Why Lebanon’s New Government Needs a New Economic Model

Why Lebanon’s New Government Needs a New Economic Model

After a two and a half year political impasse, Lebanon now has a new government. And after 12 years without a budget Lebanon’s government led by new Prime Minister Saad also has a $15.8 billion budget What is not clear is whether or not the new government will at least try to create a new economic model.

One thing is certain. Lebanon’s old economic model is dangerously over-borrowed domestically and externally. The government borrowed too much money for political patronage rather than infrastructure. Prior to the Syrian Civil War, Lebanon’s financial offsets enabled it to resist economic collapse. Strategic enablers included strong banks and capital inflow from a rich diaspora and GCC countries.

That said, the Syrian Civil War and the rise of Isis have seriously damaged the economy. Shocks include falling exports and tourism, GCC capital outflow and over 1.4 million Syrian refugees – or 1/3 as big as the local population. Thankfully, IMF notes that Lebanon’s central bank and commercial banks are still rock-solid and have kept the shaky economy afloat. However, the deterioration of an over-borrowed Lebanese economy can’t go on indefinitely. Ultimately, there are finite limits even for the financial power of Lebanon’s commercial banks. A new economic model needs to be created based on shared prosperity rather than patronage.

The biggest threat to Lebanon’s economy is prolonged period of military conflict and political instability that could undermine investor confidence. That scenario could trigger capital flight – money moving almost overnight from Lebanon bank deposits to some safe-havens overseas. That scenario could threaten Lebanon local bank’s ability to meet the huge borrowing needs of Lebanon’s government. Lebanon is also a service oriented economy which is especially vulnerable to capital flight whenever confidence dips.

Even before the Syrian Civil War, Lebanon faced some serious economic challenges. These included high unemployment, poverty and an over-borrowed public sector. But the Syrian conflict has made things much worse. The Syrian conflict has resulted in a broad-based deterioration of the Lebanese economy. This paper explains how the Syrian conflict has damaged Lebanon’s economy, how it tests its financial stability and how the Sunni-Shia sectarian conflict is spilling over into Africa when Lebanese Moslem immigrants bring sectarianism with them to Africa.

As the Syrian civil war spilled over the Syrian-Lebanese border, the war polarized Lebanon, a country with a long history of sectarian conflicts. Shiite supporters of Syrian President Assad fight against Sunni supporters of the opposition to Assad. Sunni towns like Arsal and Shiite towns in the Bekaa Valley are battlegrounds in the proxy war. In such war zones, it’s not surprising that tourism, investor confidence and trade have all taken a hit.

In this regard, tourism plays a central role in Lebanon’s economy. In fact, when times are good it accounts for 20% of Lebanon’s GDP. Times were good in 2010 when tourist arrivals reached 2 million, the most in 15 years. Many of these tourists came from rich GCC countries. But it’s been all downhill since then. As violence from Syria spilled over into Lebanon, Lebanon lost its attractiveness as a safe tourist destination. The UAE and Saudi Arabia issued travel warnings to their population. As a result, in late January 2017 the IMF Executive Board notes that “Lebanon’s traditional drivers of GDP growth – such as tourism (along with real estate and construction) – “have received a significant blow and a strong rebound is unlikely based on current trends.” Similarly, the Syrian conflict has also hurt foreign direct investment (FDI) inflows into Lebanon. The World Bank notes that remittance inflow (from Lebanese living outside Lebanon) fell 8.4% in 2014 and 3.3% in 2015.

In addition, the economies of Syria and Lebanon are inextricably connected. Nowhere is this more visible than in Lebanon’s trade. Previously, 40% of all Lebanon’s exports travelled through Syria for destinations such as Jordan, Turkey and Iraq. But due to the Syrian conflict, Lebanese trucks are now blocked from passing through Syria and the road between Damascus and Amman is inaccessible. So transport has to take more expensive circuitous routes in and out of Lebanon. Blominvest Bank in Beirut notes that Lebanon’s exports were about 25-30% lower in 2015 and 2016 than in the 2012-2013. Why doesn’t Lebanon use a maritime alternative to ship its exports? Actually, Lebanon has opened a ferry route through Suez to Aqaba. But the maritime route is also slower and rougher and damages exports of fruit and other perishables. The maritime route is also more expensive for exporters, thus sapping their competitiveness.

