LEBANON'S economy is a mass of contradictions. Confidence abounds but the actual performance always falls short of the predictions. Every year, millions of dollars flow into a country that produces precious little; the central bank devotes most of its energies to supporting the local currency, yet very little money is being lent; the government sets budget targets, but consistently fails to achieve them. Despite such discrepancies, the economy has grown strongly for the past five years. Only now is it running out of steam.

When four credit rating agencies delivered their verdicts on Lebanon earlier this year, they all commented favourably on the strengths of the economy. These include Lebanon's low foreign debt, low inflation and stable currency. They also agreed on its flaws. 'The weaknesses include a very large public sector budget deficit and a sky-rocketing debt,' said the London-based IBCA. 'The fiscal consolidation planned for 1997 urgently needs to be held on course.'

The government was obliged to be more prudent because the outlook for this year was so poor. For all its inconsistencies, the economy has over the past five years shown a remarkable degree of vigour. At its peak in 1994, GDP growth hit nearly 9 per cent. This was due largely to the low base from which the economy was recovering after the war. When growth slipped to 4 per cent last year - its lowest level since Prime Minister Rafiq Hariri came to power in 1992 - the downturn was blamed on the devastating Israeli bombardment of Lebanon in April.

Growth has failed to pick up this year, however. Faced with predictions of only a 2 per cent increase in revenues, the government clamped down on spending in the 1997 budget. The target deficit is still large, at £Leb 2.47 million million ($1,600 million), or 38 per cent of expenditure. The actual deficit in 1996 amounted to 51 per cent of expenditure and the target looks even less likely to be met this year: the deficit during the first quarter alone reached £Leb 1,064 million million ($689 million), almost 60 per cent of expenditure.

'For the next five years, revenues will never cover more than 50 per cent of the budget,' says Gerard Charvet, deputy general manager of Byblos Bank. 'But the question is more one of how this is sold to the people, so that they believe it can work, or at least behave as if they believe it. The psychological effect in this country is more important than the truth.'

The government is reluctant to raise taxes, which would offer the simplest solution to the deficit. 'If government revenues were increased to 30 per cent of GDP, all Lebanon's public financing problems would disappear overnight,' says Freddie Baz, adviser to Banque Audi chairman Raymond Audi. However, this is not an option for a government that has put low tax rates at the heart of its strategy for making Lebanon attractive to investors.

Although Hariri has staked his reputation on the success of the strategy, concern is growing at the mounting public debt and the recurrent deficits. An official forecast six months ago that Lebanon would enjoy growth of 7 per cent this year now looks fanciful. The Banque du Liban (central bank) is predicting growth of 5 per cent. Banque Audi estimates growth in the first quarter was no more than an annualised 4 per cent. The government remains bullish and says that Lebanon can achieve an economic recovery with or without a peace treaty with Israel. Others are less sanguine.

'We are in a bad recession,' says Fadi Osseiran, general manager of Banque d'Affaires du Liban & d'Outre Mer (BALOM). Even central bank governor Riad Salameh has begun to insist that the government must rein in the deficit if interest rates are to be cut and growth stimulated.

In spite of the warnings, the public debt continues to spiral: it reached £Leb 17.23 million million ($11,100 million) at the end of 1996, and increased by a further 9 per cent during the first three months of this year.

Concern that the growth in public borrowing was getting out of hand obliged Salameh to offer assurances in February that the government's existing deposits with the central bank would be sufficient to cover this year's deficit. Nevertheless, the bank has continued to issue new treasury bills, although it is shifting the emphasis to paper with longer maturities.

Separately the Finance Ministry has tried to offer reassurance about the health of the nation's finances. In February, the ministry said that GDP would exceed $15,360 million this year. According to this forecast, the target budget deficit will amount to almost 10 per cent of GDP, and net public debt will amount to about 80 per cent of GDP. Foreign debt at the end of March was just $1,883 million, which is only 12.2 per cent of the GDP forecast.

Some analysts warn against attaching too much importance to the debt figures. More than 80 per cent of the debt is domestic, they point out. And the warm reception given to the government's first Deutschmark bond issue in May suggests that the international capital markets are confident of Lebanon's ability to honour its obligations. Indeed, the government can probably afford to continue on its present course for some time. 'When you reach internal debt of 100 per cent of GDP, you get into trouble,' says Charvet. 'But Lebanon could go on like this for another three-five years without a collapse.'

By then the reconstruction efforts should be starting to pay off. 'In two-three years from now, Beirut will be one of the most modern cities in the Middle East in terms of infrastructure,' says Nabil Sawabini, president of Beirut finance house Middle East Capital Group. The view that the spending so far has laid the foundations for Lebanon's future prosperity accords with the government's strategy of creating conditions - in terms of infrastructure, low inflation and minimal regulations - that will attract private investment.

'Growth during the past three years has been entirely based on construction - excluding infrastructure works,' says Salameh. Banque Audi estimates that 50 per cent of all private investment since 1992 has gone into construction. And it was in the construction sector that the economy first began to show signs of weakening, as activity slowed in late 1995. 'The worsening of the recession in this sector explains the drop in private investments in the first quarter of 1997, which...fell by 18 per cent compared with the same period of last year,' the bank says in its report on the first quarter. Interest rates have already been cut twice this year to 16 per cent. But until they fall further, few people will be able to afford mortgages. Many buildings are likely to remain unsold, tying up capital and starving other sectors of investment.

Despite the slowdown, Lebanon can still rely on a steady influx of fresh capital. These inflows - which include net services and other invisible flows, private and public transfers - amounted to almost $2,000 million in the first quarter of this year alone. The economic downturn is unlikely to affect such capital movements, says Marwan Ghandour, head of Beirut finance house Lebanon Invest. 'Even during the war, we had plenty of capital inflows,' he says. 'They may be slowing down, but we still have a positive balance of payments.' Indeed, Lebanon recorded a balance of payments surplus of $564 million in the first quarter of this year, up from $30 million in the same period of 1996.

Whatever action the government takes to deal with its budgetary difficulties, Lebanon still has a long haul ahead. It will be 2007 before the country restores per capita income in real terms to the 1974 level, Baz estimates. And, it will take a further 20 years before it achieves the per capita income that it would have achieved had the war never happened. Many Lebanese are still happy to talk up the prospects for the economy. But an economy cannot grow on repeated expressions of optimism alone.