Economics & Policy

Afghanistan’s heroin addiction

by Adam Pletts
written by Adam Pletts

As the needle pierces Reza Etesamifard’s skin in central London, the heroin entering his blood stream is on the final stage of a journey that most likely originated in Afghanistan. The drug in his veins has traveled more than 6,000 kilometers across battlefields, mountain ranges, deserts, rivers and seas, changing hands dozens of times. Along the way it has crossed at least 10 borders, eluding customs and law enforcement agencies at every stage.

Only moments after Reza removes the syringe, the heroin starts to kick in and he begins to scratch his face irritably, a common symptom among heroin users. As chance would have it, Reza is a refugee from Iran, one of the many countries that the heroin he uses most likely passed through en route to Britain. Unlike the vast majority of the United Kingdom’s users, his path to addiction began by smoking opium when still in Iran.

Reza would be the first to attest to how addictive heroin is and confesses that he will do anything to get his next fix and avoid the withdrawal pains, which he describes as being like “ants crawling around your skeleton.”

Although the 10 British pounds [$16.20] that he pays for 0.2 grams of heroin on a daily basis may not seem like much, he is just one of more than 11 million heroin addicts across the world whose combined payments make the heroin trade a $55 billion industry. Though highly profitable to some, the trade is lethal to others, with the United Nations Office on Drugs and Crime (UNODC) estimating that as many as 100,000 people die from the use of Afghan opiates every year. Some one million people worldwide are involved in heroin trafficking alone, while as many as three million Afghans play some part in the cultivation of poppy plants that yield the raw opium from which heroin is made.

One of those poppy farmers is Wali Jon, who supplements subsistence farming with cash from poppy crops in order to help support his wife and four children. Wali is from south Helmand Province, which alone produces half of Afghanistan’s opium. If prices are similar to last year he expects to make about $250 from two acres of poppy (8,093 square meters), which he hopes will yield four kilograms (kg) of opium. Like many other farmers in the region he is fearful that the authorities will destroy his crop; when asked what he would do if they did, he to Executive, “If somebody takes away your water on a hot day, what do you do?”

Reza and Wali are both tied to opiates — one through addiction and the other through his livelihood — but the similarities end there. Reza spends roughly as much on heroin every fortnight as Wali hopes to make from his whole crop in a year, despite the fact that Wali will produce enough opium in that year to supply Reza with heroin for eight years (given that it takes seven kg of opium to produce one kg of heroin). In short, Reza pays for each hit approximately 200 times what Wali was paid to produce its raw ingredients (based on last year’s prices).

As with any commodity, prices go up and down at both ends but no matter how high they rise, the Afghan farmers only ever see a tiny proportion of the whole profit.

 

The many roads from Afghanistan

So how does Wali’s opium reach Reza as heroin? Who actually makes the profits and how did Afghanistan become the world’s leading heroin producer? Although the heroin trade is illegal, the answers lie in conventional economics that link supply to demand and more importantly, reward to risk.

Unlike most other illegal recreational drugs, which are by and large produced and consumed within the same region, the vast majority of opium production is restricted to only three areas on Earth: Afghanistan, Southeast Asia (mainly Myanmar) and Latin America (Mexico and Columbia). Since 2005, Afghanistan has controlled some 90 percent of the global total, at about 8,000 tons of raw opium per-year. It also accounts for 85 percent of the world’s heroin, most of which is processed here or in neighboring Pakistan and Iran. 

The net result of this concentration of production is a worldwide narcotics trafficking network emanating from Afghanistan, the likes of which can only be rivaled, in both the reach and value, by Colombian cocaine trafficking. Afghan production single-handedly supplies heroin to Western Europe and Russia, by far the world’s two biggest markets, which together make up 47 percent of global heroin demand, and although Myanmar and Latin America are the major suppliers for China and the United States, respectively, small proportions of Afghan heroin also feed these markets.

By the very nature of illicit drug trafficking there is no way of saying with certainty how heroin has been smuggled from one place to another. The routes are fluid and change frequently, with traffickers taking advantage of loopholes as they appear. There are, however, established flows that have been identified by law enforcement agencies and bodies such as the UNODC and the European Monitoring Center for Drugs and Drug Assistance (EMCDDA).

Essentially heroin and opium take one of three routes out of Afghanistan; either the “Northern Route” through central Asia and into Russia, the “Southern Route” through Pakistan, or the “Balkan Route” via Iran and then onwards through Turkey and the Balkans to Western Europe. Much of the drugs that transit through Pakistan subsequently also pass onto the Balkan Route.

The UNODC estimates that some 25 percent of all Afghan heroin (95 tons) leaves via the Northern Route, 40 percent (150 tons) via Pakistan and around 35 percent (130 tons) via Iran. From the combined Iranian and Pakistani routes around 37 percent of Afghanistan’s total heroin production continues onto Europe via the Balkan Route.

Global opium production

The vast majority of the 95 tons of heroin that leaves via the Northern Route is consumed within Russia, while the Southern Route’s supply satisfies Pakistan’s demand (19 tons) and that of other destinations, including Iran (35 tons), South East Asia (25 tons), Africa (20 tons) and the United Arab Emirates (11 tons), the

latter of which is almost exclusively for onward shipment, mostly to China and South Africa. Of the Balkan Route heroin, after accounting for seizures and consumption in the countries en route, some 88 tons make it tote high-value sales in Europe, where four countries alone are thought to account for more than half the market, namely the UK (19 tons), Italy (18tons), France (10 tons) and Germany (7 tons).

The Balkan Route carries the largest volume the greatest distance and to the highest value market. Heroin was smuggled along the Balkan Route well before Afghanistan became the chief producer, during the period when it originated from Pakistan and Burma.

Laurent Lamiel, an analyst at the EMCDDA, described the route as “the illegal version of the silk road.”

“Heroin was travelling on [the Balkan Route] even when the Iron Curtain was in place, which shows how strong this route is and how developed, protected and historical the networks are,” he said.

 

Control of the routes

“The thing that is very important to understand is that the big players on the Balkan Route are Turkish criminals and traffickers,” Lamiel explained. “[They] are able to concentrate a large amount of heroin produced in Afghanistan into their hands and act as wholesalers to the British market as well as other European markets.” The UK’s Serious Organized Crime Agency (SOCA) backs this assertion, believing that some 140 Turkish networks control the heroin supply to Europe.

That Turkish criminal groups have taken dominance over other criminal organizations along the route is hardly surprising, not only because the route traverses some 1,600 kilometers of Turkish territory but also because Turkey controls the Bosphorus Straits, the most direct access point to Europe from South Asia without having to pass north of the Caspian and Black Seas. Turkey also shares a long land border with Iran, where heroin can be bought at prices similar to those in Afghanistan, and there are extended communities of Turks in London and elsewhere in Europe, particularly Germany, who can facilitate connections and legitimize travel. In a similar way, Pakistani groups that smuggle direct from Pakistan to the UK, by air or sea, exploit their connections within the UK and their close proximity to the Afghan market, cutting out middlemen to maximize profits on a route where they can buy at around $3,000 per kg and sell at $30,000 per kg; that route only accounts for small volumes of traffic, however, at most some five tons between ships and flights from Pakistan to the UK or the Netherlands.

Although Turkish and Pakistani groups largely control the Balkan and direct air and sea routes, respectively, individuals and groups from many other countries are also involved, as the arrest figures for heroin traffickers attest. In the Netherlands, for example, which could be considered the end point of the Balkan Route and is a key hub for onwards shipment to various European countries including the UK, Dutch citizens account for 20 percent of arrests, followed by Nigerians (19 percent), Turkish (16 percent), British (5 percent), Brazilians (5 percent) and Americans (5 percent).

Similarly, at several points along the route ethnic groups that straddle national borders, or have large diaspora populations, facilitate trafficking, examples being Kurds along the Iran-Turkey border, Aziris along the Iran-Azerbaijan border across which a sub-route branches north from Iran into Russia or Europe, and Albanians who are particularly visible in the trade in Greece, Italy and Switzerland.

The economics of the trade

Even though Afghanistan has a near monopoly on global opium and heroin production, the economics of the trade conspire such that the country makes far from the lion’s share of revenues. At retail prices the total world opiate value is approximately $65 billion — $55 billion for heroin and$ 10 billion for opium. The market with the highest value, Western Europe, accounts for approximately $20 billion of the global total, followed by the Russian federation ($13 billion), China ($9 billion) and the US ($8 billion). At best Afghanistan makes a small fraction of the profits. In 2009 the combined total paid to Afghan farmers was an estimated $400 million. When opium trafficking and opium processing into heroin are factored in, the value of the opium/heroin industry to the Afghan economy was some $2.4 billion, which is roughly 3.5 percent of the global market value. Antonio Maria Costa, the executive director of the UNODC, quoted Afghan President Hamid Karzai as telling him: “We take 3 percent of the revenue and 100 percent of the blame.”

Nonetheless, to a poor country like Afghanistan this revenue is still substantial. To put it in context, recent projections for Afghan government expenditure this year estimate it at $4.5 billion, of which the government can only raise $1.9 billion itself, the remainder being provided by international donors. Afghan heroin revenues are one-seventh the size of the nation’s licit gross domestic product, which according to the International Monetary Fund was $16.6 billion in 2010, although even this figure is inflated by international donor money, with an estimated $5 billion in annual aid fuelling the economy.

In general, the further away from Afghanistan, the higher the potential profits from heroin. Along the Balkan route, the wholesale heroin price varies from just $2,400 per kg in Afghanistan, to $11,000 per kg at the approximate mid-point in Turkey, to $30,000 per kg in the UK (see map page 37). Part of the explanation for this is that, in broad terms, the route travels up two gradients: firstly from less developed to more developed countries, where higher prices can be charged, and secondly from an area of abundance to one of relative scarcity. There is also the fact that the further the heroin travels, the more hands it passes through and the more costs are incurred, which must be recouped in the eventual sale price.

 

Global heroin consumption

“Although the UK is the highest value market in Europe, with some of the highest street prices for heroin anywhere in the world, there is more money flowing into Afghanistan from opiates consumed in Iran than there is from the UK,” explained a SOCA financial specialist who requested only to be identified as ‘Richard’ due to the sensitive nature of his work. To understand this, one must break down the price and look at where the revenues from street sales go.

At approximately $30,000 per kg the UK’s wholesale heroin price is below the European average of $36,000 per kg. This perhaps reflects the fact that, barring Russia, the UK has the single highest consumption in Europe and the pull of the market pushes the price down even after factoring in the risk to dealers, which is considerable given that the UK makes among the highest number of seizures in Europe. However, the street value of about $ 80per gram is above the European weighted average of $77 per gram, so that UK dealers are in a privileged position of buying at lower-than-average prices and selling at above-average prices.

