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Lebanon bucking global trend - Citigroup

03 June 2010

BEIRUT: Citigroup said that although Lebanon has a high public debt and substantial twin deficits, the country has nevertheless shown resilience. The report was carried by the Bank Audi Weekly Monitor.

It added that the banking sector and inflows from the diaspora exhibited remarkable resilience in the face of significant political instability over the past six years but it warned of complacency.

“Greece’s sovereign debt crisis has shed light on public finances, especially among investors. Sovereigns running twin deficits and a high debt have generally seen a significant re-pricing of risk on their traded debt,” the report said.

But the report signaled that Lebanon was clearly bucking the trend as its Certificate of Deposist (CDs) spreads were hardly changed since November 2009, despite having the highest debt burden when compared to Greece, Portugal, Spain or even Ireland.

The bank noted the performance of Lebanon’s sovereign debt was boosted by demand from the domestic banking sector, whose balance sheets are supported by record inflows from the Lebanese diaspora.

Still, the bank mentioned medium-term significant risks that could hinder this dynamic: the Hariri Tribunal, regional geopolitics, and a renewed slowdown in the global economy.

Over the past couple of years, Lebanon has seen some success in reducing debt to GDP, but this has been driven by acceleration in nominal GDP growth rather than through any reduction of the debt stock as stated by Citigroup .

In fact, progress on structural reforms has been missing, and was deemed vital to create a significant improvement in Lebanon’s public finances.

“The key components of the reform package, enshrined in the Paris III agreement, are privatization, revenue enhancement, and expenditure control,” according to the report.

Regarding the first reform, the lucrative telecom sector, infrastructure assets (including power), and the national carrier (Middle East Airlines) are on the list for privatization.

On revenue reform, the financial institution highlighted the need for further progress on tax collection, and raising VAT.

On expenditure reform, primary expenditure (excluding transfers to EdL ) which was at a low 18 percent of GDP in 2009, is expected to increase over time as social pressures weigh on spending, particularly in much-needed infrastructure projects.

According to the document, the most critical aspect of expenditure reform is rather controlling transfers to EdL which entails significant reform of the energy sector, including a tariff shake-up, a clamp-down on electricity theft and an overhaul of production and management at EdL , possibly paving the path to its privatization.

As to Lebanon’s external situation, exports, particularly in tourism and finance, are expected to surge in 2010 but this will be offset by rising imports associated with the continued recovery in the economy, and the current account deficit is likely to widen moderately over the next two years, the report noted.

Citigroup pointed out that Lebanon’s ability to maintain its twin deficit has long rested on the Lebanese diaspora. On the external account, remittances by Lebanese workers abroad and inflows of non-resident deposits have averaged 25 percent of GDP over the past seven years, and have covered the current account deficit (excluding transfers) in each of the seven years with the exceptions of 2005 and 2007 due to political turmoil, which resulted in a relative slow down of inflows.

From a fiscal perspective, diaspora inflows are also considered crucial. At end-March 2010, the banking system held around 80 percent of total government debt.

This ability to keep financing the public sector depends on its deposit base which in turn reflects inflows from the diaspora. According to Citigroup , these inflows have led to significant deposit growth as a proportion of GDP over the past decade, and a consequent increase in the capacity of the banking system to absorb the public debt.

As a matter of fact, debt as a proportion of total deposits, a potential measure of the banking sector’s capacity to finance government deficits, is lower than it has been at any time in the previous decade.

Citigroup noted that recent history has demonstrated the remarkable resilience of the Lebanese banking system and the diaspora’s confidence.

“That said, the diaspora’s willingness to remit funds is not without its limits,” according to the report.

It added that amid political instability in 2005 and 2007-2008, sustained outflows of non-resident deposits were recorded and yields on Lebanese debt were around twice the level that they are now, as per the report. “Finally, while confidence did not scatter to the extent of a full-blown financing crisis for Lebanon, the potential exists for financing conditions to tighten significantly relative to where they are today,” according to Citigroup . – The Daily Star

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