Executive Magazine

Battling debt

by Tony Hchaime January 1, 2004

written by Tony Hchaime

The Lebanese government’s successful efforts to put on hold the almost weekly auction of Lebanese Pound Treasury Bills some nine months ago is a positive development many. Local and international economists attributed the move to the substantial increase in liquidity levels pursuant to the Paris II donor conference held during the fall of 2002. The $4 billion drawn during the Paris II conference, coupled with the $4 billion interest-free loan provided to the government by Lebanese banks, have resulted in a surge in liquidity levels, which allowed the government to stop borrowing locally through T-Bills.

As the year draws to a close, however, the treasury is opening up its auction doors once again, borrowing domestically through the issuance of new T-Bills, with maturities ranging from one year to three years. The motives behind such a move have been debated often among leading bankers and economists, in the light of the performance of the government in 2003, and the new draft budget for 2004.

Initially, the conditions set during the Paris II donor conference included radical fiscal and monetary reforms, proper initiation of the privatization of some state assets, and efforts to securitize the proceeds of others. However it seems that the funds attracted during the conference, as well as the interest-free loan by the banks, have been used to partially reduce interest on some of the public debt, and mostly to cover the steep deficit in the budget.

As such, the money was never intended to solve the problems of the government, but was rather a means to undertake economic reforms and privatization. Such efforts are ultimately used to significantly trim the deficit, spur economic growth and stop the need for additional borrowing – all of which are seemingly beyond any imminent materialization in the case of Lebanon. The money raised in 2002 was used rapidly to cover the budget deficit and has since dried up in less than a year. The direct consequence of such developments is the recently highlighted return to T-Bill auctions.

A major portion of the funds obtained during and pursuant to Paris II was used to replace existing debt obligations with new ones at lower interest rates. This has resulted in the much-lauded reduction in general interest rates in the country. As such, the new T-Bills auctioned by the ministry of finance yield between 6.85% and 8.72%, a significant drop from the 14% or higher yields common prior to Paris II, to levels unseen in over 20 years.

Moreover, it should be taken into consideration that if the government succeeds in maintaining such low interest rates while simultaneously replacing existing high yielding debt with such T-Bills, the overall cost of debt burden would be significantly reduced.

On the other hand, the government’s ability to succeed in such an endeavor should be assessed, given the sizeable deficits in the budget, and the slow pace in the implementation of reforms and privatization plans.

A comparison between borrowings through Treasury bills and the interest rates on such securities shed some light as to the government’s ability to maintain low interest rates (see chart). Historically, lower interest rates have been accompanied by lower levels of borrowing. In essence, there have been rare periods where the levels of T-Bill issues have been sustained with dropping yields.

In economic terms, the yield on any security rises with the risk associated with such a security. In this regard, the government had managed to improve its image and comfort investors following Paris II, with the central bank foreign exchange reserves reaching record highs. Such developments reduced the perception of default risk on the government, devaluation risk on the national currency, and thus justified the lower interest rates on the newly issued T-Bills. Recent developments, however, have begun to raise concerns once again, and political bickering has delayed many critical reform plans. A number of adverse factors are appearing on the horizon and are likely to render investors more risk averse. The regional arena is plagued by the situation in Iraq, increased terrorist activities in Saudi Arabia and Turkey and the slow pace of the peace process. On the domestic front, the scene does not look any better. The year 2004 is expected to witness heated presidential and municipal election campaigns, overshadowed by the Hariri-Lahoud feuds. Furthermore, much uncertainty surrounds the government’s ability to take concrete steps towards economic reforms, privatization, and securitization, and ultimately reduce the debt burden. In essence then, such increasing uncertainties are likely to push interest rates higher in the market, and consequently force the government to offer higher yields on T-Bills if it chooses to pursue this method of borrowing.

On another front, positive signs are beginning to show in the western economies, increasing the likelihood of higher interest rates globally over the next 18 months. Such increases will also have to be reflected in the yields of any securities sold on the Lebanese market, including the government’s Treasury Bills. Some argue that since the central bank will absorb a considerable portion of each issue of T-Bills – as it has done previously – interest rates may be more resilient to upward pressures. Nevertheless, although the central bank has done so occasionally, the bulk remains in the hands of banks and private investors (see chart). This renders interest rates much more sensitive to market pressures.

Banks in Lebanon are known to have profited substantially from T-Bill investments in the past, and are not likely to appreciate the sharply lower returns on similar investments offered currently. Nevertheless, the currently low rates of return on alternative uses of funds may encourage banks to invest in T-Bills. The credit situation in the country has been severely damaged by the economic recession of the past three years, while global interest rates remain at record low levels. In such a sense, the yields of 7% and 8% offered on the new T-Bills do appear attractive. On the other hand, rising global interest rates and improvements in the economic situation in the country could spawn various alternative investment opportunities. A direct correlation exists between the T-Bill yield spread over LIBOR and banks’ portfolios of such securities. As such, it is expected that as global interest rates rise and the spread between Lebanese T-Bill yields and LIBOR narrows, Lebanese banks are likely to trim their T-Bill portfolios in favor of other investments (see chart). Therefore, the government will be forced to raise interest rates to maintain or increase the spread over LIBOR in order to entice banks to keep purchasing T-Bills.

On the income side, recent figures released by banks in Lebanon reveal a marked improvement in the bottom line, despite the lack of T-Bills over the past nine months. Such a development indicates that perhaps banks are no longer as dependent on T-Bill returns as they were in previous years, and that they have successfully sought alternative sources of income.

Pressures on the Lebanese Pound have always been a major topic debated in government circles over the past years and have often put a strain on the central bank’s foreign reserves during its efforts to stabilize the currency.

As the government attempts to lower interest rates across the board through the issuance of T-Bills at markedly lower interest rates, concerns arise as to the impact of such a move on the Lebanese pound. Basic economics stipulate that as interest rates drop in one country relative to others, demand on the domestic currency also drops. In the case of Lebanon, this would theoretically reignite pressures on the Lebanese pound, forcing the central bank to tap into its foreign reserves to offset the pressure.

On the other hand, even the sharply lower interest rates on the Lebanese Pound remain at a significant premium to interest rates on international currencies. As such, the drop in demand on the currency resulting from lower interest rates is likely to be limited in the near term. Conversely though, if global interest rates were to rise, reducing the premium offered on Lebanese pound investments, demand on the currency would begin to drop, and pressures would begin to mount. Nevertheless, such a concern is somewhat distant and of little concern, especially since the central bank has recently accumulated record levels of foreign currency reserves, enough to defend the national currency if need be.

However, while the significantly lower interest rates on the securities would be a welcomed move in terms of reducing the cost of debt burden on the budget, a number of concerns arise based on historical developments and expected future ones.

The ability of the government to maintain the low interest rates is questionable. The use of the funds obtained through such auctions should be closely assessed. Debt levels are continuing to rise, and efforts to trim the budget deficit have yet to meet reasonable success. In such a sense, will the funds obtained through T-Bills be used to facilitate the implementation of economic reforms, privatization and securitization… or will they be used to just cover the deficit and contribute to the growth in our public debt levels?

January 1, 2004 0 comments

Business

Turning a page

by Godfrey Blakeley January 1, 2004

written by Godfrey Blakeley

Saqi Books, an independent publishing company run by two Lebanese, is making waves in international markets and, perhaps even more importantly, helping to counter misunderstandings between the Arab and Western worlds.

The ethos of the company is radical, progressive and international. “We believe in a cultural dialogue between the Arab and Western worlds, never more needed since the events of September 11,” said managing director Andre Gaspard, who, with his partner Mai Ghoussoub, founded the company as a bookshop in 1979 and now runs the company from offices in a cosmopolitan area of West London. Today, the company has an annual turnover of $3 million and publishes 27 English and 39 Arabic titles a year.

“We don’t think in terms of Arab or Western blocs and we don’t see all Arabs as fanatics and all Americans as imperialists – that’s crude and simplistic. We try to provide an outlet for a variety of individual voices.”

