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COUNTRY REPORT

Lebanon

January 2001

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

At a glance: 2001-02OVERVIEWLebanon’s outlook rests heavily on the ability of the new prime minister,Rafiq al-Hariri, to impose his government’s plans on the state’s fractious eliteand parliament. His working relationship with the president, Emile Lahoud,will be crucial. The government has unveiled an ambitious, growth-orientedeconomic reform programme, which is set to increase pressure on strainedgovernment finances, placing the stability of the Lebanese pound in doubt.Growth should resume in 2001 for the first time in two years, but the tradeand current-account balances will remain heavily in deficit.

Key changes from last monthPolitical outlook• There have been early signs that the rapprochement between Mr Hariri

and Mr Lahoud may be weakening, raising the prospect of a new, debil-itating power struggle between the two leaders. Hizbullah's support for thenew Palestinian intifada (uprising), and its low-level campaign to liberatedisputed territory currently controlled by Israel, has increased the risk ofIsraeli airstrikes into Lebanon.

Economic policy outlook• The premier has outlined his economic strategy, setting aside his prede-

cessor’s efforts to constrain public debt growth in favour of an ambitiousliberalisation programme focused on boosting economic growth and en-couraging trade and investment. The government has also undertaken tocut taxes and move ahead with the long-stalled privatisation programme.

Economic forecast• The reform programme will boost growth over the forecast period, pro-

vided that the government is able to maintain local confidence in the faceof a mounting fiscal deficit and increased strain on the currency. The tradeand current-account deficits will widen as imports rise.

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Lebanon 1

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual Indicators6 Quarterly indicators

7 Outlook for 2000-017 Political outlook8 Economic policy outlook9 Economic forecast

12 The political scene

17 Economic policy

24 The domestic economy24 Economic trends26 Infrastructure27 Financial and other services

28 Foreign trade and payments

List of tables

10 International assumptions summary11 Forecast summary21 Government finances25 Selected economic indicators26 Tourist arrivals29 Balance of payments

List of figures

6 External trade6 Interest rate

12 Gross domestic product12 Lebanese pound exchange rate24 Gross foreign reserves, 2000

Lebanon 3


Summary

January 2001

Lebanon’s outlook rests heavily on the ability of the new prime minister, Rafiqal-Hariri, to impose his government’s plans on the state’s fractious elite andparliament. Mr Hariri’s working relationship with the president, Emile Lahoud,will be crucial; there are already signs that their initial rapprochement hasbecome strained. The government has unveiled an ambitious, growth-orientedeconomic reform programme, which is set to increase pressure on strainedgovernment finances, placing the stability of the Lebanese pound in doubt.Growth should resume in 2001 for the first time in two years, but the trade andcurrent-account balances will remain heavily in deficit.

Mr Hariri has formed his new government, reflecting the power-sharingarrangement between the country’s major powerbrokers. Calls have increasedfor Syria to withdraw its troops from Lebanon, prompting Damascus to offer aseries of concessions, including the release of political prisoners from Syrianjails. In the south, Hizbullah has begun offering the Palestinian intifada(uprising) political support, and has relaunched low-level hostilities againstIsrael over a small disputed border area.

Mr Hariri has outlined his growth-oriented liberalisation programme, im-mediately launching an “open skies” policy to increase air traffic, and cuttingcustoms duties, as well as pledging to reduce the national social insuranceburden on business. The government has conceded that the moves will lowergovernment revenue in the short term, exacerbating the budget deficit.However, with the economy suffering low levels of growth in recent years,Mr Hariri has argued that there is no alternative other to stimulate growth, togenerate higher government receipts and a stronger fiscal position in themedium term.

Most estimates point to zero growth for 2000 as a whole. Tourism appears tohave enjoyed a strong summer season, however, and there have been somesigns of modest recovery in the construction sector. Lebanon has signed agree-ments to improve its access to international energy supplies, and the bankingsector has begun to explore growth opportunities in neighbouring Syria.

Gains in export earnings have been offset by increased import spending, andthe trade balance has remained heavily in deficit. Strong non-trade inflowshave held the overall balance of payments in check, although a growingproportion of the inflows appear to be in the form of debt, rather than directinvestment and transfers.

Editors: Simon Williams (editor); Merli Baroudi (consulting editor)Editorial closing date: January 16th 2001

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2001-02

The political scene

Economic policy

The domestic economy

Foreign trade andpayments

4 Lebanon


Political structure

Republic of Lebanon

Parliamentary republic

Based on the 1926 constitution (with amendments incorporated in 1990) and theCivil Procedure Code, the Criminal Procedure Code and the Penal Code

Under the electoral law of July 16th 1992, the unicameral National Assembly has128 seats equally divided between Muslims and Christians

Universal direct suffrage over the age of 21

August-September 2000 (legislative); next elections due by 2003 (presidential) and 2004(legislative)

The president, currently Emile Lahoud, who was elected in November 1998 for a six-yearterm by the National Assembly. Under an unwritten agreement, the president must be aMaronite Christian

The prime minister is chosen by the president after consultation with parliamentarydeputies; the government is then chosen by the designated prime minister and thepresident. Ministers need not be members of the National Assembly, but are responsibleto it. The prime minister must be a Sunni Muslim. The current government wasappointed in November 2000

Hizbullah (Shia), Amal (Shia), National Liberal Party (Christian), National Bloc(Christian), Kataeb Party (largest Christian party), Progressive Socialist Party (mainlyDruze), Syria Social Nationalist Party

Prime minister Rafiq al-Hariri (Sunni)

Deputy prime minister Issam Fares (Greek Orthodox)

Agriculture Ali Abdallah (Shia)Defence Khalil Hrawi (Maronite)Economy & trade Bassil Fleihan (Protestant)Education Abdel-Rahim Mrad (Sunni)Electricity & water resources Mohammed Abdel-Hamid

Beydoun (Shia)Environment Michel Musa (Greek Catholic)Finance Fouad Siniora (Sunni)Foreign affairs Mahmoud Hammoud (Shia)Health Suleiman Franjiyeh (Maronite)Industry Georges Frem (Maronite)Information Ghazi Arida (Druze)Interior & municipal affairs Elias Murr (Greek Orthodox)Internal refugees Marwan Hamadeh (Druze)Justice Samir Jisr (Sunni)Labour Ali Kanso (Shia)Telecommunications & post Jean-Louise Cordahi

(Maronite)Transport & public works Najib Miqati (Sunni)

Nabih Birri (Shia)

Riyadh Salameh (Maronite)

