­Lebanon: there is still a way out of the difficulties

Author: IFLR Correspondent | Published: 24 Sep 2019
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Growth was subdued in H1 2019 (Figure 1) as Lebanon’s private sector refrained from investing in future businesses. Lebanon’s economic growth stood at an estimated 0% in H1 2019, hindered by sectorial slowdowns as well as a persistent crowding-out of the private sector throughout H1 2019 due to high interest rates. In fact, the BLOM Purchasing Managers’ Index (PMI), a predictive power for economic growth, stalled at an average of 46.5 in H1 2019, compared to 46.6 and 47.1 in H1 2018 and 2017, respectively (Figure 2). The average PMI score in H1 2019 was underpinned by persisting pressures on private sector companies, which consequently adopted a wait-and-see approach as they monitored the political and economic reform plan that should gradually materialise, to stabilise the operating environment and kick start investment.

Figure 1: Historical real growth and nominal GDP

Source: BLOMInvest’s Estimates

Figure 2: Monthly PMI index

Source: BLOMInvest Bank; IHS Markit

Figure 1: Historical real growth and nominal GDP

Source: BLOMInvest’s Estimates

Figure 3: Cumulative number of tourist arrivals by May

Source: Ministry of Tourism; BLOMInvest Bank

Activity in real estate and construction (19.2% of GDP) slumped noticeably, mainly as a result of Banque du Liban (BDL) withdrawing the housing loans subsidy scheme by 2018. From a sectorial perspective, real estate and construction, one of Lebanon's two growth drivers, had markedly contracted by June 2019. The number of real estate (RE) transactions dropped by a substantial 20.07% year-on-year (YOY) to 21,957 transactions, while the value of total RE transactions stood at $2.73 billion, down by an annual 29.6% in H1 2019 compared to the softer 14.01% YOY decline recorded in H1 2018.

Moreover, despite the BDL's effort to reactivate subsidised loans, property prices continued to contract, which also weighed down on construction activity. The BDL's Circular 515 of January 2019) which relaunched the program of subsidising housing loans via banks and financial institutions. However, this was not enough to boost the sector, with the value and number of construction permits extending their decline. A total of LBP790 billion (approximately $524 million) was allocated to subsidise housing loans, of which LBP490 billion was reserved to settle 2018 dues. As such, only LBP300 billion was extended to support 2019 housing loans, with the loan ceiling set at LBP450 million per loan. In this context, the latest data by the Order of Engineers in Beirut and Tripoli revealed an annual 19.2% slump in the total number of construction permits to 4,927 by May 2019, compared to a softer 14.5% downtick registered by May 2018. The total construction area authorised by permits stood at 3.05 million square meters by May 2019, having slipped significantly by 30.58% YOY compared to an 18.6% YOY decline in the same period of 2018.

The slowdown in the real sector was also visible in the drop in cleared cheques and car sales. The number and value of cleared cheques fell to $23.41 billion by May 2019, retreating by an annual 15.47% according to the Association of Banks. The total number of cleared cheques lagged by 13.9% YOY at 4.26 million, while the number of returned cheques amounted to 111,032, which exceeded last year's 109,966.

In turn, the car market revealed a 24% YOY slump. As such, the number of new registered cars fell to 13,889 in H1 2019. The Association of Lebanese Car Importers attributed the sector's sluggish performance to myriad factors, including the higher interest rate environment and political and economic uncertainty.

Increased tourism activity, which accounts for 14.5% of GDP, partially offset the negative data dragging on economic growth (Figure 3). The total number of travellers climbed 4.43% YOY to 2.57 million by April 2019. The number of tourist arrivals grew 5.5% YOY to hit an eight-year high of 692,704 tourists by May 2019, only marginally lagging behind May 2010's tourist arrivals, which totalled 732,855 – noting that 2010 was Lebanon's golden year in tourism. The Kingdom of Saudi Arabias (KSA) lifted its travel ban in February 2019, which helped boost the sector, especially on the spending front as Saudis are the largest spenders. In the first five months of 2019, Lebanon recorded 31,069 Saudi tourists, up from 16,874 in the same period last year. According to EY's latest Benchmark Survey Report the occupancy rate in Beirut's 4- and 5-star hotels reached a four-year high of 67.8% by May 2019, compared to 58.6% during the same period last year. Annual upticks were also recorded in Beirut's average room rate and rooms yield, which climbed from $174 and $102 by May 2018 to $192 and $130 by May 2019, respectively.

