Lebanon Finds a Way to Grow

An Institutional Investor Sponsored Report on Lebanon

Through all its challenges, Lebanon has maintained stability in its banking and financial system. There have never been de-faults, and its banks, having an innate caution and conservatism, just don’t run in to trouble.

By Chris Wright

Lebanon today faces considerable challenges both domestic and external. It’s hard enough trying to spur growth and reform in a country with a rudderless government and no president. Do so while trying to absorb one and a half million Syrian refugees into the economy – in a country with barely four million people to start with – seems an unachievable burden.

Yet Lebanon is still growing despite its considerable problems. The growth is modest – the IMF projects 1.8 percent in 2014 and 2.5 percent in 2014, compared to 1.5 percent in 2013 – but it is, remarkably, still positive.

Lebanon is a story of finding the positives, which is not always easy. Take Syria. The World Bank said in September that, by the end of 2014, Syria’s conflict will have cost Lebanon $7.5 billion in cumulative economic losses, cutting real GDP growth by 2.85 per cent a year between 2012 and 2014, while doubling unemployment to above 20 percent and widening the deficit by $2.6 billion.

Yet Lebanese economists can find benefits in this unremittingly negative scenario. “The issue of the Syrian refugees is a double-edged sword,” says Marwan Barakat, group chief economist and head of research at Bank Audi in Beirut. “On one hand, it is definitely putting pressure on the country’s infrastructure and adding to the fiscal strains in Lebanon. But at the same time, the presence of Syrian refugees is contributing positively to consumption.” Indeed, consumption has actually increased by 6 percent over the past three years, fuelled by Syrian spending on basic staples: food and beverages, pharmaceuticals and energy. “So there is this other side alleviating the contractionary pressures on the Lebanese economy. We don’t have a recession. We have a slowdown, but we don’t have a recession.”

Domestically, the picture is different again. Ask almost anybody in the Lebanese private sector and they will speak in glowing terms about the central bank, Banque du Liban, and its long-serving governor Riad Salameh, while simultaneously expressing great frustration with the inertia of the government. On one hand, the government’s considered stimulus packages – sometimes straightforward soft loans, sometimes carefully targeted technical packages like Circular 331, which aims to encourage bank investment into the knowledge sector – have been a clear success. On the other, there is still no president, and the appointment of one was delayed for the fourth time in August. And when the government is active, it doesn’t always do the things economists would like it to, notably when it agreed to a considerable increase in public sector wages (something that is likely to cost the Treasury at least $1.2 billion) at a time when others hoped money might go on infrastructure development.

Public sector risks

Consequently, Lebanon’s public sector numbers are a concern. “The IMF expects risks to the public debt’s sustainability to increase under the prevailing policies,” says Byblos Bank. Specifically, it projects public debt to rise from 141 percent of GDP in 2013 to 145 percent in 2014 and 148 percent in 2015; and it believes the fiscal deficit will widen from 9.2 percent of GDP in 2013 to 11.1 percent in 2014 and 11.9 percent in 2015. The primary budget deficit is scarcely better, expected to rise from 0.8 percent of GDP in 2013 to 2.4 percent in 2014 and 2.5 percent in 2015.

Getting a handle on this clearly requires fiscal reform, and in particular a revamp of the electricity utility. “The electricity sector is the first thing that needs to be fixed,” says Saad Azhari, Chairman of BLOM BANK. “Forty per cent of the deficit comes from that. Lebanon is in need of important infrastructure projects, but most of the government spending is on salaries and interest. There is little investment in infrastructure, which would lead to higher growth in the future.” Indeed, Electricité du Liban is something of an icon of Lebanese institutional malaise; electricity is unreliable, the subsidies cripple the national finances, theft off the transmission grid is rife and, as Byblos says, “it is expected to be a significant drag on public finances in the absence of reforms to the electricity sector and without increases in tariffs.”

The Ministry of Finance says tariff changes are on the table for discussion, and that there is a plan for the $2.5 billion of investment that electricity eventually needs. But the problem is the political will to get anything through. Measures being on the table is one thing; getting them through when there is no coherent leadership is quite another.

In this environment, Salameh and the central bank have found themselves in a position of authority far greater than that of most other central banks, and probably not one he actually wants. “The central bank has been the only one doing any thinking,” says one banker in Beirut. “It’s been single-handed, and it’s about time we saw something on the legislative side.”

The central bank has applied two rounds of stimulus: 1.4 billion in 2013 and 800 million in 2014 in the form of loans at 1% interest to the banking sector, each of them triggering renewed lending. “It played a major role in driving growth in the lending rate,” says Azhari, adding that lending grew by 8 to 9% year on year in 2013 as a consequence of the stimulus. Azhari is also a big believer in the central bank’s attempts to encourage investment into technology start-ups. “We have to see growth in areas other than real estate and tourism. This is important.”