Official name

Form of state

Legal system

National legislature

Electoral system

National elections

Head of state

National government

Main political organisations

Parliamentary speaker

Central bank governor

Key ministers

Lebanon 5


Economic structure

Annual indicators

1996 1997 1998a 1999a 2000a

GDP at market prices (L£ bn) 20,417.0 23,034.0 25,337.4 25,066.7 25,040.8

Nominal GDP at market prices (US$ bn) 13.0 15.0 16.7 16.6 16.6

Real GDP growth (%) 4.0 4.0 2.0 –1.0 0.0

Consumer price inflation (av; %) 8.9 5.2a 3.8 0.5 0.0

Population (m) 3.1 3.1a 3.2 3.3 3.4

Exports of goods fob (US$ m) 736.4 633.8 715.9b 676.8b 700.5

Imports of goods fob (US$ m) 6,992.0 7,479.0 7,081.4b 6,217.2b 6,278.6

Current-account balance (US$ m) –3,687.1a –3,813.6a –3,321.3 –2,276.5 –2,199.0

Reserves excl gold (US$ m) 5,931.9 5,976.4 6,556.3b 7,775.6b 6,000.0

Total external debt (US$ bn) 4.0 5.0 6.7b 7.9 9.6

Debt-service ratio, paid (%) 6.4 14.1 9.0b 16.0 25.5

Exchange rate (av; L£:US$) 1,571.4 1,539.5 1,516.1b 1,507.8b 1,507.5b

January 16th 2000 L£1,507.5:US$1

Origins of gross domestic product 1997 % of total Components of gross domestic product 1997 % of total

Services 68.8 Private consumption 101.0

Industry 29.8 Government consumption 15.7

Manufacturing 19.5 Fixed investment 26.7

Agriculture 14.0 Exports of goods & services 10.4

GDP at factor cost 100.0c Imports of goods & services –53.8

GDP at market prices 100.0

Principal exports fob 1999 % of total Principal imports cif 1999 % of total

Food products 20.2 Food products 19.8

Jewellery 14.2 Electrical products 14.7

Chemical products 12.6 Vehicles 9.9

Metal products 11.7 Minerals & other mineral products 9.8

Electrical products 10.8 Chemical products 9.3

Textiles 8.1 Jewellery 7.4

Main destinations of exports 1999 % of total Main origin of imports 1999 % of total

Saudi Arabia 11.0 Italy 12.9

UAE 9.0 France 10.5

France 6.3 Germany 7.4

US 6.3 US 6.5

a EIU estimates. b Actual. c Total does not sum in source.

6 Lebanon


Quarterly indicators

1998 1999 20004 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

OutputCoincident Indicator (Jan 1993=100; end-period) 193.6 189.2 184.0 183.5 196.3 198.8 188.8 194.7

Financial indicatorsExchange rate L£:US$ (av) 1,509 1,508 1,508 1,508 1,508 1,508 1,508 1,508 L£:US$ (end-period) 1,508 1,508 1,508 1,508 1,508 1,508 1,508 1,508Interest rates (%) Deposit (av) 13.35 12.91 12.58 12.55 11.95 11.53 11.17 11.12 Discount (end-period) 30.0 30.0 30.0 25.0 25.0 20.0 20.0 20.0 Lending (av) 20.12 19.84 19.65 19.63 18.78 18.40 18.22 18.03 Treasury bill (av) 12.18 11.73 11.73 11.63 11.18 11.18 11.18 11.18M1 (end-period; L£ bn) 2,052 1,998 1,962 2,075 2,261 2,227 2,257 2,284 % change, year on year 6.3 13.3 3.7 6.2 10.2 11.5 15.0 10.1M2 (end-period; L£ bn) 40,139 40,845 41,642 43,124 44,825 45,936 47,009 47,983 % change, year on year 16.1 16.1 12.4 11.8 11.7 12.5 12.9 11.3BDL stockmarket index (end-period; Jan 1996=100) 89.4 49.5 55.9 41.4 56.1 42.3 44.5 42.5 % change, year on year –27.8 –56.1 –49.6 –52.2 –37.2 –14.5 –20.4 2.7

Sectoral trendsConstruction permits (end-period; ‘000 sq metres) 1,329.4 656.4 861.8 764.4 911.3 651.6 662.1 643.8

Foreign trade & reserves (US$ m)Exports fob 195 135 154 179 209 163 174 185Imports cif –1,823 –1,541 –1,492 –1,618 –1,554 –1,429 –1,533 –1,638Trade balance –1,628 –1,406 –1,338 –1,439 –1,345 –1,266 –1,360 –1,453Reserves excl gold (end-period) 6,556 6,673 6,458 6,915 7,776 7,435 6,872 6,580

Sources: IMF, International Financial Statistics; Banque du Liban, Monthly Financial Market Data.

Lebanon 7


Outlook for 2001-02

Political outlook

Lebanon’s political and economic outlook rests heavily on the ability of thenew government to impose itself on the state’s fractious elite and powerfulNational Assembly. For much of its two years in office, the previous govern-ment led by Salim al-Hoss found itself unable to act, constrained by its weakdomestic standing, the growing power of un-elected security officials workingfor the president, Emile Lahoud, and an increasingly hostile parliament. Thispolitical stalemate cannot be repeated if pressing domestic, external and econ-omic issues are to be managed effectively. At present, the prospects for an im-provement in the political process are positive. Rafiq al-Hariri, the new primeminister who came to power in November, is a forceful leader whose strongshowing in the 2000 general election established his democratic mandate andunderlined the strength of his domestic popularity. The success of his electionlist in the polls has also given him a firmer base of support in the assemblythan his predecessor enjoyed, spread across all of the main sectarian groups.

Parliamentary opposition seems certain to increase, however, as Mr Hariribegins to implement his economic reform programme, elements of which willthreaten the interests of particular sectarian groups. Mr Hariri is an experiencedmanipulator of Lebanon’s sectarian political dynamic, and this skill will bevital if parliament is to be managed. As significant will be the attitude ofMr Lahoud and of neighbouring Syria to the premier. Mr Lahoud—who was inlarge part responsible for the downfall of the previous Hariri administration in1998—made no secret of his wish not to re-appoint Mr Hariri last year, whileSyria also did not favour him. So far, though, both parties have shown them-selves ready to work with the premier, and if he continues to enjoy theirsupport, then parliament will fall in line. Mr Lahoud’s acquiescence is likely towane over time, however, as Mr Hariri tries to assert himself as Lebanon’s dom-inant actor and infringes on the president’s political privileges. Unless Syria isable to broker a working arrangement between the two men, a return to thepower struggle that led to Mr Hariri’s resignation last time could ensue, under-mining the political process markedly.

The other issue which threatens to sap the new government’s drive is the in-creasingly public debate over Syria’s role in the country. There has long beenconsiderable local opposition to Syria’s 24-year military presence in Lebanon,but until recently debate has been restricted to the margins. However, the endof Israel’s occupation of southern Lebanon, and the accession to power of theinexperienced Bashar al-Assad in Syria, on the death of his widely feared fatherin May 2000, have brought opposition to Syria out into the open. There aresigns that demands for the withdrawal of Syrian troops have spread from thehardline elements of the Maronite community towards the political main-stream. Mr Hariri will be obliged to contain this debate, but sensing weaknessin Damascus, and having broken the taboo on discussion of the issue, pro-ponents of Syrian withdrawal are set to intensify their campaign. The likelyoutcome is unclear, but as Syria’s presence has underpinned political order

Domestic politics

8 Lebanon


throughout the post-war period, vociferous demands to end it can only add todomestic uncertainty.