Gaspard cites the example of ADAMA, an autobiographical novel by Saudi writer Turki al-Hamad, which is about a young man growing up in Riyadh in the 1960s, and THE CRUSADES THROUGH ARAB EYES, by Amin Maalouf, which went a long way towards setting the crusades, one of the most distorted episodes in history, in a true light. “This is the sort of book we like to publish,” he said. The book still sells over 5,000 copies annually and is a standard text in schools and colleges.

A major coup was the publication in November 2001 of the first study of 9/11 called, TWO HOURS THAT SHOOK THE WORLD, by Fred Halliday, a Middle East specialist at the London School of Economics. The company began with the bookshop. Gaspard, who studied law at the University of St Joseph, and his friend Ghoussoub who studied math at the American University of Beirut, left the civil war in Lebanon in 1976 and moved to Paris. They found temporary jobs – Gaspard in a bank and Ghoussoub as a journalist with an Arab language weekly newspaper. They were both great book lovers and avid readers. One weekend Ghoussoub, on a visit to London, noticed that the city had no Arab language bookshops although there were three in Paris.

“She came back to Paris and suggested we open a bookshop in London and, being young and crazy, I agreed straight away. After we had opened, I met a prominent Arab bookseller who told me he had been thinking of opening a bookshop in London at the same time. He had a feasibility study done which predicted he would lose £80,000 a year and he decided to drop the idea. Thank heavens I never carried out a feasibility study!”

Before opening in 1979, Gaspard and Ghoussoub drew up a catalogue of 1,600 titles. “We printed 1,000 catalogues and ran out of them within a few months. We didn’t plan it but it proved to be the best way to launch a company specializing in mail order and library supply.” They also built up an address list of universities and colleges with Arabic departments in Europe and America. This mailing list, which began with 80 names and now has over 10,000, is the basis of the core business – mail order and worldwide library supply. This now accounts for some 70% of the shop’s annual sales of about $1 million. Mail order is increasingly overtaking “off the street” sales, as fewer Arabs visit London and more bookshops sell books about the Middle East.

He runs a tight ship. The bookshop employs seven people and is managed by Ghoussoub and Gaspard’s wife Salwa. At any given time the shop stocks some 40,000 titles evenly divided between Arabic and English books and specializes in titles with a long shelf life which often become standard academic texts.

“For a bookshop turnover in time is the key to profitability. If your allocated capital for buying books is, for example, $100,000, then the secret to financial success is how many times you can recoup and reinvest that $100,000 during the year. The average is three times, we achieve three and a half times, and the big chain bookshops aim for five times,” said Gaspard.

“Because of this huge push for profitability by the new supermarket bookshops there is a constant demand for new books, and huge numbers are being produced, the traditional bookshop atmosphere is disappearing, and it’s becoming difficult for the independent bookshop to survive.” But Saqi survives and prospers. The bookshop is “the mother” of the other two departments. The English language publishing department opened in London in 1984 and after “bumpy” progress over the years, picked up dramatically. It has increased sales by $200,000 for each of the last two years and now achieves annual sales of $1 million. All three departments now contribute more or less equally to the company’s present overall annual sales.

“I’m sorry to say that the tragedy of September 11 helped our English language publishing business. Sales increased threefold because many of our books were relevant to the crisis. Our Arabic publishing suffered at first but recovered, and the bookshop, which is a steady, ongoing business, was not affected.”

The English department is a lean and fit operation with an in-house staff of four people. Much of the nitty gritty pre-production work in London is handled by a team of some twelve freelance copy editors, proofreaders, indexers and designers. This system of outsourcing is especially effective in the production of a wide variety of specialized books. Pre-printing work accounts for about one-third, and printing and binding for about two-thirds of costs.

A publisher’s key partner is the representative who sells his books to bookshops, and the distributor who stocks his books in a warehouse, delivers orders to bookshops, collects sales revenues and, after deducting fees and expenses, sends the publisher his money.

“If my representative goes bust I don’t lose much, but if my distributor goes bust, we can suffer badly. The distributor is your money source, and if he runs into trouble, the publisher is the first to suffer – especially in England where in a case of bankruptcy other creditors take precedence over publishers,” explained Gaspard. “Over the last 16 years, four of our distributors have gone into receivership. The last time we lost six month’s sales and suffered a severe disruption of business. With nine books going through the printers we had to rent a temporary warehouse for two months until we found a new distributor and it took us two years to recover from the crisis. But each time we were able to recover because we do not borrow money from banks – that is our golden rule. Publishing and distributing books is unpredictable and risky.” When the company opened an office in Hamra Beirut in 1992, it was initially managed from London and everybody told Gaspard it would fail within a year. “We started slowly and cautiously but we picked up better than most of our competitors after the first Gulf war and our growth has been the fastest ever achieved by a Middle Eastern publisher.”

The office now employs a fulltime staff of 10 and a team of eight freelancers, has its own editorial board, and is becoming increasingly independent of London. It publishes over 50 new titles a year as well as reprints, achieves annual sales of about $1 million, and is the leading independent publisher in the region. It may also generate the company’s strongest growth in the future.

“Our list consists of some 300 writers from Morocco to Iran and everywhere in between. We try to find writers from a broader social spectrum, including women exploring new cultural and social issues, and as always we are keen on ‘new voices.’ We always treat writers fairly and this makes a huge difference in the Middle East. They recommend you to other writers and you are on a roll.”

In London, the company acts as a publisher but in Beirut it not only publishes books, it also does its own representation, distribution and wholesaling. Operations cannot be streamlined by giving exclusivity to one distributor as in Europe and America, and although the company has 40 distributors in the Arab world, some of them are unreliable and it does some distribution itself. The company stores its books in its own warehouse, employs two fulltime representatives constantly visiting bookshops throughout the region, and attends all the main book fairs. It has built its own distribution network and delivers directly to bookshops in all the major Arab cities. So where do Saqi Books go from here?

“We’ll do more of the same. We’ve always worked within our means and invested only from profits and never from borrowing. That makes it difficult to dream up master plans or long term goals,” Gaspard said. “We could open bookshop branches but we’re not going to jump into things. We don’t take easily to the idea of expanding with somebody else’s money and on their terms. We started small, we’ve grown gradually, and we like it that way.”

January 1, 2004 0 comments

Finance

Falling flat

by Faysal Badran January 1, 2004

written by Faysal Badran

Attempting to put together a commentary on the state of the Arab capital markets has become increasingly difficult for fear of being too biased, or worse, too skeptical. But as the parades of often-eloquent speakers continue to elaborate on the development of stock and credit markets in the Arab world, it is safe to say that yes, there is the proverbial “money to be made” in some Arab markets. But the question remains, are they heading in the right direction as far as growing the investor base and attracting fresh capital? The debate rages on, but recent events suggest that the notion of liquid and integrated markets is almost as far off as good governance and openness. Some recent bubbles came through newly privatized sectors, or even a real estate development here and there. But in essence, and despite some heart stopping cycles, the markets remained illiquid, and public participation weak. The main worries as they relate to the dynamics of the Arab market include, slow dealings, a somewhat opaque information and data system and the fragile economic and social structures – which the markets ought to reflect over time. These are linked to economic size and macro issues, as well as regulatory inexperience and lack of transparency and standard corporate governance. We could be cheeky and pull out a report from the UNDP on human development in the Arab countries – or a more recent obvious yet chilling diatribe on the poor state of governance in the area – to build the case that Arab capital markets are destined to remain disparate, shallow, speculative arenas, unlikely to take a path of growth and global relevance. It is unthinkable that the capital markets can develop meaningfully before there is a trajectory of openness, sensible economic planning, transparency and people empowerment. It is not a political angle it is the only angle. If we are to have capital markets that act as a faucet of growth and development of the Arab generations to come, it would be useful to link it, inextricably to political reform and a process of de-corrupting the political systems – a tall order for sure. Can we have open and deep markets for paper assets if trust in the economic, social and political future is not partly secured? Can we attract capital and develop the right environment for savings to be directed at the markets if, for the most part, we have no plan for tackling unemployment besides rhetoric and flamboyant use of “emergency” and “security” as a means of stratifying the status quo? There is ample room for Arab capital markets to exist and prosper. But without the corollaries of human development, economic depth and a prosperous and trusting population, all efforts to perpetuate the dream of capital markets are as doomed as a Road Map, which does not take into account the map itself.