The stimulus package brings us to the one remarkably positive story about Lebanon: the seemingly indestructible nature of its banking system. Lebanon has been through a civil war, war with Israel, assassinations; yet it hasn’t had a bank failure of any consequence for more than 20 years (perhaps not coincidentally, Salamé’s tenure has just reached 21 years). If one looks at a chart of bank deposits in Lebanon, it is a relentless upward-tilting wedge with just a couple of blips caused by, for example, a war. It is remarkable.

Moody’s, among others, doesn’t think as well of the banking sector as one might expect, because of its very high exposure to the state: it is pretty much funding the sovereign and Moody’s feels that represents a systemic risk. However, Lebanese bankers believe that’s missing the point.

Why? Well, nowhere else quite looks like Lebanon. There are far more Lebanese outside Lebanon than there are within it. There are three or four times as many, in fact. And they unerringly send home money in considerable quantity, remittances of around $8 billion a year, or 20% of GDP. Azhari points out that in the 2008-9 financial crisis (which, incidentally, barely touched the Lebanese banking sector), money was flowing in to Lebanese banking, because people felt the banking system was safer in Beirut than outside it. Through all its troubles, Lebanon never defaulted, and its banks, having an innate caution and conservatism, just don’t run in to trouble.

It would help if the rating agencies shared this view. Lebanon is rated B- in large part because of what is seen as this sovereign threat to the sector, but it appears the market doesn’t agree; Lebanon’s 10-year paper trades on a level more consistent with a BBB credit. Nevertheless, a higher rating would surely make capital raising easier and cheaper, which might at least create an affordable way of starting infrastructure spending.

Keeping an eye on liquidity

At the heart of the banks’ strength is a keen eye on liquidity. “Liquidity has been maintained at a good level,” says Barakat. “Liquidity in foreign currency is the most important, and we have a level of 42 percent of customer deposits there, which represents a sound bugger for any scenario of capital transfers outside of Lebanon.” Considering money doesn’t tend to flee anyway – the deposit base dropped by just 4 percent during the 2006 war with Israel – that looks more than sufficient. Barakat calculates the capital adequacy ratio of the sector, under Basel 2, at 14.5 percent, which is well above both local and international minimums.

Banks have, though, had to go overseas in order to develop such scale and stability, and everywhere one looks one sees a regional rather than a local model. Bank Audi, BLOM BANK, Bank of Beirut and Bank Mediterranean have all grown in the region and the world, not only in neighbouring Syria (obviously no longer such a good earner, though banks report their loans there have largely been repaid) and Jordan, but in Egypt, Qatar, the UAE, Saudi Arabia, Turkey and even Sudan, as well as operations outside the region. The combined assets of Lebanese banks are considerably bigger than the Lebanese GDP, and this – alongside the prudence of the sector – will insulate it for years to come.

But Lebanon needs more. Where else will growth come from? Not, in the short term, through real estate, which is volatile and suffering at the moment; nor from tourism, with numbers badly hit by regional security issues, and hotels running at below 50 percent occupancy, sometimes well below. Instead, aside from the central bank’s hopes for tech and knowledge, Lebanon’s lifeline may come from oil and gas.

The bit of the Mediterranean that Lebanon owns could contain 96 trillion feet of natural gas and 850 million barrels of oil, according to energy ministry projections. Used properly, it should mean an end to power shortages, a solution to the public debt problems, and a tremendous source of jobs in order to revive the economy.

Yet there is a sense of nervousness in Beirut about all this, because there is a fear that it could be handled badly, or even that the opportunity to exploit the sector may be missed in inertia. On one hand, one hears far-sighted talk of sovereign wealth funds; on the other, there’s precious little sign of anything actually being done – no drilling, no projects underway, no rigs to be seen. Once again, it comes down to political will and fractured leadership, and even the central bank surely can’t get involved in setting up oil and gas development projects.

In short, Lebanon finds itself on a familiar fulcrum upon which its economy really could tilt either way. One side would show the weight of the refugee influx and poor public finances, exacerbated by a rising rate cycle in the US, dragging the economy towards recession and putting unreasonable pressure on its long-suffering banking system. The other, which would be greatly assisted by an end to Syrian conflict and the reconstruction opportunities that would follow, would see the oil and gas sector galvanizing Lebanon towards economic growth, providing an environment in which its public finance problems can be tackled and a government and president can finally gain traction. Which way it goes will be decided in the year ahead.