With Syrian relations viewed as domestic policy, the most important foreign-policy issue for Lebanon over the forecast period will remain relations withIsrael. The end of Israel’s 22-year occupation of the south has so far resulted ina period of calm on the border. However, the peace is fragile and incomplete:insufficient troops are in place to enforce order in the area, while Hizbullah,the militia which led the campaign against Israel, maintains that Israel con-tinues to hold Lebanese prisoners and occupy some Lebanese land. Hizbullahhas begun a low-level military campaign to free the territory and secure therelease of its prisoners. This has markedly increased tension on the border,especially as it has coincided with escalating unrest in the West Bank and Gaza,for which Hizbullah has offered strong political support. Preoccupied withPalestinian unrest, Israel has so far failed to offer a military response toHizbullah’s “provocations”; however, there is every prospect that it willeventually do so, especially in the run-up to a security-focused prime-ministerial election in Israel in February, with the possible election of thehardline right-winger Ariel Sharon. Even the election of Mr Sharon would beunlikely to lead to an attempt to re-occupy southern Lebanon, but it wouldincrease the risk of punitive Israeli military strikes against Hizbullah andcivilian targets in Lebanon, with likely Hizbullah counter-strikes into Israelraising tension further.

Economic policy outlook

Economic policy will be the focus of the new government’s energies. Under-lining the urgency with which he feels reforms must be introduced, Mr Haririhas already begun to act, outlining an ambitious, expansionist programme thatmarks a decisive break with the approach of his predecessor. Whereas Mr Hossintroduced a range of austerity measures designed to bring the escalatingbudget deficit under control, Mr Hariri has committed himself to stimulatingprivate-sector growth, increasing trade and attracting investment, trusting thatrapid expansion will generate higher government revenue in due course, pro-viding a medium-term solution to chronic fiscal deficits and mounting publicdebt. The government has also undertaken to move forward with the stalledprivatisation programme.

Abandoning the Hoss administration’s fiscal austerity programme and seekingto grow Lebanon out of its fiscal impasse is a high-risk strategy. Public financesare already under unprecedented pressure, with the budget deficit and publicdebt stock estimated to have reached some 20% and 140% of GDP, respectively,by end-2000. While Mr Hariri’s growth strategy may stabilise public finances inthe medium term, there is likely to be a short-term deterioration. As part of itsliberalisation programme, for example, the government has already introducedwide-ranging cuts to customs duties, even though these were previously thelargest single source of government revenue. Expenditure also seems likely torise, both as a result of mounting interest payments on the debt stock, and as a

International relations

Policy trends

Fiscal policy

Lebanon 9


product of anticipated increases in growth-oriented capital spending.Projecting the deficit for 2001 is difficult, given the scope of Mr Hariri’s reformsand the delayed release of the budget, but at present the EIU expects the deficitto rise from an estimated US$3.2bn in 2000 to some US$3.8bn, the equivalentof 55% of total expenditure and 22% of projected GDP.

Sustaining an escalating deficit of this scale will prove the primary challengefor the new administration. Increased pressure on the Lebanese pound over2000 reflected a sharp downturn in confidence, generated in large part by thechronic imbalances in public finances. If Mr Hariri is to reverse this trend, hewill not only have to convince local opinion of the logic of his economicreforms, but must also show that he has the political strength to implementthese in full. Crucial tests will be the development of the privatisation pro-gramme and promised reforms to the tax system—including the introductionof value-added tax (VAT). These have the scope to ease pressure on the budget,but have been derailed in the past by parliamentary opposition. Mr Hariri’splan will also have to deliver rapid, but sustainable results, if he is to demon-strate that the potential for substantial growth in which he has placed his faithactually exists. Even if he is successful in this, the willingness of local creditorsto continue to buy government debt could be undone by any one of a series ofexogenous shocks, or by a deterioration in local or regional political cir-cumstances, such as an escalation in violence on the Israeli border or theemergence of a debilitating power struggle between the premier and thepresident. Should confidence break, the reform programme would becomeunviable, growth would slump, and the Lebanese pound’s peg to the US dollarwould be broken.

Monetary policy will remain tight, as the Banque du Liban (the central bank)continues to focus on maintaining the currency’s peg to the dollar. Given thescale of the government’s borrowing requirements, and fears over the sus-tainability of the budget deficit, there is little short-term prospect of a cut ininterest rates, despite pressure from the government for an easing of rates tolower its debt-servicing costs. Falling US interest rates also seem unlikely to bemirrored in Lebanon, although the widening differential to dollar rates shouldprevent a rate rise over the short term. There will be more scope for a reductionin 2002, assuming that US rates decline as we expect, but much will depend onthe state of government finances at that time, as well as the impact on thepound of an improved growth rate and political conditions. On balance, wecontinue to expect rates on benchmark two-year Treasury bills to remain above14% this year and next.

Economic forecast

We have revised our world economic outlook downwards slightly since ourprevious report, but the overall trend remains unchanged, with exceptionalglobal growth in 2000 expected to give way to slower, but still robust rates ofexpansion in 2001 and 2002. This should support increases in the averagedollar prices for most manufactured goods, services and commodities. Theexception will be oil prices, which are set to fall by some 18-19% in both 2001

Monetary policy

International assumptions

10 Lebanon


and 2002. The US dollar, meanwhile is projected to weaken against most othermajor currencies, drawing the Lebanese pound down with it. The slowdown inthe US economy should also allow some further easing in US interest rates,widening the differential on local rates.

International assumptions summary(% unless otherwise indicated)

1999 2000 2001 2002

Real GDP growthWorld 3.5 5.0 4.2 4.1OECD 3.0 4.1 3.0 2.7EU 2.4 3.3 3.0 2.6

Exchange rates (av)¥:US$ 113.9 107.6 108.5 104.5US$:€ 1.07 0.92 0.95 1.05SDR:US$ 0.731 0.766 0.779 0.740

Financial indicators¥ 2-month private bill rate 0.27 0.21 0.45 0.98US$ 3-month commercial paper rate 5.18 6.32 6.25 5.25

Commodity pricesOil (Brent; US$/b) 17.9 28.8 23.4 19.1Gold (US$/troy oz) 278.8 283.2 275.0 270.0Food, feedstuffs & beverages

(% change in US$ terms) –18.6 –6.0 10.6 14.1

Industrial raw materials (% change in US$ terms) –4.2 14.2 4.2 9.6

Note. Regional aggregate GDP growth rates weighted using purchasing power parity (PPP)exchange rates.

We have revised our estimate of growth for 2000 down to 0%—a figure whichmay still prove overly optimistic. Most indicators suggest that the economy re-mained in recession over the first half of the year, and our expectation of flatgrowth rests on early signs of stronger performance in the tourism and con-struction sectors over the second half, and improved confidence in politicalconditions following the removal of the unpopular Hoss administration.Projections for the remainder of the forecast period are hazardous, complicatedby uncertainty over the likely impact of Mr Hariri’s sweeping reform pro-gramme. However, we do expect demand to rise, and currently project growthat 2% for 2001, rising to 3% for 2002. The first figure falls some way belowofficial growth projections of 3-5% for 2001, and may prove overly con-servative if the reform programme has the immediate impact Mr Hariri ishoping for. The most serious risks are on the downside, however, and if thefiscal deficit does push government finances and the currency into crisis, theeconomy will return to recession.