The majority of the street value stays in the UK, with criminals making $50,000 for every kg of heroin sales, albeit most of these sales at street level will be in very small quantities, typically of 0.2 grams. Most of the wholesale import price of the heroin has to be paid down the chain of traffickers to pay costs incurred on the way, with any significant profits being retained well before Afghanistan by the controlling criminal groups.

This model is widely applicable to the high-value European markets, meaning the largest revenues from heroin sales are retained within the countries of final sale, even if they may be distributed between large numbers of dealers. Richard makes the point that, “When you go back to the cultivators and the processors in Afghanistan the price has nothing to do with the destination market, so they’re getting as much for each jirib [approximately2, 000 square meters] of land that they’ve cultivated whether the opium is smoked in Pakistan or the UK.”

Like so many things in life it’s a question of who you know.

“In reality if [Afghan traders] could get [heroin] to the UK themselves they would,” Richard said. “They’re entrepreneurs to a degree, but they can only sell it to the people they know who will buy it from them and they tend to be across the first border in Iran or Pakistan.”

Mechanisms of trade in Afghanistan

It is widely understood that the majority of Afghan opium farmers make very modest profits and are simply trying to make a living. In fact, many are stuck in an economic trap not dissimilar to that of coffee plantation laborers in various parts of the world who, after working hard in the fields, only receive a fraction of the profits that up-market Western coffee shops reap. The difference is that poppy crops are illegal and there will likely never be a “fair heroin trade” campaign. To this end the UNODC, together with most organizations, do not generally consider that the line of criminality has been crossed until the opium or heroin reaches the hands of substantial traders. Nonetheless, Afghan farmers stand the risk of having their crops eradicated by the Afghan National Security Forces (ANSF) and are often suspected of having links with the Taliban who, although not necessarily in control of the opium trade, do facilitate and profit from it.

Often Afghan farmers have turned to opium as a last resort in areas where the government provides very few services or even basic security. In such places, the Taliban or other anti-government elements can be an attractive source of support, especially in relation to poppy cultivation. At a grass roots level they provide poppy seeds and small loans to farmers to prepare for the harvest, as well as organizing collection of the opium. It’s in the Taliban’s interest to do so because the farmers in turn pay a tax on their opium, known as ushr, direct to the Taliban, which is usually levied at 10 percent.

Further down the chain, the Taliban are more closely involved with traders and lab processors, who pay for protection, facilitation and, where necessary, logistical assistance in heroin processing, storage and packaging. They also charge a zakat tax on traders, generally set at 2.5percent. Wherever they can, the Taliban levy these taxes on all goods, but with illegal crops they generally take payment in kind, knowing they can get higher prices beyond Afghanistan’s borders. However, contrary to what is often portrayed, the model is more one of the Taliban taking advantage of pre-existing trade than their having direct control of it.

The Taliban are known to apply pressure on farmers to grow opium but their decisions to do so are affected by a broad range of factors. Although it is true that opium usually fetches higher prices than alternative cash crops, other practical considerations must be taken into account. In the first place, with other crops farmers would have to get their produce to market by their own means, which can be difficult given the state of infrastructure in Helmand, or indeed most locations in Afghanistan. Secondly, raw opium acts as a form of currency, which is particularly important in under-developed rural areas where no banking facilities exist.

Some sort of transferable savings are especially valued during times of war and uncertainty, as Jean Luc Lemahieu, the UNODC’s representative in Afghanistan, explained: “Many people have been displaced, but if they are able to take their raw opium with them and their opium seeds, they have an income which will stay good for 10 years. Try to do the same with pomegranates, which only keep well for three weeks, after which they’re rotten in your pockets.”

To give some idea of the increase in earnings that opium can bring to farmers, according to the UNODC the average income of non-opium growing farmers in 2006 was $2,370, while that of opium growing farmers was $5,055. That said, the reality on the ground in Helmand and other poppy producing locations changes radically from one place to another. According to Richard of SOCA, “It’s very much a moveable feast. Village by village, prices change [and] intentions change, as does the role of authority and whether the local tribal leader or key person is sympathetic to the government or the Taliban.”

 

Price fluctuations and their causes

This year the average raw opium price in Afghanistan is estimated to be much higher than last — some $280 per kg compared to just $80 per kg in 2010. A very small portion of this rise can be attributed to successful eradication, which reduces supply and hence pushes up prices. However, there are two much more significant factors in the price increase: the first being that widespread disease triggered a blight in the crops last yearend tightened supply, second and more importantly, is speculation.

“The military operations mean that a lot of farmers are very uncertain about their future prospects and so they start to stockpile opium because in times of war it’s one of the best commodities to have,” said Lemahieu, pointing out the similarities to the classic economic model of the ‘Dutch tulips’.

Essentially the opium farmers are asking the same questions that any Afghan observer asks: “Is the troop surge going to work?” The farmer, however, must think beyond this to ask: “If the surge does work, will I be able to plant opium in the future and should I stockpile some of what I have?”

As Lemahieu notes, “It’s Wall Street all over again — except in Helmand and Kandahar — and these are not high paid bonuses for bank executives, these are poor farmers thinking ahead and saying ‘in this uncertainty, I’m not selling. I want to sit on it and see what happens to the price’.” The recent price rises are substantial enough so as to have provided many farmers who had previously abandoned poppy crops with the extra incentive to renew cultivation. The UNODC estimates that of the 20 provinces (from a total of 34) in Afghanistan that were for all intents and purposes ‘opium free’ by 2010, thanks to eradication efforts, at least four will see renewed cultivation in 2011.

Generally speaking, as the volume of opium production has increased over the years, from just 1,000 tons in 1980 to a peak of 9,000 tons in 2007, prices have decreased, but previous large price fluctuations at the supply side are not unheard of. Following the Taliban’s ban on opium cultivation in early 2001 prices rose from less than $50 per kg in July 2000 to nearly $700 per kg in August 2001. The ban was strictly enforced, making it probably the quickest and most effective, albeit short lived, drugs eradication program in history. The Taliban partly put the ban in place to appease Western governments in the hope that they would recognize the regime, not then aware that the move would be rendered redundant by the events of September 2001, which led to Western military intervention, the removal of the Taliban regime and a resumption of opium production.

Although the supply side prices may be prone to fluctuations given shortages in production, this is no different from any other commodity. The farm gate price of opium, however, is so low compared to the eventual market prices of the heroin that these fluctuations have negligible effect on heroin markets in distant locations, where the bulk of the price is driven by high risks to the dealers, combined with covering the costs of transport. Furthermore, the local mid-level traders take up some of the slack in the market, as Lemahieu explained: “[They] act as a price cushion in between the demand and the production so that some of their inflated profits from the past have gone down over the last months because they are paying for the extra cost on the production side while higher prices are not really reflected in the consumer side.”

Afghan production of opium has become so high that if it were all converted into heroin it would outstrip global demand three times over. From what has become such a strong and steady supply, European prices have gradually dropped, with the average heroin wholesale price falling from $100,000 per kg in 1990 to just $36,000 per kg in 2011. It suits the wholesale suppliers — in other words the larger organizing criminal groups — to keep the prices steady.

“They’re no different to other commodity brokers, which is essentially what they are, in terms of the ways they absorb price fluctuations and try to manipulate the market and the supply,” said Steve Coates, deputy director of SOCA.

Becoming the sultan of smack

It is only since the early 1990s that Afghanistan became the world’s dominant opium and heroin supplier and, effectively, the current war in Afghanistan has only consolidated its position. There had always been some opium production in Afghanistan but it wasn’t until the Soviet war through the 1980s that it became a major supplier. Previously, Pakistan had been the world leader in opium and heroin production, but as the Afghan mujahedin who were fighting the Russians began to use opium to fund their resistance, Afghanistan’s annual production started to increase.

As weapons were smuggled into Afghanistan, largely by Pakistan’s Inter Services Intelligence (ISI) and partly funded by the American Central Intelligence Agency (CIA), opium would be brought back and refined to heroin in Pakistan. In the early 1990s Pakistan clamped down on its production, virtually ending Pakistani poppy cultivation, but elements within the ISI continued to turn a blind eye to Afghan opium traders using the preexisting routes and processing infrastructure within Pakistan.

Following the Soviet withdrawal in 1989, a fierce civil war was fought between different Afghan factions, all of whom used opium revenues to some extent to fund their war effort. The Taliban, who had conquered all butte furthest northern reaches of Afghanistan by 2001, were no different in their use of opium as fuel for war, a fact that continues to this day.

What has changed is that opium production has roughly doubled since 2005 and has become increasingly concentrated in Afghanistan’s embattled southern areas, while it was not until the last decade that the majority of heroin began to be processed inside Afghanistan.

 

An end in sight

The extent to which the Taliban profit from the opium and heroin trade is often misunderstood. Of the $2.4 billion value of the opiates trade that is retained in Afghanistan, the UNODC estimates the Taliban’s total share would be around $125 million, with other less conservative estimates suggesting it to be as high as $400 million. Even the higher figure gives the Taliban only a 0.6 percent share of the total revenue generated from foreign sales of Afghan opiates. As a portion of Afghanistan’s share of the global spoils, it is only 17 percent. Nonetheless, in a country where entry-level police salaries are less than $100 per month, this allows the Taliban to compete with, and often out pay, state security forces’ salaries.

Successfully ending the opium trade would cut off a significant source of insurgent funding, but eradication is a double-edged sword that can sometimes act to alienate Afghan farmers, pushing them closer to the insurgents. In the past this has led US forces to back away from tackling the drugs problem, which they haven’t considered part of their main mission. Thanks to a change of policy in recent years, a slow decline in cultivation is beginning to take place.

“The real change [regarding opium] came about two years ago when the US military decided to go after the drugs, which they had not been doing for nine years,” said journalist and Afghanistan expert Ahmed Rashid. “If [former US Secretary of Defense Donald] Rumsfeld had not had that policy for so many years there wouldn’t have been such an awful situation.”

This year was the first that the US marines had a permanent presence in Marjah, previously one of the centers of the opium trade in Helmand. Although the farmers had been warned that eradication would go ahead many still planted poppy. As the harvest period approached, government tractors began to plow up the fields with marines providing security. Usually the harvest is the last quiet period before the Taliban’s yearly spring offensive begins, but this year in Marjah hostilities got off to an early start. No sooner had the tractors been sent into the fields than the drivers found themselves under fire from angry locals, some of whom had just crossed the line from farmer to insurgent. In a classic Catch-22, the eradication that is necessary to end the insurgency has also fueled it.

Until stability returns to Afghanistan it will continue supplying the world with the deadly by-product of its wars. It is estimated that there are more than 10,000 deaths per year from heroin overdoses in NATO countries, more than four times the total number of NATO troops that have been killed in Afghanistan since hostilities began in 2001. As Rashid sees it, “You cannot eradicate drugs until the war comes to an end. That’s the bottom line. When that happens, you can talk about a nationwide policy but you can’t really effectively tackle the problem until the war is over.”

