains Ghobril.
The banks, constrained by a limited domestic market and disinclined to deepen their holdings of government debt, have strived to diversify into foreign climes. Despite notable examples of expansion throughout the region, they have had limited success.
“Despite expansion being systemic and widespread, 80 percent of assets are still in Lebanon and 85 percent of profits of the sector are derived from Lebanon,” says Ghobril.
For the government’s part, they have previously stated that they want to attract more foreign and institutional investors to fill the void. However, while Lebanon’s sovereign debt may be of interest to a handful of investors looking to frontier markets, it’s simply not a handsome catch for the rates on offer. So with Lebanon’s banks now showing a concerted reticence about funding the government’s profligacy and the government unable to entice new benefactors, BDL has filled the void.
The lights come on
In short, the godfather in Lebanon’s troubled house has stepped in to keep interest rates steady and the government solvent. In the current climate of economic stagnation and high political risk the banks are not going to buy up all of the debt with interest rates as they are. BDL knows this but can’t afford to see interest rates rise, fearing an upward spiral that would further hobble an already fatigued economy. “The deficit is currently being two thirds financed by the commercial banks and one third by the central bank,” explains Byblos’ Ghobril.
This is of course an unsustainable fix if one dares to look beyond the immediate future. Unfortunately, the solution is dependent on decisive action from Lebanon’s notoriously fractured body politic. The government needs to seriously address its spending needs and combat the huge amounts of waste and inefficiency that beset pretty much every arm of the public administration. No easy task when there is no government.
In May the international credit ratings agency Moodys downgraded the outlook on Lebanon’s B1 government bond ratings to negative, and consequently revised from stable to negative the outlook on the long-term local and foreign currency deposits ratings of the three largest Lebanese banks: Bank Audi, Blom Bank and Byblos Bank.
“The government’s weakening creditworthiness weighs on the standalone credit profile of the banks given the high credit linkages between their balance sheets and sovereign credit risk,” announced the ratings agency in a statement after releasing the decision.
Despite dogged and vocal rallying calls from virtually every corner of Lebanese society, including from this publication, for extensive and meaningful government reform, there has been a contemptuous lack of action. Perhaps now that the nation’s most powerful players, the banks, are feeling the squeeze, politicians will be forced to neutralize the economy from the political environment and shake up a system that is riddled with corruption and waste.
