Lebanon's Next Government Has a Dire Economy to Tackle

IMF has said country's debt trajectory is unsustainable, and there is pressure to form a new government to maintain economic confidence

Member of parliaments attend a parliament session as Lebanon's newly elected parliament convenes for the first time to elect a speaker and deputy speaker in Beirut, Lebanon May 23, 2018.
\ HANDOUT/ REUTERS

After Lebanon’s first parliamentary election in nine years, the dire economic situation and unsustainable public debt levels are top priorities for the next government.

Before the May 6 vote, leaders from across the deeply divided political establishment sounded the alarm about the state’s finances and economy. They agree a new government, which is expected to contain the main parties, must be formed quickly, although wrangling over cabinet portfolios could take time, even months.

“The risk is if they really don’t form a government and don’t make any headway with policy in the remainder of this year,” Toby Iles of ratings agency Fitch said.

Why the urgency?

Lebanon is the world’s third-most-indebted nation with a debt-to-GDP ratio of more than 150%. It climbed from around 130% in 2011, before war in neighboring Syria and the arrival of more than a million refugees depressed growth and paralyzed government decision-making.

The International Monetary Fund has said Lebanon’s debt trajectory is unsustainable and needs immediate action, otherwise debt to GDP could hit 180% by 2023.

Annual growth rates have fallen to between 1% and 2%, from between 8% and 10% in the four years before the Syrian war. Two former pillars of the economy, Gulf Arab tourism and high-end real estate, have suffered.

Prime Minister Saad Hariri has said the unemployment rate exceeds 30%, and the UN Development Program says the number of people in poverty has risen by nearly two-thirds since 2011.

“I believe everyone has realized now that the ship might sink with everyone aboard,” leading Christian politician Samir Geagea said in a recent interview, describing the economic risks.

How has Lebanon muddled through this long?

Absent an effective government, the central bank has for years maintained stability using stimulus packages and unorthodox financial operations, made possible by the billions of dollars deposited into Lebanese banks by the large diaspora.

Attracted by high interest rates and confidence in the country’s resilience and banks, diaspora deposits have helped Lebanon’s finances survive shocks including the assassination of Rafik Hariri – Saad’s father – and conflicts between Hezbollah and Israel.

But the risk of an increasing dependence on remittances became clear in November when Saad Hariri resigned unexpectedly. Some Lebanese moved their money out of local currency or overseas.

Central bank foreign assets fell by $1.6 billion that month as it defended the Lebanese pound’s peg to the dollar, according to released data. The crisis was short-lived, but the increasingly poor state of national finances has increased the risk that Lebanon might not weather a larger shock so well.

The quicker the government is formed and gets to work, the more support this gives to vital financial inflows.

Despite losing more than a third of his MPs, Hariri was designated Lebanon’s next prime minister Thursday and said all parties agreed that a national unity government must be formed as quickly as possible due to economic risks at home and growing dangers in the region.

Central bank policies have kept growth ticking over and foreign reserves high, but they have increased risk in the financial system. The central bank and IMF say such policies should not continue long-term and government policymaking needs to step in.

The finance ministry has met its foreign currency financing needs for 2018 through a $5.5 billion debt swap with the central bank. The transaction will reduce debt-servicing costs and boost central bank reserves, the government said.

What next?

Sectarian politics and corruption have for years stalled reforms needed to boost growth and bring down debt. International donors want to see reforms to release more than $11 billion of investment pledged in April to boost the economy.

“It will be extremely challenging for the next Lebanese government to live up to these reforms. We know how hard it is to change the way things work here, and addressing the vested interests is hard. But there is no alternative way forward,” a Western diplomat said.

Beirut hailed the money pledged in Paris as a sign of confidence in the government. Donors want to preserve stability as war drags on in Syria, but say assistance depends on Beirut working to a credible economic plan and under international oversight to ensure reforms happen.

“We are going to be tough on this and I don’t see anyone else being less tough,” another Western diplomat said.

In Paris, Hariri promised to reduce the budget deficit as a percentage of GDP by 5% over five years.

Reforming the subsidized power sector, widely seen as deeply corrupt, would be a big help.

Last year the government spent $1.3 billion subsiding the state power provider – 13% of primary expenditures. Meanwhile, most homes depend on expensive private generators because state provision is so patchy.

Hariri has led calls for reform since a years-long political deadlock was broken at the end of 2016 and parliament began to take decisions such as launching an offshore oil and gas exploration and passing the first government budget since 2005.