Thursday 3rd August 2006

 

Lebanon under fire but still resilient

 
 
 
 
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Israeli military escalation against Hezbollah are exposing the very high vulnerabilities of the Lebanese economy, but also revealing the country’s 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.

Economic damage

Without question, Israel’s 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 Lebanon’s already high fiscal deficit, which reached eight per cent of GDP in 2005. The conflict has virtually decimated Lebanon’s 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. Israel’s 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 confidence.

Nonetheless, the Banque du Liban (Lebanon’s 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.

Lebanon’s gross public debt amounts to US$38.8 billion or around 180 per cent of GDP, one of the highest ratios in the world.

The IMF has estimated that, under a vicious circle of rising debt, widening interest rate spreads and weak economic growth, Lebanon’s 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

Lebanon’s 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 in Lebanon.

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 of 2006.

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 Lebanon’s 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 security risk.

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 future—How 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” strategy.

Many are now looking to Iran and Syria—both of which are playing pivotal roles in the crisis—to help contain the violence.

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 under fire.

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

Author’s 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.

CMMB and/or it employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed shall be construed to be, or constitute an offer or a solicitation to buy or sell.

 

 

 

 

 

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