Banking & Finance

The fallacy of projections

by Imad Ghandour
written by Imad Ghandour

In September 2006, the IMF in its Global Economic Output report projected that the US will be “the engine of global economic growth despite some uncertainty in the housing sector.” In its July 2008 report, less than two years later, the IMF revised downward (again) its projections for US economic growth to 1.3% (from 3.2% and 2.2% in the previous two semi-annual reports). The world’s most sophisticated economic forecaster failed to project the size and impact of one of the most serious financial crises in our modern history on the most monitored economy, although that event was on the radar screen for two years.

Recently I spent a few hours with a colleague of mine trying to “fit” the actual financial results of a company we had invested in into the model we had built for that company prior to that investment. The bottom-line projections were close to the actual results, yet we couldn’t put the right parameters in the model that will get us even close to reality.
It was an intellectual exercise, but at the end I had to pause and think: if a model cannot predict the past, how on earth were we confident that it could predict the future?
Make no mistake, this is a universal problem and is not a result of any individual incompetency.
Thousands of financial analysts pour their energy into predicting the “fair” value of stocks and other financial assets. They calculate with pinpoint accuracy the price of the stock after going through the mundane task of calculating things like future revenues, overheads, profits, discount rates, betas, comps, etc. Yet, with all the sophisticated modeling, I have rarely seen a numerical analysis explaining or predicting the “actual” market price of a stock. Furthermore, research has shown that actual prices do not necessarily gravitate towards “fair” prices, as the theory behind all this analysis suggests. In other words, the thousands of “fair” value models published by investment banks invariably fail to predict the present (or the past) and are unlikely to predict the future.
Yet we rely on projections to give us confidence in our decision. No investment is done in the modern financial world without a model. No model is without future projections. We project profits in 2015 to be $56,405,383.34, yet the only fact we can be sure of is that they will not be this number. We base our decisions on such numbers, and we focus our attention on things like the IRR as the analytical summary of thousands of assumptions and projections. We may reject an investment because the model calculated an IRR of 29%, while we all know that the same model with a little bit of subjective tweaking and twisting may give a magical boost to the IRR to, say, 39%.
Prior to inventing Lotus 123 and its successor MS Excel (and before I was born), investors relied on qualitative assessment and simple calculation to make their investment decisions. Did they take wrong decisions? Does a 1000 line model give an edge over such “unsophisticated” investors?
In his inspiring bestseller The Black Swan, Naseem Taleb skillfully argues that we simply cannot predict the future because “significant yet improbable events” (he called them “black swan events”) are the ones that will shape the future of individuals, countries, companies, and economies. We simply cannot predict or time or imagine such events, and we definitely cannot project their impact (hence the IMF miscalculation).
Projections are useful to the extent they are used as an analytical tool for possible future options. They may bring illusionary confidence, but reality will surely be different, especially in private equity investments that span several years. Embracing this fact as we price, negotiate, structure, and manage any investment is the key to sustained successful investment.

Imad Ghandour is the chairman of Information & Statistics Committee—Gulf Venture Capital Association

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Capitalist Culture

Rule of law – Deferred judgement

by Michael Young
written by Michael Young

It was an enlightening coincidence that the former leader of the Bosnian Serbs, Radovan Karadzic, was arrested and sent to The Hague shortly before Russia dispatched its army into Georgia. Where the first event suggested some kind of imposed benchmark of international justice and behavior was possible, the second made it clear we shouldn’t go too far in our expectations.

The Georgian conflict has long been a complicated one, and Russia is no guiltier than other countries, such as the United States, in respecting international law only when it favors its interests. But in the hours after its invasion of Georgia, it was telling that Russia sought to cobble together a legal case accusing the Georgians of war crimes in South Ossetia — rather rank hypocrisy given that Russia’s army targeted civilian areas in Georgia, but Moscow apparently felt the need to offer a legal cover for its actions before the international community. Effectively the Russians twisted themselves into a pretzel to make it seem that they adhered to international legal and human rights norms.
So while the world may be a long way away from an effective and comprehensive system of international justice, Karadzic’s arrest, however, showed that once institutions are actually set up to affirm the rule of law, to circumvent these and their implications can be difficult.
The Hariri tribunal, which is currently being established in The Hague as well, is a case in point. Much has been written of late suggesting that the tribunal is dead, that its prosecutor has no case, that the system of international justice has been shown to be weak in the face of the political interests of individual states. That may well be true in some regards. The former United Nations investigator, Serge Brammertz, who just so happens to be Karadzic’s prosecutor today, clearly did not progress in his investigation as rapidly as he could have, earning him the biting criticism of his predecessor, the German judge Detlev Mehlis.
However, the pessimism may also have to be qualified. The international community and the UN may behave in the most cumbersome ways, but once they go to the trouble of setting up something like the Hariri tribunal, they usually have to give it some meat and meaning, or risk considerable embarrassment and antagonism. That’s why the Hariri tribunal — despite all the doubts surrounding it and the need to lower expectations in terms of who will be directly accused — is nonetheless likely to function and create far more waves than anyone expects. Once the tribunal opens up one sensitive door, it will likely be very difficult to control what comes afterward, and what other doors are opened.
In many respects that is a lesson about the possibilities of international justice, one pillar of a capitalist culture that seeks the amelioration of human freedom in the context of open minds and open markets. Justice doesn’t usually end up working because states or politicians want to improve the world (even if that motive can exist for a time), but because states sooner or later have a selfish interest in accepting justice.
That was certainly why Karadzic was handed over to the tribunal responsible for the former Yugoslavia. With Serbia looking to enter Europe, and the fact that the continued freedom of Karadzic and his collaborator Ratko Mladic presented a major obstacle to this, the Serbia government apparently weighed the costs and benefits of allowing the two men to be protected by certain power centers in Serbia. The conclusion was that protection wasn’t worth it, at least in Karadzic’s case.
That situation does not exist in Lebanon, or at least not yet. If anything, some might argue, the Syrian- Lebanese rapprochement effected in August may make any future blame directed against Damascus by the tribunal problematic for Lebanese interests, since relations between Lebanon and Syria might suffer. In other words Lebanon may have no advantage in seeing the Hariri tribunal go through. Perhaps, or perhaps the precise opposite may be true: If Syria was involved in Hariri’s elimination, as many believe, than what kind of interest can Lebanon have in pursuing a relationship with a regime that murdered a former prime minister? And if Syria is innocent, then it has nothing to fear from the tribunal.
Whichever answer ends up being the correct one, the superficial assumption that “justice always prevails” should be discarded. The point of international justice is not that it is invariably satisfied, but that its burdensome imperatives, even when imperfectly applied, often end up shaping states’ foreign behavior. And that opens up spaces forcing states to sometimes go along with an international consensus, even if they don’t care to do so. There is no certainty here, no guarantees, not even a chance to predict that norms of justice will gradually spread over time to encompass most states. Only the ability to say that some norms of justice are more likely to be applied today than previously.
It’s not much perhaps, but it’s no little thing either.

