In numbers

26.6 per cent: Rise in tourist arrivals in Lebanon in the first half of 2010

$2.1bn: Value of real estate transactions made in the first quarter of 2010

$120.7bn: Total assets of Lebanese banks by end-May

Source: MEED

Lebanon’s estimated economic growth in 2010 will the fourth-largest in the world, according to the Washington-headquartered International Monetary Fund (IMF).

Real gross domestic product (GDP) growth could be at least 8 per cent in 2010, it says, putting Lebanon second only behind Qatar in the Middle East. The IMF has revised its own figures upwards from the 6 per cent forecast for 2010 a year ago.

The improved outlook for Lebanon’s economy is due to the political stability following the Doha agreement

It will be the fourth consecutive strong year of growth, following figures of 7.5 per cent in 2007 and close to 9 per cent in 2008 and 2009. It is a dramatic turnaround for an economy that expanded just 0.6 per cent in 2006, when growth was stunted by the conflict between Hezbollah and Israel, and is impressive even compared to the 2000-05 period, when growth averaged 3.9 per cent.

Vital economic indicators in Lebanon

Inflation is under control and unemployment, though still high, is falling. Official figures for consumer price inflation showed a 3.5 per cent increase in prices between June 2009 and June 2010, while local economists put it at about 5 per cent. Unemployment is 9-10 per cent, down from more than 20 per cent in the mid-1990s. The cabinet has even approved its first budget for five years, although it has yet to be ratified by the parliament despite almost eight months of the year having already passed.

Civil unrest or war would change everything. In the short term it would be devastating

Paul Salem, Carnegie Endowment for International Peace

The improved outlook for Lebanon’s economy is largely due to the political stability following the signing of the Doha agreement in May 2008. “The political settlement created an opportunity for growth in an economy that had been operating at just 60 per cent of its potential output,” says Marwan Barakat, chief economist at Bank Audi in Beirut.

Against a backdrop of political calm, the tourism, real estate and banking sectors are all thriving. Tourist numbers were up 26.6 per cent year-on-year in the first half of 2010, rising from 761,415 to 964,067. The occupancy rate of Beirut hotels surveyed by Ernst & Young, an international consultancy, was 72 per cent in the first half of 2010, compared with 69 per cent for the same period of 2009.

Revenues per available room increased by 21.6 per cent to $179 over the same period. For the Middle East as a whole the average increase was just 1.1 per cent.

“Tourism spending in the Middle East has been adversely affected by the global crisis, but Lebanon has grown its share of the pie at the expense of others both inside and outside the region,” says Barakat.

Lebanese real estate boom

In the real estate sector, construction permits accounting for 6.8 million square metres of land were signed in the first five months of 2010, a 59 per cent increase on the 4.8 million sq m during the equivalent period of 2009. Cement deliveries were up 10 per cent over the same period. According to Lebanon’s Directorate of Real Estate, 22,000 real estate transactions, worth a total of $2.1bn, were made in the first quarter of 2010, a 41 per cent increase on the same period of 2009.

The economic growth is underpinned by a strong local banking sector. The total assets of the country’s banks reached $120.7bn at the end of May 2010, up 18.7 per cent year-on-year. The central bank has foreign currency reserves of close to $30bn, equivalent to about 85 per cent of the country’s money supply. Although the $3.4bn increase in bank deposits in the first five months of 2010 was substantially below the $6.6bn deposited in the same period the previous year, total deposits are still set to increase by 10 per cent in 2010, according to a statement by central bank governor Riad Salameh in May.

The slowdown in deposits has not discouraged lending. Domestic loans from banks increased by $2.5bn in the first five months of 2010 compared with $3.2bn for full-year 2009. Loans to the private sector were up 10.8 per cent from the end of 2009 to $31.4bn, a 20.6 per cent increase on the previous year. Despite the slowdown in deposits, the loan-to-deposit ratio is a healthy 41.7 per cent, against a central bank limit of 70 per cent. In April, ratings agency Moody’s upgraded Lebanon’s government bond ratings from B2 to B1, citing an improvement in the country’s external liquidity and its resilient banking system.

Despite the impressive performance in these key sectors, there are major vulnerabilities in the economy. The most striking is the country’s debt problem. At the end of 2009, Lebanon’s public debt to GDP ratio of 148 per cent was the third largest in the world, behind only Japan and Zimbabwe.

