Optimism in Lebanon following the election of a new president last year may be short-lived, as the government remains embroiled in a debate over its electoral law and new data indicate a deterioration in business conditions in the country, writes Rebecca Spong.


Lebanon is a country known for its resilience in the face of adversity. It is currently grappling with a refugee crisis caused by the ongoing conflict in Syria, chronic underinvestment in its infrastructure, and up until October last year with the election of President Michel Aoun, a more than two-year-long lack of leadership.

In spite of such challenges, Lebanon has continued to function fairly well. “Despite the two and a half years of political impasse, the country hasn’t completely deteriorated, and in fact has remained relatively stable,” says Andrew Freeman, associate analyst, Middle East and North Africa at risk consultancy Control Risks.

With a new president at its helm, a tentative sense of optimism started to build, with the hope that the ever-resilient Lebanon was on the verge of an era of relative stability and renewed economic growth.

But roll on to June and that initial optimism looks increasingly short-lived. Parliament remains divided over a new electoral law that must be resolved before the delayed parliamentary elections can take place.

The lack of certainty surrounding the government’s future has already triggered some social unrest as well as damaged confidence in Lebanon’s economy. The May reading of Lebanon’s purchasing managers’ index (PMI) – a measure of business conditions compiled by IHS Markit – reached a seven-month low.

After a brief respite, it seems Lebanon’s resilience is being tested once again.


Path to stability

A much-hoped-for turning point in Lebanon’s fortunes took place towards the end of last year with parliament’s election of President Aoun. His rise to power was the result of a compromise agreement between two opposing factions, and was seen as a move that might bring a degree of stability.

Aoun, a Christian ex-army general, has the backing of the Shia group, Hezbollah. His leadership bid had originally been blocked by the Sunni-dominated group, the Future Movement, until a deal was struck that saw that group’s leader – businessman Saad Hariri – selected as the country’s prime minister. Once the leadership was in place, a new cabinet was appointed, made up of representatives from various factions.

The election of Aoun was widely welcomed and helped renew confidence in the country.

“The election of the president and the appointment of a new government helped to stabilise the political image in Lebanon and to put an end to a constitutional vacuum in the country,” says Ziad Ghosn, head of global financial institutions and transaction banking at Bankmed.

“We have seen some improvement in the country’s political stability with the election of the president and the new cabinet,” agrees Mathias Angonin, lead sovereign analyst at rating agency Moody’s Investor Services. “This has been shown through a rise in deposits. And economic growth is picking up from a low base – with a slight improvement in tourism statistics, construction and other economic variables,” he says. The agency has however so far maintained its B2 with a negative outlook rating for the country.

In the property sector, real estate transactions grew by approximately 14% in both value and volume in the first quarter of 2017 compared to the same time period the previous year, according to the Real Estate Registry and Bankmed research.

The number of tourists also grew by 12.6% in the first quarter of 2017 year-on-year, reveals data from the ministry of tourism, compiled by Bankmed. Tourists from Arab countries grew at an even faster rate of 24.5% in the first quarter. In recent years, the Syrian war and related security issues in Lebanon tended to put off tourists travelling from the Gulf region and further afield.

Furthermore, the Banque du Liban’s coincident indicator one – a measure of economic activity which includes variables such as trade flows, passenger arrivals and cement deliveries – grew by 3.8% in 2016 from 2% in 2015, according to a Moody’s report.

Against this improved economic backdrop, Moody’s has forecast that real GDP growth will accelerate to 2.8% and 3% in 2017 and 2018 respectively, an improvement from the annual average of 1.9% recorded between 2011 and 2016.


Lack of reforms

The new leadership had also spurred hopes that much-needed reforms will be pushed forward. Some progress was made at the start of the year.

In January, the government approved legislation that kick-started Lebanon’s offshore oil and gas exploration, helping the country to catch up with its neighbours already active in the hydrocarbon sector. A number of companies have now been pre-qualified for the first licensing round.

Parliament also passed the draft budget bill in March, which outlined various increases in tax designed to bolster the government’s finances. This was a welcome step, given that Lebanon hasn’t passed a budget since 2005.

However, despite initial progress, the reform agenda is grinding to a halt, in part due to the ongoing debate about the electoral law.

“Approval of a budget is postponed and could be postponed until Q3. We see the newly-formed alliance as a credit positive but we are waiting for the government to deliver on fiscal reforms,” says Angonin at Moody’s.

The electoral law aims to redraw constituency lines within Lebanon and has been argued over for years, with different Christian and Muslim parties divided over how their communities will be represented under a new system.

“Ultimately the debate is around Lebanon’s identity, what it is now compared to what the country was in 1960s when electoral law was set up. That’s an important takeaway – how the country is identified in terms of Christian and Muslim populations and how they are going to work together across sectarian lines,” explains Freeman at Control Risks.

The ongoing debate has meant that there have not been any parliamentary elections since 2013, and parliament has had to extend its mandate twice. Elections were meant to take place in May, and the current deadline for a compromise agreement to be reached is June 20 (as this publication goes to press), when the current parliament’s term ends.

“If the approaching deadline doesn’t force a compromise, parties will have to choose whether to hold elections under the current law or extend parliament’s mandate again for a third time. The parties might feel this final option is the lesser of two evils, but ultimately as the deadline approaches that may move parties closer to compromise,” says Freeman.