Nothing would be better than for Arab markets to truly enter the realm of “emerging markets” and get more visibility and respect. But realistically, without seismic changes in political governance, and policies that promote prosperity over policing, it’s a non-starter. It is a good sign that the professionals in the Arab area do hold conferences – the exchange of ideas is refreshing and does help the local hotel industry when the show comes to Beirut. However, better usage of resources would be for those sharp pros to exert pressure for change.

In this era of Texan “crusades,” the Arab capital markets will most likely be restrained on one hand by weak economies suffering structural problems and political neglect, and on the other by the stark reality of decaying political and social systems. Totalitarian regimes and equity and business cultures rarely coexist. They are stuck between local economic despair and shrinking relevance of their impact and role in the more global world. There is sincere denial from many places in the Arab world about many things, but what is striking is how many players in the region still expect to have a financial center in the region. At the latest count, two Gulf cities are sort of competing for the role of financial center. Chances are, most of the financial centers in the world have already been established. This is independent of the fact that entire daily turnover of stocks and bonds in the region is probably less than that of Intel, L’Oreal, or Nokia in a few hours.

The recent launch of CNBC Arabic seems astounding. Here is a region with little free press, harsh living conditions, autocratic “family business” type regimes, often with spectacularly high unemployment levels, and rampant corruption, and now it has its own financial news channel? Not surprising though, given that CNBC in its short life has become a sort of ATM of hyper-capitalist propaganda. It is short sighted to think that because CNBC Arabic has been launched, something good must be happening in Arab capital markets. It seems optimistic to think that 24/7 Arab financial news is needed or even justified. The clear focus for Arab capital markets in the coming year will be events outside the realm of economics and finance. In a period where the existence of some if not all current systems is on the table, and where human suffering is excruciating, where illiteracy is still an issue, and justice and representation are not the currency of choice, the Arab capital markets will remain in a rut. Developing an equity culture so crucial for markets to take form takes generations and, most importantly, requires prosperous and vibrant youthful enterprise. But to draw skill and money to the regional markets will require that the inevitable reassessment result in the triumph of the economic/human development priority. Not a sure bet, but hope springs eternal.

January 1, 2004 0 comments

Business

Gold rush

by Sarah Smiles January 1, 2004

written by Sarah Smiles

The violence still plaguing Baghdad has done little to deter a brave band of entrepreneurs – many of whom are Lebanese – to march into the capital and snap up lucrative post-war contracts with the coalition forces. Free trade and privatization, forbidden under Saddam Hussein, has plenty of opportunists biting.

“Before the war there was no chance for foreigners to invest. It was a scary regime. Who would have dared come here and try?” said Lebanese businessman George Chahine, who has a contract to maintain three US military bases with Kellogg Brown & Root (KBR), a subsidiary of Halliburton.

With $18.6 billion pledged by the American government for post-war reconstruction next year, alongside over $13 billion in loans and donations from donor countries secured recently in Madrid, the contracts – worth anywhere between $100,000 to $30 million – have overwhelming appeal. “As long as I’m happy with the contract, I don’t mind doing business in Angola or Afghanistan,” said Michel, who comes from Beirut and has a contract with KBR to supply mobile homes to the American camp at Baghdad International Airport.

Yet he was not so blasé about the dangers involved. American military convoys are often targeted by explosive devices on the road to the airport, which also comes under regular mortar attack. “The biggest risk is getting to the camp and back on the road. Also being at the airport, if the camp is shelled who knows what’s going to happen?” he said.

Despite these risks, Michel considers the contract “worth it,” although he, like most of the other contractors in Iraq has no insurance. “What insurance?” he said incredulously.

“You can get insurance but I don’t think it’s worth much because this is war. Who’s going to cover FORCE MAJEURE?”

While one upside to this is no taxes, the lack of insurance for consignments in a war zone can be costly. Chahine is constantly losing freight on the road from Kuwait to Baghdad, where his goods, accompanied by military vehicles, are inevitably targeted by looters. When a truck comes under fire, the driver detaches his load and keeps on driving.

“If I have a valuable consignment in transit, I’m always worried about it until it reaches its location because it’s my money after all,” he said.

While the security situation across Iraq is far from ideal, Yousif Abdul-Rahman, the senior advisor to the Iraqi trade minister is naturally bullish, predicting that business opportunities will abound when the situation stabilizes.

“When security prevails we expect there will be big opportunities in business in Iraq, whether in construction or in supplying commodities. The sooner companies get here, the better,” he said.

This optimism is underpinned by a burgeoning form of economic liberalization that has taken hold under the neo-liberal policies of the Coalition Provisional Authority (CPA).

“A new investment law will be issued to encourage foreigners to come and invest in Iraq,” said Abdul-Rahman of the new law currently being drafted and soon to be issued by the Iraqi Ruling Council.

Previously, state-owned businesses, from factories to the infamous Al-Rashid hotel in Baghdad – are also under review for privatization. “Each ministry is negotiating which projects need to be privatized and which need to be controlled by the government,” said Abdul-Rahman, touting the example of previously state-owned shopping malls. “We plan that in the future, these shopping centers will be rented to the private sector, renovated and redeveloped [to resemble] major chains, such as Safeways. The private sector can deal better than the government in certain areas.”

Nonetheless Abdul-Rahman acknowledged that privatization must happen slowly to ease the social fallout likely to occur if more Iraqi workers lose their jobs. This is nowhere more sensitive than in the manufacturing sector, where some 200 state-owned companies formed the largest employers outside central government – with more than 500,000 workers on their payrolls. “The unemployment rate exceeds 60%. If we speed up privatization this will have a negative impact,” he said.

With privatization is a key economic goal for the new Iraqi government, and the main focus of the trade ministry is free trade, said Abdul-Rahman. This is a sharp shift for a ministry whose former function was to control the rationing system of the UN oil-for-food-program.

“The outlook for the government is free trade, so there will be a very big support for the private sector to participate in the economy of Iraq,” said Abdul-Rahman, highlighting the ease of registration for foreign companies.

Free trade is nowhere more evident than in Iraq today. When the war ended, the CPA froze customs duties on goods entering Iraq, heralding an unprecedented opportunity for trade with neighboring countries. The streets of once-sanctions ravaged Baghdad are flooded with cheap electrical products from Turkey and food from Iran, distributed through Kurdistan. A fleet of used-cars has also made its way into Iraq through the Jordanian port of Aqaba.

This will change on January 1, 2004, when a reconstruction levy of 5% will be imposed on the total taxable customs value of all goods imported into Iraq, besides medicines, food, clothing and humanitarian goods.

While Jordanians have profited from trade with Iraq, Chahine sees the Kurds as the “biggest winners” of the post-war free market.

“The private sector is being controlled mainly by the Kurds, due to the fact that Northern Iraq wasn’t under any embargo and the Kurds, because of their territorial location on the Turkish and Iranian border, have experience with trading transactions and have already established their contracts with manufacturers abroad,” he said. “They were the first to flood the market with satellite dishes, a day after the liberation.” While most trade is coming through the ports of Aqaba, Tartoos and Um Qasr, some businessmen are choosing to ship their consignments through Beirut to avoid delays. “We have to depend on Beirut, because Aqaba is congested and there is a delay in delivering the consignments in Kuwait,” said Chahine who has a consignment soon to be delivered through Beirut.

While years of sanctions would suggest that Iraqis have poor purchasing power to take advantage of new products, Chahine believes otherwise. “Iraqis are buying. They were thirsty for everything,” he said of the country with a population of over 24 million.