The problem, however, is not simply to defeat the insurgents but to extend the government’s reach throughout Afghanistan. In many parts of Southern Helmand the first real evidence that the farmers had seen of any government action was the eradication of their precious poppy crops, before alternatives were put in place or any significant services provided. As Wali Jon, the poppy farmer, insists, “If the government provided any services or alternatives, I wouldn’t grow poppy.”

That certainly doesn’t seem like a reality in the near future and in the distant streets of London Reza Etesamifard has little concern that supply will dry up. As he strolls comfortably around his adopted city he points out the many locations where it’s easy to score heroin, from Soho back alleys to upper class suburbs. 

“In every part of London there are dealers; it’s an epidemic and nobody is dealing with it,” he said. “Plenty of users hold onto a job — it’s only the ones who have lost everything that you notice.”

Reza is frank about his addiction; he knows he’s lost everything. Although young, bright and energetic, he is homeless, penniless and without a friend he can trust, willingly confiding that the addicts he spends his time with would put heroin before their friendship, no matter the cost. The only thing forming any structure to his life is the acquisition of his next pain-staving, euphoria-delivering fix.

 

The routes

Although the so-called “Golden Crescent” covers parts of Iran and Pakistan, virtually all of the opium production in this area now takes place in Afghanistan – half of it in Helmand Province alone, which by no coincidence is also the heartland of the Taliban insurgency. The “Golden Crescent” was named after the “Golden Triangle”, consisting of Burma, Laos and Thailand, which had previously been the largest opium producing area until the1970s, when it was overtaken by Pakistan and subsequently Afghanistan. Most heroin processing occurs inside Afghanistan, but there is also significant processing along the Pakistani border. Once processed, most of the heroin transits through Pakistan, Iran and Turkey in bulk, where seizures of hundreds of kilograms (kg) at a time are not uncommon. Beyond this point, shipments are usually broken into much smaller packages with the average size of European heroin seizures in the tens of kg.

It is worth noting that seizures in Pakistan, Iran and Turkey alone accounted for 62 percent of global seizures in 2008 and almost half the European seizures in the same year were made by just three countries, namely the United Kingdom (18 percent), Italy (14 percent) and Bulgaria (13percent). The combined volume of heroin estimated to enter Iran is some 140tons, of which 14 tons is consumed in country and 32 tons is seized, giving Iran the best interception record at some 22 percent of its overall flow, compared to 18 percent in Pakistan and 10 percent in Turkey. 

Iran’s seizure efforts are not surprising given the scale of its heroin problem, with more than 400,000 addicts. Taking into account Iran’s international isolation, common ground in the fight against drugs serves as one of the few political bridges left to the West. As Jean Luc Lamahieu, the United Nations Office on Drugs and Crime’s representative in Afghanistan, explained: “It’s an area of rapprochement. Starting with counter narcotics issues we have to get the confidence to discuss other issues of importance.” Although the map show flows away from Afghanistan, some of the organized crime groups operating the routes also send precursor chemicals required for heroin processing and other drugs in the opposite direction into Turkey and beyond. There are several salient points on the map, most notably the price of heroin in Bahrain, by far the highest at $240,000 perkg (wholesale and retail), which can be partly attributed to the fact that Bahrain is a small island with few users and a strict state security apparatus that still has the death penalty for heroin traffickers.

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Bin Laden’s last laugh

by Yasser Akkaoui
written by Yasser Akkaoui

On May 2nd, television cameras broadcast around the worldimages of jubilant crowds at ‘Ground Zero’ in New York, in front of the WhiteHouse and across the United States celebrating the killing of the figurativeleader of Al Qaeda in Abbottabad, Pakistan. While many Americans may view thedeath of Osama bin Laden as an emotionally cathartic ‘closing of the accounts’,the reality is far less clear.

With the 9/11 attacks on New York and Washington, bin Ladengoaded America into invading Afghanistan, where a decade on US marines stillwallow in a grinding game of attrition against an enemy they cannot seem tokill, all the while hemorrhaging hundreds of millions of dollars of taxpayers’money daily. Riding on the coattails of the Afghan war, the Bush administrationinvaded Iraq, which provided Al Qaeda the platform it needed to ignite aninferno of sectarian hatred and killing, and recruit thousands of new adherentsto the anti-American jihad. 

Besides the hundreds of thousands of casualties, projectionshave these wars adding trillions of dollars to America’s debt, which is rapidlyapproaching a ratio of 100 percent of GDP and threatening the US’s AAA creditrating.

That it took 10 years for US intelligence services tofinally find bin Laden is a mark of failure; his killing by US special forcesis hardly a final victory, given that his legacy — his impact upon America —will likely outlive those who hunted him down. Moreover, the US militarycommanders were lucky bin Laden did not meet an untimely end all on his own bysimply tripping over stairs, or from kidney failure, in the time he spentwaiting for them.

To say the world’s only superpower is suffering decline isno controversial statement, with the limits of its once vaunted militaryexposed and its status as the global economic engine quickly eroding.

America has always been looked to as the torchbearer offreedom and democracy in the world; if the US cannot get its house in order andreverse the slide it has found itself in since that fated September day 10years ago, it faces the real possibility that bin Laden, from whichever hell heis in, will be left the last one laughing.

 

 

 

 

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Economics & Policy

Easing entrepreneurship

by Executive Editors
written by Executive Editors

The recent political unrest in Middle East and North Africa (MENA) countries has underscored the importance of boosting the region’s economic stability.

Small and medium-sized companies have an important role to play in securing the region’s economic future, and as a result, interest in entrepreneurship has surged. A recent Booz & Company survey illustrated that the face of self-employment is changing, shifting away from small shops and other relatively unsophisticated businesses toward the development of innovative products and services with the intention of building new large businesses.

This is a positive trend consistent with dynamic industrialized economies and suggests that a long-term change in the region’s economy is afoot. There was a 100 percent year-on-year increase in business plan submittals to the MIT Arab Business Plan Competition in 2010-2011. Several banks and finance centers are establishing programs aimed at appealing to entrepreneurs and start-up businesses. Many organizations, such as YallaStartup, INJAZ, Arabnet and Endeavor have created mentorship programs and other one-stop centers for entrepreneurs. Venture capital firms and banks have established specialized funding arms for small businesses.

Charting the challenges

But these initial activities and signals of interest are only modest steps in what will need to be a much larger and more sustained effort.

Booz & Company conducted a survey of more than 300 individuals, most of whom consider themselves entrepreneurs, and a series of focus groups to determine what must be done to remove the institutional barriers to entrepreneurship in the Middle East. This showed that for a number of reasons, it is difficult for entrepreneurs to establish themselves, secure necessary seed capital and family support, negotiate complex and lengthy bureaucracy and regulatory systems and then develop the necessary infrastructure to build self-sustaining businesses of their own.

The survey took place in Saudi Arabia (where it was conducted in collaboration with the National Young Businessmen Committee, associated with the Chamber of Commerce), the UAE and Qatar.

The key issue raised regarded financing; of those surveyed, 42 percent said that family, friends and government sources provided primary debt financing and 60 percent said that those same sources provided primary equity financing. Yet beyond those sources, entrepreneurs face an uncertain and challenging process to secure the capital needed to buy equipment, establish a payroll and meet ongoing needs during the startup phase. In particular, there are funding gaps in sectors such as education, technology, tourism and hospitality, which get less investment than the energy-intensive sectors that dominate regional economies. In addition, although there is funding in place for small and large businesses, few have addressed the “missing middle” — those business with an enterprise value between $500,000 and $8 million. Even financial institutions that do offer funding need to do a better job of broadcasting that fact: approximately nine out of 10 entrepreneurs we polled were not aware of financial institutions that provide entrepreneurial and small and medium-sized enterprise (SME) financing.

Meanwhile, entrepreneurs face considerable cultural barriers: in the MENA region, there is greater prestige in working in large and established businesses than in experimenting with an entrepreneurial idea. This is especially so as the fear and stigma of failure is a pervasive problem for entrepreneurs, more so in the region than in Europe and the United States, where most successful entrepreneurs routinely cite their first failed efforts as critical opportunities for learning. For example, 78 percent of those surveyed said their teachers did not encourage them to pursue entrepreneurial businesses; a similar percentage reported the same treatment from mentors. Among the major challenges facing entrepreneurs, those surveyed said lack of prestige and lack of support from family members were the biggest, outpacing competition, time, financial demands and regulatory hurdles.

Complicating the startup process even more is the difficulty of gaining access to market opportunities. In the US and other markets, governments and large enterprises reach out to small businesses and even reserve slots on tender opportunities; by contrast, in the MENA region, tender requirements tend to call for certain qualifications, financial records and business networks, all of which make such opportunities a remote possibility for startups.

At the same time, entrepreneurs have limited access to education and training in business management, such as how to develop business plans. Formal mentoring programs are not available nearly enough, judging by the fact that close to 70 percent of those polled said they resorted to mentoring from family or friends, rather than from colleagues, investors, consultants or others. This was true for training as well. While entrepreneurs reported seeking training in skills such as marketing, management, finance and planning, they resorted to training from friends and family, or self-learning, in 40 percent of cases — far more than any formal online or technical institute or university, which collectively helped 26 percent of respondents.

The way ahead

Taking on these challenges will require a multifaceted approach. Although MENA nations can’t be expected to immediately overcome certain challenges — such as cultural resistance to risk-taking and failure — they can put into place several programs and efforts to develop an active entrepreneurial ecosystem. Booz & Company, leveraging workshops with key stakeholders, has identified several opportunities to increase entrepreneurship.

One such method is the creation of entrepreneurial service centers to help start-up founders write proper business plans, learn where and how to apply for financing, understand key business financial concepts such as bookkeeping standards and income statements and master more informal but equally valuable skills such as client recruitment and retention.

In addition, such service centers could provide beneficial data and statistics for companies seeking to develop greater market awareness, which would help them to further sharpen their business strategies.

Finally, one of the most valuable offerings of such one-stop centers is informal meetings; the ability to network with other entrepreneurs gives business founders a way to share experiences, learn from others’ mistakes and connect with interested financiers.

Entrepreneurs would also benefit from a more formal mentoring process, featuring communities of advisers led by those who have succeeded in the region already. Ideally, each mentor “pod” would consist of five to 10 young entrepreneurs and one experienced and successful entrepreneur. Each pod would focus on business plan development, financing assistance, introductions to key networks and a regular review of emerging challenges.

While the region’s banks may already be launching financing arms with a focus on entrepreneurs, policymakers could streamline the financing process by establishing a one-stop shop for those seeking loans and those offering them. These may include both private lenders and government sources. Importantly, these centers will help early-stage businesses properly apply for financing and track applications so they do not stall unnecessarily. 