Syrian Refugees. In addition, the most dramatic economic and social effects that the Syrian Civil War has had on Lebanon may be the influx of over 1.4 million Syrian refugees, about a quarter of Lebanon’s population. That’s the highest concentration of refugees per capita in modern history. Despite attempts to block further refugees, before long the number of refugees is expected to grow to half the Lebanese population. Syrian refugees increase the demand for basic infrastructure. Refugees put extra economic strains on water, electricity, primary education and health care. Syrian workers also take jobs away from mostly poor Lebanese and push down wages for others.

The impact on Lebanon’s weak labor market may be the biggest economic vulnerability and the biggest threat to social stability. Syrian workers accept wages 25% to 50% lower than Lebanese workers. To make matters worse, the international community provides Syrian refugees with money to cover their health care expenses while poor, unemployed Lebanese get no health care support. Discontent and resentment from poor, frustrated Lebanese who have lost their jobs to Syrian refugees is understandable and provides fertile ground for extremists inside and outside Lebanon to exploit the situation politically and militarily in a country that already has a culture full of violent sectarian conflicts.

Poverty and high unemployment were problems in Lebanon even before the Syrian crisis. But the Syrian conflict now makes them much worse. The IMF expects the unemployment rate to nearly double in Lebanon from 11% to 20%. The World Bank estimates the Syrian crisis will soon add 170,000 more people to those already living below the poverty line.

GDP Growth Slows. Before the Syrian conflict, Lebanon’s economy was growing on average 9% a year from 2007 until 2010. But the decline in investment, tourism, retail trade and exports discussed earlier has taken its toll on Lebanon’s overall economic growth. Lebanon’s GDP growth slowed to just 1% in 2016. The GDP slowdown makes it even more difficult for the Lebanese government to reduce its huge government debt. The financial burden can be seen in terms of the debt to GDP ratio. As GDP slowed from 9% growth to 1% growth, the burden of debt increases even if the nominal debt does not increase much. In other words, the nominal debt becomes less affordable. But in the case of Lebanon, the large yearly budget deficit keeps increasing the financial burden.

Over-borrowed. How over-borrowed is the Lebanon economy? One way to measure financial vulnerability is to use EU yardsticks. An EU Maastricht criterion says entry into the EU club requires states to limit budget deficits to 3% of GDP. Another Maastricht criterion says entry into the EU club requires governments to limit government debt to 60% of GDP. The EU says anything over these two limits means economies are vulnerable to a financial crisis and therefore should stay outside the EU. Unfortunately, the Lebanese government is heavily over-borrowed according to these criteria. IMF notes that Lebanon is running a normally unstable government debt of 138% of GDP. That’s huge – well over twice the 60% Maastricht limit.

In addition, the economist Intelligence unit (EIU) notes that Lebanon’s budget deficit is about 10% of GDP in 2017. That’s over 3 times the 3% Maastricht limit. Lebanon’s trade deficit also appears in big trouble. If we use the more inclusive current account yardstick (which measures trade in goods and services), EIU notes that Lebanon is running a current account deficit of 17% of GDP. That means Lebanon is running a current account deficit as a percentage of GDP that is over twice as big Mexico and Thailand, which both ran a financially unstable current account deficit of 8% of GDP prior to their financial meltdowns.

Defying Gravity. But appearances can sometimes be deceiving. That’s because there is nothing conventional about the Lebanon economic model. This unorthodox system operates like no other economic model. Despite the rising costs associated with the Syrian civil war and the rise of Isis, this unconventional economy keeps “defying gravity.” How is this possible? Fortunately, the old Lebanon economic model has enjoyed numerous financial offsets which have given it resilience to resist economic collapse. The short answer is rich commercial banks provide liquidity to the central bank, which in turn constantly bails out the over-borrowed government.

But there is more to this story: a) investors know that the government has never defaulted on its debt payments, b) most of the debt is held locally rather than in unforgiving foreign banks and c) Lebanese commercial banks have assets that dwarf the real economy. So they roll over government debt which is relatively small as a percent of their overall assets. Although Lebanon has labored under a massive government debt, confidence in Lebanese markets has been high in recent years due to internal financing from the central bank. Lebanon has also benefitted from large incoming foreign investment and the willingness of banks to maintain large liquidity as a buffer to defaults.

In addition, the Lebanese diaspora population is 4 times the size of Lebanese living inside Lebanon. It turns out that Lebanon has one of the highest numbers of diaspora billionaires. While this diaspora makes money outside Lebanon, their hearts and loved ones still live inside Lebanon. Not surprisingly, this wealthy Lebanese diaspora consistently provides Lebanon with high remittances of hard currency.

