Just when Lebanon was showing signs of improved stability after suffering more than three years of fallout from the Syrian war, another regional conflict has dashed hopes for an economic recovery.

With the early months of 2014 relatively quiet, it was hoped Lebanon might once again attract tourists for its summer season and see visitor numbers pick up after dropping to 1.3 million in 2013 from more than 2 million in 2010.

But the rise of the Islamic State in Iraq and Syria (Isis) casting a shadow across neighbouring countries, together with Lebanon’s own failure to appoint a president, has crushed the potential for a speedy recovery.

The number of visitors fell further in the first quarter of 2014. Arrivals were down 16.5 per cent year-on-year, from 275,000 to 229,000.

While Lebanon has navigated through extreme circumstances before, a lack of foreign investment and business activity, bleak prospects for political reform, and the burden of more than 1 million Syrian refugees are reasons for concern.

Security issues

Car bombs and incidents of violence have increased as the country’s citizens and political groups sympathise with different sides of the Syrian conflict.

Security breaches, such as the suicide bombing in a Beirut hotel in June for which Isis claimed responsibility, have become more frequent and the authorities have made several arrests of people allegedly planning further attacks.

Meanwhile, protests and clashes between gunmen and militia members have flared up again in the northern city of Tripoli, reportedly a base for local chapters of various extremist groups. That put an end to a relative calm period in the first quarter, when a security plan had been put in place by the Lebanese Army.

“Recent events have reduced our expectations for the year,” says Marwan Mikhael, head of research at Beirut-based Blominvest Bank. “In May, we had projected [economic] growth for 2014 at 2.5 per cent and now we have revised it down to 2 per cent.”

That represents only a marginal improvement after Lebanon registered GDP growth of less than 2 per cent a year between 2010 and 2013, compared with about 8 per cent between 2007 and 2010.

Real domestic investment was 15 per cent lower in 2013 compared with before the start of Syria’s war, while foreign direct investment fell 24 per cent.

Not surprisingly, that coincided with poor performances in the tourism, real estate and trade-related sectors, which typically drive Lebanon’s economy.

Improved figures for real estate transactions – which grew 7-8 per cent in the first half of 2014 – are of little comfort, as the sector still has much to do to make up for its weak performance over the past three years. Construction permits issued dropped 10.9 per cent in 2013, while property sales volumes decreased 2.4 per cent.

Foreign trade activity has also contracted, while land and shipping routes through turbulent countries such as Syria remain unstable. Exports declined 2.1 per cent in the first quarter of 2014, representing a 35.3 per cent year-on-year drop, according to research by the local Bank Audi.

In 2013, the foreign trade deficit rose 3 per cent to $17.3bn, equivalent to nearly 40 per cent of GDP.

Industrial exports, meanwhile, fell 36.5 per cent year-on-year in the first quarter, and imports decreased 4 per cent.

Similarly, the agricultural sector was unable to build on last year’s strong results; in the first quarter of 2013 exports grew 26.1 per cent year-on-year, but in the same period in 2014 they dropped by 8.6 per cent. Imports went up, however, increasing 15.8 per cent year-on-year.

The sectorial breakdown of Lebanon’s economy shows a growing reliance on other industries, as foreign investment has dried up and local entrepreneurs adopt a wait-and-see attitude to opening new businesses.

Banking confidence

It is now the country’s strong banking sector, along with consumer services such as retail, that are keeping the economy afloat.

Confidence in the banking system remains robust, supported by remittances from the Lebanese diaspora and the interest rates banks pay on deposits.

Deposits account for more than 80 per cent of banks’ aggregated balance sheets. Rising by 8.5 per cent in 2013, the additional liquidity kept loan-to-deposit ratios at 35 per cent, allowing room for future credit growth.

While the banking sector is likely to continue supporting the economy, it is not immune to domestic and regional turmoil as it is heavily exposed to the government’s rising debt.

