January 24, 2011 4:35 pm

Crisis exposes Lebanon’s weaknesses

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In recent years, Lebanon has been eating, drinking, sunbathing and luxury apartment-building its way to annual economic growth rates of 8 per cent.

The expansion has been accompanied by unprecedented financial transfers, largely from the Lebanese diaspora.

Now that the western-backed government of Saad Hariri, the caretaker prime minister, has been toppled, however, the spectre of violence has returned and a protracted political crisis is anticipated. In this scenario, the vulnerabilities of the economy are being exposed, analysts warn.

The country’s growth has been driven primarily by domestic consumption, which is sensitive to the political atmosphere. According to research by Byblos Bank, consumer confidence has dropped almost every month since the latest political tensions began in July.

“The 8 per cent growth in 2010 was mostly the result of construction activity and tourism, which are not necessarily economic sectors with a great sustainability record,” says Marcus Marktanner, an economics professor at the American University of Beirut. “If the crisis escalates, the same two industries have also the potential to deflate the economy again.”

Although there is limited evidence so far, a slowdown in the real economy is widely expected. Following the government’s collapse, the Institute of International Finance revised down its growth predictions for this year from 7 per cent to 4 per cent.

The Lebanese monetary and financial systems are famously resilient and optimists say this makes it likely the economy will bounce back, as it did after the assassination of Rafiq Hariri (the former prime minister and father of Saad) in 2005, the war with Israel in 2006 and the internal armed clashes of 2008.

Lebanon’s financial institutions have evolved to withstand short-term political turbulence well. The Central Bank’s foreign currency holdings, just more than $30bn, are some of the highest on a per-capita basis in the world, which has enabled it to meet
the increased demand for dollars.

“The Lebanese pound is stable,” Raya Hassan, the caretaker finance minister, said last week. “We went through tougher crises before and there is not one time where we did not fulfil our obligations. We have resiliency to confront such crises.”

But if the crisis persists, Lebanon’s financial sector could face trouble. Although bankers say there are no signs of capital flight, rating agency Moody’s pronounces it a “significant risk”.

Moreover, the agency says a growth slowdown combined with market uncertainties could hurt the banks, even in the absence of a sharp or prolonged flight of capital.

“The stability of the financial and economic system has been based on the strong growth in deposit inflows; so a reversal of this trend or the outflow of deposits, although highly unlikely at this stage, has always been the key risk for the system in the absence of reforms to reduce the government’s borrowing needs,” says Nassib Ghobril, head of research at Byblos Bank.

Although the banks have comfortable liquidity buffers, capital flight would put pressure on their ability to refinance government debt – of which $3.5bn in eurobonds is due to mature this year – at current interest rates.

Lebanon’s government owes more than $50bn, much of which is held by domestic banks. In spite of the prosperity and stability of recent years, the government has failed to decrease the debt in nominal terms, but points out that it has succeeded in reducing at as proportion of gross domestic product. Riad Salameh, the central bank governor, warned last week that if the crisis continued, it would have a “negative impact” on the debt-to-GDP ratio.

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