Weak domestic demand and low import prices kept inflationary pressures to aminimum in 2000; we estimate that prices showed no growth over the year.Strengthening growth will offer some scope for price rises over the forecastperiod, but with only a slow recovery, and the economy operating well withincapacity, demand-driven inflation will be modest. There will be moresignificant external pressures, with the euro expected to strengthen against the

Economic growth

Inflation

Lebanon 11


Lebanese pound, and higher average import prices forecast for a range of com-modity and manufactured goods. The impact on consumer prices will be offsetby cuts in customs duties, however, and overall we expect inflation to remainlow, at some 1.5% in 2001, rising to 2% in 2002.

We expect the pound to stay within its trading range of L£1,501-1,514:US$1over the short term. Defence of this peg is the focus of monetary policy, andthe central bank has sufficient authority over interest rates and access to largeenough reserves to mount a strong defence. Beyond a six-month horizon,however, the outlook is far less certain. Confidence in the currency has pickedup since Mr Hariri was elected, but if his reform programme falters, or thedeficit accelerates beyond our modest expectations, pressure on the currencywill mount sharply. In such circumstances interest-rate increases would havelittle credibility, given the pressure servicing costs already place on the budget,while the sharp fall in official reserves over 2000 is a reminder that evenreserves as large as Lebanon’s cannot sustain a currency indefinitely. Theliquidity of the local banks—which hold the overwhelming majority of local-and foreign-currency government debt—and Mr Hariri’s allies in the Gulf couldbe tapped to provide support for the currency, but this could not maintain thepeg indefinitely, and a steep devaluation remains likely if confidence in thepremier’s programme evaporates.

Forecast summary(% unless otherwise indicated)

1999a 2000a 2001b 2002b

Real GDP growth –1.0 0.0 2.0 3.0

Consumer price inflation Average 0.5 0.0 1.5 2.0 Year-end 0.3 0.8 1.8 1.0

Two-year Treasury-bill rate 14.6c 14.6 14.6 14.6

Government balance (% of GDP) –14.3 –19.5 –22.1 –23.6

Exports of goods fob (US$ bn) 0.7c 0.7 0.7 0.8

Imports of goods fob (US$ bn) 6.2c 6.3 6.6 6.9

Current-account balance (US$ bn) –2.3 –2.2 –2.5 –2.7 % of GDP –13.7 –13.2 –14.4 –14.8

External debt (year-end; US$ bn) 7.9 9.6 11.4 13.3

Exchange rates L£:US$ (av) 1,507.8c 1,507.5c 1,507.5 1,507.5 L£:¥100 (av) 1,323.7c 1,401.5c 1,389.4 1,442.6 L£:€ (year-end) 1,514.4c 1,319.1c 1,522.6 1,643.2 L£:SDR (year-end) 2,069.1c 1,870.2c 1,997.6 2,073.0

a EIU estimates. b EIU forecasts. c Actual.

Lebanon’s overwhelming dependence on imported goods will ensure that thetrade deficit remains high over the forecast period. We expect import spendingto rise to US$6.6bn in 2001, as local demand strengthens and recent tariff cutstake effect, increasing to US$6.9bn in 2002, as growth picks up. The rise inspending will be partly offset by sustained annual growth in export earnings,but the deficit will still rise steadily, from some US$5.6bn in 2000 to US$6.1bn

External sector

Exchange rates

12 Lebanon


in 2002. The complete absence of data on non-goods transactions makesestimates of the current account highly unreliable. However, an increase intourism-related invisibles earnings should offset higher income payments onthe state’s rising external debt, and stronger services charges, leaving a current-account deficit of some US$2.5bn in 2001, increasing to US$2.7bn in 2002.

The political scene

Billionaire businessman Rafiq al-Hariri was appointed prime minister in lateOctober, returning to office after a two-year absence. Although the president,Emile Lahoud, would have preferred almost any other candidate for the job,the strength of Mr Hariri’s showing in the parliamentary election (October2000, pages 13-15), left him little choice but to appoint him. During theprivate consultations between the president and MPs—the process by which, intheory at least, the new premier is selected—106 of the 128 assembly membersreportedly pledged their support for Mr Hariri. However, the process was notentirely trouble-free, with Mr Lahoud at one point threatening to form amilitary government, following a row during the selection process.

During most of Mr Hariri’s three consecutive terms in office between 1992 and1998, he enjoyed the overwhelming support of Syria, and as a result wasafforded a free hand to implement policies of his choice and form his owngovernments. Mr Hariri is not in as dominant a position within the new ad-ministration, however, and has been required to concede more influence underthe new power-sharing arrangement. Ahead of his official appointment, aninformal agreement was reached under which he gained control of economicpolicy, while Mr Lahoud maintained control of defence and security issues.Foreign policy, as ever, remains the realm of Syria, which in reality also has adirect say over defence and security issues. At the start of the new parlia-mentary session Nabih Birri was re-elected as house speaker for a third term,allowing him to continue as the highest constitutional representative of theShia Muslim community.

Mr Hariri returns to office,despite president’s hostility

Cabinet posts are dividedbetween political leaders

Lebanon 13


Mr Hariri’s new government also reflects a power-sharing arrangement betweenthe country’s major powerbrokers, and continues the traditional division ofposts among the main religious communities. To allow him to implement hiseconomic reform programme, Mr Hariri installed his own supporters at theministries of finance and economy and trade. He also selected the educationand justice portfolios, with the latter an apparent bid to extricate some of hisassociates from the questionable corruption charges brought against them bythe previous government. Fouad Siniora—one of Mr Hariri’s supporters whohad been facing corruption allegations—was appointed as minister of finance,a position he held throughout much of the 1990s, while Bassil Fleihan,Mr Siniora’s technocrat assistant during the previous Hariri administration, wasmade minister of economy and trade. Samir Jisr, another ally of the primeminister, became minister of justice, while Mr Hariri’s former minister ofjustice, Bahij Tabbara, joined the cabinet as a minister without portfolio—apparently to support Mr Jisr’s effort to exonerate those facing corruptioncharges. In addition, Mr Hariri appointed Issam Fares as deputy prime minister.Mr Fares is a billionaire businessman with strong connections in the ArabianGulf, an identical background to Mr Hariri. More significantly, Mr Fares hasstrong ties to the US Republican Party, and is a friend of the former US pres-ident George Bush senior—a link which many Lebanese hope will offer a directline to the White House during the presidency of George W Bush.

The president chose a similar number of positions within the government,with the most significant appointment that of Elias Murr as interior minister.Mr Murr is not an MP, and has no experience in elected office, but happens tobe the son of the outgoing interior minister, Michel Murr, who served for morethan a decade as, in effect, Syria’s governor-general in Lebanon. Elias Murr isalso the president’s son-in-law. Mr Lahoud’s other choices included the in-dustry minister, Georges Frem, and the telecommunications minister, Jean-Louise Cordahi. Mr Hariri had wanted to give the latter post to GhinwaJalloul—which would have made her the first female minister— but sacrificedthe post to ensure control of the major economic portfolios. Mr Cordahi is inany case not expected to oppose the prime minister’s plans for privatisation inthe sector.

