Lebanon

Regional conflicts are weighing on the economy

D4

HIGH RISK for entreprise

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

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GDP USD56.6bn (World ranking 81, World Bank 2018)
Population 6.8mn (World ranking 107, World Bank 2018)
Form of state Republic
Head of government Saad al-HARIRI (Prime Minister)
Next elections 2022, presidential and legislative
  • Regional support from the GCC states
  • There are more Lebanese domiciled overseas than in the country itself and this large diaspora provides a major source of funding
  • Educated workforce
  • Strong foreign exchange reserves and import cover (though declining)
  • Tensions between the religious factions spill over into the political arena and into periodic outbreaks of violence
  • Regional factors, including events in Syria and Iraq and tensions arising directly and indirectly from Iranian influence
  • Large fiscal deficits and high public debt (among the highest in the world when expressed as a percentage of GDP)
  • Very large current account deficits
  • A fixed exchange rate (the LBP is pegged to the USD) prevents economic management through that mechanism
  • Relatively poor data provision

Increased political risk...

Lebanon’s political system is dominated by the need to preserve the fragile balance among its main religious groups. By convention, the three key political posts are allocated so that the president is a Maronite Christian, the premier a Sunni Muslim and the speaker of the National Assembly a Shia Muslim. However, this system, along with a power-sharing government, encourages patronage and limits the effectiveness of policymaking. Outright sectarian hostilities are never far from the surface.

Domestic and investor sentiment improved briefly at the start of 2019 when Lebanon at last announced the formation of a new government after nine months of intense quarreling between rival political factions following the parliamentary elections in May 2018 – the first ones held since 2009. But the relief proved short-lived. The new cabinet comprises most Lebanese political factions, including three posts for Hezbollah, an Iran-backed Shia group subject to U.S. sanctions. Policymaking is likely to remain ineffective, putting at risk aid and loans worth up to USD11bn pledged to Lebanon in 2018 by the international community if the country implements vital reforms to fend off an economic crisis. The most needed reforms include cutting public spending, revamping the electricity sector and fighting corruption (perceived corruption is among the highest in the world, according to a World Bank survey).

Moreover, the increased regional instability has had adverse effects on market sentiment towards Lebanon. Notably the clear deterioration of relations between Iran on one side and the U.S. and Saudi Arabia on the other side has raised fears that Lebanon could become the site of a proxy war. Also, the inter-state war risk between Israel and Lebanon is perceived to have increased as potential U.S. military action against Iran would increase the likelihood of Hezbollah conducting attacks against Israel, perhaps provoking Israeli retaliatory action.

...and persistent structural weaknesses constrain growth

The Lebanese economy is highly dollarized and essentially service-oriented (services account for over 80% of GDP, compared with around 15% for industry and 4% for agriculture). It is exposed to regional and global fluctuations. Tourism, real estate and construction are the main supply-side drivers of growth, which have all suffered  since the beginning of the Syrian conflict in 2011. That conflict has continuously spilled over onto Lebanon’s economy as it currently hosts the highest number of refugees per capita in the world (more than a quarter of the population), exerting pressures on public services, fiscal accounts and jobs (with social repercussions).

Yet, until 2016, Lebanon enjoyed financial stability due to important flows of remittances from its large diaspora. Those flows strengthened the deposits of private banks, which hold assets worth nearly 450% of GDP. Banking sector vulnerabilities have increased in recent years though, for now, the sector remains robust. Private sector bank deposits are declining (down by -1% y/y as of May 2019) despite higher deposit rates (+200bp y/y for LBP; +168bp for USD) while the dollarization rate has increased. This is mainly because the diaspora has become wary and slightly reduced their deposits on a net basis. Annual remittance inflows in relation to GDP have declined from 15% in 2014-2016 to 12.7% in 2018. This should raise concerns as diaspora deposit inflows have been crucial for financing huge current account deficits in the past. Meanwhile, the non-performing loans to total loans ratio has risen above 10%, according to the IMF. And the banking sector is increasingly exposed to Lebanese sovereign debt.

Against this background, a return to earlier high economic growth rates is unlikely. Annual average real GDP growth decelerated from +5.8% in 2001-2010 to just +1.4% in 2011-2018. In 2018, growth fell to an 18-year low of +0.3% and early indicators point to a weak start to 2019. We forecast the economy to expand by +0.5% in 2019 and +1% in 2020.

Meanwhile, the fixed exchange rate peg (LBP1,507.5:USD1) should remain in place in the next two years and keep consumer price inflation in check – we forecast annual average price increases of 3.4% in 2019 and 3% in 2020.

Financing of vast fiscal and external imbalances has become more difficult

The government has posted high fiscal deficits, which amounted to an average -8.3% of GDP over the last 10 years, with a peak of -11% in 2018 as growth nearly stagnated. Consequently, Lebanon’s public debt is at about 150% of GDP (of which 40% is foreign-issued debt), one of the highest ratios in the world. The budget for 2019 targets a fiscal deficit reduction to -7.6% of GDP but we expect somewhat higher annual shortfalls in the next two years owing to lower than assumed GDP growth and because the implementation of all planned fiscal reforms is unlikely. External financing of the deficit has become more difficult as spreads on Lebanese sovereign bonds are the highest in around a decade (as of mid-2019).

The current account balance continues to record huge annual deficits, on average -23.3% of GDP in 2009-2018 (-27% in 2018). Net FDI inflows (which have a long-term nature) covered only 31% of the external shortfall in 2018, another sign of weak foreign investor confidence in the country. Gross external debt is very high at about 136% of GDP or 385% of export earnings.

On a positive note, foreign exchange (FX) reserves are still substantial. At USD37bn in May 2019, they covered some 13 months of imports and continue to support the fixed exchange rate regime, mitigating transfer and convertibility risk in the short term. Yet, reserves have markedly fallen from a peak of USD45bn in July 2018 (16 months of import cover) as a result of debt redemptions and the above mentioned deterioration in confidence among investors and the diaspora – a negative trend that needs close monitoring. If the slowdown in deposit growth and the decline in official FX reserves continue for longer, the monetary sector's ability to continue lending to the government and support the peg could be called into question in the medium term.

Overall, the large twin deficits and the steadily rising debt levels, coupled with the exchange rate peg and the fragile political environment, signify a “toxic” mix that constitute a very high country risk.

Trade structure by destination/origin

(% of total)

Exports Rank Imports
United Arab Emirates 10%
1
12% China
Saudi Arabia 10%
2
7% Italy
Syria 8%
3
6% United States
Switzerland 7%
4
6% Greece
Iraq 6%
5
6% Germany

Trade structure by product

(% of total)

Exports Rank Imports
Miscellaneous manufactured articles, n.e.s. 11%
1
17% Petroleum, petroleum products and related materials
Vegetables and fruits 10%
2
8% Road vehicles
Gold, non-monetary (excluding gold ores and concentrates) 9%
3
5% Medicinal and pharmaceutical products
Metalliferous ores and metal scrap 8%
4
4% Miscellaneous manufactured articles, n.e.s.
Power generating machinery and equipment 5%
5
4% Gold, non-monetary (excluding gold ores and concentrates)

  • Low

  • Medium

  • Sensitive

  • High

  • Payments

  • Court proceedings

  • Insolvency proceedings

Contact

Contact Euler Hermes

Economic Research Team

research@eulerhermes.com

Contact Manfred Stamer

Senior Economist for Emerging Europe and the Middle East

manfred.stamer@eulerhermes.com 

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