Lebanon's urgent need for economic reform

Q: In 2011 there have been significant macroeconomic and political developments in the region and there has also been a new government in Lebanon since the middle of June. As a result of these developments the Washington-based Institute of International Finance has revised down its GDP [gross domestic product] growth forecasts for 2011 from 4% in January to between 1.1% and 3% in June this year. How do you see the impact of the macro and political developments in the region, and in particular those in Syria and Egypt, on Lebanon and its economy?

Mr Sader: We [haven't had], until now, a clear opinion about the rate of growth in the Lebanese economy in 2011. As you mentioned, I have heard figures of 1.1% to 3%. Others are speaking about less than 2% now; a few months ago their position was about 2.5%. Today maybe it is less than 2%, but definitely it will be a growth of much less than last year or the past four years.

We are related to the [Gulf Co-operation Council] economies and we are expecting these financial flows to continue, maybe at a slower path, but this flow will continue. The other driver of growth in the country is bank credit. And while, for sure, we have more moderate banking credit growth compared to last year – we still have about 6% credit growth for the first five months of 2011.

Mr Baz: I believe that it’s still too early, honestly, to give an opinion because as Makram mentioned, we only have the indicators for the first four months of the year and, so far, those indicators show mixed signals. If you look at the real sector indicators among them – more principally the delivery of cement, electricity production, the velocity of money, planes at the airport – they all showed increases with respect to the corresponding period of last year, which confirms some kind of dislocation in growth rates in Lebanon.

But we have to keep in mind that seasonal factors are important in Lebanon and normally the contribution of the second half of the year has always been more important than the first half of the year. But, as Makram said, because we have the same reading of the situation, we are still seeing some kind of a disconnect, I would say, between the monetary sector and the real sector.

Nevertheless, there is still room for comfortable growth in the domestic economy within a range of 2%, 2.5% to 4%. But once again, it’s still too early; we have to wait a few months more in order to be able to give a more fine tuned opinion.

Mr Azhari: I’m not going to repeat the same things, but overall, maybe to summarise, the banking system is doing pretty well. We have seen the growth of total assets of about 4% to 5% in the first five months of this year. Deposits also grew by about 4% from the beginning of the year. Lending to the private sector, if you only take the private sector, then there was growth in the first five months of 7.2% from the beginning of the year, so it’s a year-on-year growth of about 19%.

So the banks are doing well, they are providing loans, the size of the banks and deposits are growing, the size of the banking sector is very large, so we are able to provide funding to the private and public sector and this is driving growth in Lebanon.

There is definitely political uncertainty that we have seen in the past six or seven months, and political tension, regionally and in Lebanon.

So we are in a transitory period and we have to wait and see the measures that the government is going to take [and] how the opposition and the other countries and communities are going to be dealing with the new government. So, we have to wait and see how things develop in the region and in Lebanon.

But I would reconfirm that all indicators tell us that the growth this year is going to be less than last year, probably between 2% to 4%.

Mr Haddad: Well, my colleague said it all but to summarise, there is no question that this year’s growth will be significantly lower than last year, whether we’re still waiting on the second quarter or the second half, it will be significantly lower. And with the political and security tensions around us and the extreme political tension that’s affecting political life in Lebanon, it’s bound to have a negative impact on confidence and on economic activity.

There is no question that in the short term, what is happening in Syria and Egypt is affecting these economies negatively. And many Lebanese banks are resident in Syria, significantly. The two largest Lebanese banks are also present in Egypt. So the impact is negative.

Now, how will it affect the banks? The banks in Lebanon are very well capitalised, very liquid and these investments that we all made in Syria and Egypt are all the long term; we’re not short-term players. So whatever shocks will be easily absorbed, given the level of capital adequacy and liquidity. How soon the turmoil in Syria and Egypt will end and what the outcome [will] be, I think it’s too early to tell.

