Lebanon has found itself at the mercy of the war in Syria, domestic political faction Hezbollah’s constant stand-off with neighbouring Israel, and wider regional factors such as the drop in oil prices and overall geopolitical instability.

Nevertheless the country has maintained its reputation of resilience, with the economy recording fiscal growth in 2014 despite a drastic drop in foreign investment and tourism.

Lebanon is now far away from the height of the investment and development it enjoyed in the mid-2000s. Despite the glamorous reputation of Beirut, as you drive through the city it is clear it is in dire need of redevelopment.

Former Prime Minister Rafiq Hariri’s campaign to attract foreign investment, which paved the way for the real estate and infrastructure boom that created the current landscape of iconic areas such as Downtown, is now a distant memory.

Lebanon has also suffered from dwindling tourist numbers, from 2.2 million visitors in 2010 to a little over 1.3 million in 2014. Beirut and popular skiing destinations in the country’s mountains are no longer as busy as they used to be.

Limited spending

Despite this, the economy has managed to perform better than casual observers might imagine. Local banks such as Bank Audi and Blom Bank say the 31 per cent drop in the fiscal deficit in 2014 was due in part to a 12 per cent hike in public revenues. More significantly, however, it was the 2 per cent reduction in government spending that allowed for growth.

Lebanon has reached a point where limiting public spending is no longer an option. An unnatural hike in the population, caused by an influx of 1.5 million Syrian refugees, has meant increased investment is vital to alleviate a tightening infrastructure bottleneck.

“Generally speaking, emerging markets should be spending 5-6 per cent of their GDP on infrastructure, but Lebanon has only been committing to 1.2 per cent over the past four years,” says Marwan Barakat, group chief economist and head of research at Bank Audi. “I expect an increase in infrastructure spending, although it is likely to happen as the government makes cuts elsewhere in areas such as wages and maintenance.”

An increase in public spending will not be a light decision as the government attempts to manage the country’s twin deficit. A 25 per cent decline in exports, caused by the instability in neighbouring Syria, has resulted in the trade deficit soaring to 35 per cent of GDP, according to a quarterly report published by Bank Audi.

“The government must start looking at the issue of exports,” says Barakat. “The bank recommends the government looks at ways to subsidise export industries to encourage and support small-to-medium-sized local businesses.”

A positive external factor that has alleviated the strain in reduced exports has been the drop in oil prices. This has shrunk the country’s energy bill, which sat at about $3.2bn in 2010, with analysts expecting it to decrease to about $2bn in 2015 if crude prices remain low. But such a drastic drop in oil prices could have other implications on the global economy, which will eventually negatively affect Lebanon. 

Alternative revenue

The government’s priority will be to find alternative streams of revenue. While it is expected that there will be a slight increase in capital spending on infrastructure, it is likely to be much lower than what the country actually needs, and long-term solutions are required.

It is vital for the government to improve tax collection and at the same time increase other areas of taxation

Marwan Mikhael, Blominvest Bank

As exports continue to contract, the government is likely to follow the advice in a report published by the Washington-based IMF in May, which identifies taxation as an area in need of reforms. “It is vital for the government to improve tax collection and at the same time increase other areas of taxation, such as a recommended capital gains tax on real estate,” Marwan Mikhael, head of research at the local Blominvest Bank, tells MEED.

The IMF report also recommends that policymakers “seize the opportunity afforded by low oil prices to remove the value-added tax (VAT) exemption on diesel immediately, and increase gasoline excises”. The fund calls for “a modest increase in the VAT rate, by 1 percentage point, and increased transparency and regularity in the telecom transfers”.

The 1 percentage point increase in VAT would raise it from its current 10 per cent, but Mikhael admits that any increases should be tactful to avoid causing social disturbances.

Paying taxes

As with many countries in the region, Lebanon struggles with tax collection as a culture of corporate tax evasion reigns strong among local businesses. A prevalence of informal employment means income tax revenues continue to be much lower than they should be.

In order to drastically improve income and corporate tax collections, the government must install the necessary mechanisms. But even if it is able to take such measures, they will not offer an immediate answer. 

As such, unless Beirut creates the institutions needed for robust tax collection, it seems that only a VAT increase or a real estate capital gains tax is likely to offer the short-term solutions needed.

Meanwhile, foreign investment will continue to struggle as investors maintain the wait-and-see attitude that has crippled Lebanon’s ability to attract funds from abroad.

A significant decline in capital inflows since 2010 has further dampened economic activity across the country. They dropped from $7.1bn in 2010 to $6.7 this year, according to a report published by the Washington-based Institute of International Finance, which has attributed this decline to a reduction in both foreign direct investments and remittance deposits.

“The government is aware of the position it is in and is starting to take steps,” says Barakat. Despite having a functioning cabinet, which has revealed it will announce a government budget for the first time in more than 10 years, Beirut’s failure to elect a replacement for former president Michel Suleiman, whose term ended on 25 May 2014, is making foreign investors wary of the country’s stability.

Meanwhile, part of the resilience of Lebanon’s economy has been the strength of the banking sector. The sector is hailed for its profit-making nature and stability, which are aided by robust regulations.

However, the first half of this year has proved a difficult one. Deposits grew at a much slower rate than usual, with an increase of just 0.7 per cent in the first quarter. Despite the three leading banks recording profits of 9 per cent, customer loans were down by 2.6 per cent.

Overall, it seems that as the region shows no sign of stabilising, Lebanon’s resilience is being stretched and the government must start applying policies of growth rather than containment.

Stagnating economy

Although Beirut was hailed for its fiscal performance in 2014, this was due to holding back on capital spending. But as the refugee situation continues to put pressure on the country, Lebanon has found itself stagnating while the need to address core issues grows. All of this becomes very difficult with an apparently ineffective government that has not been able to provide a streamlined economic policy.

Foreign investment could serve as a lifeline, just as it has with Egypt, which held a successful investment conference in March of this year. However, if the economy does not improve, foreign investors will not be so keen to pledge support.

GCC-funded investments could provide the confidence needed to restart an economy reflecting its fragmented and stalled political landscape. Meanwhile, promises of a budget will do little in the short term unless the government is able to find new streams of revenue.