In choosing his representatives in cabinet, the parliamentary speaker, NabihBirri, selected his deputy within the Amal movement, the young and well-regarded Mohammed Abdel-Hamid Beydoun, as minister of electricity andwater. He nominated Ali Abdallah as agriculture minister and Asaad Diab associal affairs minister, with these portfolios designed to see that the interests ofhis largely rural Shia community remain well served. Mr Birri selected MichelMusa, one of the few Christian MPs from the Birri-controlled south of thecountry, to serve as environment minister, ensuring that the speaker’s patron-age network will continue to extend beyond his own Shia Muslim community.

Walid Jumblatt, the maverick leader of the Druze community, chose MarwanHamadeh as minister of internal refugees created by the war—an issue centralto the Druze, as most of the displaced are from their Mount Lebanonhomeland. Mr Jumblatt also paid back the Christian community of MountLebanon for their support during the election by demanding improved

Mr Birri and Mr Jumblatttake a smaller share

14 Lebanon


Christian representation, and appointing several Maronites, including FuadSaad as minister for administrative reform. Several of Syria’s most loyal sup-porters remained in the cabinet to ensure continuity, including Najib Miqatiand the pro-Syrian Christian strongman, Suleiman Franjiyeh. Damascus alsosaw to it that Ali Kanso—head of the Lebanese branch of the Syrian Baathparty—received a cabinet post. In total, 30 ministers were appointed to thecabinet, one-half members of the Christian community and one-half from theMuslim community.

Hizbullah, the Shia Islamist movement whose guerrilla fighters led the cam-paign against Israel’s occupation of the south, is the most glaring omissionfrom the new government. The party has 12 MPs in its parliamentary block—more than enough to earn it a place in the cabinet, especially in light of thesuccess of its campaign against Israel. In the aftermath of the polls there wasconsiderable speculation that the party would accept posts in government;however, at the last moment it declined, apparently preferring to remainunsullied on the political sidelines, rather than plunging into the mire ofLebanese government. Its reluctance may also in part reflect misgivings overMr Hariri, whose “wheeler-dealing” business mentality has always sat un-comfortably with the party’s own approach to political life, despite the strongverbal support Mr Hariri offered to the resistance during his previous term inoffice. It was significant that Hizbullah deputies made up the bulk of the par-liamentary members who refused to support the vote of confidence inMr Hariri, apparently confirming the longstanding view that the group feelsmore confident in its relations with Mr Lahoud than the new premier.

How well the power-sharing arrangement will function, and in particular, howeffectively Mr Hariri and Mr Lahoud will be able to work together, is hard tojudge, but will prove to be the major issue determining the success of the newadministration (see Outlook for 2001-02). Neither leader is accustomed tosharing power, and when they last sought to do so in 1998 the ensuingstruggle led to political paralysis, culminating in Mr Hariri’s resignation.Supporters of both men were quick to argue after the new government wasappointed that a rapprochement had been affected, with the premier himselftelling journalists that friction between the two was “a thing of the past”, andthat relations were now based “on mutual respect on the personal level andfull respect for the institutions we head”.

Despite these proclamations of good intent, there have already been early signsthat jockeying for position has begun. In late 2000 Mr Hariri publicly allegedthat the security services—and by extension Mr Lahoud—were tapping phoneconversations between himself and Mr Birri. The allegation raises long-standingclaims that Mr Lahoud is over-reaching his authority, and also points to astrengthening alliance between Mr Hariri and Mr Birri against the president.Mr Lahoud, meanwhile, convened the Higher Defence Council—a body in-tended to meet during times of national emergency—in December. None of theissues discussed at the meeting appeared to justify the first convention of thecouncil in a decade, but as the council is chaired by the president, not theprime minister, it offered Mr Lahoud an opportunity to assert his authority and

Hizbullah chooses to stayaloof from political process

Hariri-Lahoud ties arealready under strain

Lebanon 15


set the political agenda. Tensions also increased in early January whenMr Hariri invited General Michel Aoun—a former prime minister and hardlinewar-time Christian leader—back from political exile in France, guaranteeingthat he would not be arrested. The gesture appeared to be designed to buildMr Hariri’s links with the Christian opposition movement, but also impingedon political territory that Mr Lahoud regards as his own. Through anonymoussecurity figures, the president made it clear that Mr Aoun would face trial ifhe returned.

Whether or not Mr Aoun will return remains unclear, but Mr Hariri’s gesturetowards the hardline Christian community is significant in itself. Since thewithdrawal of Israel's troops from the south in May, and the death of Syria’spresident Hafez al-Assad days later, calls have been growing for Syria to with-draw its 35,000 troops from Lebanon, and reduce its control of political life.The most vocal demands have come from those elements in the MaroniteChristian community which have never reconciled themselves to their“defeat” at the hands of Syrian-backed forces in the civil war, or accepted theSyrian-orchestrated political order that has emerged since the war ended. WithChristian political leaders such as Mr Aoun either in exile or prison, leadershipof the anti-Syrian Christian movement has largely fallen to the church. In lateSeptember Maronite bishops made their most provocative move yet, issuing astatement saying that Lebanon had lost its sovereignty to Syria; calling forSyria to begin withdrawing its troops; and demanding the release of up to200 Lebanese thought to be held in Syrian jails. As ever, there was no directresponse from Syria, but pro-Syrian politicians in Beirut claimed that theChristians were seeking to support Israel, or restart the civil war. Further em-phasising the religious angle to the dispute, a number of Muslim clerics werethe most vocal in defending Syria’s presence.

The Druze leader Mr Jumblatt has long had strong ties with Syria, but he toobegan to echo the calls for a “reassessment” of the Syria-Lebanon relationship,something which helped his alliance with Christian opposition figures duringthe parliamentary election. However, his comments caused alarm in Damascus,because as a non-Christian, Mr Jumblatt offered some wider nationalist base tothe anti-Syrian movement. Seeking a way to discipline Mr Jumblatt, Syria firstexpressed its displeasure at his comments by making it clear that he would nolonger be welcomed into Syria as a VIP guest—in effect, a strong political snub.Mr Jumblatt refused to back down, but days later Mr Kanso increased the pres-sure on him by making a speech in parliament accusing Mr Jumblatt of trea-son, and issuing vague death threats against the visibly shocked Druze leader.

Many in Beirut were surprised that Mr Jumblatt, an astute political operator,had sullied his relations with Damascus. However, within weeks, Mr Birri—himself a longstanding ally of Syria and an experienced political player—encountered a similar backlash. Apparently acting on instructions fromDamascus, he made a reconciliatory trip to the head of the Maronite church,Cardinal Nasrallah Butros Sfeir, and announced that Syria would redeploy itstroops “in the near future”. Within days he was criticised by Damascus foroverstepping the line, while Mr Lahoud also made his displeasure known,

Maronite bishops challengeDamascus

Mr Jumblatt and Mr Birriearn rebukes from Syria

16 Lebanon


apparently believing that Mr Birri, with support from Mr Hariri, was interferingin matters beyond his authority. Many in Beirut suggest that the apparenterrors of two political veterans in misreading the Syrian mood is further clearevidence of a split within the Damascus elite, with different figures offeringconflicting policy.

