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03 October 2019

Lebanon: Turning the tide

Investors are confident that Lebanon’s fragile government can make the necessary reforms that will unlock vital funding to rebuild the country’s infrastructure and ease its swelling debt burden.


The political turmoil in Lebanon coupled with the influx of Syrian refugees fleeing the conflict back home have combined to dry up inflows and aid from the country’s wealthier Gulf Arab allies. Moody’s said that renewed political unrest is derailing the reform agenda which is urgently required to resuscitate the ailing economy.

According to the International Monetary Fund (IMF), Lebanon’s public debt burden will rise further to 180 per cent of economic output by 2023. However, the country has never defaulted on its obligations and officials have repeatedly ruled out any restructuring since the finance minister floated the idea earlier in 2019.

Recently, the Lebanese authorities moved in to implement the much-needed reforms to control the deteriorating economic conditions. The parliament approved a new plan to reform the electricity sector and reduce its fiscal cost, as well as a budget, in a bid to reduce the overall fiscal deficit in 2019. The electricity reform and budget are the first steps on a long path to re-equilibrate the economy that will need to involve further fiscal adjustment and radical structural reforms, said the IMF.

Lebanon has always known how to make a comeback. In April 2018, at the CEDRE Conference in Paris, international donors pledged more than $11 billion in loans and grants to help improve Lebanon’s ailing infrastructure. However, in the absence of a functional government, authorities have been unable to launch reforms and sign off on the package.

The aid was an extraordinary vote of confidence in a country that has made little progress on promised fiscal reforms due to political wrangling but the formation of a cabinet in January 2019, almost a year after the elections, revived the hope of growth. However, the current situation is offsetting the hopes of a comeback anytime soon.

Caught between a rock and a hard place

Not only are there political issues beyond the country’s control, there are struggles for power that are not only driven by internal political ambitions, but also a political unrest in the region that impact Lebanon.

Lebanon’s unique consensus government—tailored to deal with a diverse population—rests on a power-sharing structure whereby the Prime Minister, President and Speaker of the house must come from the country’s three largest religious groups. However regional powers tend to exert influence in the country through these various groups.

According to COFACE, in addition to reinforcing sectarian and political divisions at home, the growing influence of Hezbollah, an Iranian-backed party that provides military assistance to the Syrian regime, is straining Lebanon’s relations with its traditional allies. The group holds three seats in the Lebanese cabinet and when regional powers are at odds, Lebanon usually gets caught in between, a situation that has stalled progress when it comes to ratifying policies that are crucial to resuscitating the country’s ailing economy.

During his recent trip to Beirut in April 2019, the US Secretary of State Mike Pompeo pledged to choke off the financing, the smuggling and the misuse of government positions and influence that feeds Iran and Hezbollah. Pompeo’s words were followed by the blacklisting of Jammal Trust Bank by the US for allegedly facilitating banking for Hezbollah, an allegation which led Banque du Liban (BdL) to approve a request for self-liquidation by Jammal Trust.

The World Bank said that up to 1.5 million Syrians, about a quarter of the Lebanese population, have taken refuge in Lebanon since March 2011 and the situation has strained the country’s public finances, service delivery and the environment.

The Syrian crisis also resulted in fragile state of security in the region, leading countries vital for Lebanon’s tourism industry (including some key Gulf states) to issue travel advisories. However, the UAE and Saudi Arabia lifted a yearlong travel ban on Lebanon earlier this year, a move that could revive the embattled country’s tourism sector.

The health of the banking system

Lebanon’s banking system relies on bank deposits—mainly from remittances from millions of Lebanese living abroad—to keep its lenders stable with the BdL using what it describes as financial engineering to keep up an inflow of hard currency.

According to S&P, Lebanese banks fund their debt purchases through deposits, so they must expand their deposits to continue buying. To attract investors, the central bank hiked interest rates, with the reference rate reaching 12.39 per cent in March 2019, its highest since inception in 2011.

Investors seem more confident that Lebanon’s fragile government can make the necessary reforms to unlock vital funding to rebuild the country’s infrastructure and ease its swelling debt burden. A concern that has heightened fears of a state default and a run on its banks. Saad Azhari, the Chairman & General manager of BLOM Bank, said, “The banking sector’s combined profits from their Lebanon operations fell 16 per cent in 2018.”

The performance of the big four banks in the country was mixed in 2018. BLOM Bank and Bank of Beirut both saw net income increase year over year, while Bank Audi and Byblos Bank posted a decrease in income.

S&P said that BLOM and Audi have expanded to other Middle East markets to try to offset domestic difficulties. However, Moody’s stated that the next 12-18 months remain challenging for Lebanese lenders and banks dependent on the new government’s ability to fully implement highly anticipated fiscal and economic reforms.

When the music stops

In its 2019 draft budget, the Lebanese government set a deficit target of 7.6 per cent of GDP, but the IMF expects this to reach 9.8 per cent. The Lebanese authorities plan to pare the deficit primarily by reforming its ailing electricity sector and cutting public sector benefits.

Although the IMF said that the measures proposed in the 2019 budget, together with savings from electricity sector reforms, are projected to reduce the primary deficit for 2020-22, it will still leave debt on a rising path. Lebanon’s central bank recently said that it secured up to $1.4 billion in five-year deposits from private investors overseas, boosting dollar reserves and easing concerns that it could struggle to repay its debts and defend its currency.