Mr Baz: As long as our presence in those countries is a long-term presence we are building for the future. We are not driven by short-term considerations, we are not driven by our bottom lines in those countries; we are much more driven by our capacity to build a strong franchise over years. Although, we have committed to our shareholders to deliver profitability – obviously what we have been doing – starting year one in all those countries where we have expanded over the past few years.

But having said that, it’s amazing the level of resilience we have shown as Lebanese banks in those markets. If I have to take Egypt – in Egypt it was early February and now we have the luxury of statistical experience. We are almost in July, so we have a track-record of history. There hasn’t been any single downgrade to NPL [non-performing loan] status of our corporate clients.

We also took very prudent decisions, [including] allocating a major part of our pre-tax profit as collective provisioning. Today, early July, I can tell you very comfortably that most of those collective provisions taken in Egypt over the past four or five months look much more today as delayed profits for us, than definitive, real provisions.

Syria is a different context, prospects are not very clear, so we probably have to be cautious in making similar statements. But, so far, either in the corporate loan portfolio or in the retail loan portfolio, we haven’t witnessed major delays highlighting possible, plausible, political impairments or delinquencies.

Mr Azhari: The effect of Syria and Egypt on the Lebanese banks, I would say, that the growth is not going to be as strong as the years before because of the events, because of the current situation, due to this period of instability affecting economic growth in those countries. Our growth is not going to [be] significant in those markets.

We had expectations of high growth last year when there was stability in those countries, but because of Lebanese banks' conservative strategies in those countries and high liquidity I think that we are not witnessing any real problems or any increase of non-performing loans.

So really, the impact is minimal and because there is a movement now happening in country after country and there is a tendency to have more open systems. This is positive for the long term, for economic growth in the Arab world. We are not really pessimistic for the long term.

Q: One issue I wanted to address was that in Lebanon we have a new government from the middle of June and outside people want to understand how this will impact on Lebanon. From the economic perspective, there’s uncertainty there.

Mr Haddad: I will be very controversial, as usual. First of all; if you look at the Lebanese banking sector, the Lebanese banking sector is very solid, it’s well managed, it’s adequately capitalised, it’s liquid, it has a very low level of NPLs, and its profitability is good. It has a big Achilles' heel, however, we have a very large exposure to the sovereign and this represents 50% for our balance sheet. We don’t like it.

Therefore, there is a lot at stake in terms of who is running the country, so we have a new government. I am delighted, I think we are all happy to have a government; it’s better to have a government than not to have a government. The key question is whether this government will undertake structural economic reforms.

I was in a government for three years and we didn’t make reforms. I’m not proud of it – we tried, we went to the donor conference, we had, I think, a very credible programme, but we could not implement the programme for many reasons, including political.

My personal wish is that the new government should implement a programme similar to that; my expectation is that it will not implement anything and this is of grave concern because of the public finance situation. It has definitely deteriorated this year. I don’t know what my other colleagues will say and there doesn’t seem to be a willingness to discuss things the way they are.

The previous government and the previous minister of energy was concerned about reducing the price of gasoline, this is ridiculous and irresponsible. So it was irresponsible to want to reduce the price of gasoline because the impact on the public finance situation is bad.

The power sector is responsible for between $1.5bn and $2bn of the government deficit, a separate item after interest payment for debt services. And here, the obvious thing that needs to be done is to increase the tarification of our power. Iran, which is not a liberal economy, has done so and it’s high time we started doing so and we start putting issues on the table. I hope this government will do something about it, but I don’t expect it to.

Mr Azhari: To put things reasonably we cannot expect, for example, privatisation. You were saying that we cannot expect privatisation because there is no political consensus. But maybe we can hope [to] see [the] restructuring of some public institutions. Among them the most important is, as you mentioned, electricity, because it’s really leading the fiscal deficit.

