|Growth improving but Lebanese economy needs to achieve potential (Daily Star)
|External factors, including tourism, behind solid growth
Editor's note: What follows is an excerpt from Banque Audi's third-quarter report on the Lebanese economy , published this weekend. It is printed with permission.
The Lebanese economy pursued its enhanced growth performance in the third quarter of 2004 to reinforce even further its favorable performance of the first half.
According to our estimates, the economy grew by a little bit less than 4 percent in the first nine months of the year, driven both by its consumption and investment components. At such a real growth rate, the Lebanese economy is in line with the average regional growth in the Middle East, which benefited this year from rising exports driven by higher oil prices, further repatriation of offshore savings and a healthy touristic season emanating from a low 2003 base that was adversely affected by the war in Iraq.
Similar to the regional performance, Lebanon's growth drivers were mainly external: Touristic receipts, exports and foreign investment were behind this year's healthy economic performance in Lebanon. The touristic receipts benefited from a favorable touristic season, as the number of tourists reported their best growth since 1997 with 29 percent more visitors across borders over the first nine months. Foreign investment was mainly driven by Arab investment in a number of economic sectors, but mainly in real estate which saw the value of property transactions growing by 22 percent year on year. Exports likewise reported a healthy growth of 23 percent, as a result of the sustained market diversification efforts by Lebanese producers over the past few years.
A further improvement in real growth was reported relative to this year's first half figure. Our estimate of real growth of 3.1 percent in the first half rose to 3.8 percent over the first 9 months of the year. The most important economic indicators support such an additional improvement in growth. Imports, at the mirror image of aggregate demand, saw its growth improving from 31.4 percent to 34.4 percent in nominal terms. The volume of cleared checks, an indication of private consumption and investment spending, rose by 9.7 percent in the first nine months, against 7.5 percent in the first half. Government spending, which had contracted by 7.3 percent in the first half in the quasi-absence of a budget law, dropped by only 1.7 percent in the first nine months relative to the previous year's corresponding period.
The quantity theory of money likewise confirms such a positive growth performance. Money aupply grew by 11 percent year on year, more than offsetting the contraction in the velocity of money, which fell 2.9 percent over the same period. In parallel, a real output growth of 3.8 percent was generated, which, within the context of a 2.1 percent price inflation, lead to a nominal growth in output of almost 6 percent. The reported average inflation is related to the improvement in economic activity on one hand and the rising import prices relative to the U.S. dollar on the other hand. When accounting for exchange prices of specific import items, we estimate the imported inflation at circa 1.8 percent over the first nine months of the year.
The banking sector also benefited from an improved economic activity, although banks' bottom lines suffered from significantly contracting spreads and interest margins. The favorable economic activity translated in a size effect as shown by the healthy growth in customer deposits and credits to the private sector. The former grew by LL5.841 trillion over the first nine months, i.e, only slightly lower than the spectacular growth of last year's corresponding period, while the latter rose by LL 893 billion, its best growth in four years. However, with the continuing renewal of maturing bills and eurobonds at lower yields, and with the rising share of liquid uses that exceeded an all-time record high of 82 percent of customer deposits, banks' profit margins exhibited gradual declines, offsetting almost totally the favorable size effect.
There is no doubt that Lebanon had started to witness this year the beginning of improving conditions in a number of sectors of economic activity. Despite the discrepancy among real economic growth estimates adopted by the different sources, there is a general consensus that the real sector growth this year has reported a sound level unwitnessed in recent years and that the country has moved from an enduring low-growth phase to a relatively healthy activity growth. Still, growth is much below the potential of the Lebanese economy characterized by a large cyclical output gap and very low capacity utilization ratios.
This year's growth enhancement was realized despite the negative impact of lower interest rates on interest income and ultimately on private consumption. It was yet compensated by a significant growth in nonresident demand, especially by regional tourists. It is estimated that the additional tourist consumption would stand at close to $500 million on annual basis, based on the significant growth in the number of tourists and a slight improvement in the average spending by tourist. Notwithstanding the continuing rise in exports, which are hence approaching close to 10 percent of GDP for the first time in three decades.