Khalid Al-Helou, an Iraqi businessman agreed: “Under sanctions there was nothing to spend your money on. We couldn’t travel or buy new things, so we just saved it.”

Landlords are also cashing in. Since the end of the war, property prices have risen by 300%. “They are asking $2,000 per square meter for prime locations along the Tigris River,” said Chahine, obviously unimpressed at having to pay $20,000 to rent a home. “The price of land is grossly exaggerated. Why? The Iraqis believe that the price they set now is the one they will realize in the future.”

While trade and real estate present long-term opportunities in Iraq, the best money to be made right now is through American contracts, said Chahine. He said Lebanese businessmen have a clear advantage in doing business in Iraq. “The advantage the Lebanese have is that they are multi-lingual. It makes it easier for them to communicate with the locals and the internationals, and coordinate with the local market and abroad,” he said.

“I also feel at home here,” said Michel, of his experience of doing business in a war zone.

Yet despite the many business opportunities, the dangers of doing business in Iraq cannot be underestimated. Chahine drives a beat-up, dirty Toyota Corolla through the streets of Baghdad to avoid standing out, employs an armed gunman to guard his house – and admits he feels anything but secure. “But no risk, no money,” he smiled, noting the importance of gaining a foothold in Iraq now.

“To be here at this time, to become familiar with the market is very important,” he said. “This is just the beginning.”

January 1, 2004 0 comments

Finance

High hopes

by Executive Staff January 1, 2004

written by Executive Staff

The adversity of the past three-year bear market in US equities has been steadily forgotten over the course of 2003, as we enjoy the present blessings of a stronger economy and a nine-month-long rally. Investors and speculators are now stressed with the question of how much longer the good times will last. The major worry is whether it is too late to join the party. The most important question on everyone’s mind is: Am I going to miss out if I do nothing, or am I going to buy at the top if I chase this market at this point? Folks have gotten quite excited. What began with such nervousness and anxiety in early March has now flourished into a full-fledged, wide-open speculation. There’s a lot of optimism that good things are about to happen next year in the economy and the stock market. We’ve seen lots of cheerleading and speculation when not much has occurred yet. This rally was predictable by many, even the bears, but no one, not even the bulls, predicted that this rally will go this far and this fast. As always, we can find compelling arguments for both the bullish and bearish perspectives. One thing that makes the market so difficult is that very logical points of view can always be made for both sides. We can easily find ourselves swayed back and forth as we listen to the arguments. The bulls will tell you that beneficial monetary and fiscal policies, a continued decrease in risk aversion, and attractive relative valuations are evidence that positives outweigh negatives at the moment. The weakness in the dollar has no historic correlation with stock market returns. In addition, unemployment, which has stayed at a pretty high level throughout this recovery, is a classic lagging economic indicator. It is common for the unemployment rate to rise after the end of a recession. This period seems to be no exception. In addition, in the short term, seasonal factors favor stocks, as November and December are typically the strongest period of the year. The bulls conclude that we have now turned the bear page and we are currently enjoying a new bull market that could last for several years to come. Bears, on the other hand, say that there are no signs of a real improvement in the economy. The Fed has greatly increased liquidity, and this has resulted in asset inflation. This has meant rising stock prices and rising home prices. Stocks and homes are now priced at treacherously high levels. Valuations, especially in the Nasdaq, are still way high. The national debt is now around $35 trillion, as compared to a $10 trillion economy (GDP for the US).

Consumers have leveraged up appreciating home values to live beyond their means. But they are so spent up that auto sales are deteriorating, despite zero-percent financing and tax rebates. There has been some good news from certain tech companies. But that’s because they are the companies that sell to other companies that may be building up inventory. After this bear market is finally over, almost no one will remember the hyper bullish psychology that existed in the summer of 2000, the spring of 2001, the spring of 2002 or the fall of 2003. All these rallies will be labeled corrections in a secular bear market.

January 1, 2004 0 comments

Finance

Q&A: Riad Salameh

by Thomas Schellen January 1, 2004

written by Thomas Schellen

Elected as banker of the year by EUROMONEY magazine, Riad Salame, govenor of the central bank, has been a guarantor for the authenticity of Lebanon’s monetary policy of safeguarding currency stability and relying on market forces. EXECUTIVE asked Mr. Salame about the state of the banking and financial sectors at the end of the year, the impact of the Al Madina scandal, and his outlook for 2004.

E: How do you evaluate the period in terms of fulfilling the commitment and promises of Paris II, one year post the event?

RS: Paris II recreated confidence in the financial markets. Interest rates saw an important decline. In 2003, interest rates are 50% to 60 % lower than in the previous year. The confidence and positive dynamic allowed Lebanon to issue debt instruments in the local currency with three-year duration. That was the first time it was possible to do this and this was done through the CDs [Certificates of Deposit]. The other achievements in the financial sector were the different initiatives taken by the central bank to reorganize its portfolio. These various initiatives allowed savings in 2003 of more than $800 million and will create more than $1.2 billion [of savings] in the year 2004. Despite the fact that the debt has increased in 2003 to reach around $33 billion by yearend, the servicing of the debt for 2004 is going to be less by around 20% compared to what was achieved in 2003, and less than it was estimated to be before the success of Paris II, by almost 40%. On the government side, more work has to be done. The budget in 2003, according to the ministry of finance, has a deficit equal to 37% of the total budget, while predictions were for around 30%. The 2004 budget is showing a deficit of around 30%, which is good compared to what was achieved in 2003, but not in line with the decline of the deficit that was promised to bring down the dynamic of the debt. On the other side, promises of privatization and securitization were not realized this year.

E: Is the delay in privatization by at least another couple of months a threat to Paris II and what has been achieved so far?

RS: The funds that were released were not conditional. Therefore, the results of Paris II have already been finalized. The importance of reforms comes from the fact that we have to keep this confidence in our markets so that the interest rates could go lower for the economy.

E: In view of some analysts, the central bank has been focusing on monetary stability, while fiscal authorities had priorities on lower interest rates that were of a different emphasis. Do you see a divergence between the two?

RS: Monetary stability is also the objective of the government and has been the objective of all governments since independence. The divergence comes from the views on which policies would result in stability. The central bank relies essentially on market sentiment in order to determine the rates of interest in the country. There are some views that you could administer interest rates and keep monetary stability. This is not our view. Therefore, and as the priority is still for monetary stability, the central bank remains with the same policies.

E: The desire to drive interest rates further down to ease further borrowing is not what you would unconditionally agree to?

RS: We look at the interest rates to be stable. We intervene in case there are upside pressures, because we do have the means to do it through all the funds we raised through the CDs. We think that the next move would be to have lower rates but this has to be market driven, so that the confidence remains in the financial sector. And for that, we need good news from reforms initiated by the government.

E: If we turn now to the banking sector: was 2003 a good year in Lebanese banking?

RS: Lebanese banks in 2003 have realized returns that are equal to 2002 despite their contribution to lend the government at zero percent, and despite the fact that interest rates have declined on the lending side, especially for borrowers with a good rating. The balance sheets of banks have increased this year, especially on the deposit side, with growth of over 13%. There was a good progression for non-resident deposits and fiduciary deposits, which means that the banking sector in Lebanon is conveying more confidence for the region and non-Lebanese. The capitalization of the banks is now over $3 billion, capital adequacy is over the required 12%, and the situation in the sector, in terms of improving management and technology, is also good. So I think that the banking sector in Lebanon is sound and is progressing in a healthy manner.

E: What would you tell someone who claims that banks are making too many profits?

RS: The return on assets, as mentioned by the IMF, is on average 1% internationally. The return on assets in Lebanon during the past two or three years was below this 1%. Therefore, the banks’ return on assets should improve. The reason why you have big nominal profit figures comes from the quick expansion in their balance sheets. When the total balance sheet of Lebanese banks was $10 billion, their profits were $100 million. Today, as balance sheets total $50 billion, their returns theoretically should be $500 million. But in fact, due to provisioning and less income from the government, their returns are less than that. The higher profit figures for the banking sector are derived from the expansion of their balance sheets and not by increases in the spreads they are charging in the cost of money.

