Bad for Israel, Bad for Lebanon

Until a week ago, we could remain optimistic. We could cope with the damage the war did to the north and move on. But two weeks after the fighting started, the economic situation is looking much grimmer.

Business is slowing not only in the north, but in the center as well. The damage is rippling throughout the nation, touching every sector. Productivity and sales are dropping, while compensation claims are soaring sky-high. Each 1% drop in GDP growth translates into lost product of NIS 5.5 billion.

The greatest danger to the economy lies in the national mood swinging from a jubilant summery spending spree, to gloom and fear. If consumers in the center stop shopping, eating out and perhaps fearing to go to work, the result will be even worse. Demand will tumble, businesses will collapse, investments will be deferred, unemployment will rise new and budgets will be strained.

Once we fall into that hole, it will be hard to climb out.

Bank of Israel governor Stanley Fischer, who has been tracking the situation with concern, sees the stability of the shekel proving that the international markets still believe in us, and in the policies of the Finance Ministry and central bank.

He therefore believes the government must stand fast by its decision not to overspend its budgets this year and in 2007, and not to bow to the calls for increased spending. Fischer recently told Fitch analysts that Israel would stay within its budget boundaries.

According to the governor, certain social programs will have to be put on hold because of the increase in security-related spending, which had been unexpected. If the government simultaneously tackles both social and security issues, it will breach its budget, Fischer explained, and then the international investment community would lose faith, and the public will pay the price through a weakened shekel, rising long-term interest rates and impaired economic growth.

If the investment community suspects that the Bank of Israel has set aside its goal of achieving "western" interest rates, meaning inflation of 1-3% a year, they will predict a slide in the shekel, and flee it. They will convert massive sums of shekels into dollars, weakening the shekel against the greenback and sparking inflationary pressures.

Therefore, the governor said, what's needed is a signal to the markets. And yesterday he sent one: he raised Israeli interest rates by a quarter-percent, to signal the investors of the world that he seriously means to keep Israeli inflation tamed.

Unstable area, to be sure

Meanwhile, the International Monetary Fund keeps a close eye on countries that borrow money from it to rehabilitate their economies. One such country is Lebanon.

In its last report, published on July 10, two days before the latest hostilities broke out, the IMF gave Lebanon high marks.

Though civil war lasting from 1975 to 1991 ruined Lebanon's economy, the IMF wrote, and despite the assassination of prime minister Rafik al-Hariri in February 2005 that sent the nation into a political and financial maelstrom, Lebanon had proven to have a surprising capacity for rebounding. It had restored financial stability and had begun to attract foreign investment, too.

The IMF did note that the widespread projects to rebuild Lebanon's infrastructure had increased the public debt and left the government with a tricky task indeed, of reducing it again.

Today that report seems hopelessly irrelevant. Lebanon's infrastructure has been destroyed again, tourists have fled and economic activity has ground to a halt, sending the nation 20 years back in time. The IMF will have to create a whole new program for rebuilding the country. Debt holders, get in line, and prepare to wait for a long, long time.