Lebanon: A diagnostic and what needs to be done

Author: | Published: 19 Oct 2018
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Higher oil prices due to reduced production and continuing geopolitical tensions between Iran and Saudi Arabia were the MENA region's main highlights in 2017; their impacts will continue to be felt during 2018. Not surprisingly the Lebanese economy was not shielded from the region's woes, with the most prominent consequence being last November's shocking resignation of Prime Minister (PM) Saad Hariri, announced from Saudi Arabia.

2017 and the first half of 2018 marked a period of political achievement for Lebanon. 2017 kicked off with optimistic prospects following the election of a President of the Republic after 2.5 years of vacuum. A new cabinet was formed in late 2016. Major developments then characterised the second half of 2017 and were topped by the victory of the Lebanese army over ISIS in the north-eastern part of the country, the ratification of a new electoral law and successful elections in May 2018.

On the economic front the achievements were minor. In 2017 the Government approved the first state budget since 2005 and endorsed a long-awaited wage hike for public sector employees, pushing up taxes to finance the hike. In 2018, the Government again approved a budget and managed to successfully hold a donors' conference in Paris in April 2018, known as CEDRE, where it secured pledges worth $11 billion in soft loans from governments and international organisations to finance a proposed infrastructure investment plan. These pledges, however, are conditional on the Government implementing several specific fiscal and structural reforms.

Beside these developments, economic growth remained subdued. Lebanon's real GDP growth rate was 1.5% in 2017 and is estimated (by BLOMINVEST) to have remained at 1.3% in the first half of 2018. Growth in 2017 came from a recovering tourism sector and strong banking system. As for the remainder of 2018, economic growth will be sluggish but could improve slightly to hit 1.5% for the whole year.

The Purchasing Managers' Index (PMI) has continued to indicate restrained private sector activity. The PMI averaged 46.6 in 2017 and H1 2018, compared to 45.7 in 2016. Lebanon's PMI ended 2017 in further contraction, following continuous instability on the Lebanese political scene and signalling diminishing activity in the private sector. The weakness of the PMI came on the back of lower new orders as well as slowing output.

Inflationary pressures were felt in 2017 following two years of deflation and have aggravated in 2018 as a result of the recovering oil price and the increase in value added tax (VAT). Average inflation stood at 4.4% in 2017 and 6% in H1 2018. The appreciation of the euro in 2018 also partially boosted inflation, as over 45% of Lebanon's imports originate from the European Union.

Faltering momentum in key sectors

Lebanon's tourism sector marginally recovered in 2017 and H1 2018, recording a seven-year high in tourist arrivals as the security and political situation improved. The number of tourists had grown 10% during the year by December 2017, with tourist spending rising by 5.5%. The latter can be explained by the increasing number of Gulf nationals, who are the heaviest spenders in Lebanon. The former is due to the increase across the board in the number of tourists, mainly from Europe. According to Ernst & Young Middle East's hotel benchmark survey, the occupancy rate of Beirut Hotels reached 63.7% by December 2017, barely attaining the 64% rate recorded back in 2011; this was to the November crisis triggered by PM Hariri's resignation. Hotel occupancy in Beirut recuperated in the summer as well as during the Easter vacation in April 2018.

The sector had a mixed performance in H1 2018, with a paradoxical increase in the number of tourists but decline in occupancy and spending rates. The number of tourists rose 3.3% due to a jump in incomers from European countries but hotel occupancy declined to 58.6% during the first six months, as a result of the events taking place in the region and the continuing impact of Hariri's resignation. The contradiction in the increase in the number of tourists and the decline in occupancy can be attributed to two factors: the first relates to the fact that the measure for occupancy only reflects 4- and 5-star hotels in Beirut; the second, that European tourists tend to choose hotels in remote areas or book through Airbnb, in contrast with Arab tourists who prefer the fancier hotels of the capital.

The real estate sector also witnessed a partial recovery in 2017 amid the relatively more stable security situation at the local level. Progressing real estate activity translated into a 9.49% annual increase in the total number of property transactions. Likewise, real estate supply increased in 2017, with the number of construction permits recording an annual uptick of 13.6%, to reach 95,856 transactions by year-end 2017.

However, the sector stumbled in 2018 as the central bank halted the subsidised housing loans scheme, which had been in place for over three years. Real estate transaction values and volume declined by 14% and 18.2%, respectively, in the first half of the year. Building permits also fell by 14.5%.

The monetary sector remains one of Lebanon's main pillars, resilient amid the economic and political shocks to the country. Despite the fluctuations in major global currencies, the Lebanese Central Bank (BDL) managed to keep the exchange rate moving within the narrow band it had previously fixed at $/LP1,500-1,514. As such, BDL's assets recorded a 15.57% yearly increase to $118.25 billion in 2017. Foreign assets (excluding gold) went up by 3.14%, reaching $41.99 billion and equivalent to 27 months of imports. As for money supply, broad money M3 grew 4.2% year-on-year, standing at $138.38 billion by end-2017.

The slowdown witnessed in most economic sectors during H1 2018 is now putting pressure on the authorities to implement the much needed reforms promised at the CEDRE conference. This CEDRE commitment by the Government to implement overdue reforms came at the right time: the country has been in political deadlock since 2014 and no serious reform or investment in infrastructure has been undertaken since the early 2000s.

