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November 26, 2018
An Interview with Mr. Marwan Mikhael: Expert Analysis on Lebanon’s Economic and Financial Stability

Speculation is rife across Lebanon over the future of the national economy, the banking sector, and state finances. As part of its efforts to spur constructive dialogue on pressing national issues, LCPS conducted a series of interviews with economists who have varying perspectives on Lebanon’s economic, fiscal, and financial future. In this installment, we interviewed Mr. Marwan Mikhael, Head of Research at BlomInvest Bank S.A.L., Research Division. He argues that the most recent economic slowdown is different than past ones, in that Lebanon can claim less resiliency against further economic deterioration, the forthcoming government will find it difficult or impossible to implement an expansionary fiscal policy, and indicators suggest the immediate future will be one of recessionary growth levels. We invite you to read the following transcript of the interview, which has been edited for clarity.
In recent months, Lebanese news has been dominated by rumors concerning the sustainability of the national economy. How do the economic challenges Lebanon is currently experiencing differ from the challenges of the past, both in terms of internal and external factors?

This time, the slowdown in Lebanon’s economic growth is different, as it has lasted much longer than previous declines and constitutes another serious test of the resiliency of the Lebanese economy. There are many reasons for the slowdown, initially the spillovers of the war in neighboring Syria, then the decision of GCC countries to warn their citizens against coming to Lebanon, and finally the fiscal problems and structural issues that are strangling the economy. 
This time is different because the shock did not have a limited time span. The repercussions of the war in Syria are continuous and the end date of the conflict remains unknown. Hence, the policies that should be adopted to face such a large factor of uncertainty must be different. When the war erupted in Syria, Lebanon did not have the right infrastructure to attract Syrian investors. Wealthy Syrians owning factories and businesses in Syria were forced to flee their country and preferred to invest in other countries rather than coming to Lebanon. Only banks attracted a limited amount of deposits and the real estate sector attracted some buyers.
This time is different because our public debt and fiscal deficit levels do not provide leeway for further deterioration. Public debt is at 138% of GDP and the fiscal deficit reached 9.3% of GDP at the end of 2012. Therefore, the government does not have the luxury of adopting an expansionary fiscal policy to boost economic growth. In this context, the government is not able to increase its capital expenditures to improve faltering infrastructure following many years of restricted capital spending. 
This time is different because international interest rates have started to go up. Hence, Lebanon was obliged to follow and the impact on the debt service will not be negligible. The public debt increase will accelerate and the debt-to-GDP ratio will increase. If the government does not tackle its fiscal deficit problem until then, the fiscal situation will deteriorate and impact the entire economy.
On another front, weakening infrastructure is limiting the potential growth of real GDP. Following several years of high GDP growth, the Lebanese economy has shifted, during the past six years, from high to low gear economic growth. Real GDP growth recorded 1% to 2% in the past few years and this year will be no exception. This was partly due to the lack of investment in infrastructure during years of high growth. Lebanon needs to upgrade its infrastructure in all sectors including energy and water, roads and transportation, and IT and telecommunications. Since the government does not have the means to do all the necessary investments, several schemes should be considered such as public-private partnerships, the Build Operate Transfer, and privatization, only to name few.
The environment of high interest rates dominating the economy today and crowding out the private sector as borrowing costs escalate is linked to multiple external factors, including: US interest hikes in 2018, rising interest rates in emerging economies since the beginning of the year, as well as the higher interest rates witnessed in regional peers like Turkey and Egypt, and to a lesser extent, the gulf countries. Lebanon had to jump on the bandwagon of higher rates to keep attracting deposits.
Internally as well, and in the absence of an active and engaging fiscal policy by the government, BDL began using unorthodox financial tools to safeguard the peg and financial stability, leading to higher interest rates.
Similarly, the inflationary pressures in Lebanon today are attributed partly to the rise in the international average price of oil, which climbed by 38.1% by August 2018 to $72 a barrel, and partly to the decline in the US dollar index which rendered Lebanon’s imported goods priced in dollars more expensive. Moreover, other internal factors are at play today, namely the passing of the long-awaited public sector wage bill promising pay rises. The estimated cost of the salary hikes are expected to exceed the budgeted $800 million as the costs of private education services also rose.   
The slowdown this year is not only in Lebanon but also a regional one, such that the prime peer economies Lebanon depends on (the gulf states mainly) for remittances, youth employment opportunities, tourist spending, and real estate investments in Lebanon are also struggling with economic slowdowns–this regional paralysis weighs down even more on the ability of Lebanon to recover and the time needed to do so.
Foreign investors’ confidence was first deeply shaken in 2018, with no sign of reforms on the government end to tighten deficits or reduce the debt-to-GDP ratio. As such, restoring faith in the economy this year will entail more than just political breakthroughs like the formation of a government, but rather economic accomplishments.  
What are the three key economic variables by which you would define a crisis in Lebanon, and by which indicators would you measure them?

Let us first say that there are four different sectors in the economy, namely, the real sector, the fiscal sector, the external sector, and the monetary sector. Our current difficulties are primarily centered in the economic sector and fiscal sector, and to some extent the external sector, hence putting some pressure on the monetary sector.
We have a first indicator in the real economy signaling close to a recession level of economic growth. The BLOM Purchasing Manager’s Index shows that economic growth has been around 1.2% in 2017 and it will not surpass 1% in the current year. In a developing country like Lebanon, this is a recessionary level of growth, as it will create very few employment opportunities compared to the number of young people entering the job market every year. Moreover, high interest rates are crowding out the private sector and magnifying the economic slowdown. The long stretch of low growth is an indication of economic difficulties. 
Another indicator is the balance of payments (BOP) that has been in negative ground for the past seven years, except for 2016, due to the financial engineering scheme adopted by the central bank. A long stretch of negative BOP is also an indicator of economic difficulties as Lebanon is failing to attract the necessary financial flows to cover its current account deficit.
Bonds market performance—the large decline in the Blom Bond Index along with the jump in the related weighted average-yield of the Eurobonds—is an indicator of a stress in the economy.
International financial organizations repeatedly voice concern about the sustainability of Lebanon’s economic situation. If these concerns do not make clear the necessity of reform in the minds of political actors, is there a tipping point that could facilitate political collaboration on necessary reforms?

International financial organizations rightly pointed to the unsustainability of the current economic and fiscal situation. I think that we have reached a tipping point that will facilitate political collaboration, as we are in a difficult economic environment—unless authorities implement the reforms, the promised CEDRE funds will not come in and the economic situation will deteriorate further. 
To what extent would a crisis affect social groups and communities differently?

Currently, inflationary pressures are diminishing people’s purchasing power, thereby raising the costs of education, housing, health, and food costs among other things. Higher interest rates are discouraging private businesses from expanding operations, which halts the business cycles essential to nurturing economic growth.
In the case of a crisis, these impacts will be magnified, hence leading to a decline in government revenues and a rise in government spending, which will lead to higher public debt and a higher debt-to-GDP ratio.
What are your top three policy recommendations for a new government?

Reform the electricity services, namely EDL transfers—which constitute about 20% of expenditures and may save up to 2.5% - 3% of GDP (approx. $1.5 billion) if reformed adequately.
Enhance the ease of doing business in Lebanon beginning with the reform of the Code of Commerce and enforcing the rule of law, thereby inciting good governance in business practices.
Accelerate the implementation of the Capital Investment Program (CIP) through public private partnerships.
What would be the role of international actors—both states and international organization—in mitigating the crisis, and under which conditions?

The international community involved in the CIP, including European capitals, can monitor progress on Lebanon’s reforms and ensure planned projects see the light.

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