Michael Young

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Comment

The burden of luxury and the joy of taxes

by Zafiris Tzannatos
written by Zafiris Tzannatos

The July 2008 issue of this magazine was dedicated to “Luxury Economics,” focusing on the “Middle East’s appetite for surprising, exotic and authentic experiences.” A separate article in the same issue did not fail to note the move in the UAE to introduce a value added tax. Does luxury increase “happiness”? And does taxation decrease it? Paradoxically, the answer to both is “no” according to some new views. In a nutshell, luxury, once tried, becomes necessity and taxes can reduce materialism — a common theme in many religions — and help citizens preserve a healthy work/life balance. Let us examine each assertion in turn.
Historically, economists have related well-being to the level of incomes while development theories typically stress economic growth as the ultimate objective. The Gulf Cooperation Council (GGC) economies score well on both counts. The recent hike in the international price of oil has been associated with high government revenues and a corresponding fast rate of economic growth. And citizens have not only enjoyed traditionally high levels of incomes but, under popular pressure, recently managed to get unprecedented salary increases for reasons unrelated to their work effort and productivity.
However, it has been found that once wealth reaches a subsistence level, its effectiveness as a generator of well-being is greatly diminished — as if a “hedonic treadmill” were in operation: you keep moving just to stay in the same place. In other words, aspirations increase along with income and, after basic needs are met, relative rather than absolute levels of income influence well-being (“happiness”). If this is to be accepted, distributing the oil revenues across the population in some uncritical or untargeted way may have only a temporary effect on “happiness.”
The emerging theory of “happiness economics” aims to understand what determines the well-being of people. The theory has consequences for understanding happiness both as an individual as well as a societal goal. “Happiness economists” aim to change the way governments view well-being and how to allocate resources. And a new concept has been developed, the GNH (Gross National Happiness) that is broader than the conventional GNP (Gross National Product) or GDP (Gross Domestic Product).
If income alone is a poor approximation for happiness, what should economists take into consideration? The four pillars of GNH are the promotion of equitable and sustainable socio-economic development, preservation and promotion of cultural values, conservation of the natural environment, and establishment of good governance. What should one then look out for?
First, social comparisons. Happiness is derived from relative income as well as from absolute income. If everyone gains purchasing power, some may still turn out unhappier, if their position compared to others becomes relatively worse — as the case is with recent universal handouts given by the GCC governments. This effect does not necessarily turn economic growth into a zero sum game entirely, but it can diminish the way people perceive the benefits of their own hard work.
Second, adaptation. As people get used to higher income levels, their idea of a sufficient income grows with their income. In this case, if people fail to anticipate that effect, they will feel they work more than is good for their happiness.
Third, changing tastes. Individual preferences are not constant. They are increasingly mutable, shifting constantly according to the latest fashion, adapting cultural norms and what neighbors do. In turn, the perceived values of one’s accumulated possessions are subject to depreciation, ultimately having a negative effect on happiness.
All these considerations make sense. Humans adapt, often rapidly, to their current situation. They become habituated to the good or the bad. They are sensitive to the status they have relative to what they perceive others enjoy. More generally, despite the fact that external forces are constantly changing one’s life goals, happiness for most people is a relatively constant state. Regardless of how good things get, people report about the same level of happiness over time.
This has led some economists to argue that taxes can serve another purpose besides paying for public services (usually for public goods) and redistributing income (usually to the poorer citizens). This additional purpose of taxes is to counteract the cognitive bias that causes people to work more than is good for their happiness. That is, taxes could help citizens preserve a healthy work/life balance.
In short, money does not add much to happiness: Lottery winners are an example as, within a year, they are said to return to their former happiness level. And those handicapped in, say, a motor vehicle accident, usually return to former happiness levels, despite their loss of function. Some studies have suggested that a sense of “higher calling” or “purpose” can add to someone’s happiness. If so, perhaps the development of a national vision and the introduction of taxes in the GCC countries may cause the citizens to look outside themselves and become happier — even though they may consume fewer luxury goods.

Professor Zafiris Tzannatos is Advisor to the World Bank and former chair of the Economics Department at the American University of Beirut. The views expressed are his own and do not necessarily represent those of the World Bank.

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Lebanon

Politics – The guillotine for Paris III?

by Executive Staff
written by Executive Staff

Afew months ago, a Lebanese politician from the parliamentary minority hinted at the possibility of cancelling the Paris III agreements of January 2007, during which some $7.6 billion destined to support major reforms in the Lebanese economy were pledged by the international community. But can the Paris III process really be reversed? And if so, what would be the consequences?

Nassib Ghobril, head economist at Byblos Bank, is of the opinion that, “the objections of certain political factions to Paris III that were recently reported in the press about the possibility of canceling Paris III can be put in the framework of political haggling. This particular statement was made during the negotiations dovetailing the ministerial declaration. They appear to be only political motivated and are thus far from being a realistic proposal.”
During the past two years, the overall implementation of Paris III, including privatization of key sectors, among them Electricité du Liban (Lebanon’s electricity company), the telecom sector and the Casino Du Liban, has been delayed, mainly because of security problems (a war, a one-year blockade, and a few skirmishes) and political dissensions that culminated in the total paralysis of political life with the cabinet’s work severely impaired by the total closing of the parliament, making it impossible to legislate and implement any new reforms for more than a year.