E: Are you satisfied with the interest rate environment as it stands today?

RS: We would like to see the debit accounts – excluding consumer loans – with a ceiling of 10%. We are working for that with the banks in Lebanon and the Association of Banks in Lebanon [ABL]. A commission is to be formed in the coming two weeks to study professionally how to get this achieved across all accounts, whatever their size.

Interest rates on deposits are not a concern to the central bank. We think that the banks know how to manage their treasury and if they do sacrifice on their profits to pay their clients more or gain new market shares, the central bank doesn’t see this as harming the economic growth. Our focus is on debit interest.

E: If we look forward into 2004, what will banks have to achieve next year in regard to getting ready for Basle II requirements and working for the needs of the national economy?

RS: The central bank has issued a circular with the purpose of cleaning the balance sheets of the banks from redundant debts and provisions that were constituted for these debts. This includes all accounts up to June 30, 2003. Our priority to prepare the sector to be in a very good situation for Basle II – that we expect for around 2008 – is the success of this operation because the settlement of these loans will help the banks take them out of their provisions. On the part that is not settled, banks will have to reconstitute liquidity during five years, as to equal the amounts that there were no settlements on. This will give the economy a boost because many players will come back and will be able to refinance from banks as they have settled their loans and at the same time will clarify the banks’ balance sheets and will defuse the high percentage of provisions compared to the loan portfolio, which is effectively cosmetic because it is mainly constituted by reserved interest rates. This is the priority for the year 2004 and I think all banks are aware of the importance of this reorganization.

E: Is the Al Madina case closed from the perspective of the central bank?

RS: For us, the matter is closed, banking wise, because we have secured enough funds to pay the true depositors, including interest rates. We have changed the management of the bank, we have nominated a manager by the high banking commission and, therefore, ousted the previous management that brought the bank into the situation. On the legal side, all the necessary has been done. Whatever happens between the players and their disputes is not the concern of the central bank.

E: From your perspective, has the whole Al Madina affair been resolved without damage to the image of Lebanon or its banking sector?

RS: The banking sector did not suffer, on the contrary. This year we have increases in deposits by 15% and a record positive balance of payments – around $3.4 billion until the end of October. The banking system is safe. No other bank was linked to this bank and there is no echo on other banks. We do think that the way the situation was handled was quick and the results were good. Nobody lost money, neither the government nor the central bank nor the depositors.

E: Lebanon’s financial sector has been lagging behind the banking sector in the attention it has been getting. Are there any realistic prospects for establishing an oversight institution of the type of a Securities and Exchange Commission, or legislation that would enable the sector to be stronger next year?

RS: It is necessary to have such an organization. There are projected laws that were presented by the central bank to the government. We don’t know of any immediate follow-up but this is an important initiative that will help raise more equity for the private sector and increase their performance.

E: Next year is an election year in Lebanon, per chance in parallel to the US. In that country, an election year usually means a 1% better than economic growth. Would you foresee anything similar for Lebanon?

RS: Our estimates for next year are still in line with what was achieved in the economy for 2003, with some improvement. Due to the seasonality and volatility of the economy, the central bank has been reserved on putting out estimates. After the first quarter of 2004, we will follow with a better estimate.

E: Would the run up to the election here impact the economy, either positively or negatively?

RS: We hope that the debates will be in line with the interest of the country and its economy. And anyway, if things get harder, we have taken all the necessary measures so that they do not affect the stability of the economy or the financial sector. Already, the results have shown that despite the political internal tensions of the last two or three months, these were not felt by the financial markets. And this is a big improvement in the financial history of the country, where these financial markets were very sensitive to political developments.

E: Is being central bank governor a good preparation for being president of Lebanon?

RS: The time for our interview is up.

January 1, 2004 0 comments

Society

Treading water

by Thomas Schellen January 1, 2004

written by Thomas Schellen

By all signs and measures, insurance in Lebanon remains on the slow burner. Business developments and preliminary expected results for 2003 – even a somewhat conclusive performance evaluation based on unaudited results is not possible before next April because far too few members of this sector provide half-year or third-quarter reports – indicate no significant changes or additional sector growth in comparison to 2002, when the volume of insurance premiums increased by about 6%.

Aside from stronger hopes and aspirations harbored by individual companies and for specific products, insurance managers widely expect that also in 2004, their industry will see more of the same – treading water. This is not to say that the sector doesn’t breathe easier today than it did two years ago, when operators were looking at a mountain of bad news based fundamentally on increasing reinsurance costs and faltering investment portfolios. And the industry certainly appears far healthier and more promising than in the late 90s, when it was battling to emerge from a long credibility crisis and struggling to gain firm financial and operational grounds on the platform of the gradual implementation of a revised national insurance law. This period lies now behind Lebanon’s insurers, even though some of the goals for downsizing of operator numbers and consolidation have yet to be achieved. What that leaves the sector, at this point, is a mixed lot. Firms on their protracted way out and those that in best-case scenarios are broker-sized candidates for acquisition by a viable insurer, stand vis-à-vis operators investing into their growth and increasing professionalism. The latter group comprises first of all the companies with international corporate affiliation, bank-owned firms, including life and bancassurance specialists, and Beirut-based companies with regional scope, but it also includes a share of independent local companies eager for growth. Most of the straits that plagued insurers in 2003 stemmed clearly from the prevailing of adverse economic conditions; others were related to matters of public policy and the state of government affairs. The economic environment made for few interesting projects that firms could go after. “The financial and economic crisis is continuing to take its toll by keeping the number of projects for general insurance low,” said Lucien Letayf, general manager of Libano-Suisse Insurance. The company, which has growing regional activities, could secure contracts to provide coverage for three major construction projects in 2003, he added, “but there are not many of them.” On the health insurance front, persistent problems in the public sector coverage, created through non-payment of government dues to the National Social Security Fund, derailed expectations that pressures on the sector would be relieved by stronger NSSF involvement and new public health care provisions. The much-touted introduction of mandatory third-party liability (TPL) insurance for motorists turned out to be less than companies anticipated, with a plethora of organizational and regulatory difficulties slowing the implementation process. But on the bright side, as far as the government’s work is concerned, insurers widely credited the ministry of economy and trade and its insurance control commission for doing a good job in implementing the first-ever series of complete field audits of sector companies, a task that had been outsourced to two professional auditing firms. Companies across the board furthermore confirmed that essentially, the government took an excellent step in beginning to enforce that motorists obtain compulsory TPL insurance against bodily injury.

With the prospect of increasingly thorough enforcement of vehicle inspections and insurance requirements and ongoing deliberations over the expansion of the compulsory insurance to property damage liability, the motor segment stands to be the main event in occupying the sector’s attention also in 2004. However, some insurers would rather the government not rush into making motor TPL coverage for property damage mandatory. Companies have yet to review the claims ratios and evaluations of the sector’s first experiences with the new motor liability cover. “We should initiate a dialogue with the ministry of economy and trade in order to amend the law on personal injury TPL in motor before moving to implementation of property damage TPL,” said Elie Nasnas, general manager of insurer Axa Middle East.

While the motor cover is a welcome development, “it could also be very risky,” warned Letayf, who also considered the end of 2003 too early for introduction of a compulsory TPL property damage cover. “Companies are not sufficiently capitalized to pay a multitude of claims,” he said, “especially since reinsurers mandate them to retain a large share of risk.”

Numerous managers offered anecdotal evidence for massive increases in claims amounts, in cases where the courts had issued judgments reaching multiples of what plaintiffs had been customarily awarded. One judgment this year reportedly ordered payment of $100,000 to the family of the victim in a deadly car accident, significantly exceeding a long-established practice of awards in the range of $10,000 to $17,000.

