Economics & Policy

2010 MENA World Economic Forum

by Sami Halabi
written by Sami Halabi

 

From October 26 to 28 leaders and decision makers from around the Middle East and North Africa will descend on Marrakech for the 2010 World Economic Forum (WEF) on the MENA. The theme of the conference is “Purpose, Resilience and Prosperity.” To get an idea of what will be on the agenda; Executive had a chat with the World Economic Forum’s Middle East and North Africa Senior Director Sherif el-Diwany to get his insights on the issues affecting regional development.

E  The WEF Competitiveness Index shows wide disparities between oil producing nations and non-oil producing nations in the Middle East. What is the root of this problem and can the difference ever be made up as long as oil continues to provide the bulk of the region’s wealth?

One has to point out the fact that the Gulf states — but not all oil rich countries because you have Libya and Algeria at a different level — have actually gone through two booms and busts before, in the 1970s to 1980s and the recent crisis. The final one was an indication that the second time around they learned the lessons better than the first time. As a result of that, when we looked at the various indices such as infrastructure, healthcare and productivity, quite substantial investments have been made in these improvements, which brings them up the ladder of the index. Some countries that had been ahead in the region because of human resources costs,  like Egypt, have made a number of tight adjustments over the past couple of years which have brought them, not exactly in line with global [labor] prices, but relatively higher than it used to be five or 10 years ago. This means that if there is no commensurate or simultaneous increase in productivity — which comes from education — to match the increase in the costs of labor, then obviously competitiveness suffers and this was the case in some of the countries. Education seems to be the most powerful explanatory variable in where countries stand in the Arab world on the competitiveness index.

E  Do you think oil producing nations are willing to diversify away from oil as much as Dubai has, or do you think it is too important for them as a percentage of GDP?

There is not one single country in the Gulf that will not confirm to you or to me that diversification is an important strategic objective for them for the next five years, a decade, or more. The challenge is how do you realize that? The markets now have become so global and you have new players that have enormous weight in the global economy, size-wise and also in terms of productivity and quality. To be able to diversify an economy you must look at yourself within a global perspective and [find out] what lever you have to pull to bring you into the global market where you can compete.

Diversification also cannot be geared toward the domestic market; it has to be geared toward the global market. Abu Dhabi is trying to position itself in technology, but if you ask me it is a long shot. It is quite an interesting strategy when you use the capital you have and make strategic acquisitions around the world and you own important players in the global market with the understanding that this creates a diversified economy.

How do you actually imagine that this investment will come back to the national GDP? In a way that this will offset the bias toward oil as a share of domestic economy? It is not clear yet and one thing I was told when I asked this question is that you will have a home to the managerial and technological talent that will then shape the future of the industry and become a knowledge-based economy; it makes perfect sense. But how do you attract those people to your country, how much innovation or research capacity can you have in the country? Not every country can have this, and not any single player in the world actually has a monopoly on such capacities — they have some of it and they integrate with others around the world.

It remains to be seen if the United Arab Emirates can link itself globally, to leverage itself using strategic investments but it’s a very important story to watch.

E  The Gulf Cooperation Council has once again failed to impose common measures on customs and a monetary union looks as unlikely as ever. Do you think the MENA should now look to bilateral agreements instead of multilateral ones and be realistic about it?

It is imperative that the Gulf states’ regional integration plan be realized at some point — the sooner the better. Given what you just described: the obstacles, the delays, the unexpected disagreements by certain countries on how they want to move forward on a monetary union and movement of goods, it may take time.

To look at history internationally and to learn how such building of regional integration took place, then one obviously points to Europe. The two heavyweights of Europe, Germany and France, were the beginning of the… union as it is today. If this scenario takes place in the Gulf states, one can imagine an alliance between, for example, Abu Dhabi and Riyadh, where this becomes the anchor of the future GCC union when it comes around. Obviously, this will have to be done with the explicit intention that this is a point of departure to then open up to others, who will come on board and proactively seek the enlargement of this nucleus bilateral agreement. I think it is an important way to consider seriously as an alternative for this current, extended, non-fruition of the union.

E  What is the effectiveness of the WEF conference beyond being a networking site for the rich and powerful?

The next stage of development and reform has to be ‘multi-stakeholder.’ This is where the WEF comes in because we have members from the region and all over the world that have a certain approach to their business model and strategies, within the framework of enlightened self interest through helping governments, media, labor unions and all players in the game to improve and understand their point of view, while doing the same themselves.

During the crisis we had the highest attendance ever of government and business leaders in Davos because every single decision maker from every part of the world, who knows what is happening to the world, wants to know who is thinking what.

All these players have leaders — those leaders and institutions have a certain philosophy and approach. So if you and I do not know how we are going to react to the problem, the chances are that we will both take longer to get out of it than if we can align and calibrate.

E  There have been piecemeal efforts to address the issue of corruption and governance in the region through the UN and some regional parliamentary-based groups but little on the ground has changed. Do you think this is possible to address as long as most Arab countries remain autocratic or don’t have a broad-based inclusive approach to their residents?

The most important country in the Arab world that can actually set the pace of progress on that particular point is Saudi Arabia. There is explicit attention and outreach to those segments of the Saudi society excluded in one way or another, either by mistake or bad design, in the development process of the last three or four decades. There are also very significant developments on the status of women. You can see in Saudi Arabia that the current king is giving this issue a healthy degree of attention and navigating through the cultural sensitivities and the social consensus in terms of how things should be done to push it in the right direction.

The consensus in a society that is pointing toward women being unequal or denied certain rights or access to certain privileges, such as protection and opportunity in terms of economic development, is different than a society that is actually empowering their entire population and providing equal opportunities for progress, education and self fulfillment of women and men on equal footing. The type of leadership in that society is different than one where this does not exist.

