AMID the gloom surrounding cancelled loans and shelved reconstruction projects, the government at least has one positive achievement it can point to: for the first time since the end of the civil war, Lebanon recorded a primary surplus for the first half of the year. The

£Leb 347,000 million ($228 million) surplus, worth around 3 per cent of gross domestic product (GDP), has been taken as a sign that the government is finally getting the budget deficit under control, albeit with a deflationary impact on the rest of the economy.

The improvement in Lebanon's public finances has been the key economic success story of 1998, with the budget deficit averaging 35 per cent of expenditure in the first six months of the year against a target figure of 42 per cent. As a percentage of GDP, it shrank to 10.7 per cent for the first half from 18.3 per cent for the same period last year. The improvement is mainly attributed to better tax collection.

Analysts point out that the improvement is only the first stage in securing a soft landing for the economy. According to the latest quarterly report from Bank Audi, Lebanon will continue to experience lower growth, which was reported at an annualised rate of 2 per cent in the first six months of 1998. It argues that the government needs to prioritise the fiscal adjustment in the short term even at the price of slower growth. 'Lebanon can have lower growth rates for the short term provided these translate into a better fiscal situation,' says Freddie Baz, adviser to the chairman of Bank Audi.

The local business community knows the fiscal improvement is relative. In most countries, a 35 per cent deficit would hardly be a cause for celebration. But in the Lebanese context, the high current account deficit - which ran to 59 per cent in 1997 - has been a permanent threat to the reconstruction efforts. 'Achieving the target was an important step, but it's an insult to our intelligence to think that not exceeding the 42 per cent target should be our optimal position,' says Baz.

Bankers are urging that much more needs to be done on the fiscal side to improve investor confidence and restore the 4-5 per cent growth rates that the country experienced between 1992- 96. Qualitative measures are needed to get debt ratios down to manageable levels. Incremental excise taxes alone will not be enough to tackle the structural problem of Lebanon's $15,000 million public debt.

More sovereign debt issues to match the $1,000 million one last March could help restructure public debt from high-rate short-term domestic borrowing to low-rate medium and long-term foreign borrowing.

But two important reforms would ensure more stable income generation to reduce the debt burden: a commitment to privatisation and an increase in the country's resource mobilisation rate. The latest rumours circulating in Beirut suggest that Electricite du Liban could be ripe for at least a partial sell-off. The government's decision in July to award the country's postal concession to a foreign-owned private company shows it has the political will to go down the privatisation route and business leaders hope a new leadership in Baabda will give the process added momentum.

Privatisation of the country's telecommunications operations could wipe out 30 per cent of the public debt overnight, economists say.

Higher taxes are also back on the agenda. Despite its laissez-faire traditions, Lebanon knows it is missing out on critical sources of income. 'We have a resource mobilisation rate of 14 per cent compared to a regional average of around 24 per cent. To reach that level of mobilisation requires more political courage,' says Baz. A new equation in the troika could provide that momentum.

If Lebanon can emerge from its present state of politically-induced paralysis, it will need to reposition itself over the long term. It's pre-civil war position as a regional banking and services centre profiting from booming Gulf oil revenues has long been usurped by the Gulf-based banks. And the elusive peace settlement with Israel remains just that, at least for the time being.

Analysts say the best hope for Lebanon to regain its economic pre-eminence would be to capitalise on its high skills base and human capital. These point to a new role as a regional centre for business tourism, catering, consultancy and construction.

Capital markets could inject some pizzazz back into the Beirut financial scene. 'There is no single leader in capital markets in the region. Smaller places like Dubai and Kuwait have developed, but they haven't replaced Lebanon,' says Baz. 'We need to provide a specific framework for capital market activities to gain an edge. We have an advantage in all areas because of our highly skilled labour force, and capital markets are real human expertise businesses.'