Paris or no Paris?
“These reforms, which are at the heart of Paris III, can only be implemented by a functioning parliament and cabinet,” said Ghobril, which means that in the absence of political consensus, the full implementation of Paris III might be postponed indefinitely.
The economist underlined, however, that the actual cancellation of Paris III is impossible as the agreement made in Paris in 2006 is backed by contracts signed by Lebanon and international governments and institutions, some of which have disbursed part of the funds.
Louis Hobeika, a professor at the American University of Beirut (AUB), tends to agree with Ghobril. He added, however, that although the Paris III agreement cannot be cancelled it may be modified or adapted to the new economic reality. “The scenario submitted to donors during the Paris III conference was certainly too optimistic when it came to certain aspects of the economy such as inflation, economic growth and government expenditures,” Hobeika explained. The AUB economist underlined that Lebanon’s needs in aid have also grown significantly since the deterioration of the economic situation in the last few years.
“One of the purposes of the Paris III conference was to allow the government to reduce its public debt, which since 2006 has increased significantly by $6 to $7 billion. Forecasts should therefore be modified accordingly,” Hobeika said. A recent Lebanon This Week report put the Lebanese public debt at $44.4 billion in June 2008, up from $40.37 billion in December 2006.
Hobeika explained that he was initially opposed to holding Paris III at the time for several reasons. The scenario put in place was overly confident and optimistic, forecasts were inaccurate and the local political context unfavorable. “Supporters of the Paris III conference argued at the time that it was imperative it should be held before French president Jacques Chirac, known for his personal relations with the Lebanese government, stepped down. The government could have asked for Arab funding and postponed the Paris III conference until the situation improved, without committing itself to unrealistic objectives which has reflected negatively on Lebanon’s image,” he argued. None- theless, he underlined that once a government committed itself to an economic program in coordination with international countries and institutions, its decisions can in no way be recanted by subsequent governments that come to power.
In addition to the impossibility of breaking international agreements, Ghobril pointed to the fact that many sections of the Paris III agreement have actually been implemented with disbursement of funds. According to the economist, some $4.5 billion have been committed by international donors, amounting to 63% of the total funds pledged during Paris III.
The Byblos Bank report highlights the different amounts pledged: while budget support agreements totaled $1.86 billion, equivalent to 39.4% of total signed agreements by the end of June 2008, private sector support amounted to $1.27 billion (26.9%) and project finance support to $1.03 billion (21.8%). “Project finance has witnessed the lowest disbursements as it requires parliamentary approval, while Central Bank support has been fully disbursed,” emphasizes Ghobril.

Able to swim without aid
Although the donors’ lifeline seems essential to Lebanon, it does not account for the country’s survival, which can be essentially attributed to its resilient economy. Hobeika believes that foreign aid bestowed on Lebanon will not insure the country’s resistance to economic shocks while implementing reforms related to budget deficit and the establishment of proper structure could.
Ghobril agreed, stating that, “Lebanon has been able to survive through extremely adverse conditions and repeatedly proven its economic buoyancy. Compared to other countries such as Jordan, which would suffer tremendously from foreign aid drying up, Lebanon relies on much smaller amounts of foreign aid.”
Putting forth indicators of Lebanon’s economic resilience, Ghobril discussed the recent relatively easy renewal of the treasury bonds that matured this year, in spite of the unstable Lebanese situation. “Byblos Bank jointly with BLOM manages a 500 million Eurobond that was recently twice over subscribed due to large demand. This proves that that Lebanon does not essentially rely on donors’ aid and foreign investors,” he said.
Lebanese investors are also dedicated to their banking sector and have proven numerous times that they will not exit the market at the first shock, as it has been the case in some countries in South America. In addition to the Lebanese state never having defaulted, the Lebanese banking system has proven repeatedly its ability to face one crisis after another.

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Lebanon

Development – Raising a new bourj

by Executive Staff
written by Executive Staff

Beirut seems in a building frenzy, and Bourj Hammoud, a suburb east of the city on the other side of the Beirut River, is no exception. Parallel to the highway in an area known as Sandjak, the municipality is to construct three residential-commercial towers, a multi-story parking and a public garden. The project has generally been well received as a sound attempt to upgrade the area and improve access to Bourj Hammoud. The remaining inhabitants however, await eviction and an uncertain future. They complain that the compensation by the municipality is not sufficient.

With an estimated cost of $20 million, the Sandjak project is an initiative from the municipality, which is quite a rarity in Lebanon. The local authorities bought the land from its Lebanese owners for some $2 million and are currently in the process of securing loans. The two-and- three-room apartments of up to 120 square meters, however, will not be available for just anyone.
“Bourj Hammoud is saturated,” said Raffi Kok Oghlanian, project manager at Sayfco Holding and deputy mayor of Bourj Hammoud. “A lot of young people are leaving. One of the goals of this project is to offer affordable housing to the newly-wed and young people born in Bourj Hammoud.”
When completed, the project is to significantly change the face of Bourj Hammoud, offering direct access from the highway, as well as ample parking facilities. This to great relief for Bourj Hammoud’s thousands of shopkeepers, as the area today is only accessible from two narrow entry points and suffers from endless traffic jams and a chronic lack of parking.
As always, however, progress comes at a price. While half of the Sandjak area has already been demolished, the other half is still standing, yet awaits a similar fate. The some 100 families still living there await a notification to leave, which is likely to arrive between 6 and 12 months from now. “I was born here 43 years ago,” said the owner of a small supermarket. “I now live in Antelias, but my parents are still here. Where can they go? The municipality gave us $13,000. The house next to us got $5,000. What can you do with that? ”