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Economics & Policy

Breaking ground

by Ahmed Moor
written by Ahmed Moor

Blame for missing the submission deadline for the 2010 budget is still being tossed around between the finance ministry and the opposition. To avoid a similar situation next year, Finance Minister Rayya Hassan last month made good on a promise to put forward the 2011 budget for cabinet’s submission to Parliament in October ahead of the constitutional deadline, something she considers “a major achievement.”

The 2011 budget grew out of many of the assumptions and data used for the 2010 submission.  It also includes targets for countrywide development plans and total deficit reduction, with the overriding objectives being development of core infrastructure to boost economic growth; increased access to, and quality of, social services, education and healthcare; identifying and honoring all payments in arrears; increased tax efficiency; strengthened security; and, in the absence of actual debt reduction, controlling the debt-to-GDP growth rate and reducing the deficit. 

In a first for Lebanon’s post war annual budgets, debt servicing will fall from 23.4 percent of the total budget in 2011 to 20.6 percent in 2013. Figures released by the ministry predict that debt servicing in 2011 will be $3.851 billion, down from $4.067 billion in 2010.  

The total 2011 budget size is $13.182 billion, up from $13.025 billion in 2010. Government revenue is expected to rise from $8.587 billion in 2010 to $9.574 billion in 2011.  Correspondingly, the deficit will shrink from $4.439 billion in 2010 to $3.608 billion in 2011 (a reduction of 19 percent), if the underlying budgetary assumptions hold. 

The 2011 budget also carries provisions for building a new 700 megawatt gas-powered electricity generation plant. Notably, there will be no increase in the value-added tax even though Hassan had previously hinted that she would impose one in the 2011 budget. As an alternative, a more efficient tax collection regime is being developed to capture lost revenue. Moreover, the ministry will enact a 1 percent increase in capital gains tax while imposing a 5 percent one-time tax on fixed-asset and real estate revaluations conducted by companies. Furthermore, penalties on taxes and fees will be reduced by 90 percent to encourage the payment of taxes in arrears. 

The budget was submitted to the cabinet on September 23 where it was debated and its discussion postponed until the next cabinet session. The following day, Charbel Nahas, minister of telecommunications and an economist in the opposition, held a press conference where he criticized the government’s financial strategy in the period after the onset of the global financial crisis, citing an increasing primary surplus due to growing revenues from taxes and capital inflows but no tangible difference in the management of public finances. 

“When the government debates the budget it cannot act like this is not happening,” said Nahas, adding that a planned increase in capital gains tax should be foregone in favor of a tax on real estate profits to bring in $99.5 million dollars per year, as well as an increase in the tax on deposits in banks, something that the finance minister also proposed in the 2010 budget.

 
Editor’s note: Text replaced Oct 27, 2010, 8:44 pm

 

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Economics & Policy

Propping up the State

by Sami Halabi
written by Sami Halabi

During the civil war, when the residents of Lebanon would give directions, they could always rely on one landmark from which to guide visitors to their homes — the mountain of garbage that had built up in each neighborhood over the years of violence and absence of a functioning state. Today those mountains may be gone, but other remnants of those terrible years are still as pungent as the stench of rotting trash.

After the war ended, Lebanon’s public institutions were literally in a shambles. “We used to go to general directors of ministries and they would say to us, ‘before you talk to me about computers there is the window that needs fixing because the employees are freezing’,” says Nasser Israoui, project manager of United Nations Development Program (UNDP) at the Office of the Minister of State for Administrative Reform (OMSAR). 

Recognizing the dire need for reform, in 1992 an agreement was made between the Government of Lebanon and the UNDP to begin a joint partnership at the finance ministry, aimed at reforming the institution. The agreement was the start of what became known as the ‘UNDP program.’

As Executive went to press the program consisted of 67 projects, and is now influential across ministries and public administrations throughout Lebanon. Their activities range from clearing mines to drafting laws, effectively creating “a different executive arm that could provide policy formulation as well as policy implementation in key ministries,” says Hassan Krayem, policy specialist and portfolio manager of the governance program at the UNDP.

The expansion of the projects began at the Office of the Minister for Administrative Reform (OMSAR), which itself was created as a result of a needs assessment study of public administrations carried out in the mid-1990s by the Lebanese government with money from various donors.

At the time, in order to channel donor money for reforms, a UNDP unit was established at OMSAR. “It was supposed to play the role of a catalyst; this was the plan,” says Israoui, who doubles as the director of the technical cooperation unit at OMSAR. “Unfortunately, this did not take place.”

Ffat and dysfunctional government

Since the UNDP unit which today comprises around 40 percent of OMSAR’s staff — was created, the organizational structures at most ministries have not been made more efficient. Of the 18 new organizational structures proposed to ministries by OMSAR, only the environment and sports ministries have implemented them.

 

The problem is that OMSAR has tiny teeth, if any. Unlike the other ministries, it was not created by any law but exists only as a legal entity through a vote of confidence it received from parliament and the budget it receives from the finance ministry. It cannot impose reform policies on public administrations nor can it, for instance, actually enter into ministries to review staff performance and then recommend they be promoted or fired. The only way OMSAR can effectively push through reform is if the minister, currently Hezbollah Member of Parliament Mohamad Fneish, takes the case to the cabinet that then, with a two-thirds majority, can impose reform on public institutions. That scenario has yet to occur.

Without new organizational structures, ministries are subject to the haphazard dictates of whichever minister happens to be on the top of the pyramid — and there have been many, given the amount of times the cabinet has been reshuffled since the civil war. What this also means is that a review of salary structures is impossible, which has been identified by every person Executive interviewed for this article as one of, if not the largest, hurdle to civil service reform.