The challenging security conditions have forced Lebanon to increase spending, causing it to record a growing deficit from 2011 onwards. The debt-to-GDP ratio increased to 142 per cent in 2013, after plunging from 180 per cent to 135 per cent between 2005 and 2010.

“The crisis is hurting Lebanon’s already structurally weak public finances. In 2013, we expect the deficit will widen to 9.5 per cent of GDP. Revenue is depressed and expenditures have increased,” says a report from US-headquartered ratings agency Standard & Poor’s published in November.

“An increase in public sector wages after a one-off cost-of-living adjustment in 2012, and increased pension costs due to the rising number of pensioners caused the deficit to [climb] to about 10 per cent of GDP in 2013.” Personnel costs account for more than one-third of expenditures, the report added.

Fiscal deficit

The salary increase was not the end of the saga, however, as a long-standing wage scale issue still remains unresolved. Public servants are demanding a salary increase and have staged strikes and protests across the country in a bid to get the government to take action. Cautious of further burdening the state’s budget, it is refusing to pass through a draft law.

The fiscal deficit, estimated at $4.7bn in 2013, stands in stark contrast to the situation in the three years prior to 2010, when the country had a surplus of $16.7bn. The good news is that the positive balance is not yet exhausted and will still provide a buffer for the coming few years.

“For the next two to three years I don’t think there will be a problem financing government debt,” says Mikhael. “What can put pressure on the situation is if the balance of payments is negative in the coming years and liquidity at banks is squeezed, becoming insufficient to finance both the public and private sectors’ needs. If that happens, the public sector could crowd out the private sector.”

The cost of financing public debt will be one of the factors to watch, as bankers anticipate a rise in interest rates, linked to the US Federal Reserve’s plans to increase interest rates from record lows at the end of the year. The Lebanese pound is linked to the dollar, making it vulnerable to changes in US monetary policy.

“[The rise of interest rates] will add a burden on the fiscal situation, but that can be dealt with as long as surpluses and banks’ liquidity remain strong,” says Mikhael.

Improving the government’s revenue sources is a major challenge, and the country is in dire need of political reform to optimise the collection of taxes and reduce evasion.

It is unlikely, however, that much progress will be made on that front while the government is locked in a stalemate, with infrequent parliament sessions and a lack of consensus holding up crucial decisions.

In the short term, it is up to the Lebanon’s central bank to introduce measures aimed at managing the situation and reviving the business environment.

In 2013, the central bank made available a $1.4bn stimulus package, which allowed banks to borrow at an interest rate of 1 per cent. This was only provided the funds be used to charge lower rates on the financing of housing, education, renewable energy projects, innovation schemes, research and development ventures, entrepreneurship and other productive sectors of the economy.

The initiative was widely seen as a success and prompted a repeat. The central bank subsequently announced another stimulus package of $800m, which included about 25 per cent in unused funds from the first round and will be made available throughout this year.

In addition, lenders are allowed to participate in the equity capital of start-ups, incubators and accelerator firms, as well as venture capital companies, through interest-free facilities covering up to 75 per cent of their investment. The central bank has reserved $400m to support the creation of business that can help drive innovation.

Plans also include developing the capital markets by privatising the Beirut Stock Exchange and creating financial districts for private equity firms that operate separately from the rest of the system.

Long-term solutions

Once the private sector is able to operate more independently from the public sector that could boost investor confidence and slowly help the economy to recover.

Other long-term solutions are still being developed, with plans for offshore oil and gas exploration having the potential to become a major game-changer. If Lebanon becomes less reliant on energy imports, it will drastically reduce public spending, as the high energy needs of the utility Electricite du Liban mainly weigh heavily on the budget.

In the near term, however, it is unlikely the economy will improve dramatically. The country still has to make up for years of halted business activity and the burden of Syrian refugees, which now form about a fifth of the population, is not going away any time soon.

The best Lebanon can hope for is a slow economic recovery, provided that it does not descend into a spiral of violence amid increasing regional turmoil.

Key fact

  • Lebanon’s debt-to-GDP ratio increased to 142 per cent in 2013

Source: MEED