Lebanon’s Challenged Economy Keeps Expanding, Against the Odds

An Institutional Investor Sponsored Report on Lebanon

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By Patrick Werr

The Middle East’s political and economic storms have continued to batter Lebanon, but despite all the odds, its economy has continued to expand. Growth had been sizzling along at an average 8.5 percent from 2007 to 2010, only to take a major hit when civil war broke out in 2011 in neighboring Syria. In addition to dampening tourism and foreign investment, the war sent 1.5 million refugees into Lebanon, boosting its population by a third and putting tremendous strain on government finances.

The Syrian civil war has had less direct consequences on the economy as well. Remittances from Lebanese working abroad, a mainstay of the economy, slipped in 2014, although they somewhat stabilized last year at about 15.9 percent of GDP, according to the World Bank. Fallout from the war has upset Lebanon’s delicate political balance and the government’s ability to take decisions: there has been no president has since May 2014 and parliament has been in gridlock. Saudi anger over the bigger role that the Shi’ite group Hezbollah was playing in Lebanon’s government and in Syria led it in February to suspend an annual $4 billion in aid it had been giving to the Lebanese military and security services.

To add to the misery, the United States enacted a law in December that is forcing Lebanese banks to close the accounts of members, affiliates and intermediaries of Hezbollah, a militant group and political party with several deputies in parliament. Hezbollah has strong support among Lebanon’s Shi’ites, who make up more than a quarter of the population, and the US legislation threatens to shake the country’s political balance even further.

The regional instability and domestic political paralysis have reduced investment, exports and capital flows and put tremendous pressures on public finances, says Saad Azhari, chairman and general manager of BLOM Bank.

This caused the ratings agency Fitch to downgrade Lebanon’s sovereign credit rating in July. Both Moody’s and Standard and Poor’s had already given the country a negative outlook rating. Still, given the circumstances, Lebanon seems to be weathering the storm tolerably well. “The economy has been growing at no more than 2 percent annually since 2011,” says Azhari. “But the fact that the economy is growing at all is also an achievement, amidst all the negative influences surrounding us. And that is what is keeping me optimistic about the prospects for the economy – it remains flexible, agile, and ready to seize on opportunities. The country has promising prospects in sectors like oil and gas, IT, finance, and tourism. Add to that the strength of remittances, which has remained stable at about $7.5 billion annually.”

Lebanon’s GDP rose by an estimated 1.5 percent in 2015, according to the World Bank, partly due to an uptick in tourism. The bank expects growth to increase to 2.5 percent over the medium term, assuming the war in Syria continues, and faster if the conflict is resolved.

Key to the country’s growth and stability and the health of its banking system is the large inflow of remittances from Lebanese expatriates. But there is a risk in relying on remittances too much. So far the collapse of international oil prices in mid-2014 has been a net positive for Lebanon, making energy imports cheaper. But up to two-thirds of remittances come Lebanese working in oil-producing countries, and there is concern that at some point the lower oil income of the Gulf states may start eating into the ability of Lebanese to send money home.

The remittances, which account for more than 17 percent of GDP, have also allowed the government to finance yawning budget deficits for years, resulting in a debt ratio that has mushroomed to around 140 percent of GDP, the third-highest in the Arab world and third highest among all the world’s mid- to large-size economies, just behind Japan and Greece. The remittances are equally crucial for Lebanese banks, which held 56 percent of outstanding treasury bills at the end of April, increasing their deposits and helping them to remain viable with good liquidity and sufficient capital cushions.

Riad Salameh, governor of Lebanon’s central bank, Banque du Liban (BDL), expects bank deposits to increase by 4.5 to 5 percent this year.

Lebanon’s two biggest banks, BLOM and Audi, have adopted a strategy of regional expansion to diversify their risks at home and seek out new opportunities. Both are positioning themselves to become Middle East’s banking powerhouses.

BLOM was one of the early banks to expand into Syria. But when war broke out it cut its exposure there, reducing its loan book from $675 million in 2011 to less than $20 million now. “We surely will expand it once the economy and the overall political situation improves in the future,” Azhari says. “We are not abandoning the Syrian market because we are there for the very long term, and we think it will be a lucrative market once the crisis ends.”

BLOM is contemplating expanding at home as well, with its eye on acquiring the Lebanese assets of HSBC, which is withdrawing from the local market.

Bank Audi also has been expanding regionally, mainly in Turkey and in Egypt, the Middle East’s two most populous countries, and its foreign operations now account for more than half of its profit. In August it increased the capital of its Turkish subsidiary Odeabank by one billion Turkish lira ($338 million), or 42 percent. The International Finance Corporation subscribed to $110 million of the increase and the European Bank for Reconstruction and Development $90 million, with Bank Audi and other Middle Eastern investors taking the rest. The increase has left Bank Audi with about 75 percent of the Turkish bank’s capital.

“Odeabank is expected to use the proceeds to expand its financing in the real sector, to improve access of SMEs and to make investment in its digital banking channel and technology,” says Bank Audi chief strategist Freddie Baz.

Since Audi set it up in late 2012, Odeabank has expanded rapidly and is now among Turkey’s ten largest private banks. It has 56 branches in 16 cities with more than 1,500 employees. Bank Audi reported that net profit rose 11.7 percent in the first half of 2016 to $226 million. More than half of its net profit came from its operations outside Lebanon. Baz says that in the medium term Bank Audi intends to explore further regional expansion opportunities, including in Latin America and Sub-Saharan Africa. “Furthermore, we plan to establish a footprint in the United Kingdom through a light structure,” he adds. The central bank is taking all necessary measures to keep the financial sector safe and sound, and is closely monitoring the performance of Lebanese banks in the region, says BDL governor Salameh. It is requiring them to allocate adequate capital and to take necessary provisions ahead of time so that the banking sector can remain immune to any negative fallout from the region’s events.

“Lebanon is a small country and its economy does not depend on natural resources or exports, but on its people. Our productive sectors, such as our industries, hold good potential; yet they are not sufficiently contributing to GDP growth,” Salameh says.

“The Lebanese economy has been, indeed, performing below its potential. Yet, taking into account the social and political tensions, in addition to regional turmoil, our economy remains resilient.”