The lack of a proper organizational structure has also resulted in a bizarre situation in which ministries are bloated and over-staffed and yet, at the same time, chronically understaffed in key positions, and therefore they cannot fulfill the basic functions of their mandate. This does not look to be changing anytime soon because of the government’s apparent, yet unwritten, policy of halting new hires in public administration, with the exception of the security services and the army.

“You know that further employment is [essentially] not allowed,” says Israoui. “There is some but it is limited.”

According to a source at the UNDP who spoke on condition of anonymity, in the Lebanese civil service there are three levels of employees: those within the organizational structure, contracted employees and temporary workers. The first two categories are subject to the authority of the Civil Service Board (CSB), which regulates public sector employment and is independent of any ministry, including the labor ministry, but reports to the prime minister’s office. The temps, however, are not regulated by the CSB and are appointed by the ministry.

The issue is that, more often than not, the number of contractual workers and temps exceeds those required by the departments.  This, in effect, results in staff employed at the ministries and in public administration without a position, receiving salaries paid for by the people who in turn suffer from inefficient public services.

It’s an open secret that these ‘workers’ — many of whom do not do the jobs they were hired for — are often little more than political appointments, turning civil service bodies into patronage departments. For instance, the latest plan to reform the electricity sector in Lebanon noted that Electricité du Liban, the state-owned electricity company, “employs around 2,000 contractual and daily workers, many of whom are political appointees and unqualified workers.”

“If you want to recruit an effective team that can implement reforms, new policies and can speed up the delivery of services and so on… in the structure of the current state you need civil service reform, a new salary scale, new ethics and probably it will take years,” says Krayem with a half sigh.

Karim Makdisi, associate director of the Issam Fares Institute for Public Policy (IFI) and assistant professor of political science at the American University of Beirut, suggests that Lebanon’s political class needs to be pragmatic about getting rid of the ineffectual workers they themselves hired.

“Between yourselves,” he says, as if speaking to the political patrons, “pay these guys off in a lump sum. If someone has been in a ministry for 10 years and was a political appointment, and they are not coming to the office, either fire them or figure it out.”

“It’s more than patronage; its control, its power,” Makdisi adds. “If you are [Prime Minister Saad] Hariri or [Parliamentary Speaker Nabih] Berri you come and you say ‘when you work for me, in or out of government, you are my guy, you are not a Lebanese government employee.’ As long as you have that mentality, all the reform business is nonsensical.”

The other civil service

Until the government gets its act together, the UNDP projects are continuing to do much of its work. The stated purpose of the projects is to fill specific gaps at the various ministries and public administrations, build their capacities, then pull out and let the government bodies do the work themselves. As yet they have not had the opportunity to pull out, effectively creating a counter-bureaucracy that circumvents the malfunctioning public institutions.

“We try to make sure that what we are providing [in terms of staff] is not available and could not be available because of the lack of civil service reform and the salary scale,” says Krayem, adding that “99 percent” of their staff is Lebanese, unlike most countries the UNDP works in. Though not universally true, UNDP staff tend to meet the qualifications of the high-level advisory positions they fill, and demand corresponding salaries. 

As part of some of its projects, the UNDP ends up providing basic services to the public instead of the ministries or municipalities doing so. In collaboration with the Council for Development and Reconstruction (CDR), headed by current Future Movement MP Samir el-Jisr, (which itself does much of the work the public works ministry should be responsible for), the UNDP has commissioned pavement repairs, purchased septic trucks, built storm water conduits and rehabilitated public parks.

According to the IFI’s Makdisi, when Rafiq Hariri came to power in the early 1990s he “consciously” created a counter-bureaucracy with teams of advisors and quasi-government institutions including the CDR and Solidere, to circumvent the inefficient and patronage-based state structure, but also to consolidate power.

“The logic at the time was too much red tape and too much Syrian influence and ‘I’m a businessman and just want to do my thing’. What happened over time is they replaced these teams with UNDP,” he says. “The creation of counter-bureaucracies has its logic up to a point. The problem is that at best, you are talking about a transitory period within which you are training your people so that they can take over within a plan. Those of us who cared to know at the time knew that it was not going to happen, and it didn’t.” The CDR was not available for comment.

“These UNDP projects have been criticized many times as parallel administrations,” says Mazen Hanna, economic adviser to the prime minister, who did not reject the idea outright but suggested that such criticism is politically motivated rather than rooted in actual opposition to the UNDP projects. “Most of the ministers that criticized UNDP projects did not criticize them when they became ministers. In the absence of a civil service reform overhaul the need for UNDP projects will always remain.”

Some of the projects that are ongoing are partnered with opposition ministers, but many — if not all — of the project documents are missing the opposition minister’s signature. This was the case with the “Country Energy Efficiency and Renewable Energy Demonstration Project for the Recovery of Lebanon” (CEDRO), that would in theory be signed by the opposition energy minister, but instead carries the signatures of only the UNDP and the CDR. In this case, the energy ministry is categorized under “other partners.”

What’s more, the financial scales are heavily tipped toward the projects in the ministries controlled by the ministers from the parliamentary majority, as well as the CDR. The most expensive project the UNDP carries out is at the finance ministry and is budgeted at $18.5 million, followed by a project aimed at increasing decentralization and strengthening strategic partnerships between municipalities of the North and the South, budgeted at $11 million through CDR, with another project at the Ministry of Economics and Trade rounding out the top three at $8.7 million.

How the deal works

Today, in order to start a UNDP program in a public administration, an agreement has to be made between the UNDP and the public body on what is to be done, how long the project will take, and who will pay for it. Depending on the public institution, the project must “reflect the policy of the national coordinator who is either the minister or eventually the CDR,” says Samir Nahas, senior economist at the UNDP project in the office of the prime minister.