The good of the many
Oghlanian said he understands people’s grievances, yet added that the problem of a few cannot stand in the way of a project that benefits the whole community. What’s more, according to him, the municipality has done everything to soften the suffering of current and former inhabitants. “We asked the Lebanese court to look into the dossier and formulate a recommendation regarding compensation, according to which we paid everyone up to $15,000,” he said.
To understand the specific difficulties related to the Sandjak Project, within the wider context of urban development in densely populated Bourj Hammoud, it is necessary to have a brief look at the area’s history. Situated on the eastern bank of the now nearly waterless Beirut River, Bourj Hammoud is one of Beirut’s most distinctive areas, for several reasons.
Although having become more and more mixed in recent years, the quarter is still predominantly Armenian. The area was only developed from the 1920s onward when survivors of the Armenian Genocide (1915-1918) arrived in Beirut. Until then, it had been an area of fields and agricultural land dotted with farms. In fact, Bourj Hammoud is named after the only two-storey house that existed at the time, which happened to be owned by the Hammoud family.
The first development centered around four clusters: Marash, Cis, Adana and Sarkis. Apart from the latter, they were named after cities in what is today eastern Turkey, yet what Armenians refer to as “historical Armenia.” Gradually, as wood made way for concrete, the former refugee camp became an integral part of the Lebanese capital. In fact, with some 150,000 inhabitants cramped together on an area of some 2.4 square kilometers, Bourj Hammoud ranks among the most densely populated areas in Lebanon and the region.
Bourj Hammoud has also become one of Greater Beirut’s most popular shopping districts. The area offers a true high street, mainly catering for a middle class clientele. In addition, it is famous for its many jewelers, watch makers and goldsmiths. Finally, it is quite an industrious area as well. Inside the labyrinth of little alleyways, there are hundreds of textile, shoe and metal workshops, while heavier industry is located on the seashore.
“The first urban development in Bourj Hammoud took place on land donated to the Armenian community,” Oghlanian explained. “The land was divided in smaller plots, on which people constructed their homes. Later on, the municipality bought land and allowed people to construct their homes. They own their homes, yet can only sell with permission of the municipality. The third form of urban development was technically illegal. People constructed their home on land that was not theirs. Such was predominantly the case in Sandjak.”
One should know that Sandjak was not just any area within Bourj Hammoud. It had a bad reputation. “Even the police would not dare go inside,” one shopkeeper said. Others claimed it was a hotbed for criminality. Yet, despite the occasional “mafia” graffiti on some of the walls still standing in Sandjak, one hardly feels unsafe when walking around. Regardless of its reputation being true or not, the fact is that Sandjak was one of the quarter’s poorest areas.

Local demographics
“There were essentially three groups of people living in Sandjak,” Oghlanian explained. “First of all, there were a number of foreign workers who in recent years had rented rooms. Second, there were people who had been renting from the original Armenian owners for a very long time. And third, there were the people who constructed the houses and still lived there.”
The first group was given notice to leave and look for alternative lodging. The second group was paid between $2,000 and $5,000, while the third group received between $5,000 and $15,000. That may not seem a lot, and has to do with the fact that most of the dwellings were constructed illegally in the first place.
“The Lebanese owners of the land were more than happy to sell, as it was quite impossible for them to remove the inhabitants,” Oghlanian explained. “Now, we could have gone to court and just thrown them off the land. However, that would be rather inhumane and cause a major upset within the community. Hence, we asked the Lebanese court for a recommendation and paid compensation.”
The Sandjak project is part of a wider initiative by the municipality to upgrade Bourj Hammoud. “The government has long considered Bourj Hammoud as the backyard of the capital,” said Oghlanian. “Every time it planned a sewage treatment plant or factory, Bourj Hammoud was proposed. We, as a municipality, have worked very hard to change that perception. Bourj Hammud is a not only a residential, but also a very productive commercial and industrial area.”
Over the past decade, the face of Bourj Hammoud has indeed changed. The municipality invested significantly in a beautification campaign. Streets and pavements were widened, trees planted, public lightning improved and building facades were cleaned and painted. By law, building owners are obliged to take care of the façade, but the municipality decided to exercise that right instead — all in all, some $10 million was spent.
In addition, with financial aid of the central government the area’s infrastructure was improved, notably the sewage system — which often was not able to absorb severe rains — was upgraded for $7 million. Where 10 years ago streets would flood after a heavy shower, today everything stays dry.
As Bourj Hammoud offers relatively little room for expansion, the Sandjak Project has the potential to significantly alter the area, as well as one of Beirut’s main access roads. Construction is expected to start within a year and could be completed by 2010. The compensation paid to Sandjak’s inhabitants and their future, however, is not the municipality’s only worry.
According to Oghlanian, the municipality calculated that the project is to cost some $20 million. But seeing the rapidly rising costs of construction materials such as steel and concrete, the price could increase significantly. In that sense, it seems construction should start sooner rather than later, at least seen from the municipality’s point of view, though the remaining inhabitants of Sandjak no doubt have a different opinion.

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Lebanon

Industry – Diamonds from the rough

by Executive Staff
written by Executive Staff

Lebanon is a country of great diversity, which has proved to be its greatest weakness and most powerful asset. Seemingly, Lebanon’s industry reflects this permanent contradiction.

Lebanon’s exports are a good indicator for the condition of its industry. According to Fadi Abboud, president of the Lebanese Industrialists Association, “electrical products contribute to a large chunk of our exports accounting for as much as $500 to $600 million. Food items come in second, while jewelry (including scrap metal) and finished products are faring quite well.” On average, jewelry figures exceed official ones as many Lebanese artisans export their precious works without declaring them to customs.
Mazen Soueid, Head Economist at Banque de la Mediterranée, underlined that manufacturing only represents about 6% of the country’s GDP. He identifies jewelry to be among the best performing segments, which interestingly enough is partly exported to Switzerland, whether under the form of scrap metal or finished products. Foodstuffs come in second, followed by machinery and chemicals in third place. “The worst performers in terms of exports are the plastic and optical instruments industries. However, it is quite interesting to note that the export value of works of art has doubled last year,” he said.
When highlighting profitable sectors economists seem to agree. Marwan Mkhael, head of research at BLOM Bank, believes that the Lebanese players should focus on those industries that are flourishing and try to understand the reasons that contribute to their growth. “Lebanon has to focus on industry segments in which it has a competitive advantage, whether in the form of know-how, or high added value. One of such examples is the agro- industry, which presents very interesting opportunities for Lebanon as our country has the right products, the proper machinery and the know-how, to which can be added excellent marketing skills,” he said.
Products can be easily exported to Europe, where items such as Conserva Chtaura (a local Lebanese brand of canned food) or high-end Patchi chocolates can be easily stocked on shelves in countries like France, Italy or England.
“Lebanon can’t compete when it comes to the production of mass items, and can only succeed with high value added product categories,” Mkhael underscored. Such products require skilled workmanship and belong to sectors such as IT, pharmaceuticals, design, fashion, any industry backed by R&D.
Abboud also said a number of industries are protected by either high custom duties or import bans — such as mineral water, cement and electrical cables — and have thus thrived inside the country. “This indicates that local industries should be protected by tariffs when they have an economic sense,” he said.