Regional entrepreneurs could also secure greater access to opportunities if large corporations and government-backed entities initiate programs to attract SMEs as potential suppliers. Such a program would call for these organizations to set aside a certain amount of tender contracts for entrepreneurs and small and mid-sized enterprises. This would greatly reduce the barrier to entry for such startups and elevate their visibility to key purchasers.          

Taken together, these actions will provide a powerful tool to support and fund startup founders and will provide a valuable outlet for those entrepreneurial individuals who have been frustrated in the past. Importantly, such a coordinated effort would demonstrate to the rest of the industrialized world that MENA countries are ready to move to the next major stage of economic development — one that is led by innovative and small companies focused on building value throughout the economy and which are seeking to compete regionally, if not internationally.

Ahmed Youssef is a partner, Chady Zein a principal and Raymond Soueid a senior associate at Booz & Company

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Economics & Policy

Wasting away

by Executive Editors
written by Executive Editors

For the most part, a drive out of Beirut down Lebanon’s southern coastal highway offers a scenic respite from the city; to the right lies the sparkling waters of the Mediterranean and to the left the mountains of the Chouf. But the natural beauty becomes marred when another mountain emerges to block the seascape. It is the gargantuan massif of garbage just outside the southern city of Saida that has been growing for some 40 years, due to the lack of solid waste planning and program implementation by the government.

“It was a mountain, now its two mountains and there is no place to have a third one,” said Mohamad Seoudi,  head of Saida’s municipality, which is charged with managing Lebanon’s most infamous waste disposal site. “The dump yard is overloaded. It was always overloaded. We have had to deal with this dump yard for over 40 years and the situation is now critical.”

Last month a crisis erupted in the areas around Saida when Seoudi refused to accept the garbage from the city’s surrounding municipalities. He said the reason was that they were not willing to allocate 40 percent of the money they receive from the Independent Municipal Fund to pay for separation and solid waste treatment.

This same process occurs in Beirut, where the money goes to the private waste management company Averda. This arrangement is far from cost effective, however. According to Seoudi the price of processing one metric ton of garbage comes to $170 in the capital when you include sweeping costs; by comparison, the upper estimate of the average cost of waste treatment in Germany ranges between $81 and $91 per metric ton, according to a report published by the European Commission.

Garbage began to pile up on the streets of Saida at levels reminiscent of civil war days, when the lack of functional government left garbage uncollected around the country.

“Nobody pays [for] anything,” said Seoudi “This is the difficulty, you tell them to come and share the burden and let the government manage the plant, and to deduct 40 percent from their budgets, and they don’t accept because they are used to paying nothing.”

What adds to the incredulity of the issue is that a solution is already present. Just next to the dump, a solid waste treatment plant sits idle. The plant belongs to the Lebanese-owned, Saudi funded IBC company, according to Seoudi. He said that an agreement was signed with the company to process the waste as far back as 2003 with operations slated to begin in 2005, yet nothing happened due to a dispute over pricing.

“We asked Prime Minister Hariri to deal with the issue and with the owners and they have to negotiate,” he said, adding that discussions are ongoing between the company and members of the ministries of interior and environment.

The annual cost of environmental degradation in Lebanon could be around $1.48 billion

The tip of the trash mound

The Saida dump seems to be only the tip of the iceberg when it comes to Lebanon’s environment issues. The new Country Environmental Analysis (CEA) study on Lebanon currently being compiled by the World Bank sheds light on many of the environmental problems Lebanon faces and will continue to face if action is not taken. The study seeks to identify the difference  between the cost of mitigation and the current level of government financing to recommend policies to improve the country’s environmental standing.

As ever in Lebanon, timely figures are few and far between. But extrapolating the latest figures available (from 2005)  — which set the annual cost of environmental degradation in Lebanon at 3.7 percent of gross domestic product  — into a context of today’s economy , poor environmental practices could be costing the country some $1.48 billion per year.

Proportionally, this figure is actually a decrease on the last estimate taken in 2000 when the figure was put at 3.9 percent of GDP, with the fall attributed to the one piece of major environmental policy passed by a post-war government targeting pollution. Before 2002, anyone driving down from the mountains above Beirut could hardly make out the empty Burj Al Murr tower through the thick layer of smog. Thankfully, that is no more the case, after a 2002 decision to ban diesel engines in cars.

Not surprisingly, the CEA document predicts Lebanon will most likely not achieve United Nations Millennium Development Goal Seven, which aims to “ensure environmental sustainability,” mostly due to a lack of adequate reform in reforestation, solid waste and wastewater management. The problem of solid waste was highlighted as a “major environmental problem with more than 700 open dumps used by the municipalities and where some of the waste is still burned.” 

The lack of proper solid waste management also weighs down Lebanon’s poor ranking on the World Bank’s 2010 Environment Performance Index. The index ranked the country 90th of 163 countries in the world, according to the CEA study, with a noted rapid decrease in environmental sustainability since 2008.

May Jurdi, director of the department of environmental health at the American University of Beirut, said that in addition to the disease-ridden cockroaches and rodents that come with these open dumps, there are also long-term health risks associated with the lack of action. “When it rains all the garbage goes into the groundwater and into the rivers,” she said.

But getting an accurate reading of the problem and how it affects the population is difficult.

In order to assess how much the issue is affecting public health, real monitoring figures are needed, and these currently don’t exist. Jurdi said the health ministry has collected some data, but it is far from sufficient.

“The problem is that there are no clear indicators,” she said. “In countries like ours [the government is] afraid of indicators. We are a country of conspiracy theories and doubts. Everything is a conspiracy because we don’t have trust.”

Already citizens consider water from the taps undrinkable. Groundwater is the most commonly used source of water in Lebanon because of the widespread prevalence of wells in the country, and the lack of dams. The Ministry of Energy and Water estimates that the total number of private wells exceeds 42,000, compared to the 620 officially sanctioned and government-owned wells. Private wells’ total yield is estimated at around  440 million cubic meters per year while the government wells draw only 260 million cubic meters.

However, due to the fact that most of these wells are illegal, ministry officials admit that the number could be as high as twice the official estimate. As a result, no one really knows how much of the water being consumed by the people is safe or how much is contaminated by garbage.

“People are unhappy if VAT is increased but they don’t want to pay directly for services”

Wasting water

Probably the most work that has been done in the past decade toward protecting the environment has been in the wastewater sector. At present 11 wastewater treatment plants operate in the country, with six others constructed but not yet connected to a network, according to the CEA study [See page 100]. When the existing facilities are all online, the country will have the capacity to treat 400 million cubic meters a year (CM/yr). At present, only 46.5 million CM/yr are being treated, according to the study.

Furthermore there is dispute over what constitutes a treatment plant and also what is being achieved. “Ghadir is not a plant because it does not have secondary treatment, Saida is a pumping station and at Baalbek, 20 percent is reaching the plant because people are stealing the wastewater for irrigation,” said Jurdi. 

That practice is causing widespread public health risks, which at present are not being measured. For starters, when wastewater is used to irrigate plants, carcinogenic trace metals accumulate in the soil; change in the soil’s PH levels can cause them to enter the plants and thus be ingested by humans. Fruits and vegetables destined for market shelves are often ‘cleaned’ with wastewater, causing fecal material to accumulate, not to mention the parasites, bacteria and viruses that are attracted to such material.

Manfred Scheu, principal advisor at the German Agency for International Cooperation (GIZ), said that the development of the wastewater sector over the past decade is “remarkable,” given that just to find a place for a treatment plant in Europe takes around a decade. “If you are not a dictatorship [that] can expropriate land without worrying about people then this takes time. Its absolutely normal,” he said, adding that by 2020 most of the wastewater discharged in Lebanon should reach a treatable level.

“Today the treasury is broke, the institutions are broke and the people are broke”

Paying for it

Paying for everything will be a monumental task. At present, just covering operations and maintenance (O&M) in the wastewater sector will require an estimated 50 percent increase in the lump sum tariff that consumers pay, according to Scheu. “That is only O&M. That is not going to cover your investment. But in Lebanon it’s much cheaper, in Europe you have to double [the tariff],” he said.

So far no government official has been willing to stick his or her neck out and propose such an increase on a highly sensitive political issue of this kind.

“People are unhappy if VAT is increased but they don’t want to pay directly for services,” said Fadi Doumani, an environmental analyst and World Bank consultant who worked on the CEA report.

Last month Gebran Bassil, caretaker minister of energy and water,  declined to comment on any increase in the tariff structure associated with building new water infrastructure. When pressed by Executive on whether the plan was to borrow the money needed for water infrastructure, such as dams, he responded that the debt is already mounting due to the subsidies to the regional water establishments.

“Today the treasury is broke, the institutions are broke and the people are broke,” he said. Since Lebanon’s only law protecting the environment was passed nine years ago, no government has issued the implementation decrees needed to put it into effect. The law covers many areas of environmental protection, including mandatory environmental impact assessments for approval of projects that would affect the environment and the formation of a National Environmental Council to protect Lebanon’s natural sustainability. Other laws also call for the environment ministry to house environmental police to implement the law. However, there is currently little legal means or active framework to mitigate the effect of environmentally harmful developments. The environment has “remained a secondary priority characterized by an uncompleted legal and institutional framework as well as by ineffective policies to address the challenges and political constraints to deliver reforms,” states the World Bank report.

Still, even if the Lebanese government does not implement the reforms needed to protect the environment, it is unlikely to affect their ability to attract funding, as World Bank funding has continued despite the lack of substantive reform measures by any post-war government. 

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Economics & Policy

For your information

by Executive Editors
written by Executive Editors

Economy taking knocks

The political upheavals in Lebanon and around the region, coupled with a natural cyclical downturn, may signal the end of Lebanon’s economic honeymoon of the past several years. According to a statement issued by the International Monetary Fund, Lebanon will grow at just 2.5 percent this year — the worst rate since the 2006 war with Israel. To make matters worse, the inflation rate is also expected to climb to 6.5 percent this year. The IMF estimated the economy’s growth rate last year to be 7.5 percent. This year’s low growth rate was attributed to the cabinet’s collapse in January and the continuing political deadlock over the UN Special Tribunal for Lebanon investigation, according to investment bank Merrill Lynch. The bank cited the drop in the balance of payments to $2.6 billion in January along with $1 billion in capital outflows, an increase in dollarization and a deposit growth deceleration as the main reasons for the prediction. The central bank’s coincident indicator, an average of eight weighted economic indicators published on a monthly basis, echoed this sentiment, falling from 254.4 points in January to 243.2 points in February, the lowest since September 2010, indicating a deteriorating economic situation.