Funding for projects comes from three sources: the government, international donors, and the UNDP itself. The amount of money spent has seen exponential growth, increasing by 4.6 times since 2004 and last year reaching $39.1 million. Of late the lion’s share of the money spent has come from “international donors,” who contributed $34.3 million last year.

The UNDP’s breakdown of the money individual government bodies have “committed” to projects since 2004 shows the Ministry of Finance has spent $20.50 million, the Ministry of Telecoms has spent $5.9 million, the Office of the Prime Minister spent some $3.1 million, CDR has $1.8 million, and the Ministry of Agriculture $100,000, totaling $31.4 million. But separate UNDP data for government contributions since 2004 pegs it at $27.7 million — a discrepancy of $3.7 million.

The reason for this, Krayem explains, is that much of the funding from ministries and government bodies comes through a maze of separate bilateral agreements with donors that are then funneled to the UNDP programs. Hence, figuring out how much the government is allocating from the national budget is nearly impossible to do without going into the books of every ministry to find out where all their donor money is coming from and going to.

Still, a closer look at the donor list reveals a strong connection between some UNDP projects and the prime minister’s private business interests. Solidere, for example, contributed $120,000 to the UNDP this year. Krayem explains that the money was an in-kind contribution for an environmental campaign, and as such insists that there is no conflict of interest. The “Institutional Support to the Ministry of Environment,” project began this year under Future Movement Minister Mohamad Rahal.

“Political affiliation is none of our business; we work with Berri or Hariri,” says Krayem who stressed that the UNDP is “apolitical, but not naive.”

…but for how long?

Politics aside, there is little doubt that Lebanon has benefited greatly from the expansion of UNDP projects. At the moment many of the projects are being evaluated to see whether they will be renewed, extended, changed or discarded at the end of the year. The projects include those at the finance ministry, the Ministry of Economics and Trade, poverty reduction at the ministry of social affairs, support to mine affected communities, support to the Lebanese parliament, strengthening the electoral process in Lebanon, and improving the performance of the justice ministry, among others.

While Hanna says it is unlikely UNDP projects will ever become larger than their affiliated public institutions, he believes that they will continue to grow at the same pace they have since 2004. Krayem disagrees, noting that thanks to the country’s economic growth and increasing per capita income, Lebanon could soon graduate to the UN designation of ‘net contributing country’ (NCC), which would make it ineligible for certain levels of developmental support. The UN press office in New York, however, said Lebanon’s case was “far from decided.”

“The argument has been made and sold to the UN that the developmental needs of Lebanon are not affected by the GDP growth because there are imbalances such as regional imbalances and so on,” says Hanna. Makdisi also agrees that the transition to NCC will have no effect. “We have a class of political elite who are very adept at building royal palaces and begging for money from abroad,” he quips.

Conditional love

“The problem is that the system is malignant and the UNDP are doing the minimum to keep it afloat and give it a certain respectability,” says Makdisi. Hanna adds: “You have this patient [Lebanon’s civil service], thank god you have this doctor because without this doctor this patient will die.” 

One way to force the issue forward would be for the UNDP to offer further assistance on a conditional basis, but Nahas says it is not the UNDP’s job to impose reform on the government. “We cannot intervene if there is a director general or a staff that is not performing, this is their duty,” Krayem adds.

Without that reform the ministries and public administration bodies continue to work without a system to measure their output or effectiveness. Only the environment ministry and the public works ministry have taken on pilot programs to implement systems similar to the Key Performance Indicators used by the UNDP.

Ministries also do not have human resources (HR) departments, although a law has been proposed by OMSAR to implement HR departments in all ministries. As such, the only way that their performance can be evaluated is by the various ministers and heads of administrations. This runs contrary to the constitutional principle of administrative decentralization enshrined in the Taef Accord.

More fundamentally, what the Taef Accords also proposed was the implementation of a process to abolish political sectarianism. This has yet to happen and the ongoing sectarian division of the government hampers the creation of open, effective governing bodies.

“As long as I have Shia, Maronite, Sunni, Greek Orthodox and all the politicians and their interests, that’s it — you have a system that is essentially dysfunctional,” says Krayem. “You cannot imagine that your children will live in this system. But this is what I thought when I was young and I’m sure my father thought the same when he was young too.” 

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Economics & Policy

Profits over principles

by Sami Halabi
written by Sami Halabi

 

Summer in the Middle East is typically a time when life slows down;  business deals are put off until everyone has finished their vacations and the weather has cooled off. So in August when Credit Suisse issued a statement that it was embarking on a $1 billion-plus fund “with a small group of Credit Suisse’s key shareholders,” it perhaps thought that no one would notice.

Not so. Almost immediately the Israeli press picked up on the announcement and began to report that the Jewish state’s economic prowess had once again managed to circumvent the Arab boycott. The reason being that Credit Suisse’s largest shareholders are the Qatari government’s sovereign wealth fund, the Qatar Investment Authority (QIA) and the Saudi Olayan Group, who own 8.9 percent and 6.6 percent of Credit Suisse respectively, alongside Koor Industries (3.24 percent owners) — part of influential Israeli businessman Nochi Dankner’s empire.

Then it was the Western press’ turn to jump on the bandwagon with Reuters reporting that Koor’s parent company, Dankner’s IDB Group, would put up $250 million through its subsidiaries Koor and Cal Insurance — each contributing $125 million — to be matched by an equal contributions from “Credit Suisse and two of the bank’s largest shareholders.”