An uneven playing field
In Lebanon, as in the rest of the world, energy intensive industries are facing difficult times. Inflationary trends fueled by oil prices reaching towering heights have put a toll on energy intensive production. Many of Lebanon’s trading partners are benefiting from subsidized energy bills, mostly in oil producing countries, causing regional inequality when it comes to energy costs. “This situation creates unfair competition that contradicts the principles underlying agreements such as GAFTA or the WTO,” Abboud said. One of the new local victims of the rise in fuel costs is Uniceramic — a ceramic wall and floor tile manufacturer — whose energy costs jumped to 25 times those of Egypt, rendering the company unable to compete and forcing its closure.
Abboud envisions four possible solutions to solve the energy problem, and alleviate pressure on the Lebanese industry sector.
The first solution resides in industrialists lobbying for cutting energy subsidies in oil producing countries — an issue that cannot be realistically enforced. The second solution entails imposing additional tariffs on energy intensive goods imported. The third option is based on the creation of a fund financed by oil producing Arab countries that would subsidize industries in non-oil producing nations such as Lebanon, a proposal also suggested by Indevco’s CEO Neemat Frem. Finally, Abboud argues that in the event that the Lebanese government comes to the conclusion that energy intensive industries cannot be competitive in our current environment, it should provide players with a viable exit strategy.
In Frem’s words, “The problem of energy in Lebanon has taken the dimension of a national disaster. After all, the country is much more vulnerable to fluctuations in gas prices than other neighboring countries boasting significant oil reserves.” Indevco currently produces about 12 MW to cover part of the electricity needs of its local factories, and is thus directly affected by spikes in international oil prices.
Soueid underlined how the difficulty faced by Lebanon’s energy intensive industries is partly due to their inability to transfer cost increases — resulting from rising fuel prices — onto the final consumer.
“Lebanon has been historically considered as the Switzerland of the Middle East; maybe it is time to take this expression seriously by reproducing the Swiss model and concentrating on high-end items,” Mkhael suggested. Industries that are currently performing well belong in various fields — jewelry, fashion, or high end food items. “In this particular segment we can replicate the example of Thailand that has been successfully selling Thai microwavable food on international markets. We could easily export Lebanese food all over the region and build on the popularity of our local cuisine,” said Soueid.
The economist also explained that the IT sector, though small and somewhat fragmented, definitely holds promising opportunities for the future. According to Soueid, a project to create an IT village was under planning before it was recently abandoned.
Industrialists, on the other hand, do not share the economists’ Manichean view of Lebanon’s economy. Many believe the contrary: that growth in Lebanon’s industrial sector can only be built on a real twinning of the traditional as well as state-of-the- art niche industries. “Lebanon’s industry needs to be rebuilt on a dual approach, which preserves its existing traditional industries and develops new innovative ones, focusing on high end products” said Frem.

Economies past and present
Abboud maintains that Lebanon’s traditional industries are the backbone to the Lebanese economy. “Lebanon already does not recycle its paper or metal. Can you imagine if we have to cover all our needs in plastic bags, cups and other items by importing such items? Lebanon’s industry sector can’t be only built on niche markets,” he said, also pointing out that a balanced approach would also allow the absorption of the additional 50,000 job seekers that come on the market every year.
Frem argued that, “One has to keep in mind that any business still operating in Lebanon’s complex environment can be viable on the long term. After all, it has survived in spite of extreme and adverse conditions! ”
What is the role of the state in shaping the industrial sector and the economy? Regarding the agro-industry, Lebanon definitely needs to become more self-sufficient in terms food requirements, while also trying to cater to the newly rich who are more health-conscious and look for better, fresh produce. According to Soueid, the most urgent task faced by the government is devising a successful national strategy for reducing the deficit, while simultaneously developing industry segments that are profitable. He emphasized the importance of a clear national strategy that will effectively plan for emergency food needs. Other measures that should also be undertaken by the government include the reduction of debt levels, which will
allow interest rates to fall and promote private sector lending. As Soueid asserted, “When one has the opportunity to place [their] money in treasury bills and obtain a comfortable return on investment, one will not be motivated to open a plant or a business!”
Another essential reform identified by the economists is that of the power sector. In 2008, it will cost the Lebanese government about $1.5 billion. This situation leads to inefficiencies in the industrial sector, where most companies end up settling two different power bills instead of one, in order to cover both their generator and EDL costs. “It seems to me that the industry has been abandoned by the government as it remains, after all, one of the rare sectors in Lebanon not to be protected,” said Abboud.
Frem agrees that the political instability hinders the government’s efforts. In addition, he does not think that the various governments that came to power over the years ever “realized the industry’s essential role, one that can create powerful synergies with other sectors such as services or tourism. A salad sold in one of the capital’s many restaurants made with vegetables produced locally will have a multiplier effect that eventually reflects on various segments of the economy.”
Mohamad Choucair, CEO of Patchi, deems that former industry minister Pierre Gemayel had put in place a plan for shaping Lebanese industry, which was never implemented because he was assassinated. However, he hopes that it “will be eventually implemented by the new minister in charge of the sector.”