Inflation eased in H1 2019 (Figure 4). Lebanon's average consumer prices rose by 3.58% YOY by May 2019 compared to the more pronounced annual growth of 5.68% recorded in the same period of 2018, according to the Central Administration of Statistics. The main components pulling up the CPI are the average prices for food and non-alcoholic beverages (20% of the CPI) and education costs (6.6% of CPI), which registered annual increases of 6.21% and 5.17%, respectively, by May 2019. In turn, average prices of clothing and footwear (5.2% of the CPI) also rose by an annual 14.05% in the first five months of 2019.

Figure 4: Average inflation rate by May

Source: Central Administratiun of Statistics (CAS), BLOMInvest Bank

Balance of payments

Although the balance of payments (BOP) is still suffering from the drying of capital inflows and the large deficit in the trade balance, the unlocking of CEDRE funds can change the trend (Figure 5). The BOP registered a deficit of $5.19 billion by May 2019, reversing the $430 million surplus recorded by May 2018. Actually, the substantial BOP deficit of $1.88 billion registered in May 2019 resulted from prolonged delays in endorsing the government's proposed draft budget. As a result, commercial banks' net foreign assets (NFAs) fell by $508.2 million in May 2019, while BDL's NFAs shrank by a monthly $1.37 billion. The latter is mainly attributed to a $650 million payment for maturing Eurobonds on May 20 2019. However, the unlocking of CEDRE funds will help break the vicious cycle of BOP deficit and attract capital inflows back into the economy.

The trade balance continues to reveal a chronic deficit. The most recently available Lebanese customs' data shows that the trade deficit widened from $3.99 billion in Q1 2018 to $4.09 billion in Q1 2019 owing to an annual 2.9% uptick in total imports to $4.95 billion, while total exports grew 5.06% YOY to $855.8 million over the same period.

Figure 5: Yearly balance of payments (in $M)

Source: BDL; BLOMInvest Bank

Fiscal dynamics

Lebanon's fiscal performance reflected a substantial $6.3 billion cash-basis deficit in 2018, but the budget for 2019 is a promising change from last year. The fiscal deficit reached 10.9% of GDP (or $6.25 billion) in 2018, compared to a $3.8 billion deficit in 2017 (Figure 6). The latest deterioration of the country's fiscal dynamics was underpinned by a 15.68% annual growth in public spending to $17.79 billion (~29% of GDP) by December 2018, which represented a full materialisation of the public salary hike passed by parliament in 2017. Meanwhile, public revenues retreated by 0.4% to $10.74 billion, or 18.67% of GDP, over the same period. As for Lebanon's primary balance (the fiscal balance excluding debt servicing costs), it unveiled a primary deficit of $635.6 million in 2018, or 1.11% of GDP, compared to a primary surplus of $1.43 billion in 2017.

The fiscal deficit in January 2019 showcased an improvement on the previous year, partly due to lower oil prices. The Ministry of Finance's (MoF) latest data showed that the fiscal deficit narrowed from $378.91 million in January 2018 to $72.83 million in January 2019. Against this backdrop, the primary balance posted a surplus of $231.74 million compared to a deficit of $106.34 million in January 2018. In fact, the smaller fiscal deficit came on the back of a 16.09% yearly decrease in government expenditure to $1.1 billion, while fiscal revenues rose by 8.45% YOY to stand at $1.08 billion. In detail, Electricite du Liban (EDL) is a company owned by the government whose transfers in 2018 shot up by 32.26% YOY to reach $1.76 billion, owing it to a 30.98% surge in oil prices. However, by January 2019, international oil prices slipped by an annual 12.78% to $60.24/barrel and EDL transfers were then reduced by 26.17% YOY to $65.85 million. Nevertheless, total debt servicing reached $304.57 million in January 2019, up by a yearly 11.74%. This resulted in interest payments alone rising by 12.77% YOY to $287.34 million.

Figure 6: Fiscal deficit in $B

Source: Ministry of Finance; BLOMInvest Bank

In turn, non-tax revenues were pulled up public revenues in the first month of the year while tax revenues slipped. Non-tax revenues (16.60% of total revenues) increased substantially from 84.92 million in January 2018 to $179.57 million in January 2019, largely due to the annual rise in 'telecom revenues' (46.31% of total non-tax revenues) reaching $83.17 million in January 2019. Meanwhile, tax revenues (83.40% of total revenues) declined by an annual 1.13% to $902.51 million in January 2019, such that VAT revenues (33.84% of total tax receipts) dropped 16.12% YOY, to $305.40 million, despite the 11% VAT rate effective January 2018.