Growth had a positive dual-impact on fiscal adjustment this year, through both numerator and denominator effects. With debt to GDP representing the most significant indicator of financial vulnerability, growth has contributed to lower the deficit (numerator effect), i.e, debt growth, through a significant expansion in public revenues by 14 percent year-on-year, mainly those that are at the mirror image of economic activity at large. The denominator effect is tied to a wider economic base, with a slight dilution impact on all fiscal ratios. While there is no doubt that growth has helped stabilizing debt ratios, it is yet still quite below the requirements of a soft-landing scenario in public finance conditions.
The question that thus arises is related to the sustainability of the trend reversal in growth and the outlook for the last quarter of 2004 and the full-year 2005, in the aftermath of recent political drifts. Within the context of a cloudy political environment, the impact of the recent political turbulence on growth could be limited, particularly if some confidence signals are rapidly sent by the state. With additional growth this year mainly driven by non-resident spending, it is unlikely to be drastically by local political issues. On the other hand, the adverse effect of the declining rates of interest on interest income and ultimately on private consumption this year, should be almost dissipated in the year to come. Within such an environment, rescuing a damaged domestic confidence is key to sustain local demand or strengthen economic growth at large.
The confidence enhancement requirement imposes on all state authorities the challenge of regaining the confidence of the Lebanese in their public institutions, restoring the process of structural adjustment and ultimately sending the right "assurance" signals to the private sector at large. The adoption of clear policy directions and objectives with well-defined adjustment measures and specific and explicit means to achieve them can have a strong impact on fiscal adjustment and reinforce the favorable trend of deficit reduction observed this year. The new policy statement adopted by the government concretizes a serious adjustment will, but needs to be undeniably complemented by concrete and viable measures for direct implementation, the signs of which are lacking so far.
One cannot but welcome and acknowledge any initiative that hinges over reducing the size of the public sector in the economy and giving room for the private sector to expand drawing on its large growth reserves, estimated at a minimum of 40 percent of potential output. Such a scenario, if realized, would contain further fiscal ratios, building on the recent fiscal performances that were recently acknowledged by the IMF. Whenever adopted, such measures would provide confidence signals to markets helping to extend the favorable real growth performance recently witnessed and sustain monetary resilience at large.
The suggested 2005 budget proposal has showed a possible way out of the public finance crisis in Lebanon. This does not mean, however, that the measures considered in the budget itself are binding and exclusive. A large number of alternative adjustment measures could still figure on any serious and credible reform agenda. The most important is that the aggregation of adopted measures would have a significant impact on the bottom line that is close to the one suggested in the budget proposal. It is crucial that the containment of deficits would be in line with the economy's growth rate in order for public finances to move into the so-called "virtuous circle" where the annual growth in public debt would be lower than the rise in nominal output at large.
There are actually a number of alternative spending cuts plausible through further austerity and rationalization of current expenditures, in addition to the containment of persisting leakages. In parallel, stringent revenue enhancement measures, even in the absence of increases in tax rates, could boost significantly resource mobilization. It is estimated that the gap in the collection of income taxes and electricity bills stands at over $1.5 billion. Bridging only partly this gap can have important spillovers on adjustment prospects. Notwithstanding the favorable effects on debt dynamics that could emanate from debt management efforts such as the securitization of the state's revenues or alternative structuring schemes in the context of seemingly absent tangible privatization measures at the horizon.
Disregarding the directions that the state is apt to adopt, it needs to show both willingness and capacity to implement reforms. In the absence of such measures, fiscal adjustment over the medium term will prove more difficult and may turn disorderly and therefore more disruptive of economic activity. Caught in the debilitating political struggle, economic policymaking has continued to lose momentum lately. What is hence required on behalf of economic policymakers is not to linger in their adjustment initiatives in order to avoid the high costs of paralyzing the country's reform process. It is certain that no one can today bear the devastating economic and financial consequences of a prolonged status-quo, with all its possible adverse spillovers on generations to come.
The Daily Star