Is Lebanon's economy crisis proof?

Gauche Caviar is a popular nightspot among Lebanon's wealthy young elite. It is Monday night and the bar is packed. Outside, top-of-the-range Mercedes and Range Rovers disgorge young Lebanese party-goers. The bar is part-owned by Paddy Cochrane, a half-Lebanese businessman who moved to the country from the UK in the early 2000s. Aside from Gauche Caviar, he and his business partner own another nightclub, a tanning salon and they are building a restaurant.

Mr Cochrane is typical of a generation of young, middle-class Lebanese, determined to succeed in the face of stiff odds. Since he arrived on Lebanon's shores he has operated in an environment of severe political instability that has seen civil unrest on the streets of Beirut, the assassination of prime minister Rafik Hariri, and outright war with Israel in 2006. Every time volatility spills over into violence, Lebanon's small, service-based economy is hammered. However, the country's businessmen and financiers have shown remarkable resilience to such crises and never fail to rise again, sometimes quite literally, from the ashes.

So far, so good

It has been a good year so far. In the first seven months of 2009, tourist numbers topped the 1 million mark, a 60% rise on the corresponding period last year. There is a tangible sense of optimism on the streets of Beirut. Mr Cochrane points out the Sky Bar, one of Lebanon's most popular venues, located on the rooftop of the Palm Beach Hotel in Beirut's Hamra district. He explains that its owner was almost forced to shut the place down in 2006 when Israel began a bombing campaign on the city. Israel's invasion was a revenge attack after Hizbollah, the Shia organisation that leads the opposition in Lebanon, captured two Israeli soldiers. Looking at the bar now, it seems hard to believe that only two years ago it was on the verge of closing down. Like every other bar or restaurant in Beirut's busy night-time streets, it is full to bursting with free-spending tourists and locals.

Political deadlock

Last June's peaceful election, which saw victory for the March 14 Alliance and the appointment of Saad Hariri as prime minister, was an event that many hoped would herald a new dawn of peace and reconstruction. Mr Hariri, who leads the anti-Syrian coalition March 14 party, had promised to unite the myriad religious and political interests in Lebanon's parliament and create a unity government. Three months on, however, and Mr Hariri has yet to achieve that goal. It is a source of great frustration for Lebanon's business leaders and financiers.

Political stability is the final part of the puzzle that would complete Lebanon's economic reconstruction that started with last year's Doha Accord. Many people in Lebanon regard the accord signed in Doha in May 2008 as a turning point in the country's political fortunes. It ended six months of political deadlock, put in place a unity government and established the date for the recent elections. Since that time, the economy has held up in the face of a global economic downturn and the nation's banks have won universal acclaim for avoiding the worst effects of the financial crisis.

A recent report from the International Monetary Fund (IMF) praised Lebanon for its sound financial management during a time of acute global economic turmoil. The fund even went so far, in August, as to say that the country could exceed its gross domestic product (GDP) growth rate forecast for 2009 of 4%. "Once more, Lebanon has mocked the doomsayers," says the IMF's Middle East and central Asia department. "[Its] ongoing economic resilience bolstered the banking system, with deposit inflows now growing at nearly 20% annually, and the central bank has accumulated international reserves, up 60% within a year to the equivalent of 70% of GDP." Lebanon's substantial overseas community has undoubtedly helped the country to stave off recession. Deposit inflows from the estimated 12 million Lebanese people that live outside the country have continued to soar in 2008 and 2009, despite predictions to the contrary.

Despite this solid economic performance, Lebanon still has a long road to travel before it can claim to have balanced the books. The critical issue for most observers is reform of Lebanon's archaic public finances - and for that the country needs political consensus. "The public sector is a burden on the private sector," says Nassib Ghobril, head of economic research at Byblos Bank in Beirut. "The private sector has been able to adjust to all the crises, expand regionally and be profitable. The public sector is the polar opposite. It is bloated, it is overstaffed and it is very expensive. It needs to be reformed so that the Lebanese economy can compete in the region and attract investment," he says.

Ballooning deficit

The government's biggest challenges will be to reduce the nation's $44bn-worth of public debt, which is equivalent to 160% of GDP, and to reduce its ballooning annual fiscal deficit. According to figures released by Lebanon's ministry of finance, the fiscal deficit was up 18% to $1.55bn in first half of 2009, compared with the equivalent period last year. Overall, government expenditures reached $5.8bn, up 21.9% year on year, and total revenues increased by 23.4% to $4.26bn over the same period. The good news for Lebanon is that the solution to the country's debt problem is at hand; the bad news is that it will need political consensus.

Dr Freddie Baz, chief executive of Lebanon's biggest bank, Bank Audi, is optimistic that the debt will be cleared eventually. "It is a question of cash flow. If you look at the assets still held by the government - public utilities, water, infrastructure, mobile phone licences and fixed lines - the solution is there. We have our own means of exiting. What we need is key policy issues to be implemented as soon as possible, but we lack political consensus," he says. Privatisation is the key to transforming the economy, but until Prime Minister Hariri succeeds in forming an effective unity government, it will remain a distant dream. The first priority will be for the government to reform the country's archaic electricity sector, which is a huge drain on public finances.

The IMF has also recommended that the government works towards a decisive structural reform of the energy sector to spur growth and privatise the country's two mobile phone providers. At present the mobile networks, MTC Touch and Alfa, are operated on behalf of the government by Zain of Kuwait and Orascom of Egypt, respectively. They contribute just over $1bn to government coffers annually, less tax, but their sale could potentially net $7bn.

Foreign relations

Looking ahead, one of the most critical determinants of Lebanon's prosperity will be its relations with its neighbours. War with Israel in 2006 was a violent reminder of how volatile these relations can be. According to a recent risk report by consultant Exclusive Analysis, published in this supplement, there is a "significant risk" of an Israel-Hizbollah war in the next two years. If true, this would be a major setback for the country's reconstruction and would certainly hamper attempts to turn Lebanon into an attractive investment environment.

However, if Lebanon has shown one thing since its independence from the French Mandate in 1943, it is a supreme resilience to both internal and external strife. The country is once again reinventing itself. Lebanon's central bank, under the prudent stewardship of Raid Salameh, has effectively protected the country's banks from the worst effects of the financial crisis and has built up more than $20bn-worth of foreign currency reserves. Despite the endemic security and political problems of Lebanon, its currency has remained stable against the dollar and so far this year, both deposits and lending in Lebanese pounds are up.

Saad Azhari, chief executive of Blom Bank, is optimistic for the future. "We have seen a strong shift towards the Lebanese pound. More and more people have confidence in the local currency and the central bank is intervening every day in order to avoid the currency appreciating against the dollar. This is a healthy sign," he says. "What we have seen are Lebanese investors with businesses abroad coming and investing in the country - opening new shops and offices. There is a feeling that Lebanon is a secure place to come for investment."