A sensitive issue

The QIA and the Olayan Group did not respond to Executive’s repeated requests for comment, while Credit Suisse said that they “don’t disclose or comment on the parties.” The query apparently raised some eyebrows, as several days after the request was made Executive was contacted by Credit Suisse’s Middle Eastern Public Relations contractor to confirm if it intended to cover the story.

“At a time when Israel is not exactly popular around the world, particularly the Arab world, the agreement by two large investment companies from the Gulf states to cooperate with an Israeli group is no trivial matter. It can even be assumed that they will come under fire for it,” wrote Israeli columnist Irit Avissar in business newspaper Globes on the day the announcement was made. “For the Saudis this is less worrying. There it’s a matter of a private body that can always use the Qatar government as a fig leaf for the approval of an investment alongside an Israeli company. The participation of Qatar, however, has real significance, because that is a matter of a sovereign fund of a very rich and important Arab country.”

The fact that the announcement came at a time when Israel and the Palestinian Authority were debating whether to re-engage in direct peace negotiations has prompted some to suggest that the impetus for the deal was a political sweetener for the Israeli’s via the Qataris.  “[Qatar’s] role in the peace process is to lubricate and the only thing they have to lubricate with is money and increasing normalization by trying to incentivize the Israelis,” said Karim Makdisi, professor of political studies and associate director of the Issam Fares Institute for Public Policy at the American University of Beirut. “It’s like a woman lifting her skirt and showing you her leg saying: ‘Come on board, and you are going to get a lot of pleasure out of this.’”

It is difficult to gauge whether the move is in line with the QIA’s previous investment strategy because, given that the fund is considered one of the world’s less transparent SWFs, few people are really sure what that strategy is. According to the Linaburg-Maduell Transparency Index developed by the United States-based think tank the Sovereign Wealth Fund Institute, the QIA features on the lower half of the index with a score of 5 out of 10.

“The exact execution of the investment strategy of the QIA is very opaque,” said Sven Behrendt, Associate Scholar at the Carnegie Middle East Center. “There is no information about the strategic asset allocation, like other SWFs publish. Therefore one can only refer to anecdotal evidence.”

Profits over politics

According to Ashby Monk, co-director of the Oxford SWF Project, what that anecdotal evidence suggests is that pure economics rather than political considerations were the impetus for the deal. “I think the QIA saw a unique and compelling investment opportunity, and they took it,” he said. “I really doubt that the QIA is being used as a pawn in some sort of financial diplomacy.”

Monk explained that because the QIA, Olayan and IDB are all major stakeholders in Credit Suisse, it would most likely mean they received better terms and will sit on any investment committee that will make decisions regarding where to place capital.

That would mean that representatives of a Qatari state-owned agency, a Saudi company (albeit based in Greece), and representatives of an Israeli conglomerate will be sitting around the same table mulling investments. It’s not hard to imagine this not going over well with the Arab public, given the ongoing occupation of Palestinian lands.

At the same time, a number of non-Arab SWFs, such as the Norwegian Government Pension Fund, have excluded Israeli companies from their portfolios in response to their actions in the occupied territories.

“What is ironic is that you have an increasingly active global society that is just beginning [to boycott the occupation],” said Makdisi. “This [deal] is the opposite. The Arabs are saying to the Israelis: ‘Come join us in the middle and we will be your main markets, your main buyers of technology and at the same time we will have a common initiative to fight terrorism and the whole Iran/Hezbollah/Shia issue.’”

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Finance

Executive insight – Warring bankers line up on Basel III battle lines

by Fabio Scacciavillani
written by Fabio Scacciavillani

More than three years after the start of the financial crisis and two years after the default of Lehman Brothers, the world economy is still struggling to climb back from the depth of the latest Great Recession.

The summer of 2010 has seen probably the quickest recovery pace since late 2008, thanks to the rebound in manufacturing, the resilience of China (and other Asian economies) and the fiscal stimuli enacted in early 2009, but the forecasts for the rest of the year are less upbeat.

One of the areas of major concern is the state of the banking sector. Until recently, the measures to tackle the aftermath of the crisis have been limited to unprecedented injections of money by taxpayers and liquidity from central banks (which also comes from taxpayers, just under a different heading).

Despite this, plans to revamp prudential regulations and buttress the pillars of the world’s financial architecture had remained on the drawing board. But on September 12, the Group of Governors and Heads of Supervision — the oversight body of the Basel Committee on Banking Supervision in charge of establishing the framework of international financial regulations — achieved a major breakthrough in a long and thorny negotiation round, announcing a substantial increase in banks’ capital requirements, even above the levels preliminarily agreed to in July.

The announcement was cheered by markets as quite positive for financial stocks, especially those banks seen as well capitalized, not least because the reforms will not be introduced immediately. In fact, the implementation by member countries of the Bank of International Settlements (BIS) is due to start on January 1, 2013, although national laws and regulations must be in place before that date, and the minimum common equity and tier 1 capital requirements will be phased in gradually between January 2013 and January 2015. All in all, that is more than five years of transition, a horizon hardly in line with the bombastic rhetoric on swift and draconian actions heard from politicians and regulators after the quasi meltdown of the international financial system and the trillions of dollars spent to rescue major banks.

Buffer boost

The BIS reforms will increase the minimum common equity from 2 to 4.5 percent of the banks’ risk-weighted assets (RWA). In addition, banks will be required to hold a capital conservation buffer of 2.5 percent to withstand potential losses during periods of stress, bringing the total common equity requirements to 7 percent. Tier 1 capital (i.e. including liquid financial instruments) will be increased from 4 to 6 percent of RWA (hence to 8.5 percent if one includes the conservation buffer) while total capital will reach 8.5 percent of RWA (or 10.5 percent with the buffer).

