military escalation against Hezbollah are exposing the very
high vulnerabilities of the Lebanese economy, but also revealing
the countrys resilience to shocks.
Indeed, Lebanon successfully weathered the confidence shock
generated by the February 2005 assassination of its Prime
Minister Hariri, a testament to the solidarity which prevented
concerns over the solvency of the sovereign from triggering
a banking, balance of payments and debt crisis.
Without question, Israels disproportionate military
attacks have severely hurt the Lebanese economy.
The Ministry of Finance estimates infrastructure damage from
the first week of hostilities at around US$2 billion or 40
per cent of total government revenue.
Financing reconstruction and relief efforts would further
widen Lebanons already high fiscal deficit, which reached
eight per cent of GDP in 2005. The conflict has virtually
decimated Lebanons summer tourism industry.
A record 1.6 million tourists were expected in 2006, and arrivals
were already up over 50 per cent in the first five months
of the year. Israels air and sea blockade closed the
Beirut international airport and major ports, obstructing
critical trade flows.
Real GDP growth is now expected to slow sharply from the four
to five per cent initially projected for this year, on the
back of weak growth in 2005. More importantly, the attacks
entail a substantial humanitarian toll, so far claiming 350
lives, mostly civilians, wounding one thousand people and
displacing close to half a million.
Resilience to shocks
Lebanon is a very highly dollarised economy; foreign currency
deposits account for close to 75 per cent of total deposits.
People hurt by the financial collapse during the 1975-1990
civil war sought refuge in hard currency, mainly US dollars.
With fears mounting of a prolonged siege after Israel blockaded
Lebanon from sea, air and land, citizens have rushed to convert
Lebanese pounds to foreign currencies, placing pressure on
the currency peg which has always played a key role in preserving
Nonetheless, the Banque du Liban (Lebanons central bank)
has about US$13 billion in gross international reserves and
appears well positioned to relieve pressure on the Lebanese
pound. Saudi Arabia has ordered the transfer of US$1.5 billion
to the Banque du Liban, adding to the strong reserve buffer.
Lebanon relies heavily on foreign direct investment flows
to finance a very wide current account deficit, which hit
nearly 13 per cent of GDP last year.
The decline in imports, as a result of the blockade, is likely
to offset the impact of a slowdown in tourism and higher oil
prices so that the current account deficit may not worsen
much in 2006.
Traditionally, Lebanese banks have been able to tap into the
pool of Gulf savings to comfortably finance these large external
imbalances, and presently there is little evidence to suggest
that the situation could drastically change.
Gulf Arab investors, while naturally cautious, seem unlikely
to reduce their longer term exposure to Lebanon although a
prolonged crisis could have a more serious negative impact
on shorter term portfolio inflows.
Lebanons gross public debt amounts to US$38.8 billion
or around 180 per cent of GDP, one of the highest ratios in
The IMF has estimated that, under a vicious circle of rising
debt, widening interest rate spreads and weak economic growth,
Lebanons public debt to GDP ratio would rise steadily
to more than 210 per cent by 2011.
The arithmetic suggests that the Lebanese government has a
solvency problem. Yet, a closer examination reveals that Lebanese
banks are the main holders of sovereign Lebanese Eurobonds,
which they carry till maturity. This helps to reduce debt
rollover over risk and to avoid massive capital outflows.
While the banking system remains vulnerable, with claims on
government and the central bank accounting for more than 50
per cent of total assets, the strong profitability of Lebanese
banks should help them to ride out a drawn out crisis. In
these circumstances, a soft exit out of the onerous debt overhang
still remains a viable option.
Solvency fears still exist
Lebanons refinancing risks have diminished this year,
but since the start of hostilities investors believe that
the country is at greater risk of default.
In April, the government issued a US$750 million eight-year
Eurobond and in May it used part of the proceeds to settle
a maturing sovereign bond worth US$321 million. Markets, nevertheless,
continue to price in a growing risk premium for investing
By end-July 2006, Eurobond spreads on Lebanese debt had risen
to around 390 basis points from a record low of 180 basis
points in mid-March. Many foreign fund managers are now limiting
Lebanon to market weight in their portfolios.
Concerning the Lebanese stock market, the mood has been quite
sombre. Prior to the conflict, the Beirut Stock Exchange,
pushed by small but growing flows of petrodollars and crumbling
bourses in the Gulf region, saw share prices jump by 100 per
cent in 2005 and by a further 18 per cent in the first half
By mid-July, however, share prices had tumbled to close at
almost the same levels at the start of 2006. The Beirut Stock
Exchange is now temporarily closed for security reasons but
also to avoid any further drop in share prices, particularly
of Solidere, the real estate holding company which owns much
of downtown Beirut.
Fitch Ratings announced a change in Lebanons credit
rating outlook from Positive to Stable
while affirming its current credit rating of B-.
Fitch expects the Lebanese economy to suffer from the damaged
infrastructure and the current crisis to further delay long
pending structural reforms.
In parallel, S&P placed the outlook for Lebanon B
sovereign credit rating on CreditWatch with negative implications.
Although S&P expects that the ongoing Israeli attacks
will negatively affect the Lebanese economy and complicate
policymaking, it expects Lebanon to continue receiving funding
from regional countries, thereby avoiding a debt default.
Overall the crisis is expected to most hurt the Lebanese and
Israeli financial markets.
Other Arab stock markets, which nosedived in March 2006, may
also be further affected by concerns about elevated regional
As for the rest of the emerging markets, the repercussions
are being felt in manifestly higher oil prices, increased
global risk aversion and fears of a possible return of stagflation.
Time for action
Lebanon has room to manage the difficult economic conditions
and weather the unfolding crisis, as it has done in the past.
But a key uncertainty relates to the futureHow long
will the hostilities last?
Crisis talks in Rome between US, European and Arab foreign
ministers, joined by the UN Secretary General, failed to agree
on a ceasefire, allowing Israel to stick to its incursion
Many are now looking to Iran and Syriaboth of which
are playing pivotal roles in the crisisto help contain
Others are pointing to the increasing carnage in Iraq as well
as the continuing battering of Lebanon by Israel as signs
that the US vision of democracy in the Middle East is being
consumed in the fires of myopic US foreign policy.
The rest of the world curiously watches on while Lebanon remains
All information contained in this article has been obtained
from sources that CMMB
believes to be accurate and reliable.
All opinions and estimates constitute the
Authors judgment as of the date of the
article; however neither its accuracy and completeness nor
the opinions based thereon are guaranteed. As such, no warranty,
express or implied, as to the accuracy, timeliness or completeness
of this article is given or made by CMMB in any form whatsoever.
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