With an explosion of bodily injury claim judgments, even the most conservative insurance providers would face challenges to maintain a sustainable level of profits from mandatory motor insurance, given the low minimum premiums set by the regulators. And indeed, the reputable insurers have either discouraged clients from obtaining only the TPL cover or priced their packages considerably above the minimum. As a consequence, these companies did not see their motor portfolios grow by major percentages in 2003.

In sharp contrast to that are the practices of a handful of insurance operators that have been selling TPL motor policies not only at the $43 minimum annual premium rate but seem to have cut their effective prices even below that threshold. These unsound practices could well escalate to become the Lebanese insurance industry’s main problem in 2004. Akin to several companies that amassed unsound medical insurance portfolios in the nineties and crashed toward the end of the decade, shaky providers that are running up risk from signing cut-rate TPL coverage commitments could rapidly be facing bankruptcy, many insiders fear. “This possibility could be verified sooner than some expect,” said Max Zaccar, chairman of Commercial Insurance. If confronted with these concerns, managers of the companies in question did not respond, said Nasnas. “They don’t care.” Some in the industry observe their lesser colleagues’ game of accident roulette with a touch of social Darwinist attitude, claiming that a few insolvencies would simply purge the ranks from unfit operators. But in the opinions of outspoken insurance managers like Nasnas and Zaccar, such stoicism would be ill placed. A crash of insurance companies with big motor portfolios would lead to a loss in consumer trust, especially among the most-likely first-time clients who went for the offers of these firms, Nasnas advised. “It would shake the market.” Another weighty concern for the industry could arise from fairly widespread disparities between high increases of costs – which local insurers had to carry due to massive hikes in reinsurance rates since 2001 – and much less pronounced premium increases (in some cases, even lowered rates) they charged their clients. This could force some providers to make painful adjustments to their rate structure at moments when such sudden moves would come both late and be hard to explain. The problems that the industry could encounter in 2004 are juxtaposed by a notable share of potential growth and opportunities, some of which is outside of Lebanon. Domestically, life insurance and products optimized for the bancassurance distribution channel are the best growth candidates. “With all we hear about 2004, I don’t foresee any potential growth outside the life market,” Nasnas said. “The life business is getting better, due to bancassurance,” said Letayf.

The trend to buying more life insurance indeed seems to be on the rise in Lebanon. While the absence of tax incentives for life policy owners is still an obstacle, the country’s socioeconomic troubles have alerted larger numbers of people to the increasing unlikelihood that they will be able to rely on their families for a retirement income, thereby tempting many to buy into retirement plans and capital life policies. Companies that in 2003 overhauled their life business and stepped up their marketing, like regional player Arabia Insurance, and firms that devised new life and capitalization plans for distribution in bank branches, such as Adir (a company owned jointly by Bank Byblos and French insurer ADP), have been bullish about their prospects. Also many companies with a license to write life insurance but presently have less than extensive life portfolios, see the need to increase their relevant activities. Axa and Libano-Suisse are both firms that intend to address the market with new life products. For firms with regional ambitions, however, some of the most appealing expansion opportunities are in Arab countries, from Damascus to Doha. The Saudi market for medical insurance alone carries potential for new business worth billions of dollars, Letayf said. The parent company of Libano-Suisse insurance is engaged in a 50/50 joint venture with the El-Seif Group for an insurance company in the kingdom at a total capitalization of $27 million (SR100 million). Other Beirut-based insurance companies have equally staked their claims in the Saudi market, which is in the process of opening to greater international participation. Iraq’s insurance needs are massive and Lebanese firms aspire to play a big role in Baghdad, but most see the evolution of that market as likely to take shape at some later time. The opportunity closest to home and in time is the Syrian market, rife with high potential for insurance partnerships from both sides of the border. “What we hope to see in 2004 is opening of the Syrian market,” Nasnas said. “Lebanese insurers could offer added value here. ” As a member of the European Axa Group, the focus of Axa Middle East covers the Levant and Cyprus. If their aspirations and activities are regional or local, there are few doubts among Lebanese insurers that greater institutionalization of sector companies and consolidation of their numbers are prerequisites for their long-term developments. “We believe that even if we are a profitable and strong regional player,” Letayf said, “a partnership with a strong bank would be good news for Libano-Suisse.”

“Consolidation will happen at all levels; even the largest players in Lebanon write very little in premiums in international comparison.” said Zaccar, and Commercial Insurance, although confident of its capacities and proud of its independence, would be interested to look at merger prospects. “Our partners could be one or more banks, one or more local insurance companies, or one or more international ones,” he continued, emphasizing, “we are open but we are in no rush.” Financial standards and auditing supervision for Lebanese insurance companies will further tighten in 2004, supporting the thrust for consolidation. However, industry managers expect the process to need two to three years to gather speed and reduce provider numbers by a substantial margin from today’s some 60 companies.

January 1, 2004 0 comments

Society

Vital cover

by Executive Staff January 1, 2004

written by Executive Staff

April 2003 saw ACAL succeed in reaching a viable framework for the implementation of the 1972 law governing compulsory third party car insurance covering bodily damage. Although some may argue that the early period of implementation may not have been as smooth as one may have hoped for, it did not take long to appreciate that the scenario whereby uninsured bodily injuries and/or deaths arising out of motor accidents have been eliminated. Most importantly, the “hit-and-run” culture has also been significantly reduced as those involved in accidents are less likely to flee the scene of an accident and more likely to help those injured.

The subject of extending this policy to include third party material damage is under review and may be implemented in the near future. No more will we hear stories from friends and acquaintances about how they have had accidents with cars that could not afford to offer indemnification. Statistics have proven that many accidents happen in the work place, especially construction sites. Another observation was that the low-income labor bracket has the highest exposure not only to minor injuries, but also to disabilities that can jeopardize their and their dependents welfare. Following fruitful discussions with the relevant authorities, providing proper insurance for workers has now become a prerequisite to obtaining a construction permit. Such insurance provides compensation for medical treatment (including hospitalization) and compensation following work related disabilities or deaths.

We all remember the tragic scenes of collapsed buildings and the consequences to the tenants. The government has now felt the need to promote safety standards for new buildings starting with early in the design phase. ACAL was actively involved in working with the official committee that took charge of studying this issue and the result included a recommendation to have various insurance policies for the different stages, including a 10 year insurance plan following the completion of the construction to compensate for inherent structural defects. A parliamentary committee is now reviewing these recommendations and we feel that it will not be long before building safety standards are significantly improved.

From our perspective, our work is not only contributing to the improvement of the quality of life in our society but also gradually creating new opportunities for our sector and increasing the size of the Lebanese workforce. ACAL has also been working to improve the difficult working conditions of insurance companies, including the slow recovery and development of the Lebanese economy following the years of war and the high increase in the cost of reinsurance following 9/11 with no possibility of increasing the price of insurance in our market. The latter has led to a drop in profit margins, the relatively small size of the Lebanese market and structural features not facilitating the expansion of Lebanese insurance operations in other countries Faced with these challenges, the insurance sector has worked individually and collectively through ACAL towards maximizing the potential of their development. We have seen remarkable progress in the quality of insurance contracts made available to the customers and I believe that this has been the natural result of our free market economy. In this sense, traditional single cover policies are being replaced by a variety of covers with competitive premiums.

Although debatable, there was surely extensive innovation in the distribution channels of insurance policies and here we have to acknowledge the introduction of Bancassurance and e-business. These reduce administrative costs of insurance sales transactions and the cost of premium collection, as well as the time dedicated to complete the sales operation

In conjunction with the above, the challenge will always be to provide the client with professional consultancy on his risk transfer requirements and the adequacy of the insurance contracts that he is buying, aspects that still seem to be better served through the traditional insurance intermediaries.