The way forward
Another problem plaguing the Lebanese economy, according to Mkhael, is that some businesses have not been able to adapt to changes and blame others for their failings. The fact that many businesses in Lebanon remain family owned further hinders the evolution of the industry while a modernization of the sector would attract investment as well as allowing a better application of economies of scale.
According to Frem, “The future of Lebanon’s industry lies in businesses requiring multiple skills such as IT industries, video games development or movie production or any business which is built on system integration.” In his view, Lebanon’s image, its brand, can also be efficiently put to use in a region with a trillion dollar economy.
Another opportunity lies in more exports to the Euro zone, further pushing Lebanon to look outwards, instead of inwards.
But in the end, quality is the sector cornerstone. “I believe that our company has been extremely successful because of its minute attention to quality. This, in conjunction with an original concept and good branding, has allowed us to succeed internationally,” Choucair said. Frem pointed out, however, that before being able to turn the country’s individual corporate success stories into a collective success, there is a need to fix Lebanon’s political structural issues and to build the right system for governance and decision making processes that focus on real creation of value.

 

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Banking & Finance

Aviation – LCB wind for MEA’s wings

by Executive Staff
written by Executive Staff

As most airlines across the globe are responding to high oil prices by making personnel cutbacks, being especially selective with their routes and even grounding planes, there is no sign of crisis at Middle East Airlines (MEA), where the plans for continued expansion are still materializing.

As part of its continued efforts to encourage and support various sectors of Lebanon’s economy, in early August Lebanese Canadian Bank (LCB) signed a cooperation and finance agreement with MEA. LCB was the sole benefactor of the $65 million dollar deal, which is aimed to help the Lebanese national carrier increase and update its fleet with a new Airbus 330-200 aircraft.
The agreement, a clear indicator of the confidence that regional corporations have in their national carriers, was signed by both chairmen-general managers, George Zard Abou Jaoude of LCB, and Mohamad El Hout, of MEA.
“Middle East Airlines has proved that it is a very good company,” explained Elie Azar, LCB’s marketing manager. “They’ve made a lot of reorganization efforts, they’re re-engineering their administrative ways and they are doing excellent. Results are good, and we are expecting them to double this year, depending on the political and security issues in Lebanon.”
Aside from Lebanon’s infamously turbulent political atmosphere, LCB has minimal concerns about contributing such a sizeable 10-year loan, as MEA has offered not only its moral assurance, but also a significant collateral. “In this operation, the plane acts as collateral. It’s insured in London with Lloyd’s, plus it’s a mobile entity, so MEA can rent the plane to other companies if there are any big problems,” Azar outlined.
According to the International Air Transport Association, the airline sector in the Middle East expects to be bolstered by about $54 billion over the next decade, as the region plans to pour its resources into airport expansion. In addition to MEA’s most recent acquisition, over the last three years airlines across the region have ordered 700 new planes to the tune of $140 billion.
MEA appears to be on its own very impressive course of expansion, pursuing the growth of company capacity, productivity and supplies. Choosing LCB’s offer over those of other regional banks such as Bank Audi and BLOM Bank, MEA is following the path of greatest returns. “Middle East Airlines was very interested in our terms because we were able to offer the best loan at a very low interest rate,” Azar explained.
“This deal is very good for the Lebanese banking sector because it shows that Lebanese local banks now have the capacity to lend or to give such big amounts. Finally,” he concluded, “the deal is very good for Lebanese Canadian Bank; it’s one of our biggest operations yet, and we hope it’s only the beginning.”

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Banking & Finance

Banking – Fertility loans

by Executive Staff
written by Executive Staff

In a notoriously image-conscious society, the launch of First National Bank’s (FNB) plastic surgery loan last year in Lebanon made sense. Though some social controversy initially surrounded the idea of a bank facilitating cosmetic enhancement procedures, Lebanese consumers were quickly won over as their inner vanity saw new opportunities.

FNB’s corporate strategy is to offer customized products for the Lebanese market, keeping in mind the consumer as well as the behaviors and needs of Lebanese society. Perhaps FNB was en pointe with the world’s first plastic surgery loan — hailing it as a way to “have the life you’ve always wanted,” however, may have been a bit of an exaggeration.
Despite the sensationalism of that tag line, FNB has made its point: it is in the business of offering the Lebanese life-changing opportunities. Most recently, FNB introduced another new product to Lebanese consumers. Though it is not “the first of its kind,” as the website claims, FNB’s fertility loan will facilitate individuals and families to have the life they’ve always wanted.
FNB’s fertility loan stands to accommodate those who would otherwise be unable to finance fertility therapy. The loan covers costs related to fertility operations, stem cell collection and preservation, delivery, and even baby accessories. Loan seekers maintain the freedom to choose their own doctor, and can borrow up to $7,000 for three years.
Worldwide it is estimated that one in seven couples have problems conceiving. Medical treatment of infertility generally involves medication, surgery, or both. The high cost of treatment means that for many, fertility therapy remains out of reach. Or, at least, it used to. FNB’s fertility loan offers a real chance for those who have difficulty conceiving.

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Banking & Finance

Real estate – Loan for a home

by Executive Staff
written by Executive Staff

With property prices around the country appreciating significantly, more and more Lebanese are trying to beat the inflationary trend by buying a home. And the country’s banks are offering a plethora of home and housing loans.