Although compliance with these ratios is due by 2015, in January 2013 the process will start with new mandatory minimum requirement ratios: 3.5 percent common equity/RWA; 4.5 percent tier 1 capital/RWA, and 8.0 percent total capital/RWA.

While banks will be able to use the conservation buffer during downturns, as their regulatory capital ratios approach the lower threshold, their dividend payments will be increasingly restricted. An additional countercyclical buffer up to 2.5 percent of common equity or other fully loss-absorbing capital (for example convertible bonds) will be left to the discretion of national authorities.

The purpose of the countercyclical buffer is to underpin macro-prudential stability, because risk piles up during booms, but materializes during recessions — hence the need to devise a mechanism for reining in the banking sector’s excessive credit growth in good times and sustain lending to the enterprises during bad times. Finally, systemically important banks will be subject to stricter loss-absorbing capacity beyond the standards announced, but specific measures are still being debated and were undergoing a consultative process as Executive went to print.

A sense of déjà vu

The new regulatory framework is certainly a step in the right direction, although given the harsh lessons from the crisis it could have been more ambitious. One can be forgiven for suspecting that the boost to banks’ shares was not only a sign of relief for the delayed implementation of the new prudential parameters, but also an acknowledgement that the new rules are not as strict as feared by bank executives. Nevertheless, it is likely that national authorities will go beyond the BIS standards (which set merely a minimum common criterion), especially in Europe.

Rather than being the final word, the agreement reached at the Basel Committee on Banking Supervision represents merely the initial salvo in a battle that will be fought on many fronts: accounting rules for financial instruments, definition of risk weights, powers of inspection by supervisors, countercyclical buffers and so on. Unfortunately there is never a simple receipt for ensuring the stability of financial institutions.

It is a recurrent problem and it dates back to the dawn of modern finance (and arguably earlier). For example, the Austrian economist Ludwig von Mises, writing in 1928 about the monetary policy of the Bank of England during the 19th century, observed:

“It was usually considered especially important to shield the banks that expanded circulation credit from the consequences of their conduct. One of the chief tasks of the central banks of issue was to jump into this breach. It was also considered the duty of those other banks that, thanks to foresight, had succeeded in preserving their solvency, even in the general crisis, to help fellow banks in difficulty.”

Some 10 years later, Von Mises’ colleague and friend Friedrich von Hayek  commenting on the Peel Act, a law forbidding the extension of bank credit in England through banknotes (but not through deposits), observed that each time there was a financial crisis the Peel Act was suspended. From these episodes he drew a damning conclusion:

“The fundamental dilemma of all central banking policy has hardly ever been really faced: the only effective means by which a central bank can control an expansion of the generally used media of circulation is by making it clear in advance that it will not provide the cash (in the narrower sense) which will be required in consequence of such expansion, but at the same time it is recognized as the paramount duty of a central bank to provide that cash once the expansion of bank deposits has actually occurred and the public begins to demand that they should be converted into notes or gold.”

Does it sound familiar? It should, because it is exactly what happened in the aftermath of the financial tsunami in the fall of 2008 and is still happening today with quantitative easing and other creative ways of describing money printing by central banks.

Indeed, like the Peel Act, the articles of the Amsterdam Treaty forbidding the European Central Bank to monetize the public and private debts have been suspended (or thrown to the bushes). Hence, it is not surprising that the gold price is setting new records.

 

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Finance

Healthy growth or a warped market?

by Emma Cosgrove
written by Emma Cosgrove

Buildings go up and banks earn profits; it’s a simple fact of life in any reasonably functioning economy. Both the banking and the real estate industries would most probably prefer the public not see exactly how those two things go together. Some, such as Fadlo Choueiri, head of corporate finance and economic research at Credit Libanais, argue that the link is limited. “The way things differ between Lebanon and the region and the United States when we are talking about real estate development is that new real estate projects are not financed though banks,” he said.

Relative to other markets, this is partially true. Banque du Liban (BDL), Lebanon’s central bank, limits commercial bank financing available to real estate developers to a greater extent than other central banks, and property purchases are often equity financed. For incentivized Lebanese lira lending, only 60 percent of the value of the land may be loaned, according to Antoine Chamoun, general manager of Bank of Beirut Invest. Dollar lending is not capped, though Chamoun insists that 100 percent financing is never given.

However, what a developer may build on top of that land can be financed as much as the banks deem appropriate, based on cash flow analysis, which often includes a high dependence on off-plan sales.  The truth is that the real estate sector is a big part of the Lebanese economy and is therefore a driving force behind the banking sector.

“It is not true that developers are not leveraged,” said Nassib Ghobril, head of economic research at Byblos Bank. “Some of them are using their money; some of them are using part of their money. They do have loans from banks. It doesn’t mean that they are overleveraged, but it doesn’t mean that they are leverage free.”

Since banks’ published balance sheets are not broken down far enough to find out, Executive set out to go beyond the rhetoric and find out the real extent of real estate lending — a difficult task when the financial power players are trying their best to ride out the wave of the real estate boom for as long as possible.

“There are banks who directly have real estate affiliates who are building and directing projects. So what do you expect them to say? Everything is rosy, everything is nice… you end up living in a fantasy land,” said Ghobril.

According to a sector breakdown of aggregate bank lending provided by BDL, when all relevant cogs of the real estate machine are combined, the total comes to about 36 percent of the banks’ private sector loan portfolio. This is a significant amount and a much higher portion than many bankers have said publicly in the past. And so with a significant amount of bank lending tied up in an industry that has proven to be a ticking time bomb in other parts of the world, it is essential to understand where Lebanon’s real estate market is going and how the banks could be affected.