The retreat can be linked to the stagnating economy and recession in many sectors, such as in the car market where VAT is paid post-car registration. However, the data from the Association of Lebanese Car Importers revealed a 26.1% YOY decline in the total number of newly registered commercial and passenger cars to 1,948 in January 2019. In their turn, customs' revenues (11.79% of tax receipts) dropped 6.49% YOY to $106.38 million.

Monetary policy

On the monetary policy front, the BDL has preserved the currency peg. Despite the negative developments in the BOP, the foreign exchange reserves level at the BDL remains adequate enough to preserve the Lebanese pound's peg to the US dollar. The BDL had in excess of $36 billion in foreign assets (excluding gold) at end of June 2019, which covers of 22 months of goods imports and around 75% of LBP deposits at commercial banks.

Deposits at commercial banks declined in H1 2019 due mainly to one-off factors related to the delay in the formation of a new government, which led to a delay in approving the new budget. The high interest rate environment persisted through 2019 and since Q3 2018 commercial banks are have continued to compete to attract deposits, mainly LBP-denominated. The total customer deposits (resident and non-residents) dropped 2.06% YTD to stand at $169.6 billion by May 2019.

Interest rates climbed further (Figure 7), to reach highs of 8.6% on LBP and 5.68% on USD by April 2019. The upward trend seems to have become the norm.

In an environment of high interest rates, credit to the private sector is sliding (Figure 8). The lending rates in their turn continued to record upticks, and hit highs of 10.74% on LBP and 9.34% on USD-denominated loans. In fact, loans to resident and non-resident customers slid by 5.13% YTD to $55.9 billion by May 2019. Moreover, despite the BDL reinitiating the subsidy program in January 2019, the amounts made available to accommodate for new housing loans remained very limited.

Figure 7: Average interest rates on deposits

Source: CAS, BLOMInvest Bank

Figure 8: Average interest rates on loans

Source: BDL; Blominvest Bank

Eurobond market

The yield curve remains inverted as the difference in yields on short and long-term bonds squeezed interest margins. Yields on 5Y bonds are still higher than those on 10Y bonds in H1 2019. In fact, the inverted yield curve exhibited in Lebanon's Eurobonds market since September 2018 continued to reflect investors' lack of confidence in the economy in the short term. This explains higher demand on long-term bonds that resulted in yields on 5Y bonds exceeding those on the 10Y (Figure 9).

Accordingly, during H1 2019, the yields on 5Y and 10Y Lebanese Eurobonds climbed to highs of 13.4% and 12.12%, respectively. Pre-government formation then eased until mid-June before they again hit highs of 12.42% and 11.65%, respectively, as investors awaited progress on the reforms. In parallel, the 3M and 10Y yields on US treasuries decreased to 2.20% and 2.07%, respectively, over the week ending July 11, which indicates an inversion in the US Treasury yield curve and thus a squeeze in interest margins for banks relying on maturity mismatch for returns.

Figure 9: Yields on Lebanese Eurobonds

Source: BDL; Blominvest Bank

Figure 10: Lebanon’s 5Y CDS from 01/01/2018 to 30/06/2019

Source: Banque du Liban (BDL); Blominvest Bank

Although low, investor confidence in the country improved in H1 2019 and is set to gain traction once budget implementation kicks off. Notably, JP Morgan recently upgraded Lebanon from market weight to overweight. After nine months of delay, Lebanon's government was formed on January 31 2019. Prior to this date, Lebanon's Eurobond prices saw declines, as depicted in the performance of the Blom Bond Index (BBI).

Since the government formed on January 31 2019, the BBI grew by 4.55% and Lebanese 5Y credit default swaps (CDS) slumped from 786 basis points to 699 basis points (Figure 10). JP Morgan's recent upgrade stated that: 'the spread widening has gone too far against [their] base case that a credit event should be averted near-term, even as FX deposit flows have shown signs of declining this year, and political impasse remains a hurdle to unlocking the $11 billion of CEDRE funding to the country'.

Stock Market

The Blom Stock Index's (BSI) trend scoring below the index's initial capitalisation of 1,000 persisted through H1 2019 (Figure 11). Starting in September 2018, the BSI fell below the 1,000 mark for the first time since November 2005, with the index reaching its lowest level at 839.6 points by mid-May 2019, stabilising at an average of 852.6 points in June 2019. The performance of the stock market remained subdued in H1 2019, especially as investors adopted a wait-and-see approach towards progress in the government's proposed reforms.