Definitely, the [new] prime minister is a known businessman and he is very much concerned about the fiscal deficit and the debt and he always says that this is his concern. We hope that what he [is] always [talking] about, [indicates that] he wants to tackle this issue, that he will be able to tackle it. I think we have to give them a chance, as you mentioned, they are just starting.

Q: I was going to come to the privatisation question later, but perhaps it seems appropriate now. So I want to ask a broad question to all of you because the banks would clearly be involved in this, how possible is privatisation, how necessary is it and who will be the possible buyers?

Mr Azhari: May I just repeat that – I don’t think it’s now possible. I don’t think so because if you look at the new government formation there are clearly some parties that are important parties in the new coalition who are openly against privatisation.

So I don't see that this government is going to go ahead with privatisation. I see it more in terms of restructuring, in terms of restructuring of public institutions, trying to control the spending, increase revenues; but privatisation I think it’s difficult in this environment.

Mr Baz: I believe, personally, that the delay we observed so far in launching comprehensive financial reforms, among them most importantly privatisations, are much due to the lack of vision among decision makers.

Why is there opposition towards privatisation? Because there is a belief that the state of Lebanon is selling assets to reduce the principal of its debt, which is not necessarily in my view the objective of the privatisation. First of all, we don’t need to sell assets to adjust our persisting fiscal imbalances.

What people do not know is that the revenue gap in the budget represents close to 8% of GDP in Lebanon.

If the objective of selling assets to the private sector is supported by clear proof that it’s done to improve the overall efficiency of the economy much more than just to sell assets to reimburse a part of the debt to put into coherence the level of the debt with respect to the size of the rest of the economy, I believe that there will be a consensus. 

Q: Can I conclude on this that privatisation is not necessary to cut down the deficits?

Mr Haddad: It’s very necessary, unfortunately we are not talking about it. We are talking about it here. In the political sector people don’t talk about it. The media unfortunately doesn’t discuss these things.

So, there is nothing wrong in selling assets to reduce the debt because we are heavily indebted. It’s not the only objective but it is one objective, and in my view one objective should be to sell assets to reduce debt. There’s nothing wrong with that. 

Second, the main asset we have to sell is the telecoms sector that has a fair value and, if it is sold at market prices, could reduce our dollar-denominated public debt by up to a third or more. It’s not insignificant.

The key thing here is privatisation may be an aim in itself, it may not be, but the main thing is to create jobs, which we won’t discuss or very little, and to create more competition. What does the central bank have to do in owning an airline and why should we have a monopoly in the airline sector? We always had competition in our banks. We are good because it is a very competitive sector and well regulated. The central bank has no business owning Middle East Airlines and should sell it yesterday. 

Q: I want to focus a little on the micro performance of the banks, how you see them doing?

Mr Sader: Last year we had an average return of our assets of 1.1% and a return on our equity of about 18%. This year we will not have this level of returns on equity or on assets, a little bit less because we have less activity, our profit from outside Lebanon will be definitely less. But we are still expecting good performance in terms of return on equity and assets. Maybe on equity we can expect a 14% return if the trend of the first five months continues.

Mr Azhari: The results of the first quarter [of 2011] were better than the first quarter of 2010. I would say most of the banks are expecting to see the full-year result close to the results of 2010. So, they are going to be able to preserve the record profits that they had in 2010, which is pretty good in this environment in Lebanon and in the region.

And this is really amazing in this difficult environment for the region and also Lebanon. We have witnessed up to now from year to date an increase of assets, deposits and loans. The increase of loans to the private sector is 7.2%, an increase of deposits of 4% to 5%.

I am speaking to the private sector and there is relatively good growth. I mean, not as high as the year before because the year before we had witnessed a very high level of growth of lending and deposits – higher growth than this year. But at least we are seeing some growth. The margins are a bit squeezed but at the end we are expecting – or at least what we are hearing from different banks – expectations that they will be able to maintain their profitability or the profits that they had in 2010.