The rise of real estate prices and stagnation of consumers’ purchasing buying power in regards to acquiring property, especially homes, has compromised individuals’ ability to purchase a home in Lebanon, according to Société Générale de Banque au Liban (SGBL). “The weakness of the local rental offer in regards to meeting consumers’ growing needs and high demand, in addition to the over- cautiousness of these local lenders, has magnified the severity of this situation,” said Michel Fiani, strategy and marketing manager at SGBL.
Banks have identified this need and targeted a population of prospective homeowners with housing loans that may vary from one banking institution to another, whether in their features or their potential market.
The Intercontinental Bank of Lebanon (IBL) home loan is dedicated to a large client base whether employees, member of syndicates or entrepreneurs, Lebanese residents or nonresidents, whose age may vary from 21 to 64 (at loan maturity). Borrowers are expected to earn a minimum wage of $600 while salary domiciliation is required for employees who also ought to have a minimum two years experience in their respective field. The minimum amount for the IBL loan varies between $5,000 and $500,000 (special cases for more than $500,000 are also treated on exceptional basis), while the total amount of the loan will not cover more than 90% of the property price. Interest is digressive and based on the US-$ LIBOR.
Last June, SGBL introduced a new version of its SOGEHOME loan. The program has carefully adapted and responded to the current needs of the market and most individuals’ financial profiles and capabilities. The SOGEHOME loan from SGBL is characterized by a longer amortization period that may stretch over 25 years, a diminution of the personal down-payment requirement (starting from 14%), as well as, for a limited period of time, a 0% interest rate granted on home loans acquired before the end of 2008.
The home loan offered by Credit Libanais is also destined to finance the purchase of a residence or land as well as the renovation or the enlargement of a property. While repayments are usually done in equal monthly installments with each equal to or less than one third of the borrower’s salary, no ceiling is actually imposed on the amount lent. In addition, loan applicants benefit from a grace period of up to six months and the bank is ready to cover as much as 80% of the property value. Credit Libanais offers a special interest rate of 4.5% for the first year, and afterwards the interest rate is revised annually depending on market rates (LIBOR + 4.5% with a minimum of 7.75 %). “To succeed in our corporate mission, we at Credit Libanais have developed a new approach to serve retail customers and marketing our countless products. We have turned each branch into a one- stop-shop that offers clients a wide variety of products and services to meet specific needs,” said Alain Hakim, assistant general manager at Credit Libanais Group.

Range of loan options
The Lebanon Home Loan offered by HSCB, “allows customers in Lebanon and throughout the region to arrange all financial transactions regardless if they’re in the country or in, say, Dubai, since HSBC has such a wide regional footprint,” said Tony Graham, senior manager at HSBC Lebanon. And because HSBC Lebanon is a branch of HSBC Middle East Ltd. it profits from Moody’s AA2 rating, and can offer the lowest international rates at LIBOR plus 2.75%.
Byblos Bank offers a loan dubbed “the doctors and dentists housing loan,” which caters to this particular segment of professionals. Single applicants are expected to boast a minimum monthly income of 900,000LL ($600), and 1,200,000LL ($800) if married. Like for other loans, candidates are required to have been employed over two years in the same company, or the same sector if they are self-employed. The loan amount covers 80% of the price of property in the case of a finished apartments, 60% of the rent amount for rented apartments, 50% in the case of a house construction project, and 100% in case of renovation of house as long as the investment does not exceed 50% of the house value. The bank does not place a limitation on the loan amount and the interest is calculated on the base of LIBOR to which 3.5% are added. Repayment period is usually between seven and 30 years.
At BBAC, home loans usually cover an amount of up to $500,000 or its Euro equivalent, on which is applied an interest rate of LIBOR plus 4% when the loan is dollar denominated, or Eurobor plus 4% when denominated in Euros. A grace period of up to 18 months is granted, while first year interest is an average of 5%.
Muhiedine Fathallah, head of consumer credit product at Bank Med, where home loans also know no ceiling or limit whether on the salary amount or property value, underlined that most home loan products are all linked to the LIBOR, varying from 7% to 10% on average. “In the last year, we have noticed an impressive growth in the home loan market. More and more people are buying property in order to either try beating the towering real estate market prices or for investment purposes. This has prompted the Lebanese Central Bank to issue a circular preventing banks from lending an amount covering more than 60% of a specific property value to borrowers who already have one apartment,” he added.
The manager expects the interest on home loans to remain low for the next two years, a factor which should further encourage clients to seek home loans. “Loans provided by the Housing Bank (Iskan Bank), which is an institution jointly owned by most large Lebanese banks offering special loans up to a certain value [$250,000] and excluding registration fees [on average amounting to 6%] have nearly doubled this year alone,” Fathallah said.
In addition to the loan offered by the housing bank, most Lebanese banks also offer the Iskan or PCH loan in coordination with the Public Corporation for Housing (PCH). “This product is relatively the same from one bank to another, the only differences residing in the down- payment on the property and insurance fees” said Charles Mansour, head of loans at IBL.
At Bank Audi the PCH loan amount range is between 20,000,000LL ($13,300) and 180,000,000LL ($120,000). This particular type of loan provides financing for 80% of the property value with an interest rate based on the price of two-year treasury bills (40% of two-year T-Bills to which 3.5% is added).
The repayment period is scheduled over a maximum of 30 years split evenly between the bank and the PHC, and when a loan is destined to renovation works, the amount will cover up to 50% of the apartment value. The loan is free of any registration, mortgage or stamp fees. Eligible candidates’ income may vary between 1,000,000LL ($666) and 3,000,000LL ($2,000) if they are employed in the private sector and between 800,000LL ($533) and 3,000,000LL ($2,000) if in the public sector. Borrowers will have to opt for the domiciliation of their salary at the bank and provide a proof of registration in the National Social Security Fund (NSSF).
Like in all housing bank loans, monthly installments should not exceed one third of the borrower’s revenue and one quarter of his income if he is self- employed or belonging to a liberal profession. For the latter two categories, candidates are expected to submit proof of income: a balance sheet covering the last three years of operation, a statement of account and legal documents when borrowers are also shareholders of a company. File fees are applicable to the loan, which amount to 1% of the total loan along with life insurance premiums, calculated on the base of the applicant’s age and tenure.