Market Adjustment

In a market like Lebanon’s where lending to the private sector is relatively low, credit conscientiously provided can be a positive force for economic growth. But one man’s growth is another’s exposure, and the real estate market in Lebanon is not what it was a year ago. Prices have increased 250 percent since 2005 due to what Ghobril says is a combination of positive forces that is unlikely to ever come together again. Political stability, rampant speculation between 2007 and 2008, strong expat demand and market crashes elsewhere in the region have made for seemingly insatiable demand in the last three years.  But “the pace of demand has slowed already and everybody is talking about it,” said Choueiri. Large luxury apartments have become so expensive that experts say developers will need to adjust their plans in order to stay on top of market trends.

“For developers who are looking to pursue their operations and their developments as if nothing has happened, this is a risky endeavor,” Choueiri added. After such astronomical price growth in only a few years, Lebanon is at a potentially precarious point and is less of a failsafe investment than it used to be.

“You no longer have this gap where the market here is undervalued and attractive compared to the rest of the region or the world,” said Ghobril. “In fact if you look at the actual indicators of the sector, the gross rental yield, the price to rent ratios, you see that valuation of apartments in Beirut have become higher than the rest of the region.”

According to The Economist, for a 120 square meter apartment gross rental yield has declined to reach about 4 percent, while the price to rent ratio — the number of years you need to rent an apartment to recover the cost you bought it at — for an apartment that size is currently 24 years, the highest in the region.

Further, Ghobril says that the indicators that do exist in Lebanon are insufficient and often misleading. For example, the number of construction permits issued is often used as an indicator of sector health, but the number of permits cancelled is not published.

He adds that Lebanon’s real estate market cannot be properly assessed without statistics such as the time it takes to sell an apartment, population growth and round trip costs for the person investing and divesting.

Fuel to the flames

In an effort to soak up excess local currency liquidity and spur lending, BDL lifted reserve requirements on loans for primary housing in June 2009 and has extended the incentive until June of 2011. This is where the two sectors become incontrovertibly tied. At first glance, the measure appears to be a success. Housing loans reached $3.1 billion at the end of March, increasing by $750 million since the introduction of the circular.

But there is growing disagreement as to whether the measure was a prudent one in the first place, though it has obviously achieved its objectives. The difference in opinion seems to be based on a preference for short or long-term thinking.  The circular allowed banks to drop mortgage rates to new lows, with most hovering around 5 percent and some currently available below 4 percent for the first year. At rates this low, if inflation is factored in, the interest effectively disappears.

Bank of Beirut’s Chamoun says that the popularity of these loans is evidence of growing rather than fading demand.

“The number of demands [for loans] and loans granted since 2000 has been always increasing… that means demand is still going up,” said Chamoun.

But the availability of financing is one of the many factors pushing prices up. This is not a problem as long as the facility is still available and cheap mortgages abound. But if and when the facility ends, and banks are forced to raise their rates, Lebanon will be left with expensive mortgages and expensive property. And this is where the disagreement comes in. 

Chamoun says that the good the facility has done for ordinary Lebanese citizens outweighs the future risk.  “It’s better for me to be able to buy an apartment even with a higher price than not to have the possibility to buy any apartment,” he says.  But Ghobril is more wary. As Chamoun admits, “prices are going by [the elevator] and our income is taking the stairs.” This, Ghobril says, is why after the circular expires in July 2011, it should not be extended.

So, we’re left with rising prices and an ever-growing dependence of banks on real estate market-dependent revenue. This is not to say that Lebanon is headed toward anything close to a Dubai-style bust. Only time will tell whether prices will retain their lofty position, as most believe. But this summer has shown that real estate in Lebanon, and especially Beirut, cannot keep climbing in value and sales forever. As gravity kicks in it is important to understand not only the forces at work in the real estate sector, but also how they can affect the keepers of our cash.  

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Dark days are upon us

by Paul Cochrane
written by Paul Cochrane

It’s been a long hot summer. Temperatures hit all-time highs and Ramadan demand put power grids under serious strain across the Middle East. Few countries were spared as power outages hit Kuwait, Saudi Arabia, Bahrain, Sharjah, Yemen, Iraq, Lebanon, Syria and Egypt. But in those places suffering from power cuts, people seemed largely unaware of the rest of the region’s electricity woes.

While Lebanese carried out their daily litany of complaints about blackouts, damning and blasting the government, many were surprised when I told them that Sharjah had such an electricity deficiency that residents were sleeping in air conditioned cars to avoid baking in concrete apartment blocks. It was so hot in the emirate that hospitals were inundated with cases of heat stroke and a construction worker died from heat exhaustion.

 In Damascus, residents hot under the collar due to a lack of air conditioning knew of Lebanon’s long-term electricity conundrum, but were unaware that Saudi Arabia and Kuwait — those rich Gulf countries where many Syrians seek work — were also having blackouts. With an 8 percent annual deficit, the situation was so bad in Saudi Arabia that school children were passing out while taking exams and airplanes were grounded. Kuwait’s network hit 99 percent of capacity.

Power shortages in the region’s poorer, more corrupt and war ravaged countries — Iraq, Yemen, Lebanon — are daily occurrences and are not unexpected, but why are they happening in the energy-rich Gulf?

The problem is that peak demand occurs every summer at the same time across the region. Populations growing in size and affluence means more air-conditioners — and industrial activity is increasing. All of this, coupled with exceedingly low electricity tariffs and an incredible lack of forward-planning has resulted in a major shortage of megawatts (MW). And without the modern day wonder of air conditioning, the region, particularly the Gulf, is not a place conducive to working or living as the mercury rises.