A dream of sanitation

The Ministry of Energy and Water last month released a new wastewater management plan entitled “Wastewater strategy: not to waste our water”. Lebanon creates more than 310 million cubic meters of wastewater each year, and while 60 percent of the population is connected to wastewater collection networks, only 8 percent of the generated wastewater is treated. The plan seeks to connect 80 percent of the population to wastewater collection networks by 2015 and 95 percent by 2020. It also seeks to achieve full operations and maintenance cost recovery in the sector within nine years. The ministry said that so far only four major wastewater treatment plants exist in the country. The total existing investment in the sector was set at some $1.5 billion. A further $1.69 billion is needed to complete all existing plants, while further investment is needed to fulfill all the objectives by 2020 was put at more than $3 billion. The plan will need to be passed through the cabinet to become policy; the money required must come from either a national budget, treasury advances or donors.

Damming the future

The Ministry of Energy and Water last month unveiled the new “Lebanese Strategy for Surface Water Storage,”part of the National Water Sector Strategy, which aims to build 30 dams across the country to address Lebanon’s water shortages. The document serves as an unofficial plan to invest $1.98 billion to build the structures, which will have a static storage capacity of 680 million cubic meters (MCM) and dynamic storage capacity of around 900 MCM. The plan is an updated version of a previous 10-year plan to build 27 dams, approved by both government and parliament over the last decade. Of those 27 proposed dams, only one saw the light of day.  A total of 10 were said to be ready for implementation while the remainder required further studies before they could be priced and implemented. Caretaker Minister of Energy and Water Gebran Bassil put the annual water deficit in 2010 at an estimated 426 MCM. In response to a commonly voiced objection to building dams Bassil admitted Lebanon’s geological formations were “not helpful,” but insisted that the projects go ahead. He added that even if all other reforms — including groundwater regeneration, network reconstruction and demand side initiatives — are enacted, it would only reduce the water deficit by 369 MCM as of 2015. Bassil declined to comment on a new tariff structure when asked how much citizens’ bills would increase as a result of the measure. He added, however, that citizens would be happy to pay one bill instead of three and that the reform would help the water establishments and relieve the public purse from having to cover their losses, which weighs on the public debt.

The cost of sectarianism

On the back of protests calling for the downfall of the sectarian system, a study by American University of Beirut Professor of Economics Jad Chaaban has put the accumulated cost of sectarianism to the Lebanese economy during the span of one lifetime at a minimum of 9 percent of GDP, or an estimated $3 billion. The report combined the costs of the sectarian system and its added costs from birth, to schooling, to housing, to marriage, to living expenses and old age, to arrive at a per capita burden of around $114,000. It identified the cost of residential segregation at $800 million and estimated that 16 percent of public servants are employed solely due to their confessional affiliation. Chaaban told Executive that the study was only preliminary and that he expected the actual cost to be much higher.

Suing to open the telecom market

Lebanese Internet Service Provider (ISP) and broadband operator Cedarcom is taking legal action against the country’s Ministry of Telecommunications (MoT) and government-owned GSM mobile network operators, Alfa and MTC. Cedarcom is mounting a legal challenge against Mobile Interim Company (MIC) 1 operated by Alfa, and MIC2 operated by MTC for monopolistic and unfair competition practices. Lebanon’s largest ISP claimed that the MoT, Alfa and MTC had breached telecom Law 431, ratified in 2002, by taking active steps to implement 3G networks and services without having received the required licenses from the Council of Ministers and the Telecommunications Regulatory Authority (TRA) in Lebanon. Cedarcom stated that the Lebanese Telecom Association, which includes a number of Lebanese ISPs, had repeatedly cautioned the MoT and TRA on the threat of a new monopoly in wireless broadband services if 3G services were introduced in the absence of proper licensing, unequal taxation and fair competition among government-owned and private operators. Cedarcom also argued that fixed-line and mobile GSM monopolies are already there, adding that private ISPs and data operators are kept on interim transitory yearly licenses, prohibited from increasing their DSL capacity and forced to pay up to 60 percent of indirect and direct taxes, all rules and regulations from which Alfa and MTC are exempt. VAT scandal

Al Akhbar newspaper last month reported millions of dollars had been stolen from government coffers by front companies claiming to be foreign import-export firms eligible to claim refunds for Value Added Tax (VAT) receipts. According to the newspaper, the finance ministry had paid out some $254 million in refunds to these companies,  which had accounts with the ministry, and that no inspections of the claims had been made to investigate any wrongdoing. In theory, the newspaper reported, these businesses had a right to file for refunds, while  the ministry has four months to check the legitimacy of their claims, otherwise refunds are automatically made. The newspaper claimed that this practice had been going on since 2005.  The finance ministry responded that such practices were common around the world and that it had uncovered the cases and forwarded requests for legal action to the general prosecutor’s office. The ministry added that its responsibility was not to inspect whether companies were truly established or not, but to inspect the financial statements it receives from companies. The ministry claimed inspections were in fact the responsibility of the commercial registry department at the justice ministry. In addition, the finance ministry refuted that $254 million was stolen, instead claiming that figure was the total amount refunded to all companies in 2010. The finance ministry did not reveal how much had been stolen by the front companies.

Tipping the scales

The balance of payments (BOP) continued its downward trend after registering a deficit of $668.8 million during the first two months of 2011, compared to a surplus of  $714.2 million over the same period in 2010. The BOP did post a surplus of $103.3 million in February, however, constituting a turn into the black after January registered a deficit of $772.1 million. The turnaround was attributed to a rise in the net foreign assets in Banque du Liban, Lebanon’s central bank, and that of other banks and financial institutions. This is the first time in the past three years that the first two months of the year did not see a BOP surplus.

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Real estate

Venus towering over Phoenician past

by Executive Editors
written by Executive Editors

The threat that cultural heritage faces in Beirut as a result of rising land prices and the scarcity of empty plots is a familiar theme. There seems to be no shortage of fresh cases to highlight and local and international media, as well as local NGOs devoted to preserving national heritage, are doing their part to raise the issue.

Over the last several weeks, Venus Real Estate has been in the spotlight over the discovery of what local news media has claimed is an ancient Phoenician port on “lot 1398”, an approximately 7,000-square-meter site where the company is preparing to construct a luxurious three-tower high rise complex called Venus Towers. 

“I haven’t seen the site; it is closed to the public and even to archaeologists — this is what happens every time there is an important discovery in the Beirut town center,” said Leila Badre, museum director of the Archeological Museum of the American University of Beirut. The Directorate General of Antiquities (DGA) has been carrying out work on the site since the discovery of the ruins by the Ministry of Culture nearly two months ago. At present, the ministry is consulting with local and international experts to determine the value of the site, and as of April 27 five reports had been submitted, signifying that a final decision is coming soon. “We found slopes going down toward the sea that can be interpreted in many ways,” said caretaker Minister of Culture Salim Warde. “It might be a port, a shipyard, or even a quay, but it is surely something very interesting, and we are seeing how we can work with the owners of the land to save this site,” he said.

Over the month of April, An-Nahar criticized Venus Real Estate in two reports that cited numerous experts on the potential archeological value of the site. On April 27, Venus Towers issued an official statement to “clarify” the situation to the general public, threatening media outlets with legal action for making damaging accusations. The statement contends that the plot is too far from the sea to have been used as a port, and too far above sea level, but did not address any historic changes in sea level since the period when the ruins are thought to have originated from.

“The coast of Beirut today is not as it was over 2,000 years ago,” said Warde. “We know for a fact that over the last century this area was covered by stones at least four times. Before then, we don’t know how many times this occurred.” The last time land reclamation like this occurred was by Solidere, whose damage of historic sites was notorious during the post-civil war reconstruction boom. Disturbed by the situation and what he referred to as yet another challenge between the national interest and the private sector, member of Parliament Walid Joumblatt expressed his concern to Executive following the issuance of the Venus Real Estate statement. “I don’t believe a word they say; it’s all rubbish. They will find any excuse for the sake of a few square meters,” he said.

Prior to the publication of the statement from Venus Real Estate, Venus Towers spokesperson Wajih al-Bazri told Executive on April 25 that there was a great difference of professional opinion from archeological experts about the importance of the site. Bazri claimed that while local experts believe the site is important, the international expert brought by Solidere ruled the site unimportant. “The Ministry of Culture and Solidere are working together to get more opinions,” said Bazri. “There is no final opinion yet, but they are working to finalize as soon as possible to be able to go ahead with the project.”  He added that the real estate company will abide by the ruling of the Ministry of Culture, whatever it may be. In the worst case scenario, “we will build around it,” said Bazri, explaining that the ruins only cover about 1,000 square meters of land, then adding: “The newspapers are making a bigger fuss out of this than it really is.”

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Real estate

For your information

by Executive Editors
written by Executive Editors

Illegal buildings on public property

Security forces in Lebanon are cracking down on the illegal construction of residential buildings on public land. Particular areas of concern are Hezbollah-controlled regions in the southern suburbs of Beirut and south Lebanon. According to As Safir, the Ouzai district was constructed entirely on public property while nearly 1,000 residential units were built on thousands of acres of public property in southern Lebanon. On April 18, six policemen in the southern suburbs of Beirut were injured while attempting to evict the occupants of illegal houses. A similar incident on April 21 in Tyre left two civilians dead and two others wounded by police gunfire. According to the Associated Press, caretaker Prime Minister Saad Hariri indicated that Hezbollah has turned a blind eye to the construction. Hezbollah defended itself against the accusation, urging officials to severely punish such violations.

Syrian tycoon Makhlouf in the spotlight

Last week, London-based World Finance magazine announced that it was reconsidering an award it had presented in March to Syrian businessman Rami Makhlouf, calling it “appropriate to factor in the wider political agenda” after Syrian protestors have been widely vocal about his perceived corrupt business dealings in the country. Makhlouf, the 41-year-old maternal cousin of Syrian president Bashar al-Assad, was commended for “visionary leadership and contribution to the Syrian economy” through his holding company Cham Holdings (Syria’s largest private company), which includes businesses ranging from aviation to telecommunications, energy and banking. Makhlouf’s businesses control more than 60 percent of the Syrian economy. His main property group, BENA holdings, is developing mixed-use, resort and hotel properties on a total of more than three million square meters of land from Aleppo to Damascus. In an email to the Financial Times, later published in an April 20 article, Magda Sakr, chief executive officer of Makhlouf’s telecommunications firm Syriatel, said that “Makhlouf is a businessman and is therefore seeking — as any serious businessman — to get investment opportunities… The fact that he is ‘well connected’ does not make him a criminal who has to justify each contract he gets.” The email went on to ask, “Is somebody going to claim that Mr. Makhlouf’s success was due to him using Syrian intelligence officials to intimidate the Syrian public to use the services of [his] companies?” Makhlouf has been widely criticized by the international media and was sanctioned by the United States Treasury in 2008, banning him from operating with any American person or business.

One big hotel purchase

Monaco resident and Lebanese businessman Toufic Aboukhater has coughed up $643 million to Morgan Stanley Real Estate Funds (MSREF) for seven InterContinental hotels in France, Vienna, Amsterdam, Madrid, Rome, Frankfurt and Budapest, according to a report by the Reuters press agency. Arguably the most prized asset in the portfolio is the Carlton Hotel overlooking the Mediterranean coast in Cannes. MSREF had bought the hotels in 2006 for $925 million using a debt-heavy strategy, with Barclays Capital organizing an assortment of lenders to complete the deal. The reclusive buyer once owned London’s Dorchester Hotel and Monte Carlo’s Grand Hotel, in addition to others throughout Europe.