Figure 11: BLOM Stock Index (BSI)

Source: BLOMInvest Bank

Ways forward

Despite budget approval still pending, the government made progress by improving other laws that could help restore Lebanon's governance. The authorities took a recent number of decisions within the framework of fiscal adjustment and this is a step in the right direction. For instance, in the week of July 8 2019, the government published the newly amended and updated version of the Code of Commerce. This may directly contribute to mending the business environment and improving the ease of doing business. The savings promised from freezing public sector hiring for the next three years and capping allowances for public sector employees may also help. These actions are key, as they trigger short-term progress on governance and the operating environment whilst the structural reform agenda for more sustainable improvements is launched.

The government's target is to achieve a deficit of 7.6% of GDP instead of 2018's 10.9% to lift external competitiveness and regain confidence. This is an ambitious goal that necessitates reforms in the short term and long term. The former may focus on reducing the fiscal deficit and taking measures to increase public revenues and/or reducing costs by tackling problems such as waste management or EDL's subsidy costs.

In fact, EDL's reform plan passed in April 2019, which encourages more optimism this time round when it comes to implementation. The IMF's concluding statement in 2019 found that 'eliminating electricity subsidies is the most significant potential expenditure saving'. In fact, policy-makers made public promises to improve the provision of electricity in Lebanon that may hold them more accountable. Moreover, in real figures, EDL transfers constitute around 20% of public spending, which can save up to 2.5% to 3% of GDP, or at least $1.5 billion post-reform. The March 2019 paper released by the Ministry of Energy & Water (MOEW) emphasised and delineated the main, practical steps the reforms plan to prioritise during 2019-2026 in collaboration with the World Bank. These comprise: substituting the fuel oil used by EDL with natural gas (thus reducing production costs by diminishing EDL's reliance on volatile oil prices); boosting EDL's generation capacity; and raising tariffs to 'result in a decrease of the overall electricity bill that citizens are paying because of the anticipated timely decrease of their private generator bills during the same period'.

In the long-run, the business environment and pro-growth reforms must become a policy priority. This would entail simplifying administrative procedures, bureaucracy, and the time it takes to open and close a business. In fact, the new Code of Commerce will largely support this priority. Enhancing the ease of doing business in Lebanon can return the country to its position as a capital hub. In addition, a government with good governance on all policy fronts is of utmost importance because transparency spurs accountability, credibility, and confidence.

About the author

Marwan Mikhael
Head of equities and economic research, BLOMInvest Bank
Beirut, Lebanon
T: +961 1 991 782
E: marwan.mikhael@blominvestbank.com
W: www.blominvestbank.com

An expert in monetary, banking and fiscal issues, Marwan Mikhael has been heading equities and economic research at BLOMInvest Bank (part of BLOM Bank group) since 2008. He has also been working on investment banking M&A deals since 2014.

Before joining the bank, Marwan was an advisor to the Minister of Economy and Trade H E Dr Sami Haddad for two years. Marwan joined the International Monetary Fund in Washington DC as an economist in 2002, working in both the African and the Middle East and Central Asia departments, where he stayed for four years and dealt with a number of issues, including: trade development; fiscal competitiveness; fiscal and debt sustainability; microfinance; and monetary and financial matters.

He started his career at the Ministry of Finance dealing with public sector reforms, budget preparation and public debt issues. Marwan is a lecturer at the Saint Joseph University in Beirut and has published many papers on Lebanon and other countries in the region.

About the author

Rouba Chbeir
Senior economist, BLOMInvest Bank
Beirut, Lebanon
T: +961 1 991 784 Ext 324
E: rouba.chbeir@blominvestbank.com
W: www.blominvestbank.com

Rouba Chbeir is a senior economist, lecturer and mentor. She holds a master's degree in financial management from Cardiff, UK. Her major work has focused on studying the role of supranational institutions, socioeconomic parameters and public policy in the EU after the 2008 global financial crisis.

Rouba joined Beirut-based BLOMInvest Bank in 2016 where she became the expert on sectorial market research in Lebanon, with industry professionals using and commending her published work. She also specialised in the macroeconomics of Lebanon and the MENA region. Her portfolio entails more than 30 publications and she is frequently referenced and quoted by professionals, students, policy makers and in media outlets such as HORECA, Hospitality News Middle East Magazine, City University London magazine, the National UAE and Lebanese Association of Banks.

Rouba is also a lecturer, delivering practical and contemporary sessions in entrepreneurship, marketing, organisational behaviour and international ethics, among others. She also collaborates with guest speakers and regional and international industry professionals to broaden her research, share knowledge and mentor students.