The Time For Action To Save The Lebanese Economy Is Now
We are a group of Lebanon and diaspora-based Lebanese finance professionals. As an apolitical group fully funded by our members, we are committed to a strong Lebanon with a vibrant economy and banking system.
We have been watching, with growing concern, Lebanon's negative fiscal and monetary trends. Immediate remedial policy action is needed to correct the path we are now on.
While we think there is still time, ours is an urgent call for economic action. We highlight Lebanon's key economic and financial vulnerabilities and propose a series of policy changes and structural reforms that we think should help Lebanon avert a crisis and set it on a course for a more sustainable and equitable economic model.
To start, Lebanon is highly indebted. A debt crisis is likely if fiscal consolidation does not start now. Lebanon's current fiscal consolidation efforts are non-existent. Even as a budget was finally ratified this year after nearly twelve years of budgetary absence, it brings little in terms of much needed tangible fiscal consolidation efforts. A key fiscal measure used to analyse a country’s debt position is debt relative to the size of the economy (or GDP). In Lebanon, it exceeds 150% of GDP and could soon exceed 160%, given a budget deficit expected to reach 10% of GDP in 2017. Lebanon is the third most indebted economy in the world, after the highly developed economy of Japan, which is the third largest economy on the planet and one of its most sophisticated, backed by immense local savings, taxable capacity, vast assets and persistent current account surpluses, and Greece, which after experiencing a major sovereign debt crisis, was bailed-out by the European Union and implemented a major fiscal and structural reform program to address its severe fiscal problems.
The Lebanese government now spends around half of its revenues just to service debt. In 2012, this number was less than 30%. Less than 3% of government spending is used for investment and maintenance purposes. In other words, servicing debt is taking the lion’s share of government revenues, leaving little for anything else. This situation is made even more untenable in an external environment where the credit cycle has peaked and global policy rates are rising, making it more expensive for Lebanon to service its debt. Lebanon’s already weak credit ratings (which B- by Standard and Poor’s, far below what is considered “Investment Grade” and reflecting weak credit metrics and debt servicing capacity), could be downgraded further, making it more expensive for Lebanon to borrow.
Debt and debt service have been sustained thanks to Lebanon’s large banking system. In fact, most of the Lebanese debt is purchased by Lebanese banks, which have been effective in attracting deposits from residents and remittances from the large non-resident Lebanese diaspora. To quantify this, deposits at Lebanese banks equal about 280% of GDP. Importantly, these deposits have not been directed to build economic capacity, capital investment or upgrade the infrastructure. They have served to sustain an inefficient system and increase moral hazard by encouraging the government’s reckless spending.
Those deposit inflows have been able to anchor the Lebanese debt, the Lebanese Pound and also went a long way in covering Lebanon’s persistent current account deficits.
In a nutshell, a current account measures the flows related to the services, trade and other net transfers between the country and the rest of the world. For instance, a country that imports more than it exports, which is the case for Lebanon, will have a trade deficit, which is an important component of the current account. A current account deficit implies that a country is a net borrower from abroad.
Those borrowings have to be financed somehow. In Lebanon, a conservative estimate of the current account deficit is a staggering 17% of GDP and is being financed, at least partially, by foreign currency inflows.
In other words, the Lebanese macro financial stability is dependent on the stability of the deposits and its ability to continuously attract remittances and other foreign currency inflows.
Herein lies the problem. Lebanon has been generally attracting less deposits. As per the IMF, after rising by USD8 to 12 billion a year since 2011, those have started to noticeably decrease in the past few years, driven by a number of reasons relating to the economic environment of Lebanon’s diaspora host countries as well as concerns around the stability of the Lebanese financial system. In 2016 for instance, non resident deposits were growing at a tepid 1.52% YoY in April 2016 before recuperating to 6.6% YoY in December 2016, catalyzed by BdL engineered transactions. Lebanon is at risk therefore of getting less foreign currency inflows to allow it to service its debt and maintain financial and monetary stability. Lebanon’s debt dynamics and their dependence on attracting a continuing and large inflow of deposits are not sustainable.