Eco-design is flourishing

The Build it Green conference held at the end of March highlighted the vitality of eco-friendly living in Lebanon. Host to more than 300 real estate professionals from Lebanon and the Middle East, the conference addressed several aspects of green building. Featured at the conference was a new project by the event sponsor Greenstone. ‘La Broceliande’ in Yarze, outside Beirut, is to be Lebanon’s first residential BREEAM (an environmental assessment method and rating system) green-certified building, scheduled for completion by mid-2012. Fouad Hanna, an architect with Dagher Hanna and Partners, who worked on the La Broceliande project, emphasized the increased demand for green construction in Lebanon. “The interest that we find today is phenomenal compared to even just a few years ago,” he said. “Though consumers focus on quality and location when making purchasing decisions in Lebanon’s real estate industry, quality living and energy cost saving through environmentally-friendly architecture are gaining popularity.”

Jordan retains value

Despite the political unrest in the region, Jordan’s property market has not experienced dampened prices, according to a first quarter report from property consultancy Asteco Property Management, with some residential sales transactions exhibiting higher prices. The report noted that during the first quarter of 2011 the activity of sales and leasing of small and medium sized apartments has kept the same pace as in 2010, partly due to scarcity of land in  high-demand areas and low housing budgets. “The Jordanian government moved swiftly in adopting policy changes… [and] as a result of these changes, which included limitations on price increases and the waiving of transfer fees, Jordan’s property market has shown little sign of slowing,” said Elaine Jones, chief executive officer of Asteco Property Management. However, average apartment sale prices in Amman’s 4th Circle street have decreased by 1 percent to $1,340 per square meter compared to an average price of $1,481 per square meter in Abdoun, the most expensive residential area in Amman.

Egyptian land mogul detained

Former Egyptian housing minister Mohammed Ibrahim Suleiman was arrested by Egyptian Authorities on April 6 for allegedly awarding government land to real estate developers in the country for less than fair market prices, according to the Assocated Press. Suleiman, who is the second former housing minister to be arrested since the fall of the government, is believed to have approved biased deals while in office from 1993 to 2006, generating the possibility that land transactions made under previous governments may be annulled, much to the dismay of some regional real estate investors. Authorities also arrested Egyptian businessman Magdi Rasikh, accusing him of purchasing public land through a deal brokered with Suleiman, which indirectly lost the public purse some $100 million. Property companies have already been battling a series of legal challenges after a court ruling last year that an earlier land deal made with the country’s biggest developer, TMG Talaat Moustafa Group, was illegal.

Coughing up for the coppers

Construction company Saudi Oger – owned by the family of the Lebanese Caretaker Prime Minister Saad Hariri – plans to finance the construction of police training facilities in Saudi Arabia with a $2 billion syndicated loan. Saudi Oger last participated in the loan market in August 2010, borrowing $250 million via Credit Agricole, which will mature in December 2014. Bank sources claim that Saudi Oger has nearly reached the limits of its credit lines and has been trying to diversify its financing beyond domestic banks. According to Maktoob, Deutsche Bank has been attempting to put together a syndication of small banks to provide the loans. Similarly, lenders have each been asked to contribute $200 million.

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Banking & Finance

Regional equity markets

by Executive Editors
written by Executive Editors

Beirut SE  

Current year high: 1,111.39    Current year low: 912.21

>  Review period: Closed April 25 at 924.62 points Period Change: -1.1%

With government formation stuck for a third month, the BSE failed to excite and the market finished the review period treading negative territory. Shares of actively-traded Bank Audi shed 3.7% and Byblos shares inched up 1% during the review period. Shares of market cap leader Solidere moved about as much as the Lebanese cabinet. Bank of Beirut reported a 1.38% YoY increase in Q1 2011 net profits to $20 million. For good news, the Lebanese central bank and Washington both denied rumors of US Treasury Department hunting more Lebanese banks for money laundering.

Amman SE  

Current year high: 2,575.47                Current year low: 2,149.11

> Review period: Closed April 26 at 2,202.38 points Period Change: 1.23%

After hitting a multi-year low in March, Jordanian stocks rebounded in early April as investors were lured by lower valuations and positive earnings news. Political unrest seemed to subside after King Abdullah promised reforms, but security and economic concerns rose as Syria shut its border and a pipeline carrying natural gas from Egypt through Israel was set sabotaged, costing Jordan $4 million a day. Amidst all the unsettling news from the neighborhood, Al Rajhi Cement Company issued a $120 million seven-year Sukuk, the first Jordanian firm to use Islamic finance for funding.

Abu Dhabi Exchange  

Current year high: 2,833.09                Current year low: 2,471.70

>  Review period: Closed April 26 at 2,689.3 points Period Change: 3.15%

Waves of strong economic growth and abundant liquidity continued to wash positively across ADX stocks. Although the ADX index closed the review period still down half a percent for the year to date, its April performance was second only to neighboring DFM. While National Bank of Abu Dhabi fell victim to higher provisioning, Abu Dhabi Islamic Bank and Abu Dhabi Commercial Bank posted strong results, driving the banking sector index up 6.4%. Real estate companies Aldar and Sorouh were among the most traded stocks, rising 3.3% and 10.6% respectively.

Dubai FM  

Current year high: 1,859.96                Current year low: 1,352.24

>  Review period: Closed April 26 at 1634.75 points Period Change: 5.06%

After a slight pause at the end of March, DFM index led MENA financial markets higher in April despite a brief gasp over disappointing first-quarter earnings by Emaar Properties, the market’s heavyweight. Positive results helped leading bank Emirates NBD finish our review period up 30% and support the benchmark index. Investors were optimistic about the possibility of the DFM finally winning emerging market status from MSCI. Being in the black and having Fridays off, the DFM crowd at the end of April was all primed to focus on Buckingham Palace and the royal wedding.

Kuwait SE  

Current year high: 7,309.70                Current year low: 6,134.60

>  Review period: Closed April 26 at 6,493.5 points Period Change: 3.14%

For Kuwait’s investor community, April was a month with a somber note due to the death of Nasser al-Kharafi, the Kuwaiti billionaire and chairman of Kharafi Group with significant interests in companies ranging from KFC franchisee Americana to NBK and telco Zain. Zain and NBK are the KSE’s two market cap leaders. The banking sector closed our review period up 6.14%, as NBK reported 6.2% higher Q1 2011 net profit, sending its shares up 8.8%.  

Saudi Arabia SE  

Current year high: 6,916.79                Current year low: 5,323.27

>  Review period: Closed April 25 at 6,684.7 points Period Change: 1.86%

Share prices of companies listed on Tadawul continued to steadily increase, although with slowing momentum. The usual suspect for driving the SSE action, as in the past 18 months, remains the petrochemical sector, which grew net profits by 51% in Q1 2011, according to a Jadwa report. Petrochem shares were up 4.9% during our review period, led by market heavyweight SABIC at 6.4%. However, earnings at non-petrochemical companies rose only 3.7%, according to Jadwa.

Muscat SM  

Current year high: 7,027.32                Current year low: 6,058.11

>  Review period: Closed April 26 at 6,327.49 points        Period Change: 2.6%

Trading activity was limited on Oman’s stock market in April but the benchmark index gave a bit of an Alpine performance in the review period, losing some gains from the first half of the month. First quarter results at Omani banks came in strong with BankMuscat and NBO, the country’s two largest banks, posting respective 13.5% and 17% YoY increases in net profits. Investor sentiment appeared still wobbly after the Sultanate’s roller coaster first quarter that saw several protests and strikes in various companies. However, investor moods appeared pacified by announcements of dividend distributions.

Bahrain Bourse  

Current year high: 1,591.94                Current year low: 1,361.19

>  Review period: Closed April 26 at 1,400.27 points                 Period Change: -1.71%

Bahrain stocks continued to suffer from the fallout of the ongoing protests, although foreign banks in the country have denied rumors that some are planning to relocate. The expulsion of an Iranian diplomat has further escalated Bahrain’s war of words with Iran whose testy reactions pose a bigger risk to regional stability than the UK press’s badmouthing of the Bahraini Royal Family. Investors took a breather from the distribution of $118.5 million in dividends by Al Baraka Bank Group. Bank share prices seesawed during the month, with NBB dropping 8.4% during the review period.

Qatar SE  

Current year high: 9,242.63                Current year low: 6,647.18

>  Review period: Closed April 26 at 8,441.91 points              Period Change: -0.17%

The Qatar Exchange desert market rally that started in early March wound down in mid-April, the benchmark index skidding into the red by the end of our review period. Despite strong economic growth expectations on a record budget and the bullish credit and stock ratings of Qatari banks, business optimism entered the second quarter of 2011 on a low note. While Qatar National Bank and Commercial Bank reported strong results, investor unease was fueled by below estimate profits at Qatar Islamic Bank and by layoffs at Barwa Real Estate, the biggest listed property developer in Qatar. 

Tunis SE  

Current year high: 5,681.39                Current year low: 4,058.53

>  Review period: Closed April 25 at 4,235.36 points              Period Change: -3.37%

Stocks listed on the Tunis stock exchange are still paying the price of freedom, although the second half of April witnessed an uptick in trading volumes and showed signs of a return of investor confidence. However, the uncertain political situation led Capital Intelligence, the global credit agency, to assign a negative outlook for Banque Internationale Arabe de Tunisie, which holds 10% of the sector’s assets. Going forward, stock exchange activity may remain subdued as the country gears up for the July elections and amid continued military operations in neighboring Libya.

Casablanca SE  

Current year high: 13,397.47              Current year low: 11,499.64

>  Review period: Closed April 26 at 12,017.17 points              Period Change: -1.29%

Limited trading activity on the Casablanca Stock Exchange was not reflective of the political mood in Morocco, which appears to have escaped the networking grasps of the North African uprisings. Following peaceful protests across the country, the Moroccan government quickly agreed to increase public sector payrolls and the minimum pension. While the royal family was invited to London for social obligations, its investment holding SNI talked its 2010 profits down.

Egypt SE  

Current year high: 7,500.56                Current year low: 4,951.00

>  Review period:  Closed April 26 at 4,996 points   Period Change: -8.57%

Stocks continued to slide on the Egyptian exchange as companies calculate how heavy the protests of the past few months will weigh on 2011 earnings. But as the high drama of February was being replaced by talk of a Mubarak court appearance, the Egyptian economy and the exchange are set to benefit from a prospective $1 billion Kuwait Investment Authority Fund for Egypt and from a potential $6 billion IMF loan. In addition, the country is looking to hike revenues by renegotiating foreign gas deals.