Faced with evidence of increasingly vocal anti-Syrian sentiment, the newSyrian president, Bashar al-Assad, has begun a policy of dialogue and ap-peasement with the Christians, apparently against the advice of his morehardline advisers. In December Syria began to release Lebanese prisoners heldin Syrian jails—many of whom were supporters of Mr Aoun and had been heldwithout trial or charge since the civil war. Within weeks, several hundred ofthe Syrian troops stationed on the outskirts of Beirut were moved out of thecapital overnight. In January there were reports that Mr Assad would soonmake a visit to Lebanon, implicitly recognising it as an independent state.Sources in Damascus suggest that Mr Assad is considering the redeployment ofall Syrian troops in Lebanon away from the main populated areas back to theBekaa valley area, on the Lebanese side of the Syrian border. The same sourcessuggest that the new president will not withdraw Syria’s forces completely,however, until there is a comprehensive peace agreement in the Middle East. Inany case, the removal of only the most visible signs of Syria’s presence isunlikely to be sufficient to appease the most hardline critics of Syria’s role inLebanon, who will probably interpret Syrian concessions as weakness and presstheir demands for Syrian withdrawal further. The concessions also fail toaddress the underlying issue of Syria’s influence over domestic Lebanese affairs,which seems set to come increasingly to the fore.

Meanwhile, the Shia movement Hizbullah appears to be going through aperiod of reassessment, as it seeks to establish its new role following Israel’swithdrawal from south Lebanon, which brought an end to its guerrilla cam-paign against the occupation. The movement’s indecision over a possibleposition in the new government appeared to underline a broader uncertaintyover its political role; in July a senior party delegation travelled to Tehran,holding consultations with the leading Iranian figures who, in effect, createdHizbullah, and are still its strongest political, financial, and military backers.

This uncertainty was brought to an end by the escalation of violence in theWest Bank and Gaza in October 2000, and the start of the “al-Aqsa” intifada(uprising), which Hizbullah has seized as an opportunity to maintain its mili-tantly anti-Israel stance. Over recent months it has stepped up its politicalbacking for the Palestinians, and even tempered long-running criticism of theleader of the Palestinian Authority (PA), Yasser Arafat, urging the Palestiniansto persist with their struggle against Israel. While Hizbullah has not offereddirect military support to the Palestinians, it has been able to sustain its owncampaign against Israel by maintaining that Israel has not yet fully withdrawnfrom Lebanese territory. It argues that the Shebaa farms area—a small patch ofdisputed land on Israel’s side of the “blue line”, which Lebanon and Syria claimis Lebanese, but Israel and the UN say belongs to Syria—is still occupiedLebanese territory, offering the group a pretext to launch small-scale, but

Damascus offersconcessions to Lebanon

Palestinian intifada givesnew direction to Hizbullah

Lebanon 17


highly publicised attacks against Israeli positions in the area. These actions,coupled with the capturing of Israeli soldiers to use as bargaining tools for therelease of Islamists held in Israeli jails (October 2000, pages 18-19), maintainthe impression that Hizbullah is still a “resistance” movement, putting off theday when it will eventually have to come to terms with a non-military role.

So far, Hizbullah’s renewed belligerence has not generated a substantial Israelimilitary response, but observers in Lebanon—including UN commandersoperating in the south—have expressed growing fears that it may do soshortly (see Outlook for 2001-02). Hizbullah’s stance appears to support thearguments of Israeli rightwingers who opposed the decision of the Israeliprime minister, Ehud Barak, to withdraw Israel’s forces unilaterally from thesouth in May 2000. At the time they argued that a withdrawal would set aprecedent, proving that the Israeli army was not invincible, and giving thePalestinians the idea that armed conflict eventually works. The prominenceof the Hizbullah flag during the intifada seems to confirm that thePalestinians have indeed been inspired by the Lebanese group. At the sametime, the failure of the UN and Lebanese army forces to deploy along theLebanese side of the border—leaving Hizbullah as the dominant force in thearea—coupled with continuing protests at the border fence and occasionalHizbullah raids across the blue line, has raised anxiety among Israel residentsin the north, even though there have been no attacks into Israeli territoryand no civilian casualties.

The attitude of Syria with regard to Hizbullah’s actions remains unclear.Mr Assad was reported to be “impressed” by the group’s success, but sug-gestions that he is encouraging their campaign seem misplaced. AlthoughDamascus has traditionally used insecurity on the border as a means ofpressuring Israel to make concessions to Syria in peace talks, there is little pros-pect of such negotiations taking place in the near future. Given Mr Assad’s ownpressing domestic difficulties, and signs of growing anti-Syrian feeling inLebanon, it seems unlikely that Syria would support a Hizbullah campaign thatincreased the risk of renewed Israeli attacks. This suggests that since the changeof leadership in Damascus, and Hizbullah’s “victory” over Israel, Syria’sinfluence over the group has waned, removing a constraint that in the past hasprevented Hizbullah from provoking Israel too far.

Economic policy

The new prime minister, Rafiq al-Hariri, has begun to outline his economicreform programme, committing his administration to an aggressively expan-sionist, liberalising agenda. Confronting a fiscal deficit which will exceed 20%of GDP in 2001, the largest regional public debt stock as a proportion of GDPafter Iraq, and an unstable currency, Mr Hariri’s response has been to cut taxes,ease capital spending controls and open the economy more fully to the com-petitive global marketplace, arguing that only by encouraging trade, invest-ment and growth can the government hope to restore medium-term fiscal andmacroeconomic stability.

Fears grow of fresh conflictwith Israel

Mr Hariri offers “shocktherapy” to revive growth

18 Lebanon


This radical approach marks a sharp break with the conservative policiesadopted by Mr Hariri’s predecessor, Salim al-Hoss, who sought to reduce themounting budget deficit by introducing a raft of new taxes to boost revenue,and by restricting expenditure where it could. According to Mr Hariri, thisapproach succeeded only in pushing Lebanon into recession, undermining taxyields by driving down economic activity and thus offering no scope forrestoring balance to public finances. By contrast, Mr Hariri’s ten-point plan (seebox) commits his government to boosting short-term growth at the expense ofa temporary rise in the fiscal deficit, trusting that over the medium term higherfiscal revenue from increased economic activity will restore balance to thegovernment’s finances, and allow Lebanon to re-establish itself as a regionalservices and business centre.