Thomas Edison, one of the inventors of the light bulb, once said: “I shall make electricity so cheap that only the rich can afford to burn candles.” In much of the Middle East, Edison’s saying has been translated as: “We shall make electricity so cheap everyone uses too much of it, and only the rich can afford to run generators.” Lebanon is a case in point, with power “provider” Electricité du Liban to generate $800 million in bills this year, while the Lebanese will spend $1.76 billion on running generators.

But there is hope that such electricity shortages will be abated, with the cuts prompting such furor among the people that governments have been forced to invest in more power production.  The Gulf countries are to spend an estimated $200 billion on power plants, Lebanon some $4.7 billion, Iraq up to $10 billion. Everywhere else there are plans for upgrades and new plants. Renewable energy and nuclear power are also in the pipeline, as is the $560 billion Desertec solar power project in North Africa. And if other solar power initiatives get underway in the rest of the Middle East and North Africa, the region will be able to produce up to 470,000 MW of sustainable electricity by 2050, according to research by the German Aerospace Center.

While such initiatives are laudable, practical solutions to the current shortages need to be implemented. It takes around three years to build a conventional power plant, and once output is increased, there is usually a corresponding rise in demand as people use more electricity. It’s a vicious cycle.

Before these projects get underway, thinking about how to lower overall consumption across the region should be part of every national power plan. Can we really call a ski slope in a mall in the desert an efficient use of electricity? Do empty office blocks have to be lit up like Christmas trees in the middle of the night? And when the whole of Lebanon lacks electricity, did the Maronite Church have to erect the world’s largest illuminated cross at Qanat Bekish in Mount Lebanon, a 240 foot high construction lit by a staggering 1,800 spotlights?

If temperatures are as high again next year and such wanton waste of electricity continues, power cuts are likely to be worse. In the meantime, higher tariffs to encourage people to use power more wisely would help to ensure more people are sleeping in their houses rather than their cars this time next year.

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Finance

Balance sheet blues

by Natacha Tannous
written by Natacha Tannous

Running the gauntlet that is Gulf finances these days, Emirati bank balance sheets are being battered; double-teamed by deteriorating asset quality and non-performing loans. Fortunately for them, however, the fight is effectively rigged, as both the government and the Central Bank of the United Arab Emirates have readied their checkbooks to pay up whatever it takes to keep the banks from going down.  

Asset quality deterioration

A major blight on statements has been Dubai World exposure; UAE banks hold 45 percent of the up-to $26 billion of outstanding debt, of which Emirates National Bank of Dubai (ENBD) and Abu Dhabi Commercial Bank (ADCB) have the highest shares (see estimated exposure table).

As Executive reported in March, even if Dubai World offered full debt repayments, the net present value would only amount to 62.1 cents on the dollar (with a five-year extension at a 10 percent discount).

However, a pledge by the Dubai government on March 25 to “support proposals with significant financial resources” and inject fresh funds of $9.5 billion through the Dubai Financial Support Fund, has eased the Dubai World situation and will lower the discount rate for the debt proposal.  This now entails a higher net present value for the “100 percent principal repayment through the issuance of two tranches of new debt with a five and eight year maturities,” said the Dubai government.

This could avoid additional provision charges but will not help healthy balance sheets show up at UAE banks.

“Problems at Dubai-based banks will not end after the restructuring of Dubai World, with the economy of the Emirate almost in a standstill,” says Marcel Kfoury, senior trader for the Middle East and North Africa region at Nomura Holdings in London. “The default rate on the consumer side will just rise further, adding to an already deteriorating loan-book, as more contractors fail on their obligations.”

UAE banks were already suffering from retail loan portfolios and real estate exposure via lending books, subsidiaries or direct investments in properties. First Gulf Bank (FGB) is the most exposed bank in this matter, as it had in December 2009 a real estate portfolio of $1.6 billion, the market value of which has undoubtedly decreased. With the current oversupply situation, particularly in Dubai, the banks are now left with vacant and non-cash flowing real estate projects that have lost 50 percent of their value; approximately one third of aggregate projects have been postponed or even cancelled.

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Time to boycott failure

by Yasser Akkaoui
written by Yasser Akkaoui

It is a measure of how far Lebanon has come in recent years that a new roof is being placed on the synagogue in the Beirut Central District. It is also a reflection of Lebanon’s unique multi-faith make-up and the country’s tolerance for all religions.

But tolerance alone does not make a strong state.

It is no secret that today Israeli companies are outsmarting the Arab boycott, a concept so archaic and so self-defeating it stopped having any real meaning decades ago. Israeli manufacturers are re-branding and re-labeling their products to compete in the new and vibrant Arab markets.

Furthermore, Israel has set itself up as a shop front for global manufacturing, attracting some of the world’s biggest brands to their industrial parks. The upshot is that, while the Arab world tears itself apart, Intel — to take just one example — churns out Israeli-made processors destined for a global market.

And yet while Arab regimes would deny us the right to buy those same processors, they are also denying us the chance to move forward and compete in the name of a strategic ideal they call the Arab boycott.

The real Arab boycott should be one that stops us from denying ourselves the right to take our place in the community of nations that make up the new globalized economy. It should involve us making an effort to produce and compete on an equal level.

Contrary to popular belief, the strategic goal of the Zionist state is to place an emphasis on economic dominance. It is as much economic as military or political leverage that drives Arab-Israeli negotiations. After all, the victor is the nation that can achieve economic sustainability.

The Arab world, and the countries of the Levant in particular, need to understand the essential connection between the state, the public sector and the welfare of the people. Without this economic angle, a state can never succeed; indeed it can never be a state.

Lebanon is a case in point. The private sector has the talent and it has the will. The state now needs to hitch this potential to its creaking wagon so that it can start competing with Israel at its own game. Lebanon needs to start empowering, competing and attracting foreign investment.
It is that simple.

Yasser Akkaoui
Editor-in-chief

 

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