What's choking the economy

Before tackling the reforms, it is important to explain why the economy is choking and why the slowdown is weighing heavily on the private sector. This slowdown in economic growth is different to and has lasted much longer than previous declines. As such it will constitute a test to the resilience of the Lebanese economy. The reasons for the slowdown are many, starting from the spill-overs of the war in neighbouring Syria, passing to the decision by GCC countries to warn their citizens against coming to Lebanon after Hariri's resignation and ending with the fiscal problems and structural issues that are strangling the economy.

The shock from the Syrian war has an unlimited time span, and this exacerbates its impact on the economy. The repercussions of the fighting are continuous and the war does not seem to have a predictable end in sight. The policies that should be adopted to face such a large factor of uncertainty have to be different. When the war erupted in Syria, Lebanon did not have the right infrastructure to attract Syrian investors. Wealthy Syrians who owned factories and businesses in Syria were obliged to flee their country and preferred to invest in the UAE or Turkey rather than in Lebanon. Lebanon was not equipped to welcome such investments. Only the real estate sector attracted some buyers.

In a pegged exchange rate system and a dollarized economy, the balance of payments role in boosting economic growth is magnified. Since 2011, the balance of payments has been in the red (except for 2016) due the financial engineering scheme of the central bank. The negative balance of payments means that there are more outflows of foreign currencies from the country than inflows into the economy. Lebanon has never had a negative balance of payments for such a long period of time let alone the deficit amounts witnessed during some of the past years.

On another front, the country's creaking infrastructure is limiting the potential growth of real GDP. Following several years of high GDP growth, over the past two years the Lebanese economy has shifted from high- to low-gear economic growth. Real GDP growth was 2% in 2011 and 1.2% in 2012 and 2018 will be no different. This is partly due to the lack of investment in infrastructure during the high growth years. Lebanon needs to upgrade its infrastructure in all sectors, including energy and water, roads and transportation and IT and telecommunications. Since the government does not have the means to do all the necessary investments, targeted schemes should be considered, such as public private partnerships (PPP), build-operate-transfers (BOT) and privatisations, to name a few.

Political stability and security are not at a sufficient level to attract capital and improve economic growth. Lebanon used to boom when political stability was in place but due to the regional meltdown and to the non-implementation of serious economic reforms since 2005, investors have lost confidence in the economy. This downturn is different as even political stability is not attractive for investors. The government had promised many reforms during the Paris II and Paris III donors' conferences, but none of these reforms were implemented. Therefore it will be more difficult to convince investors this time round. Hence the disbursement of the money pledged during the CEDRE conference being conditional on the implementation of structural reforms. This is in contrast with what took place during previous donors' conferences.

A need for serious reform

There is a need to implement serious economic reforms in order to lure investors again and the electricity sector could be the winning horse in this respect. Investors need an achievement to start believing in the Lebanese model again, especially as some of the promises made at the CEDRE conference by the Government are so ambitious, such as reducing the fiscal deficit by one percentage point of GDP every year over the next five years. One important reform that may help to achieve this target is the electricity sector. The government can start to implement the plan to improve the provision of electricity to its citizen and at the same time increase the tariffs to cover the state run electricity company (EDL)'s deficit – the company's deficit currently reaches 2.5% of GDP. It is expected that in two years, the Government will be able to reduce its fiscal deficit by this 2.5 percentage point of GDP.

The Government may also benefit from this low growth trend to embark on other equally important structural reforms. Enhancing the business environment is a priority. Of course, it is well known that a perfect setting will not be able to attract investments if security and political conditions are not stable. However, needed reforms regarding laws and regulations have to be upgraded – such as the cost and time it takes to open and close a business – in order to be ready for when the situation in the Levant improves. The outdated Commerce Law should be revamped to incorporate new developments. The judicial system has to be modernised to speed up decisions over business-related cases. In this regard, the enforcement of the law is a matter of utmost importance, as Lebanon ranks very low on rule of law indexes. Revamping the tax system and putting in place regulations and laws to encourage transparency and reduce corruption are also necessary (Lebanon is currently positioned near the bottom of world rankings regarding transparency and corruption).

About the author

Marwan Mikhael
Head of Research, BLOMINVEST Bank
T: +961 (1) 991784
W: www.blominvestbank.com

Marwan Mikhael has been working at BLOMINVEST Bank since 2008 as head of research and has been involved in fixed income deals including several Eurobonds issues for the government of Lebanon. He has an extensive experience in market and sectorial studies in Lebanon and the MENA region, in addition to macroeconomic research and analysis. Marwan has also worked on many M&A deals in the MENA region including structuring, negotiating and marketing. He oversees equity and valuation reports of publicly listed and private companies.

Marwan previously worked for two years as an advisor to the Minister of Economy and Trade of Lebanon and head of the Ministry's economic division. He advised the Minister on strategic issues and economic policy, including market and sectoral analysis. He also developed a wide network of public relations with major stakeholders of the Lebanese economy.

Marwan also worked for four years at the International Monetary Fund, where he advised several governments in the MENA region on macroeconomic issues including privatisations, monetary and fiscal policies and economic sector development. Prior to that, he worked in a management consulting firm advising companies on strategic, managerial and organizational related matters.

Marwan holds a master's degree in economics from Université Saint Joseph in Lebanon. He is a lecturer at the economics department of the same university where he teaches financial planning for graduate students.

He has conducted many interviews on TV (CNBC Arabia, Al Jazeera, MTV, NBN, NTV), newspapers and magazines, and written about the capital and financial markets in renowned magazines (Al Iktisad Wal Aamal, Euromoney Magazine, Financial Times, The Excecutive, Annahar, Assafir, L'Orient le Jour, etc).