The government’s ten-point plan

The government’s ten-point plan forms the basis of its economic reform programme. Insummary, the government proposes to:

• draft laws to create a favourable investment environment;

• restart work on frozen infrastructure projects, where resources are available throughinternational soft loans but have yet to be tapped;

• enhance confidence in the economy by marketing and promoting Lebanese goodsand services, both domestically and internationally;

• adopt policies—such as the “open skies” policy—to further open the economy,including easing visa regulations, reducing customs barriers and eliminating non-customs barriers;

• simplify administrative procedures;

• reduce some fees, taxes and communication charges to boost economic activity;

• pursue trade agreements with Arab and European economic groups, as well as theWorld Trade Organisation (WTO);

• improve the collection of taxes;

• begin privatisation of projects and utilities, with the proceeds being used to reducepublic debt; and

• stress the principles of free trade and an open economy, and the need for the state tohonour its obligations, commitments and pledges.

Underlining the centrality of the economic reform programme to the newadministration’s overall agenda, the prime minister was careful to ensure thathis own allies were given control of the major economic portfolios, even at theexpense of losing control of other sensitive policy areas (see The political

First liberalising measuresare introduced

Lebanon 19


scene). Mr Hariri also began to act immediately, taking advantage of the pol-itical strength his election showing offered him, and thereby investing policy-making with a much-needed sense of urgency, in contrast to the lethargic Hossadministration.

In early November the government launched its first initiative, an “open skies”policy which removes many of the restrictions imposed on foreign airlineswishing to use Beirut’s new US$400m international airport. The new approachis designed to increase the volume of flights passing through the airport, whichshould raise fees and, more importantly, increase the number of visitorstravelling to Lebanon and improve communications for businesses based inthe country. Mr Hariri claimed that open skies would increase passengerthroughput to close to the airport’s 6m annual capacity, compared with the1.5m currently using the airport. While the projection seems optimistic, anumber of foreign airlines are reportedly interested in establishing new routesthrough Lebanon, while anecdotal evidence from Beirut suggests that inter-national airfares have already begun to fall, ahead of increased competition. Assignificantly, the government succeeded in implementing the reform despitefierce opposition from the state-owned national airline, Middle East Airlines(MEA). As the home carrier, MEA had enjoyed considerable privileges at theairport and was protected from competition under the “quota and feed”system. The airline warned that open skies could force it into bankruptcy, as itlost its market share to other, lower-cost carriers. When Mr Hariri last sought tointroduce the policy in the 1990s, MEA was able to use its parliamentary in-fluence to prevent the reform from coming into effect. Mr Hariri’s willingnessto challenge an entrenched, local interest group for what he views as the bestinterest of the broader economy is a battle he will have to fight many timesover the coming year if his programme is to be successful.

Within days of the open skies policy being introduced, the government alsoannounced wide-ranging cuts to the country’s customs duties. The reductionsnot only undid tariff increases introduced by the previous administration, butwent further, cutting duties on some goods to their lowest levels since the civilwar. As with the open skies policy, Mr Hariri argued that the reductions wereessential if Lebanon was to make progress with its bid to join the World TradeOrganisation (WTO) and sign a full Association Agreement with the EU. Thecuts were also designed to revitalise the retail sector by lowering prices, and topromote the development of the export-oriented manufacturing sector byproviding cheaper access to capital and intermediate goods. This attempt todevelop a low-cost, sophisticated business infrastructure also marks a firststage in Mr Hariri’s bid to encourage more foreign businesses to establishthemselves in Lebanon. Under the ten-point plan, further measures will beintroduced in the near future to promote free trade, including moves to speedup customs formalities at Lebanon’s main ports and the removal of all non-tariff trade barriers.

Wide-ranging tariff cutsare implemented

20 Lebanon


Main tariff cuts

As part of its reform programme, the government has proposed a range of tariff cuts.These include:

• abolishing a 3% tariff on imported raw materials not found locally;

• scrapping a 6% duty on imported semi-finished goods not manufactured locally;

• lifting all duties on imported computers and accessories;

• reducing duties on finished imported goods already made in Lebanon, by at least25%. For example, the tariff on imported flowers is to be cut from 105% to 30%.The tariff on cosmetics and perfumes will be cut from 55% to 15%;

• reducing tariffs on other imported finished goods which are not made in Lebanon,from between 10% and 100%, down to between 5% and 70%; and

• cutting duties on imported cars by up to 54%—bringing duty down to between24% and 50% of a vehicle’s value.

The government has also undertaken to reduce the direct tax burden onbusiness, committing itself in late 2000 to cutting private companies’ contri-butions to the state social security system—the National Social Security Fund(NSSF). Currently, companies are required to pay 35.5% of an employee’s salaryto the fund, with the employee also contributing 3%. The high contributionlevels have encouraged a culture of non-payment, with few companies regis-tering their employees in full, and many massively under-reporting theirearnings, to avoid the system. In the first six months of 2000, for example, theNSSF collected just US$386m—less than 3% of estimated GDP. Despite theselow levels, the fund has built up a substantial surplus, and this has encouragedthe government to believe that it can cut contribution rates by some 10%without affecting the benefits offered, especially if the cuts are coupled withimprovements to the tax-collection system.

Mr Hariri’s broad strategy, and the specific measures so far introduced, havebeen welcomed by most local commentators, and have considerable popularappeal after two years of poor economic performance and steadily waningdomestic confidence. Private business—a natural constituency for the billion-aire businessman Mr Hariri—has given the approach a particularly strongendorsement, despite concerns over the threat of increased competition.Enthusiasm from this quarter is likely to rise further if additional capitalspending is included in the 2001 budget, which was being discussed by thecabinet as this report went to press.

However, while Mr Hariri claims that the failure of the austerity programme ofthe previous administration gave no alternative to his strategy, his argument issomewhat misleading. A number of the most difficult problems that Mr Hossand his beleaguered finance minister, George Corm, were forced to grapple

The government pledges tocut NSSF contributions

Lebanon 21


with were the product of Mr Hariri’s last period in power, and were so severethat they could not realistically be resolved within a short space of time. TheHoss government also found itself continually hamstrung by its politicalweakness, with many of the most important measures it wished to put inplace—such as the introduction of value-added tax (VAT), and a privatisationprogramme—repeatedly thwarted by parliamentary opposition or divisionswithin the cabinet.

Mr Hariri’s characteristically bullish optimism also cannot disguise the seriousrisks that are associated with his reform programme. The entire programme, forexample, appears to stand on a conviction that Lebanon will re-establish itselfas the Middle East’s business and services hub, implying that all that is requiredis the removal of a series of obstacles and an injection of confidence for thecountry to return to the position it enjoyed before the civil war. There is a greatdeal to support this claim, with Lebanon’s well-educated workforce, large,wealthy diaspora, and natural beauty affording it considerable appeal as adestination for investment and tourists. However, in contrast to 1975—whenthe civil war saw the end of the country’s reign as the region’s premier servicescentre—there are now a large number of other countries in the region withbusiness- and tourist-friendly infrastructures. Lebanon will have to competewith these to win back market share. Revolutions in communications have alsoundermined many of the advantages that were previously associated withLebanon’s geographical location, while the reputation for violent instabilityLebanon developed as a result of the war has yet to be erased from its inter-national image. If these factors prevent growth from reaching the levelsanticipated by Mr Hariri, Lebanon will find itself with an expensive, under-used airport and empty office space, much as it has now.