However, S&P Global Ratings poured cold water on the excitement, saying that while Lebanon’s foreign currency reserves remain sufficient for immediate financing obligations, there is a risk that customer deposit flows, particularly by non-residents, could continue to decline. And this could result in an accelerated drawdown of foreign currency reserves that would test the country’s ability to maintain the currency peg to the US dollar.

Moody’s said that the stable outlook for Lebanese banks assumes slightly higher economic growth and deposit inflows, and any negative political developments are a key risk for banks. Lebanese banks’ large sovereign exposure remains their main source of financial risk. The political developments affecting the pace of economic reform and depositor confidence are also a key risk for lenders.

Similarly, Fitch Ratings also downgraded Lebanon’s sovereign credit ranking into junk territory, as one of the world’s most indebted nations finds its finances stretched with a dwindling flow of cash from abroad. The downward pressure on banking sector deposits and central bank foreign reserves as well as increasing dependence on unconventional measures by the BdL to attract inflows, illustrate increased stress on financing.

The downgrading of Lebanon’s credit rating reflects intensifying pressure on the country’s financing model, increasing risks to the government’s debt-servicing capacity. While recent policy steps point to promising fiscal adjustment, a credible medium-term plan to stabilise the government’s debt to gross domestic product ratio lacks firmness, said Fitch.

In March 2019, the IMF cautioned the BdL saying that the regulator risks undermining its credibility if it agrees to a government proposal to buy treasury bills at below-market rates. The warning by the IMF followed the finance minister's proposal to issue LBP 11 trillion ($7.3 billion) of treasury bonds to commercial banks at a rate of one per cent (about a tenth of the market rate) in order to cut LBP 1 trillion from debt-servicing costs, a proposal that was also turned down by Lebanese lenders.

Bone of contention

Lebanon’s Prime Minister Saad Hariri finally announced his new cabinet line-up in January 2019 after nine months of political bickering and mounting economic challenges, a period long enough to create a mammoth task for authorities to manage the country’s faltering public finances. Political disputes between Prime Minister Hariri, President Michel Aoun and Hezbollah had stalled the formation of a government since an election in May 2018, undermining plans for much needed fiscal and structural reforms that would unlock $11 billion in grants and loans. Alexios Philippides, AVP-Analyst at Moody’s, said that the new government formed in January provided some respite from months of investor and depositor uncertainty.

Moreover, the newly formed Lebanese government approved its 2019 draft budget in March 2019 after months of delays. Subsequently, the hotly contested budget was passed almost two months after it was first endorsed by the Cabinet, with 83 MPs voting in favour, 18 against and one abstaining.

The World Bank praised the government for pulling out all the stops to push through a budget touted as the most austere in the country’s history, in hope of appeasing investors, donors and rating companies.

The build-up of arrears that lies behind the turnaround is masking fiscal risks that could snowball later. Under the budget recently ratified by parliament, deferral of payments and postponement of ministerial projects make up almost half of the total reduction in spending, said the Lebanese Centre for Policy Studies (LCSC).

Lebanon seeks to reduce deficit by an estimated LBP 1,740 billion ($1.16 billion) this year. Forty six per cent of this decrease is due to a deferral of dues for ongoing ministerial projects and these postponed payments are distributed across the years 2020-2023, with five per cent of them being due in 2020, 65 per cent in 2021, 17 per cent in 2022 and 13 per cent in 2023.

The remainder of the projected reduction will be the result of cuts made to consumption expenditure, a three-year employment freeze, reduction in personnel costs and reduction in the contributions to non-profit entities, among others, added LCSC.

All-weather friends

In February 2019, Lebanon said that it is in talks with allies to secure financial backing that would help it manage one of the world’s biggest debt burdens, following the Qatari authorities’ pledge to buy Lebanese government bonds worth $500 million.

In addition to the Qatari pledge, the Saudi’s Finance Minister Mohammed Al Jadaan also said that the Kingdom would support the Lebanese economy “all the way”, without giving much details. Saudi Arabia has traditionally been an economic patron of Beirut and one of its top investors, however, the Kingdom withheld a $3 billion aid package to Lebanon in 2016 in response to the rising power of Hezbollah.

Lebanon also secured $11 billion in aid at the Paris CEDRE Conference in 2018 and the pledges include $10.2 billion in loans and $860 million in grants. However, donors want to see Lebanon commit to their long-stalled reforms. In a nod to those demands, Prime Minister Hariri pledged to reduce their five per cent of their budget deficit in the coming five years. Bloomberg reported that the aid included $4 billion in World Bank loans, EUR 1.1 billion ($1.35 billion) in loans from the European Bank for Reconstruction and Development, and the renewal of a previously pledged $1 billion credit line from Saudi Arabia.

The country has long suffered from large fiscal deficits which have left public debt at over 150 per cent of GDP, the current account deficit is over 25 per cent of GDP, and growth has been low since the start of the Syrian crisis. The Lebanese central bank has successfully maintained financial stability in difficult circumstances for some years, but the challenges it faces in doing so have grown.

This cast a grey cloud on the growth of the country. The IMF said that it is of paramount importance that Lebanon begins a process of significant fiscal adjustment and structural reforms to contain public debt and raise growth, adding that adjustment and reforms are the only path out of Lebanon’s conundrum.





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