Monetary policy, however wisely and pro-actively conducted in the face of extremely challenging circumstances, cannot continue to be the only support for the financial stability of the country.
The Lebanese banks, which have been generally well managed with ample liquidity and capital, will need a fiscal consolidation plan to be clearly articulated and implemented to be able to continue to play their effective intermediation role and reduce their balance sheet risk, given their large exposure to Lebanon government debt.
A comprehensive economic strategy focusing on both structural reforms and policy changes is urgently needed to address Lebanon’s key vulnerabilities, namely its persistent need for inflows and its increasingly fragile fiscal situation. Fiscal consolidation is required along with incentives and structural reforms to stimulate economic growth to ease Lebanon’s economic transition.
We call for a number of short-term measures to be immediately undertaken to restore investor and public confidence and create fiscal space.
First, we need to immediately and decisively deal with the persistent excessive spending relating to Electricité du Liban ("EDL"). The government now spends more than 4% of Lebanon's GDP every year to support EDL. This is to subsidise one of the worst electric infrastructures and inefficient production in middle income countries. It is high time to start dealing with it decisively and the way to do that is the creation and immediate implementation of a plan to furnish Lebanon with permanent electricity, in line with most developed and middle income countries. This should include increasing tariff rates and using Public Private Partnerships (based on the recently issued legislation) on production, distribution and collection. This will help deal with a constant fiscal leakage, enhance investor confidence and provide an essential service owed to Lebanese citizens and businesses. This will also alleviate substantial environmental problems relating to the thousands of polluting generators throughout the country currently providing an alternative source of electricity.
Second, we call for a concerted effort to substantially invigorate the Lebanese tourism sector. This is a low hanging fruit made possible by the relatively benign security conditions in Lebanon. Lebanon has a long and proud history of excellence in hospitality. Its touristic value proposition is impressive. The tourism sector and its linked sectors in Lebanon have the potential to grow much faster. This can bring much needed foreign currency inflows and drive economic activity.
Third, we call for the adoption of a widely supported strategy for fiscal consolidation, reinforcing the rule of law and economic transformation.
The fiscal consolidation strategy should have as objectives to:
- Rein budget deficit to a more sustainable level of 3% of GDP from the current 10%; and
- Reduce Debt/GDP from the current estimated 150% to less than 130%. Both goals should be achieved by 2020 to break the deteriorating trend and create fiscal space.
Lebanon needs to reduce the level of its debt. This can be achieved through a well-studied strategy for the full or partial privatization of some state assets (such as the EDL, but also Middle East Airlines, Casino du Liban, ports, Beirut Airport and other etc…) to reduce the ballooning debt stock, attract private sector investment, increase productivity and create jobs.
Lebanon's natural resources should be also used to reduce the sovereign debt. We call for the commencement of offshore oil & gas extraction within a fully transparent framework. The revenues from those resources should be channeled into a sovereign wealth fund, managed at arm’s length that will:
- Help address Lebanon's debt stock
- Invest in Lebanon's knowledge and creative economy
- Invest in Lebanon’s capital markets
- Strengthen Lebanon’s social safety net to protect its more disadvantaged citizens
- Invest in the reform of Lebanon’s educational system allowing it to become a knowledge based economy
- Leverage Lebanon’s significant water resources that can also be used to generate hydro-electric power in a sustainable and environment friendly manner
There also needs to be a re-assessment of all public spending and the size of the public sector, such as the number of government agencies needed, and abolish or consolidate the unnecessary or unproductive ones. All public employees should be accounted for and productive. One way to address that issue is to make sure every public employee is accounted for and is paid through a verified account at a Lebanese bank.
We also call for the digitisation of the government services. This will reduce public waste and widespread corruption, increase the productivity and quality of government services and bring Lebanon’s government services to the 21st century.
Perhaps most importantly, we call for a concerted effort to fight corruption and the substantial waste of public resources. Lebanon’s ranks at 136 out of 177 countries on corruption. Anti-corruption measures should be accompanied by a strict adherence to the rule of law. There’s no question that investments will only follow if investors believe the legal framework is robust, modern and their investments will be duly protected by an independent judicial system, as opposed to political connections and nepotism.