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Banking & Finance

Simon Cooper

by Executive Editors
written by Executive Editors

Simon Cooper is deputy chairman at HSBC Bank Middle East and North Africa (MENA). He recently sat down with Executive to discuss the effect of the regional unrest on business and investment in the MENA region, as well as growth opportunities for the future.

  • With all the capital outflows, the foreign investments that have been stopped, the people who have been laid off, the expectation that unemployment will rise rather than fall, the lost tourism and the fact that the government is not spending yet, it seems it will take a lot for Egypt to not to fall into a very vicious circle. Banks in general and HSBC are exposed to a lot of risks there. There’s a risk of default from corporate clients and absolutely from individuals for the retail banking division. How are you going to manage this crisis?

I think you’ve got to step back here. First there was the physical crisis that hopefully has passed. We were able to manage that through being part of a regional network so we were able to immediately support what was taking place onshore in Egypt with our infrastructure offshore. We were the first bank to re-open in Egypt.

In terms of the credit risk, we saw a short-term blip in delinquency in February when people on the retail side were not paid because businesses weren’t open to issue payrolls. But we’ve seen that reversing in March.

We as a bank are at the higher end of the economic spectrum in our client base so we have a natural advantage in terms of segmentation of our customer base. When you look at the corporate side, the central bank of Egypt was very disciplined for many years in terms of making sure that foreign currency borrowing was mirrored by foreign currency earnings. So again the impact of foreign exchange has been largely self-hedged by the regulations over many years.

There’s certainly going to be a short term impact on tourism. Hotel occupancy is definitely lower this time this year than it would have been this time last year. I understand that people are starting to book again for October-November, which will be the next peak season for Egypt’s tourism industry. It’s too early to say whether that will be successful or not. It will be a very important barometer to see how many people do come back in.

There’s definitely a bump in the road; exactly how long that bump will last is too early to say. To my mind, it’s probably a year or two to get back on its historic trajectory but I don’t think it will take 10 years, after a sort of downward spiral from where we sit today. We now need the constitutional reform to be moved forward; we need the government to come into place and hopefully it will be a sustainable one.

  • You were one of the first to be in Iraq along with Standard Chartered, but in the end it wasn’t really operational. What’s your prospect for Iraq and why there?

I can’t take credit or blame; it was done before I was in the region. But talking to Lebanese customers, there’s a huge amount of interest in business opportunities in Iraq. A number of people distribute their products into Iraq – all told me that their only constraint was in getting enough product into the market, whose potential they believe is significant. I think if you look at foreign investment coming into Iraq we’ve done a lot in terms of some of our multinational clients looking to establish or grow their business [there]. It’s not going to suddenly take over the United States as a top-five economy in the world, but in terms of growth potential it’s significant. Physical security remains a high operating cost of having a branch network in Iraq. But the business potential I think is significant. We used to manage the business predominantly from Jordan, and we increasingly put more and more people into Iraq as security becomes much more stable.

  • Bahrain’s image as a financial hub has been tarnished recently. Is doing business there at the moment such a good idea?

There are clearly a number of companies that ran regional businesses from Bahrain that had to move their operations very quickly elsewhere. So clearly that is a memory that people will retain for some time and it will cause people to think twice when they are looking to really invest. So yes, there has been some damage to its brand. But we’re absolutely staying there. We’ve been through a number of wars in the region and turmoil — we’ve seen it all before. So we’re very much here to stay and to continue to invest more.

  • How would you assess potential for Syria and Libya?

In Syria we have a representative office. We applied for a branch license last year, which we didn’t get. In terms of Libya, there’s a tremendous opportunity in terms of the economy and to be part of the economic growth. But I don’t know what’s going to happen in terms of the current conflict; that has to resolve itself one way or another before you can form a view as to where the economy is going and how long it’s going to take to get there. But the potential is absolutely huge. In Syria, I’m sure the economics are strong; but from a banking perspective, as an international bank doing business in Syria, given the US sanctions and everything else, it is too difficult. 

  • Will the ‘Arab Spring’ provide new opportunities for the region?

Look at what’s been the reaction for a number of governments. There’s been an increase in infrastructure spending. There’s a renewed or heightened oil price. Both of those things are economic stimulants for much of this region, and that gives tremendous opportunities for employment, gives opportunities for bankers, for project financing. So, yes, I think there will definitely be some benefits coming from it.

Many of the countries’ infrastructure is not at as high levels as you would expect given these countries’ wealth. So as infrastructure investment comes in, it is a real sustainable investment and a real sustainable benefit to the economy. It’s not just the initial sort of cash injection; it’s what it does to enable businesses going forward.

  • Who benefited from the capital outflows within the MENA region?

There’s definitely a flow of capital around the region. While there’s been an FDI [foreign direct investment] outflow, some of it has come back into some of the other countries. The UAE [United Arab Emirates] has definitely benefited from some of the unrest that’s taken place around the region. It’s become a safe haven for some direct investors.

It’s also become a safe haven for tourists. Tourism numbers in the UAE have risen dramatically in the last few years…because perhaps people are more concerned than they were about holidaying in some of the other destinations they would have otherwise gone to.

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Banking & Finance

The warning shot has sounded

by Executive Editors
written by Executive Editors

The United States government’s recent designation of Lebanese-Canadian Bank (LCB) as a “prime money laundering concern” crippled the bank, prompting a shotgun marriage merger that will effectively erase LCB from the country’s banking sector. The event has highlighted the shortcomings of the country’s anti-money laundering (AML) and counter-terrorist financing regime, and has been a wake-up call for Lebanese banks to both the ramifications of non-compliance and the long reach of the US Treasury’s Financial Crimes Enforcement Network (FinCEN). It is also almost certainly a warning that Lebanon will be hit where it hurts most if it plays politics against the interests of the world’s largest economy.

When asked about LCB’s merger with Société Générale Banque au Liban (SGBL), Lebanon’s alpha banks refused comment across the board — indeed the topic of money laundering in Lebanon is so sensitive that officials and experts from multiple local and international organizations interviewed for this report would speak only on condition of anonymity.

As rumors circulated that the United States Department of the Treasury could be eyeing three or four more banks over dirty money allegations, the sealed lips of Lebanon’s biggest banks have left important questions unanswered regarding preemptive risk measures, such as scrutinizing bank accounts and transactions, upgrading compliance measures and related software and avoiding high-risk individuals and politically exposed persons (PEPs). But their actions have spoken volumes.

As the first quarter of 2011 came to a close, financial investigative units in Lebanon received a deluge of suspicious transaction reports (STRs) — required notifications filed by banks to the Special Investigation Commission (SIC) within the Banque du Liban (BDL), Lebanon’s central bank — with many regarding transactions that were only faintly suspicious.

“We had an STR on a $300 cash transfer — banks are worried,” said one financial investigator.

Lebanon’s banking sector has long been praised for its conservative nature and its contributions toward stabilizing the country’s economy, but now it is in the limelight for all the wrong reasons. While the storm seems to have subsided, the LCB scandal may well blow the cover of other banks before it blows over. With suspicion of vast amounts of dirty money circulating in Lebanon, the many loopholes through which it enters and the foreign pressures to expose it, the scene is set for an LCB sequel.

Dirty money

LCB’s connections to Lebanese-Colombian drug lord Ayman Joumaa’s shady money transfers, risky liaisons and a mix of inconclusive accusations by the US Treasury helped bring LCB down nearly overnight. But Joumaa is likely far from the only Lebanese bank customer engaged in suspect drug trafficking and money laundering.

While the vast majority of the estimated 8 million Lebanese and their descendants living abroad have exported their mercantile sensibilities to contribute to the economies and societies where they now live — and do so within the legal parameters of those countries — this massive diaspora and its strong family and community ties has also aided in the formation of a number of international networks engaged in illicit business.

Lebanese expats have built large communities abroad, mainly in South America, but also in South and West Africa, Canada, Australia, the United States and Europe; among the small number of more shady expats, law enforcement agencies have documented patterns of organized involvement in black market dealings involving illegal narcotics, ‘blood diamonds’, car-theft mafias and the like.

According to the United Nations Office on Drugs and Crime, in the early 1990s Lebanon gradually transformed itself into a regional hub for cocaine and heroin trafficking. And drug busts over the last few years indicate that the business continues to boom, especially those networks working out of South America.

In October 2008, United States and Colombian investigators dismantled a cocaine-smuggling and money-laundering ring that had been working with a Colombian cartel and a paramilitary group to smuggle cocaine into the US, Europe and the Middle East. In the middle was Lebanese kingpin Chekry Harb, the liaison between South American cocaine traffickers and Middle Eastern “militants”. Some $23 million was seized and 170 arrests were made, while Harb’s drug ring was believed to be laundering millions more monthly through what is called the ‘Black Market Peso Exchange’ using Asian-based financial institutions

In mid-2010, a record drug bust was made at the Port of Beirut when 102 kilograms of pure South American cocaine, worth $10 million, arrived in Lebanon packed under a layer of lead inside machine cylinders. And in September 2010, Lebanese security forces uncovered another network that the Central Office for Drug Control (CODC) called “one of the most important, highly complex networks” smuggling drugs between South America and Lebanon. The CODC confiscated 50 kilograms of cocaine, worth $8 million, of the 255 kilograms that one Venezuelan and four Lebanese had confessed they had planned to smuggle.

Heading north, car theft rings in Canada have also found their way to Lebanon. According to the Insurance Bureau of Canada (IBC), Lebanon is among the top 10 destinations for stolen Canadian cars, by way of containerized vehicles that usually make their way through Genoa, Italy to Eastern Mediterranean ports, including Beirut. In February 2009, Hanna Tanios and Ayyad Tirani, two Lebanese residing in Canada, faced charges of fraudulent concealment and possession of stolen property, namely cars. The vehicles were being cut in half and shipped via the port of Montreal to Lebanon where they were reassembled or sold for parts.

And then there is the Ivory Coast, which fosters one of the most notorious industries that Lebanese expats have engaged in: ‘conflict’ or ‘blood’ diamonds. In 2009, the Kimberly Process Certification Scheme (KPCS), the international regulatory body specific to the trade, recognized the Lebanon-Guinea Axis as an emerging diamond laundering route. In almost three years, leading up to 2009, Guinea had reported a 600 percent increase in diamond production and went from providing zero to 85 percent of Lebanon’s diamond imports. Although attributed to the discovery of new mines within the country, Guinea’s production pump was also connected to conflict diamonds coming from the northern Ivory Coast. As 2008 came to an end, 73 percent of Guinea’s total diamond exports were heading to Lebanon.

