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Lebanon's resilience will see it through instability

05/Jan/2015

Read article on The Banker

 

Political instability is keeping Lebanon from achieving its potential, according to central bank governor Riad Salameh, who is targeting three major sectors as engines of economic growth. 

The conflict in Syria and the unrest more widely found in the Arab world has had a widespread impact on Lebanon’s economy. Our real economic growth rate of 2% needs to be seen in the context of the wider security crisis. Prior to the Syrian war, Lebanon’s economy was growing at an average annual rate of 8%. The decline in growth is putting pressure on the general finances of the country and the ratio of debt to gross domestic product [GDP] has been rising after a period of continuous decline.

Debt is expected to rise again in 2015 by about $4bn. The debt-to-GDP ratio has risen from 130% to about 143% and we cannot give any forecast on the future growth rates as security and political events are so unpredictable, but the International Monetary Fund [IMF] expects growth of 2.5% for 2015. Our inflation rate is about 4%.

Despite the regional instability, capital continues to flow into the country from the widely spread Lebanese expatriate community. This stabilises our monetary situation and adds confidence in the economy, when so many political risks impact on it.

 

Energy reforms

I strongly believe we need to see reforms in the public sector to deal with our rising public sector debt. But Lebanon’s reforms are being hampered by internal political issues. We particularly need to reform the energy sector, which is the cause of a large part of the budget deficit. Lebanon imports all its energy and our electricity monopoly, Électricité du Liban, is a loss-making institution. The cost of the subsidy is almost 4% of GDP.

Why are we having such difficulty bringing in reform measures? The problem is our internal political instability. The parliament and the country need to support these reforms as they will have a far-reaching effect. But, for the time being at least, we have no president. Our coalition government has prioritised preserving continuity rather than risking dissension with possibly unpopular reforms. Until we have a president, every decree has to be signed by all the ministers so I do not expect to see a reform project coming to fruition until then.

Political instability is most certainly a factor in many aspects of Lebanon’s economy. Interest rates are below the level suggested by our credit rating of B-. Lebanon’s rating is unduly influenced by the political situation and security issues. The resilience of the economy has been demonstrated during stressful periods, which include wars, political assassination and street fighting. While we respect the opinion of the rating agencies, I believe there is a discrepancy between how the rating agencies rate us and market perceptions. If we look at interest rates, Lebanon could qualify for BB+ or even BBB. Standard & Poor’s recently confirmed its rating with a 'stable' outlook.

 

Refugee crisis

Despite external pressures, Lebanon’s economy has shown resilience. We are one of the few countries in the region that did not ask for assistance from the IMF to provide foreign currency during the crisis. We are now supporting at our own expense 1.3 million Syrian refugees without meaningful financial assistance from the international community.

As for the wider economy, Lebanon needs to get its act together and develop three major sectors as economic pillars. These are banking and finance, oil and gas, and the knowledge economy. These pillars will enhance other sectors. We need to develop infrastructure without creating another debt burden. The association between the public and private sectors is essential and can help fund the development of infrastructure. We need to create proper roads, communication systems and transportation systems.

Turning to the banking sector, it is clear this is crucial to Lebanon, because we do not have institutional entities holding liquidity to enhance the economy. Sound banking has been a very strong foundation during periods of instability. We are very prudent in our approach to banking. Local banks have a solvency ratio of more than 10% based on Basel III criteria and we hope to get to 12% in 2015. Liquidity is more than 30% and leverage is below 10%.

We are highly mindful of banking risks and we require the separation of commercial and investment banking, so we don’t see depositors’ money put at risk. We do not allow commercial banks to invest in investment banks but where a banking group includes both an investment and a commercial bank, there needs to be a Chinese wall between them.

 

Bank confidence

One impact of this policy is that our return on equity is not as high as some countries in the region, but banking is not about having continual growth in profits, but rather it is about safe profits that can retain confidence in the bank and allow the bank to increase its capital. One has only to look at our resilience in the international financial crisis in 2008 to see the good sense of this approach. If the two forms of banking were mixed, bankers would pursue investment rather than commercial banking as it promises more profit.

Our bankers would like to see more opportunities to expand their business but the Central Bank of Lebanon [CBL] believes the stability of credit and the growth of the country are at stake, so we cannot venture into risky areas. This is accepted by the banks and we manage our risks by having continual and close co-operation between the central bank and our banks. Our banks understand this is of particular importance as our external security and political risk lead us to want to moderate risk in the banking sector.

We have created several units that monitor bank risk, including the Banking Control Commission, a unit dedicated to financial stability, and our Special Investigation Commission, which fights money laundering. The governor who leads these institutions has a complete view of the risks and he can assess which of these can become a systemic risk. We have a complete set of regulations to moderate these risks.

 

Strong governance

Given our location and the risks of our region, the application of the sanctions regime is of particular importance. We have issued a circular stating that banks cannot deal with a country, a party or an individual that has been subject to international sanctions. Likewise, Lebanese banks cannot deal with the currency or a bank located in a country that has been subject to international sanctions. Lebanese banks respect that circular. Banks have developed systems and procedures to prevent the exposure of their institution to illegal money.

The application of this policy is enhanced through strong banking governance systems and circulars from the CBL have focused on the need for independent board members. Most Lebanese banks are family owned so this is particularly important. Banks are also required to have committees on governance and risk. These committees need to report to the entire board, as well as the chairman.

What of the future? Success will surely come from harnessing the talents of our people to build our economy. The knowledge economy in particular offers great promise. CBL has issued a circular allowing banks to invest up to 3% of their capital into start-up companies operating in the knowledge economy. The CBL guarantees 75% of the investment. The project was launched a year ago and some $150m has been committed by the banks and invested in start-up funds and companies.

Three funds have currently invested in start-ups using the scheme, while the banks have invested directly in both companies and accelerators that help to bring entrepreneurs into the market and shape projects linked to the sector. We have approached the UK government for help with the scheme and they have agreed to supervise its development. The initiative was taken as part of our strategy to enhance internal demand to sustain the country’s growth and create jobs.

The Lebanese are optimistic as a people and I am an optimist. Despite political and security difficulties, we have grown our GDP and our banking sectors. Bank balance sheets have grown more than 15-fold over the past 21 years, the period of my governorship. I have great confidence Lebanon will move ahead.

Riad Salameh is Lebanon's central bank governor.

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