An open economy such as Lebanon should also continue to fully adhere to the international laws and regulation and be regionally and internationally integrated.
While the tax system can be modernized, we believe better tax and customs collection and waste management should be the priority as opposed to raising taxes and stifling an already dangerously fragile economic environment. By the same token, increasing public sector wages in the absence of a holistic approach to rein in the public debt is fiscally dangerous. Sadly, this seems to be the case for this year’s budget.
A series of infrastructure projects should be initiated, starting with the electricity, the road & transportation network and the telecommunication infrastructure. Those well monitored projects can be funded through a combination of public and private funds. This can encourage the substantial untapped wealth of non-resident Lebanese to invest back in Lebanon, without fear of corruption or undue delays.
Other projects can include the building of LNG terminals to supply power generation stations with cheaper gas, as opposed to the costly and polluting oil.
To encourage inflows into Lebanon, we call on the invigoration of investment developments agencies, such as Investment Development Authority of Lebanon (“IDAL”), that should play an instrumental role in defining a strategy for attracting investments and inter-agency coordination. For instance, Lebanon is ranked 123rd (out of 189 countries) in the World Bank’s Doing Business report which measures regulatory quality and efficiency.
Lebanon’s Privatization and PPP Authority should be tasked with undertaking a wide privatization and PP program as an urgent priority.
The Lebanese capital markets should also be developed. Policy makers can encourage this by listing some of the national champions, which will help develop the capital markets, increase inflows into the system and increase government revenues. Corporate debt issuance should also be supported, which will help a better distribution of corporate debt (which is another risk to the system, often not discussed).
We also need to invest in Lebanon's human capital, Lebanon’s most important resource. Lebanon's productivity needs to be enhanced through a number of measures, and should be one of the main anchors of Lebanon's long term success and its transformation into a more sustainable economic model. The Central Bank initiated some welcome laws to support Lebanon’s knowledge economy and promising start ups. There needs to be more, particularly to support technological innovations and knowledge-intensive sectors which Lebanese can excel in. Lebanon is uniquely positioned for instance to be a hub for renewable energy and clean tech.
Given technological advances, it is now feasible for global corporations, where a large number of the Lebanese diaspora works, often at senior levels, to outsource jobs such as call centers, back and middle office jobs etc…This suits Lebanon’s multi lingual highly entrepreneurial population.
A coherent trade strategy is needed to encourage promising productive sectors such as high-end craft industries, fashion, advertising, technology start-ups, wine, eco-tourism, tourism, medical tourism etc…Free zones can also be created to leverage Lebanon’s ports and airport. Lebanon is not a member of the WTO yet, even though a working committee was formed in 1999. In that, it is in the company of countries such as Afghanistan, Equatorial Guinea and North Korea.
All of these are policy stimulus measures aimed at creating jobs for the Lebanese, often unfairly disadvantaged in their own country and forced to emigrate.
A pre-requirement for all these reforms and economic measures is a strong and collective political resolve. Unity among all Lebanese is needed to face the dire economic environment we are in, and emerge stronger.
Some of those reforms will be painful, but the alternative is by far worse. Lebanese often praise their system’s resilience and its fabled ability to somehow find a way to survive. For instance, Lebanon impressively has never defaulted on its debt. This is true and is a testament to the impressive ability of the Lebanese for survival.
But resilient is not unbreakable, and survival should not be our goal. Our goal should be a thriving economy for all Lebanese to enjoy and benefit from.
Hope is not a strategy. A holistic systematic approach is needed to create hope again for all Lebanese.
While we believe the economic situation is dire, we are also firm believers in Lebanon and the boundless potential this innovative, resourceful and proud country holds.
The Time For Action To Save The Lebanese Economy Is Now.
LIFE stands ready to offer its substantial expertise and resources in the service of Lebanon.
Lebanese International Finance Executives (“LIFE”)