Regionally, Lebanese insurance companies have a proud tradition of regional expansion, especially in the Gulf. However, their role may be gradually diminishing due to the development of Arab insurance sectors with large financial capitalization and national interests. At present, there seem to be good prospects in Syria. There are high expectations that Damascus may be granting licenses to Lebanese insurance companies. ACAL is working closely with the Syrian insurance representatives and we have already established an excellent level of cross border co-operation.

Elsewhere, we have been witnessing serious efforts to optimize the potential of the Lebanese insurance companies to grow and compete. These efforts are the result of the joint commitments of the legislators, regulators and ACAL. Capital adequacy and regulatory control have formed the essential elements of our efforts. From the legal side, the law governing the insurance operations in Lebanon was subject to serious review, resulting in the promulgation of the amended 1999 law. The outcome was surely a step in the right direction but ACAL is aiming at further improvements and is currently working on further law amendments, which we shall reveal in due time.

ACAL has initiated the framework for the continuous evaluations of the sector, and we shall continue to issue the necessary recommendations within a context of active co-operation with all concerned. We do however hope to change our role to become binding with all licensed insurance companies.

To elaborate, we have created what we call CENTRALE DE RISQUES, where we will collect risk related data from all insurance companies to be made available to all member companies with the aim of improving the quality of insurance underwriting and minimizing the risk of fraud. We have also established a joint committee with the regulatory bodies that will be concerned in building up market statistics to promote transparency. Our agenda for the future will be to increase communication with the authorities on the taxation imposed on insurance clients and beneficiaries. The readers may well be aware that clients acquiring all non-life insurance contracts have to bear tax and stamp duties ranging between 9% and 11% of insurance premiums. Also, compensations received from life contracts are also subject to 5% tax deductions. Although these would appear to contribute in the public income, they do not promote growth in the insurance market, a growth that may well compensate for any loss of tax and stamp duty. Other economies have been long promoted the acquisition of insurance by making it tax deductible. Our system has instead contributed to lost local insurance opportunities, mainly in the marine and life sectors, where internationally rates are attractive and easily available and the loss of potential foreign direct investment.

Finally, it is an honor for me to announce that the 25th General Arab Insurance Conference will be held in Lebanon in May 2004 with the participation of a large number of participants from both the Arab and international insurance companies. The event will be presided by ACAL and the theme will be “Arab Insurance: An Outlook to the Future.” In brief, our work will concentrate on setting recommendations of a proactive nature that will allow Arab insurers to meet the challenges of the future with a high level of readiness.

January 1, 2004 0 comments

Economics & Policy

Road ahead

by Eleanor Blanch January 1, 2004

written by Eleanor Blanch

“I’ll be glad if my watch could stop today,” said Jacque Sarraf, chairman of Malia Holding and former head of the Association of Lebanese Industrialists (ALI). “The year 2004 offers a vision of turmoil regionally and locally.”

Lebanon in 2004 will have to elect a new president or renew the mandate of President Emile Lahoud and hold municipal elections, two big political events that could shake the economy, said Sarraf.

“If you look in the region, there is no war but there is also no peace in Iraq. New problems are emerging in Saudi Arabia and the Gulf, with increased threats to Syria and Iran,” he added.

For the record, official government figures show that 418 new industrial units were created up to September 2003, while industrial exports in the first three quarters of the same year increased by 20% from the same period 2002. However, industrialists are not celebrating.

The US-led war on Iraq may have been shorter than previously expected, but it paralyzed a segment of industrialists who relied on an Iraqi market that catered to 24 million people. Many of the Iraqi officials Lebanese industrialists had dealt with were no longer around and some industrialists spent the latter part of the year trying to get money owed to them by the ousted Baathist regime. Major hostilities in Iraq were declared over in May, but oil prices continued to rise and industrialists had to endure higher fuel oil and electricity bills, which were will already steep in the run-up to the war.

The impact of the war on the economy as a whole was cushioned by last year’s Paris II donor conference, which gave Lebanon a breathing space and $4.4 billion in soft loans to reschedule its high public debt over a longer period and at a cheaper cost. The conference banished talks of a financial meltdown that would have hit industries hard. The Paris II loans worked on significantly lowering interest rates on government treasury-bills and deposits at banks, but most industrialists and merchants who were expecting a similar drop on loans were asked to wait.

Industrialists in 2003 also entered into a virtual free trade zone with Syria, which had signed with Lebanon an agreement that phases tariffs on industrial products traded between the two countries by the beginning of this year. The agreement has not rectified the trade imbalance with Syria, which has low labor costs, a vast range of raw materials and large swathes of industrial land.

Lebanese industrialists also entered into a semi free trade zone with the European Union when an interim free trade agreement with Lebanon’s number one import market came into force in March 2003. The interim Association Agreement, signed in the middle of 2002, gave many of Lebanon’s industrial, agro-industrial and agricultural exports nearly tariff-free access to the EU before the actual agreement was ratified. The Arab world remains the number one export market for Lebanese goods, but they are importing less and less products from Lebanon as production costs increase. The agro-industry sector is one victim of such high productions costs. “We were exporting $600 million of agro-industrial goods in 1996,” said Ateff Idriss, head of the Syndicate of Agro-Industries in Lebanon. “We lost in the last ten years more than 50% of agro exports, which stand today at $250 million a year.”

Industrialists are increasing exports because they cannot afford not to. Reducing production costs was top priority for industrialists in 2003 and will be their obsession in 2004. “In Lebanon the cost of land, financing and energy are more expensive than regional countries,” said Fadi Samaha, director general of the industry ministry. “Fuel costs alone represent 20% to 30% of general production costs,” he continued, adding that the ministry is working with the central bank to help cut the cost of financing for industrialists. Currently, the central bank subsidizes interest payments on loans extended to productive sectors.

“The Central bank subsidies are for a short period of seven years, but industrialists need loans for seven to 20 years,” said Samaha. “The loans subsidized by the central bank only cover investing costs, but not operating cost such as the financing of raw materials imported by industrialists.”

The central bank began this year to help the private sector lower the cost of its financing needs by urging banks in Lebanon to lower interest rates on loans, and one bank obliged. It also brokered an agreement between banks and the private sector to reschedule bad loans that banks wanted off their balance sheets and clients, such as industrialists, wanted to reschedule over a longer period of time.

Fadi Abboud, head of the ALI, estimates that 18% to 20% of the $4 billion in bad loans in question belong to the industrial sector. “Yes, the agreement will settle problems, but it does not address how a company is going to refinance itself,” said Abboud.

The industrial sector requires vast investments to help it modernize and compete with a influx of cheap and competitive goods that are finding their way into the Lebanese market. Meanwhile, many industrialists argue they will not be able to export much to European Union under the Association Agreement because they do not have the means to upgrade their industries to meet European standards.

“The EuroMed partnership allows us to have access to markets, but it has its own price because we have to have standards,” said Samaha. “It is not a given for everybody and we have to work on quality to reach European standards.”

Compliance with standards is another issue that is dogging the Lebanese industry, particularly the agro-industrial sector, which got a bad rap this year with rumors of contanimated dairy products finding their way onto the shelves.

“We need a food safety law, a sound legal framework, accreditation and research centers to modernize the agro-industry,” said Idriss. “Research is important for increasing exports because we cannot export unsafe packages to the European Union.”

For the meantime, many Lebanese industrialists are concentrating on a less demanding market, such as Iraq, Lebanon’s former number one export market. But insecurity and US control of government decisions in Iraq is not helping. Nonetheless, Lebanese industrialists returned to Iraq as soon as the war was over, trying to revive contacts and make new ones.

“The war on Iraq paralyzed industries for four to five months and we lost the work of seven years,” said Ahmad Kabbara, head of the export committee at the ALI. “But the Iraqi private sector has started to import from us goods such as cement and electronics.”

There are no accurate figures about the amount of goods Iraqi traders are currently importing from Lebanon, particularly as no proper Iraqi government is yet in charge.

“If the war did not take place, we were expecting to sign contracts worth $1 billion a year,” said Kabbara. “If the Iraqi private sector is revitalized, I think we can export $300 million a year to Iraq.”