IMF notes that Lebanon’s remittance inflows are sizable and have averaged almost $7 billion in the last 10 years. Lebanon is among the top five emerging-market receivers of remittances as a share of GDP, at 20 percent of output. In per capita terms Lebanon tops the list by a wide margin. Most importantly, remittances to Lebanon also comprise a key part of Lebanon’s de-facto safety net. In addition, Lebanese banks find themselves in the enviable position of having excess capital. Bank deposits have been high and its loan/deposit ratio has been low. In addition, the liquidity of its banks has been extraordinarily high.

Finally, if all else fails, the Lebanese central bank has lots of financial ammunition. A common rule of thumb is that foreign reserves that can cover 3 months of worth of imports is adequate. In fact, most over-borrowed economies would be hard pressed to maintain 3 months of import cover. In contrast, EIU notes that the Lebanese central bank has amassed a huge supply of foreign reserves which cover 18-20 months of imports. More importantly, the Lebanese central bank has this stockpile of foreign reserves to defend the foreign exchange rate of the Lebanese pound against financial attacks. But the same thing was said in 1993 when Mexico had $25 billion in foreign reserves. Things can change quickly. In January 1994 Presidents Clinton and Zedillo were toasting NAFTA. 11 months later there was a run of the peso, capital flight and Mexican reserves disappeared virtually overnight.

Conclusions. Syria’s civil war and Isis are ultimate tests for a deteriorating Lebanon’s economy and in particular its financial stability. The Lebanese commercial banks have been up to the test and proved to be a pillar of strength. The booming banking sector prevented further deterioration of the economy. Rich commercial banks provide liquidity to the central bank, which in turn draws from its huge stock pile of foreign reserves to bail out the over-borrowed government. But Lebanon’s commercial banks are the last line of defense. Had the banks not been strong and resilient, the IMF was the next stop before financial turmoil. The deterioration of the Lebanese economy also can’t go on indefinitely. Ultimately, there are limits to the financial power of Lebanon’s commercial banks. So there is no time for complacency.

Implications for Africa. For over a century and a half, a combination of political instability, famine and other economic hardships as well as military conflict has brought successive waves of Lebanese immigrants to several African countries, most notably Ivory Coast, Senegal, Sierra Leone, Liberia and Zaire. Lebanese immigrants formed industrious communities, integral to many West African economies. The first Ivory Coast president described them as “a gift from God.”

The economic roles of Lebanese immigrants have evolved over time. At first, they were content with their role as small businessmen with a low political profile. But over time these Lebanese immigrants became increasingly successful. Some of their economic interests expanded into vast business empires in construction, telecommunications and import-export trade.

Why are Lebanese businessmen in Africa so successful? The Economist cites a number of reasons: First, Lebanese immigrants enjoy large trade networks among Lebanese diaspora all over the world. Second, the Lebanese are flexible and able to adapt to changing political and economic situations in African countries. Finally, successful Lebanese businessmen have been able to translate their financial success into political influence with those African leaders facing difficult economic problems in their countries.

Ezra’s Eid, a rich Lebanese businessman in Liberia, claims that 60% of Liberia’s economy is in Lebanese hands. To make matters worse, Lebanese immigrants tend to send back remittances to their family in Lebanon rather than investing it in African countries. Not surprisingly, many native Africans resent Lebanese businessmen and accuse them of corrupt practices in the process of gaining their fortunes. Many also use the Lebanese as scapegoats for the African country’s poor economic performance. African governments tend to strike a balance between a) slapping Lebanese businessmen on the wrist to pander to populist anger and b) not doing anything major that would cause the Lebanese business community to cut and run away from Africa.

On the religious front, early Lebanese immigrants were Christian. But that has changed and most Lebanese immigrants into Africa today are Moslem. Lebanese immigrants are both Sunni Moslems as well as Shia Moslems. In the process, the Sunni-Shia conflict has increasingly spilled over into parts of Africa. And finally, Salah Cheaib notes that some Lebanese in Africa are now questioning their role in Africa. Many Africans of Lebanese origin are struggling with their historic roots. They are also searching for their identity and their place in the world. Even their economic achievements are meeting resentment rather than gratitude from many native Africans. Native Africans also are frustrated with Lebanese immigrants bringing Sunni-Shia conflicts and possible terrorism into African countries.

To change these negative perceptions, Lebanese immigrants who feel like they want to belong more to the continent need to pursue social inclusion and shared prosperity with native Africans. In concrete terms, a positive social impact begins when wealthy Lebanese businessmen in Africa strike a balance — invest more money in their host country in Africa and send less money back to their family in Lebanon.

Dr. Leif Rosenberger, Head of the Global Division of the Global Economic Institute for Africa