Loans in phases
In addition to these loans, in August Bank of Beirut (BoB) unveiled its new housing loan. Roger Dagher, head of the finance department at Bank of Beirut underlined that the PCH Plus loan offered by his bank, although similar to regular PCH loan, carries additional interesting features. Like the regular PCH loan, PCH Plus is granted over a maximum of thirty years, depending on the borrower’s age at loan inception. Eligible candidates are required to earn a monthly maximum of as much as ten times the minimum official salary (equivalent to $2,000). Like in regular loans, the maximum monthly payment should not exceed one third of the average monthly income of the borrower. The PCH Plus time period is divided into two equal phases like the regular PCH loan, where the borrower pays back to the bank the principal of the loan during the first phase and the accumulated interest to PCH during the second phase.
The loan interest is set by the PCH protocol and reviewed every two years, being tied to the two-year T- Bills coupon rate. The borrower is required to deposit 10% of the loan amount in the bank at inception, which will be discounted from accumulated interest during the first phase. In addition to a first degree mortgage, a mandatory insurance including life and fire coverage for the whole loan period is settled during Phase One.
The main difference between PCH Plus and the regular PCH loan, Dagher explained, “resides in one variation that allows the borrower to pay back only the principal of the loan during Phase One without paying back the accumulated interest to the PCH during the second phase, which is why we call this particular product the ‘zero interest loan’.”
In order to benefit from this cost saving, the borrower is required to make a deposit representing up to 11% of the chosen loan amount. This deposit earns interest at the regular loan interest rate and can be returned to the borrower at his request, if he chooses to end the relationship prior to loan maturity, which is subject to full settlement of the loan. With the PCH Plus program, BoB finances up to 100% of the loan, contrary to other housing loans. The customer may pay to BoB, as the required deposit, the down-payment he would pay to the owner of the apartment.
Dagher believes that the PCH Plus loan is more borrower friendly as the bank settles accumulated interest on behalf of the customer. In addition, the property will also be free of any lien at the end of Phase One, which provides the borrower with a greater margin of freedom.
“The PCH Plus loan provides young Lebanese the possibility to finance property at low interest rates. This particular loan emphasizes the social role Bank of Beirut is currently playing,” Dagher added. On the other hand, the manager estimates that this particular type of loan offers the bank greater exposure and reinforces its leading position in the marketplace.
“We believe this product will definitely be successful because it provides borrowers with flexible and advantageous conditions. In my opinion, the product has massive potential: it is possible for Bank of Beirut in one year to grant clients more than 1,000 loans”, Dagher said.
Around, the city, large billboards touting the merits of various home loans seem to be mushrooming. And the campaigns certainly generated popular interest. As Fathallah concluded, “Not only is it attracting attention on the banks commissioning the campaign, but it is also encouraging clients of the different institutions to seek home loans from their own bank as they become aware that buying a house on credit is a relatively easy and affordable process.”

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Banking & Finance

IPO Watch – A Saudi summer

by Executive Staff
written by Executive Staff

The leader in Middle Eastern primary market action in August came — as has been the case for several other months of this year — from Saudi Arabia. The initial public offering of Methanol Chemicals Co (Chemanol) was worth $193 million and accounted for 79% of the aggregate amount of $245 million available last month in IPOs around the region. Different to numerous other recent IPOs which were green-field ventures, the Chemanol flotation originated from a company that has a substantial history of manufacturing activity — it was established in 1989 — which sought a flotation to obtain new capital for corporate expansion.

Its area of activity may be less splendorous than Islamic banking, but Chemanol allocated 70% of the offering to retail buyers, demonstrating confidence that it would be able to get retail investors interested in its offering at a price of SAR 12 ($3.2) per share, which included an offering premium of SAR 2 ($0.53). First results of the IPO showed that demand indeed reached high, with subscriptions totaling $1.1 billion.
Last month saw four other smaller IPOs seeking to raise between $7.8 million and $16.3 million in capital, all in Jordan. Two firms in the real estate sector each offered slightly less than half of their equity to investors; the other two offerings came from a credit card and an investment company.
A total of five companies started trading around the region in an environment of traditionally low August volumes, with international markets additionally subdued by worries over volatile energy markets, unending financial crises and recession talk. The five firms are Sohar Power in Oman, Tunisian conglomerate Poulina Group, Astra Industrial Group on the Saudi Stock Exchange, Jordanian real estate firm Amwaj Properties and the UAE’s Dar al Takaful insurance company.
Even as the last month was tough on MENA bourses, all five debutants had a decent or good start, achieving first-day gains of 12% to 437% — the latter feat was accomplished by Islamic insurer Dar al Takaful on the Dubai Financial Market and it underscores the current comparative edge of Arab bourses in the emerging markets theater. The BRIC (Brazil, Russia, India, China) markets’ top summer IPO of China South Locomotive, which raised $1.49 billion in August on the Shanghai and Hong Kong stock markets, managed a 58% gain on its first trading day in Shanghai, but disappointed in Hong Kong with a measly 1% burp. India’s Reliance Power, which has been battered on the bourse since its Jan 2008 IPO, in August scrapped the IPO of a telecoms equipment subsidiary, Reliance Infratel.

Heavyweight Arab IPOs
Although Middle Eastern investors were expected to have their minds a little less on sprinting after shares and a little more on summer diversions, two well-known Arab companies chose August to start large rights issues that will extend into September. Big money was sought by regional telecommunications operator Zain Group through its $4.5 billion rights issue for a 75% capital increase on the Kuwait Stock Exchange, which opened on August 17 and will run until September 18. A second notable rights issue was that of Egypt’s Al Ezz Steel. The company, one of the country’s leading manufacturers and an important player on the regional materials scene, announced on August 7 that it would seek to triple its share capital by offering almost 365 million new shares between August 26 and September 25 in a rights issue worth $341 million.
Also a September timeframe was selected for the $98 million telecommunications industry IPO of Kuwait’s third mobile operator. Kuwait Telecommunications Co, which was formally established in July as a company with 26% stake holding by state entities and 24% ownership by Saudi communications group STC, is offering 250 million shares, representing 50% of its capital, for subscription at a share price of $0.39.
Much more is expected for September and for the fourth quarter of 2008, with travel and tourism related IPOs something to watch for. The National Air Services offering on the Saudi Stock Exchange has been announced with a size of $600 million for 30% in the company, although the subscription period has yet to be set. In October, the Al Tayyar Travel Group will look to raise $320 million, also on the SSE, while Dubai-based retail and real estate group Aswaaq is said to plan offering 55% of its equity for participation in the same month.
Media reports from Kuwait said that the Kuwait Stock Exchange’s technical committee approved listing of four new companies, including Wataniya Airlines (or Kuwait National Airlines Co), which had sold 350 million shares, for $123.5 million, through an IPO in early 2006 and intends to start operating as a luxury carrier in 2009.

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