Before the war started in March, Lebanese industrialists and businessmen signed over $1.1 billion in contracts with the Iraqi government under the United Nations brokered oil-for-food program. Some $450 million of these contracts were unpaid when the Iraqi government lost power in March. “The United Nations has rescheduled all contracts signed under the oil for food program,” said Kabarra. “We were paid $250 million and some $200 million have yet to be paid.”

For Kabarra and many other industrialists, Iraq still remains a market worth venturing in, despite security concerns and current competition from Americans, Europeans and other countries that were shunned by Saddam. “Lebanon, Iraq and Syria is the most important economic triangle that is capable of solving our problems and making us self-sufficient,” said Kabbara. “We will not need to rely on any other country as this triangle has sufficient raw material and human resources.”

Achieving this triangle requires a broader vision from Arab countries, which are usually more adept at erecting trade barriers, as is the case with the much-feared Greater Arab Free Trade Area that will come into force in the beginning of 2005. Most of the signatories to the agreement have not honored their commitments, leaving Lebanon’s open markets prey to their goods without reciprocal treatment.

“We are not prepared for the Arab invasion because Arabs are implementing the agreements in an Arabic way,” said Kabbara. “We face problems in transportation and transit taxes.”

Many industrialists lament the government is quick to sign trade agreements without studying their effects on the Lebanese industry, particularly as the broad cuts in import duties in 2000 reduced tariffs on industrial imports to an average of 5%.

Most industrialists expect exports to increase by 15% to 20% next year, but they do not think much of the increase. Lebanon will be preparing itself in 2004 for GAFTA and entering into serious talks with the World Trade Organization, which will leave Lebanon’s open markets without protection barricades. “We are seriously planning to address the WTO and EU that at this moment we can’t afford to have customs duties abolished due to high production costs,” said Abboud.

January 1, 2004 0 comments

Economics & Policy

Industry woes

by Executive Staff January 1, 2004

written by Executive Staff

In 2003, the manufacturing sector witnessed some improvements, mainly related to healthier exports. By and large, though, 2003 has not been much different from previous years. The fact remains that Lebanese manufacturers are still operating in a moribund economy. Furthermore, mixing politics and economics is adding to our woes. Lebanon doesn’t know in which direction it is heading. The Lebanese Government has run out of ideas on how to promote growth, as was clear most grievously in the tariff-lowering decisions of the year 2000, when the death sentence was passed on the Lebanese manufacturing sector. However, the last wish of the condemned was not even granted, when, upon lowering tariffs, the government reneged on a promise to create a ministerial committee to assess and bring down the costs of production, to offset the damage resulting from lower tariffs. In fact, instead of bringing down costs of production, the government burdened the private sector with additional costs, namely transport and education allowances. Moreover, the government maintains relatively high tariffs on goods that are NOT made in Lebanon, rather than the other way round, such as cars, petrol, alcohol and tobacco, which represent more than 85% of custom duties. Even raw materials, which are not made in Lebanon such as iron roads, and spare parts for generators, still pay high duties. This is an anomaly that is probably unique to our country.

Some of the consequences of the government’s decisions in 2000 have begun to appear in 2003, with the tariffs coming down by 60% from already historic lows in 2003, as a result of the Arab Free Trade Area. The damage will continue in 2004 and 2005, when tariffs come down by 80% and 100%, respectively. This will bring down tariffs to zero among the Arab nations with whom we trade, except that, these Arab countries have a huge advantage over us, as their costs of production are much lower that ours.

The political fabric of Lebanon unfortunately encourages negative behavior (witness the government’s speedy reaction to farmers spilling apples in the streets). Now tariffs (recently imposed to protect local apple growers) are part of the government’s dictionary again. But for three years, the government refused to consider similar tariff increases for the industrial sector, even though such tariffs provide a safety net for manufacturers trying to compete with subsidy-laden Arab and Asian goods.

How can businesses and manufacturers grow in such a fluid environment? Lebanese businesses are required to defy logic by working in a burdensome and costly operating environment. If the government is concerned with, or even a little embarrassed by, closing businesses, emigration and unemployment, among others, it must change its priorities, policies and habits. It must become obsessed by promoting growth and job creation all over Lebanon. If the government cannot bring down production costs, which are the result of inefficient monopolies, then it should seriously consider imposing higher tariffs on imported goods, just as in the case of apple growers.

In addition to Lebanon’s unusually high production costs, including labor, energy and transport, Lebanese manufacturers have to remain nimble and competitive against an onslaught of non-traditional expenses, deriving mainly from bureaucratic red-tape, inefficiency, poor postal services, prohibitive communication costs and restrictive labor markets,

If these practices continue, Lebanese factories will vanish at an accelerated rate. Unfortunately, this would not be the result of “Creative Destruction,” where industries disappear today and new ones are born tomorrow. Far from it – if factories go bust under the prevailing conditions, it is difficult to foresee the birth of new enterprises and the new jobs that go with them.

It is, therefore, imperative today to tackle the causes that keep our factories shackled and unable to compete. Most of the detrimental costs that were mentioned above are relatively easy to deal with since they need no more than a bold government decision. But labor issues need a change of mentality.

So let us concentrate on restrictive labor practices and ask why, for example, Petrol Station owners, according to an informal survey, prefer to hire non-Lebanese workers, even though the wages being paid to those foreign guest workers are $350 per month on average. This is almost double the minimum wage in Lebanon, and therefore a respectable enough salary for Lebanese workers to be seeking. It is no secret that some Lebanese employers shy away from hiring Lebanese workers because they are desperately trying to avoid getting mired in the maze of Lebanon’s restrictive labor laws, including expensive and time-consuming Social Security procedures. The outcome of this state of affairs is almost unique to Lebanon, whereby Labor Laws hinder employment creation, specially for Lebanese citizens. This is the only country in the world which punishes, from a tax point of view, he who employs a Lebanese citizen, and gives tax breaks if you employ foreign workers such as transport and education allowances, while affording the employed worker very few benefits and no safety net in the case of redundancy.

It is a true tragedy that our archaic labor laws have done so much damage to employment levels, not to mention to productivity, as the currently employed have little incentive to work hard while they feel secure in the job that the law protects, not the worker’s performance.

We agree with the government and all concerned parties that our workers are a major resource. Manufacturers should know because they spend years and make large investments in training their workers.

But it is futile to promote growth, employment generation and social development if the restrictive labor practices remain unchanged. We must possess the vision and the courage to change laws, practices and even mentalities. The priority now, as far as we are concerned, is for the country to move forward. Frankly, quibbling is a luxury that the economy cannot afford at this time. But this does not absolve the government of responsibility towards the industrial sector, as many promises have been made and few delivered, particularly concerning promoting exports.

Are manufacturers making unreasonable demands on a government with few resources to spare? Not at all, especially if one considers fast-paced developments in the world. Actually, Lebanon is far behind other countries in recognizing that sustainable industrial development is a prerequisite to fighting marginalization in a global economy. Our government does not even speak the same language as our international partners.

There is a vacuum in strategic thinking on industrial development that needs to be filled. Lebanon must show more commitment to the competitive capabilities of its industrial sector. We are not alone in having identified some of the major hindrances to growth. Independent European consultants have also found that Lebanon’s operating environment suffers from weak interactivity between state and industry, no public or international-standard industrial zones, costly public services and heavy and expensive administrative procedures. If the government does not solve these problems, how then are businesses supposed to survive, grow and thrive? How can we create enough jobs to keep people, especially the young, in Lebanon? Right now, Lebanon produces only one-third of the jobs it needs.

We know for a fact, and we have seen it all over the world, dynamic growth is a product of vision, policy, incentives and support Institutions. In 2004, as in years before and beyond, the manufacturing sector and the economy will continue to trudge along at best, if the Lebanese government does not become obsessed with promoting growth, before it is too late.

Fadi Abboud is the President of the Association of Lebanese Industrialists

January 1, 2004 0 comments