Already the debate has caused protests, and could spark greater social unrest as the public become frustrated about being denied their right to vote. What’s more, it will likely stall progress on economic reforms.


Trade and business confidence

Inevitably, renewed political uncertainty in Lebanon has started to affect confidence in the economy, as evidenced by the results of May’s PMI. The measure declined to a seasonally-adjusted 46.6, its lowest score since October last year. Any reading below 50 marks a deterioration in conditions.

“The spurt in the PMI following the presidential election in October 2016 is proving to be short-lived,” says Ali Bolbol, economic advisor at Blominvest Bank, in an official statement. “Output and new export orders fell at faster rates, while employment, purchases and backlogs of work witnessed further declines.”

According to the report, the measure of new export orders fell to 48.4 in May from 49.3 in January, and the level of new business from abroad fell for the 22nd consecutive month. The reading suggests that export activity in Lebanon could stay fairly depressed as businesses scale back operations and wait to see how the political environment evolves.

Indeed, trade flows in and out of Lebanon have suffered since the onset of the Syrian war, as overland transit routes into the rest of the region have been cut off due to fighting. “As such, exporters and importers are forced to use sea [the Port of Beirut] and air freight to transport goods,” says Karim Nasrallah, general manager of the Lebanese Credit Insurer (LCI). These options are usually more expensive, although the low oil price did offset some of those additional costs.

A decline in gold prices has also hampered Lebanon’s exports, as have fluctuations in global demand for precious stones and jewellery, a key export for the country.

Lebanon’s goods trade deficit worsened in 2016, increasing by 4.1% to reach US$15.7bn, around 30.3% of GDP, according to a Moody’s report published in March.

Some companies haven’t suffered as much as others. “Some exporters have recorded growth, due to the drop in production in Syria, particularly in beverages, tobacco and some food items, mainly wheat,” says Nasrallah.

There were signs of a potential revival in exports at the start of the year, with exports rising 10.1% in January/February compared to the same time last year, according to Lebanese customs data.

The number of letters of credit (LCs) opened in the first few months of 2017 also began to rise, with L£702.6bn-worth (US$464.8mn) of export LCs opened in March, up from L£234.2bn in the same month last year. However, this figure dropped back to L£285.9bn in April.

“Something we have been monitoring from the banking side is documentary letters of credit, and we saw reductions in the past several years due to trade transiting through Syria being affected by the regional situation, but there has been some improvement up to March. It is a bit early to say it is a trend that will continue – but there is at least positive development until now,” says Alexios Philippides, lead banking analyst at Moody’s.


Resilient banks

In the face of renewed political instability, one area of the economy that remains relatively strong is the banking sector.

“Lebanese banks have proven resilient to several crises in recent years and managed to record growth and remain profitable, while being ahead of international requirements and regulations,” says Bankmed’s Ghosn. “The domestic political situation did not dampen appetite for private corporate borrowing, where it doubled between 2011-15,” he adds.

The assets of commercial banks continue to grow each year, reaching US$204.3bn in 2016, 385% of GDP, according to data from Banque du Liban and the Association of Banks in Lebanon, compiled by Bankmed.

Commercial banks also have a large private sector deposit base, which reached US$162.5bn in 2016, representing 80% of total commercial banks’ liabilities.

Deposit levels are a key indicator of the strength of Lebanon’s economy, due to the fact that it is the commercial banks that keep the country liquid through purchasing and rolling over substantial government debt. According to IMF data from April, total government net debt stood at 137.2% of GDP in 2016 and is projected to be 141.1% in 2017.

Lebanese banks collected US$10.9bn in new deposits in 2016, compared to US$7.2bn in the previous year, according to Moody’s data. Much of the deposit growth is thanks to Lebanese living overseas and sending money back in the form of remittances.

Yet, the rate of deposit growth did begin to slow in 2016, before recovering in 2017, potentially in reaction to the appointment of the new president.

Given the dependence of the government on deposit volumes, there have been efforts to attract even more deposits. “We have seen interest rates on foreign currency deposits going up. The latest figure for the average interest rate on new and renewed foreign currency deposits as of March this year went up to 3.53% – from 3.27% the year earlier,” Philippides from Moody’s says.

“In the first quarter of this year, we have seen L£1.9bn private sector deposits entering the system again compared to L£0.9bn in same period last year,” he says.

The strength of the banking sector has helped underpin its trade finance activity, by ensuring foreign counterparties remain confident in the financial stability of their Lebanese partners, explains Ghosn.

“Foreign correspondent banks have strong appetite and maintain sizeable limits in favour of Lebanese banks,” he says. “We have even seen situations where Lebanese banks benefited from reduced pricing in view of the competition between the foreign correspondents to cater for Lebanese banks’ needs.”

He says that Bankmed has even been able to increase its market share of Lebanon’s LC business up to 15.8% last year from 11.5% in 2014.

The domestic and regional instability has also played into the hands of the country’s trade credit insurers. “There has been increased demand both in Lebanon and across the region for trade credit insurance. More companies are seeing the importance of having their biggest asset, their trade receivables, insured,” says Nasrallah.

And so it seems that despite being tested yet again, Lebanon and its financial institutions continue to live up to their reputation for resilience in the face of regional and domestic difficulties.