Lebanon’s irregular trade statistics, mentioned in a 2009 report by the United States Geological Survey (USGS), also raised some eyebrows; though it has no diamond mines, in 2009 Lebanon somehow managed to export 386,000 carats more in gem-quality diamonds than it had imported, while recording a trade deficit on industrial diamonds, which are worth 10 percent of the value of their gem-quality cousins. According to Partnership Africa Canada’s “Diamonds and Human Security Annual Review 2009,” “some 250,000 more carats leave [Lebanon] as gem-quality diamonds than arrive — worth 36 times their import value.” The discrepancies in numbers led the KPCS to investigate possible tax evasion, with Lebanon accused of importing gem-quality diamonds from Guinea as industrial diamonds, as the latter are taxed at a lower rate relative to their value.

“There is a large spectrum of criminal activities that involve some Lebanese abroad. But smuggling coffee from Colombia or counterfeit products from China is overlooked in Lebanon, which begs the question, what is dirty money?” asked one economist at a global banking watchdog organization who was not authorized to speak to the press.

But, according to the “International Narcotics Control Strategy Report” (INCSR) published in March 2011 by the US Department of State, these small-time illicit businesses in Lebanon are not the primary sources of funds laundered through the formal banking system.

“Laundered criminal proceeds come primarily from organized crime [networks],” the report says, not from smaller black market dealers.

However, a 2009 mutual evaluation report carried out by the Middle East and North Africa Financial Action Task Force (MENA-FATF) — the regional arm of the global Financial Action Task Force, an organization dedicated to stemming money laundering and terrorism financing — noted that drug trafficking in Lebanon “is limited to 150 dealers, [with] the average value of the business of each ranging between $4 million to $5 million.” That means a possible $600 million to $750 million may be entering the Lebanese economy each year, and potentially through the banking system.

The loopholes

According to the World Bank, some $8.2 billion in remittances found its way back to Lebanon in 2010, and this, according to the INCS report, poses significant potential for money laundering and ‘terrorism’ financing (as classified by the US), given the involvement of Lebanese networks abroad in underground finance and trade-based money laundering.

But, according to the global banking expert, the ambiguity in classifying transfers makes it hard to spot the shady ones. “The numbers are seemingly transparent, but they are hardly indicative,” he says. For one, remittances are not categorized; there is no distinction between capital, income transfers and money that goes straight into households. The inability to sift through this money makes it difficult to spot potential abuses.

There is also the issue of ‘fiscal residence’; Many expats use the fact that their fiscal residence is not in Lebanon to avoid reporting the source of their funding, meaning the Lebanese government is unable to trace money back to its source.

However, when it comes to capturing financial flows, there are certain unimplemented mechanisms in Lebanon that would provide the opportunity for greater scrutiny and oversight.

While financial institutions’ reports are major indicators of these flows, there is a shortage of economic, business, household and investment surveys indicating how much one earns on a monthly or yearly basis and the nature of those earnings. These surveys can catch inconsistencies in numbers once compared to those of financial institutions.

“How can the Central Bank do cross-checking if there is nothing to cross-check with?” the banking expert asked. The National Statistics Office, the severely neglected data collection wing of the government, has been too poorly funded to conduct large-scale fieldwork that can produce reliable figures.

Additionally, inconsistent reporting and inadequate enforcement of tax declarations by individuals and companies makes assessing income levels and possible suspicious transactions harder to spot. The issue is further compounded by Lebanon being primarily a cash-based society with a minimal paper trail, whether for tax and income declarations or for the authorities to monitor for suspicious transactions.

The shortcomings of such oversight at the governmental and fiscal level have knock-on complications for compliance units at banks in carrying out customer due diligence, more commonly known as ‘know your customer’ (KYC), procedures, where compliance officers (COs) are required to know the customer’s background, their profession, income and business dealings.

For instance, KYC can involve unannounced visits to a business to confirm that the declared business is what it claims to be, and whether it is generating the amounts coming in and out of the client’s account, but such investigations are few and far between in Lebanon. Complicating matters are the often very personal relations at the branch level between banker and client, where clients see it as an intrusion for the bank to probe into a customer’s life.

“Banks here are wary, and although interested in curbing money laundering, they need to do more [to improve] compliance, training and implement policies,” said a source close to the BDL.

These efforts are being undermined, however, by the lack of authority COs have within the management structure of financial institutions.

“If you took a survey of banks’ compliance and asked about the independence of the CO vis-a-vis management, the powers they have, their background [and] professional experience, and their salaries compared to other officers in the bank, it would come up short,” the source said.

A CO at a major Lebanese bank considered the compliance departments’ lack of authority a major obstacle to curbing money laundering and protecting the bank.

“One of the weaknesses we have here is that Lebanese banks are family businesses, so they can do anything they want,” said the CO. “COs should work more closely with the SIC without going directly to the chairman of the bank… Compliance should have the veto over whether to take on a client; otherwise what’s the point if the CO can’t say no?”

Easily secret

One concern specific to cash flows is the shortage of cross-border checks. According to a FinCEN report, cross-border currency reporting in Lebanon is requested of those carrying into the country more than $10,000 in cash, but currently is not enforced by law. This creates a significant cash-smuggling vulnerability. The SIC is working to draft laws to mandate cross-border checks but for now it goes largely unregulated. There is also no oversight of the buying and selling in precious metals, with ounces and kilos of gold and silver able to be bought over the counter, in cash, without any identification or paperwork required.

Another issue, once a forte for Lebanese banks, is banking secrecy. “There have been concessions with regard to banking secrecy; when transfers are fishy, banks are required by [AML Law 32] to lift secrecy,” said one financial investigator. But the global banking expert noted that banking secrecy itself is not the issue.

“The problem is that [secrecy] comes as a free gift for all,” he explains. In Lebanon, there are no disincentives for hiding records. In Switzerland, on the other hand, there are two strings of depositors: those who have banking secrecy and those who do not. The latter pay progressive taxation on revenues of deposits based on brackets; as their deposits reach higher brackets, they pay higher taxes. The former, on the other hand, are automatically subject to the tax rate corresponding to the highest bracket.

“Basically, if you want banking secrecy you pay for it,” he said. This taxation system does not spare banks from money launderers, but it is a form of insurance for the banks.

Banking secrecy does not mean that there is no oversight, however, as the SIC can request that it be lifted in the case of suspicious accounts. Indeed, the SIC lifted bank secrecy on 23 cases in 2010, which were then passed on to the General Prosecutor.

Money launderers in Lebanon are also protected by a lack of investigative work into their past. Only once banks notice irregular patterns in transfers and flows do they file an STR, after which the individual is looked into; the US State Department’s narcotics report notes an over-reliance on STRs to initiate investigations rather than an emphasis on predicate offenses that could involve money laundering. Notably, last year there was an uptick in the reporting of suspicious transactions, with the SIC receiving 245 cases — 160 from local sources and 85 from foreign — up from 2009’s 202 cases, of which 127 were from local sources. Lebanese banks, however, have only recently upgraded their IT systems to include money laundering detection software, as well as subscribing to databases that list high and heightened risk individuals and entities.

With Ayman Joumaa’s network linked to exchange houses in Lebanon, it was the amount of funds allegedly able to flow through them that was of concern. Effectively the exchanges were acting as banks. “Exchanges shouldn’t do parallel banking,” said the CO. “Only recently did they start doing third party (transactions), and they shouldn’t. They should let banks handle wire transfers.”

There are 383 exchange companies in Lebanon, 13 percent of which fall under “category A”, enabling them to trade in higher denominations and to carry out electronic transfers. The SIC is aware of the risks posed by exchange dealers; nearly half of the 154 on-sight examinations carried out in 2010 focused on money dealers.

But additional threats continue to surface. New payment methods (NPM) are providing money launderers with additional means to do their work. In its 2010 “Money Laundering Using New Payment Methods” report, the FATF highlighted the particular dangers of prepaid cards. These plastic cards, which are provided both by banks and private operators, allow customers to bypass credit checks and other forms of financial scrutiny. Some can be used in multiple countries.

“These high limit prepaid cards are like a mobile, transferable, untraceable, anonymous bank account,” the banking expert said. They allow virtually anybody to place money on a card, with little to no background check, and to do with it as they please, including in some cases using it outside of the country, as well as allowing others to access it. The latest BDL figures show a 7.1 percent increase in the number of prepaid and charge cards in Lebanon since 2009.

Dangerous bedfellows

With Washington keen to crack down on banks dealing with designated terrorist organizations and countries under US and international sanctions, Lebanese banks are exposed — like LCB was — to risk when dealing in financial transactions with America’s enemies: notably Hezbollah, Iran and Syria.

With the US intent on freezing transactions that go via or into the US from such parties, Lebanese banks, subsidiaries and affiliates face hazards. For example, the state-owned Commercial Bank of Syria (CBS) is on the US blacklist, a potential concern for Lebanese banks dealing with CBS; risks also exist for Lebanese banks simply operating in Syria, as well as Lebanese interacting with Iranian banks, such as Saderat and Melli. Bank Saderat, which was blacklisted by the US Treasury for providing funds for Hezbollah and Hamas, has branches in Lebanon.

Such risk exposure is not to be taken lightly — LCB executives can surely attest to the potential repercussions. In the case of British bank LloydsTSB, it was fined $350 million by a New York court in 2009 for transferring funds in a manner that contravened US sanctions, on behalf of clients in Sudan and Iran, including for Bank Saderat.

“The US Treasury can do anything they want. We’re helpless here and need to be very careful. Everyday banks, even US banks, get fined,” said the CO. “The SIC should do the same and give fines,” he added.

The politics

Evidence from the investigation justifying LCB’s designation as a primary money laundering concern has yet to materialize, let alone justify the hasty arrangements made between BDL and the US treasury. “So far, we have not found the links they are talking about, whether about the bank itself or about Joumaa,” one investigator close to the case told Executive.

US reports on money laundering in Lebanon mostly focus on drug trafficking and conflict diamond trade involving Lebanese abroad, often heightening concerns on illicit proceeds financing terrorism. As far as the US government is concerned, any money wired to Hezbollah supporters in Lebanon falls under the umbrella of terrorism financing, as was the case when Lebanese kingpin Chekry Harb’s cocaine ring was believed to be bankrolling Hezbollah. So seems to be the case with nearly every exposed drug trafficking ring the Lebanese have been involved with.

This poses a dilemma for Lebanese banks, as Hezbollah, despite the controversy, is recognized as a legitimate political party and resistance force by the Lebanese government. The US has denied any political agenda in the decision to designate LCB. The fact that it was announced exactly one month following the dissolution of the cabinet and the appointment of Hezbollah-backed prime minister-designate Najib Miqati, however, is seen by many of those who spoke with Executive as a clear message to Lebanon.

Given the apparent vulnerabilities of Lebanese banks, and the paltry standard for evidence the US Treasury showed it required to bring the hammer down on LCB, should the US decide to scrutinize more of Lebanon’s banks in the months to come there would almost certainly be more institutional casualties.

On the other hand, according to the global banking expert, “If no other banks are targeted, it means that LCB’s was a warning. No more, no less.”

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