With the exception of Djibouti and Iraq, Lebanon is also forecast to have the highest current account deficit in the Middle East and North Africa in 2010. The deficit is expected to increase to 12.8 per cent this year, up from 5.3 per cent in 2006 and 11.5 per cent in 2008, according to the IMF. The next-largest projected deficit in the region is Jordan, at 8.9 per cent.

Widening deficit

Under the draft 2010 budget, the fiscal deficit is set to widen too, to 10.7 per cent of GDP from 8.8 per cent in 2009. “The draft budget has met the demands of all political sides in the cabinet at the expense of the deficit,” says Nassib Ghobril, chief economist at local Byblos Bank. “The government is relying on continuous high growth to keep the primary balance in surplus, but frankly it’s not a wise decision.”

“They’ve gone from sending positive signals worldwide to investors that they’re able to manage the country’s greatest economic weakness to announcing that they’re going to have a deterioration this year,” says Barakat.

Some measures have been taken to increase government revenues, including the removal of the cap on gasoline taxes, and others, such as an increase in the tax on deposit interest income, are included in the draft budget. But the government’s efforts to increase its income are still falling short, say economists.

“Plans to increase value-added tax and close loopholes for luxury items have been left out of the budget,” says Ghobril. “And there is room to improve tax collection.”

According to Barakat, tax evasion costs the government an estimated $2.5bn a year.

The loss-making state power company Electricite de Liban (EDL) is another drain on government income: in 2010 alone the company is expected to lose $4.4bn. The government has introduced a new five-year strategy to balance EDL’s books, but the industry is sceptical that it will be successfully implemented. “The energy strategy is no more than a paper,” says a senior diplomatic source in Beirut. “Every minister has had one, and there is no reason to believe that this one will be any more concrete.”

The government’s high level of indebtedness is mitigated by the ease with which it can refinance its loans from a deposit-rich local banking sector. But this is not a risk-free strategy. “People say there is no need to worry because most of the debt is held domestically by Lebanese banks,” says the Beirut diplomat.

“But this is very fragile. One government default, or a banking crisis, and the whole thing collapses.”

Not only this, but deposits into the banking sector rely heavily on the Lebanese diaspora. Deposits over the past two years from Lebanon’s overseas population, numbering an estimated 12 million, have ensured that the country not only escaped the worst effects of the global financial crisis, but actually benefited from it. While the conservatism of the local banking sector insulated it from much of the contagion that inflicted the financial services sector elsewhere in the world, it also attracted inflows of capital from Lebanese investors overseas. In 2009, capital inflows accounted for 9 per cent of GDP growth.

“Capital inflows grew by about 25 per cent in 2009 because Lebanese abroad were encouraged to transfer money to the home economy by the strict regulatory regime and the conservative policies of Lebanese banks,” says Barakat. “The diaspora is an important buffer for the Lebanese economy, especially during periods of turmoil.”

But the flip-side to the benefit of capital inflows from Lebanese overseas is that there is always a risk of capital flowing in the other direction. “Nostalgia isn’t enough for them to risk losing their money,” says the Beirut diplomat. “Any crack could lead to systemic failure.” Capital inflows, though still healthy, are already falling in comparison to last year. Non-resident foreign currency deposits fell 18.4 per cent in the year to end-May 2010.

There is also scepticism that growth in other areas of the economy is sustainable. Despite healthy results in the tourism sector, there is disappointment in the industry that the sector’s performance has still fallen short of expectations in what was set to be a bumper year. And there are real fears that rapidly increasing prices are creating a bubble in the real estate market.

New challenges for Lebanon’s economy

“The market is overvalued against regional indicators,” says Ghobril. “People are buying on expectation of price increases, but it’s not clear who they will be able to sell to.”

Meanwhile, more sustainable areas of growth are being neglected. “Everything that should be underpinning economic growth is not there,” says the Beirut diplomat. “The infrastructure is atrocious, whether it be for water, electricity, transport or telecoms. Nobody is taking any decisions on any of these things. Instead growth comes from over-inflated construction.”

The economy is also highly vulnerable to political instability, as was shown by the reaction of the stock market to an incendiary speech by Hezbollah leader Hassan Nasrallah on 22 July. “Solidere, which is the country’s bellwether stock, fell 2-3 per cent in one day after Nasrallah’s speech,” says Ghobril.

“Civil unrest or war would change everything,” warns Paul Salem, director of the Carnegie Endowment for International Peace in Beirut. “In the short term it would be devastating.” Fortunately, Lebanon has a habit of rebounding.