So, the results show that if you are already conservative and adopt conservative lending and conservative provisioning levels, you are able to withstand difficult times. This is what really makes the Lebanese banks resilient. It’s because we are managing in a very conservative way and we have high levels of provisioning and a high level of liquidity. 

Mr Baz: The best answer to the question of why Lebanese banks are maintaining profits is the sustainability of our revenues, because we are wondering how come the increased provisions are translating into sustained bottom lines. It’s because our revenues have increased in 2011 and even in Egypt and Syria revenues are sustained and our monthly averages show increases by 10% to 15% with respect to the monthly averages of 2010. This puts [Lebanon] in a very comfortable position whereby [banks] have the luxury of having the revenues and then deciding between breaking down what is put in the bottom line and provisions.

Q: Lebanon relies a lot on deposits coming in, as we all know. Now, how do we talk to the Lebanese diaspora and convince them to continue to send money to Lebanon when Syria is in the news every day and all the other problems? How do Lebanese banks continue to maintain those deposits? 

Mr Haddad: It’s a good question. I hate to use the expression 'old-fashioned conservative bankers', but we are taking good care of these deposits. This is why they keep coming. It is really quite remarkable.

I also confirm that for Byblos Bank we expect similar profitability, maybe a little higher, than what we had in 2010. The reasons why deposits keep coming – they are continuing to come but at a much reduced pace – is that we take good care of them. No depositor has lost any money in the Lebanese banking system over the past [few] decades and so it is, especially in this regional turmoil, the banking sector in Lebanon is a safe haven and the depositors seem to like it.

Mr Azhari: Yes, but I have to say that Lebanon is a special country. You have many more Lebanese living outside Lebanon than inside Lebanon and you have a lot of Lebanese living in the Gulf, in Africa and a lot of them have immediate families living here. So, there is a natural flow of deposits. 

Somewhere between 30% and 40% of our customer accounts receive monthly transfers from relatives abroad, so from either a husband or a son or a father. So really there is a continuous flow and I think it’s going to continue. This amount, usually between $6bn and $8bn, we always have seen that.

Q: How do you see the outlook for 2012? Some suggest lower growth in 2011 but some see higher growth in 2012, is this valid? And what about international issues such as Basel III?

Mr Sader: I think if we have political stability during the remaining period of 2011 and during 2012, I think we will resume again an economic growth rate of maybe about 4%, if not more, because the demand component, domestic and regional, will be there. And it is not just organic growth in Lebanon. We are determined by the regional situation and I think we will have in 2012 a much better economic growth rate.

We decided in Lebanon as the banking industry and as the regulator, to implement seriously Basel III and it is not hard for us to implement it. We have the required liquidity, we already have good capital adequacy ratios, we already have a stable deposit base, etc. But we don’t know what will be the exact international standard to be implemented.

Mr Haddad: I agree that potentially we can have a good year in 2012 but there are a lot of Lebanese political and regional political uncertainties and because of that in Byblos Bank we are being very cautious in terms of our lending policy and we are very cautious in terms of our liquidity. We are very liquid and we are adopting a wait-and-see attitude. But potentially, yes, you can have a phenomenal 2012 if things beyond our control are stabilised.

Mr Azhari: If you look year on year, a year ago the equity of the banking sector was about $8.4bn to $8.5bn, now we are close to $10.4bn to $10.5bn. There is an increase of 22% of the capital of banks in Lebanon. Maybe this was the highest increase in any item of the balance sheet, the equity. And the size of the assets are also increasing significantly. 

Banks in Lebanon are well capitalised and most of the major banks are above the Basel III requirement in terms of equity. On liquidity the central bank in Lebanon has for a long time also forced us to have a high level of liquidity. We have to have 15% of our deposits with the central bank as liquid. Over and above that most of the Lebanese banks also have an internal requirement to have a high percentage of liquidity with foreign banks.

So, the Lebanese banks are highly liquid, they are well-capitalised and they are ready for Basel III.