Government finances(L£ bn unless otherwise indicated)

1999 20001 Qtr 2 Qtr 3 Qtr 11 months 1 Qtr 2 Qtr 3 Qtr 11 months % change

Total revenue 967 2,126 3,369 4,262 1,023 2,138 3,520 4,244 –0.4 of which: customs revenue 472 937 1,464 1,812 422 873 1,333 1,643 –9.3

Total expenditure –1,522 –3,790 –5,880 –7,546 –2,123 –4,554 –7,138 –8,883 17.7 of which: debt service 609 1,748 2,533 3,303 842 2,013 2,980 3,893 17.9 % of total expenditure 40.0 46.1 43.1 43.8 39.6 44.2 41.8 43.8 – % of total revenue 63.0 82.2 75.2 77.5 82.3 94.2 84.7 91.7 –

Balance –555 –1,663 –2,511 –3,285 –1,101 –2,416 –3,618 –4,639 41.2 % of total expenditure 36.5 43.9 42.7 43.5 51.8 53.0 50.7 52.2 –

Source: Ministry of Finance.

Moreover, it is clear that the economy will have to weather a period of in-creased instability in the short term before it is able to enjoy whatever longer-term benefits may be associated with the reform programme. The economy’s

Reforms are high risk

Fiscal pressures are set toincrease

22 Lebanon


most vulnerable point remains the government’s own finances, which thelatest outturn figures show have continued to deteriorate. Over the first11 months of 2000 revenue was 0.4% lower than in the same period of 1999,constituting just 78% of the earnings level targeted in the budget for the fullyear. Expenditure, meanwhile, continued to accelerate, exceeding the 199911-month total by over 17%. The net result was an 11-month deficit of morethan L£4.6trn (US$3.1bn), an increase of over 40% on the deficit for the sameperiod of 1999, and equivalent to a remarkable 52% of total expenditure.

For 2000 as a whole, the EIU anticipates that the deficit will have reached19.5% of estimated GDP—the highest level in the region by far. There appearsevery prospect that it will deteriorate further in the near future, as the gov-ernment prioritises growth over short-term budget stability. By cutting customsduties, for example, the government has reduced a vital source of revenue,which has accounted for some 40-47% of total earnings over the past fiveyears. While increased volumes will offset some of the fall associated withlower duties, the net effect is almost certain to be negative, and overall revenuewill fall. The government has yet to present its budget, but comments from thenew finance minister, Fouad Siniora, suggest that there will be some increase incapital spending in order to stimulate growth further and complete the in-frastructure projects necessary to support private-sector growth and attractforeign businesses to Lebanon.

These are not the only elements likely to widen the budget gap; the newgovernment has also inherited a range of high-expenditure commitments fromits predecessor. These include a series of arrears obligations built up by the Hossadministration, which local economist Marwan Iskander has estimated couldbe as high as L£1.4trn. Given that the Hoss administration criticised Mr Hariri’slast government for leaving it with arrears, the size of these debts is ironic.Many of the arrears are owed to companies such as the garbage collection firmSukleen, which was awarded its contract by Mr Hariri in the 1990s, and willtherefore have to be settled. The most serious draw on government resources,however, will be interest payments on public-sector debt. These payments haverisen sharply over the past two years, and according to our estimates willaccount for more than 45% of all expenditure in 2000, absorbing almost all ofthe government’s revenue in themselves. With the debt stock continuing tobuild, interest payments seem certain to rise as well, which will widen thedeficit still further.

To finance the deficit, the government will seek to sell additional debt on thelocal and international markets, driving the public debt stock even beyond itsrecent record highs. According to the latest figures from the Banque du Liban(the central bank), net public debt had risen to L£33.8trn by the end ofOctober 2000, equivalent to US$22.4bn or 135% of estimated GDP—a 4%increase over the end of the second quarter of the year, and a rise of almost17% compared with the same period of 1999. A breakdown of the debt stockshows growth in both the local- and foreign-currency components. Netdomestic debt—in the form of government Treasury bills with terms of up totwo years, and mostly held by local commercial banks—rose from L£20.6trn atthe end of October 1999 to L£24.1trn by October 2000. The government also

Debt growth accelerates

Lebanon 23


sold additional debt on the Eurobond market (see Foreign trade and pay-ments), with the foreign-currency component of the public debt stock risingfrom US$5.5bn in October 1999 to US$6.4bn a year later. This amounts tosome 28.5% of the total public-sector debt stock, close to the proportion itconstituted in 1999, and is likely to rise as the government seeks to takeadvantage of the lower interest rates available on the Eurobond market.

If Mr Hariri is to build the confidence of the local and international businesscommunity in such an environment, and maintain access to the debt market,progress on the long-stalled privatisation programme will be crucial. While thesale of state assets would add momentum to planned private-sector growth, itsmost important impact would be the realisation of substantial revenue whichcould be used to pay down the debt stock. Privatisation is included in the gov-ernment’s ten-point plan, and the premier has attached considerable im-portance to it in interviews. Some of the privatisations should be straight-forward, most notably the sale of operating licences for the mobile telephonenetwork. These came close to being agreed in 2000, before being delayed byinfighting within the Hoss cabinet. The two existing operators are known stillto be keen to buy a long-term licence to replace their current build-operate-transfer (BOT) agreement which expires soon, despite the poor treatment theyendured at the hands of the last government (October 2000, pages 22-23). Athird licence could also be sold under the terms of the BOT, and despite theappointment to the telecommunications ministry of Jean-Louise Cordahi—regarded as an ally of the president, Emile Lahoud, rather than the premier—the sales should be concluded this year. They could generate in excess ofUS$2bn, easing pressure on the government’s finances considerably.

Other elements of the planned privatisation programme are likely to be provemore difficult and time-consuming. The fixed-line monopoly run by the tele-coms ministry, for example, is one of the few state-owned assets that generatesa profit, and the government may be reluctant to give up a long-term recurrentrevenue stream for a short-term capital injection. Other assets face moredifficult obstacles. The loss-making power company, Electricité du Liban, hasbeen slated for sale, but is in such poor condition that it would take manyyears of reform before it could be sold as a commercial concern. Many of thenecessary measures—such as higher tariffs and improved collection rates—would also be politically unpopular. The state airline, MEA, has also beenmentioned as a privatisation candidate, but this too needs radical restructuring.The airline is notoriously overstaffed, employing over 150 full-time pilots, forexample, despite operating only nine aircraft. Introducing redundancies wouldbe highly unpopular, and would prove even more of a political challenge thanthe introduction of the open skies policy in late 2000.

Even if the privatisation process is introduced, and growth picks up as thegovernment hopes, it is by no means certain that confidence will remainsufficiently high to support Mr Hariri’s programme into the medium term. Thestate is vulnerable to a range of exogenous political and economic shocks, anyone of which could undermine confidence if it came at the wrong time.Potential shocks include developments in the regional political environment

Privatisation revenue couldbuy time for reform

Currency pressure forcesdrawdown in reserves

24 Lebanon


which could rekindle conflict on the Lebanese-Israeli border, or instability inneighbouring Syria, which would threaten the political order in Lebanon. Adeterioration in working relations between Mr Lahoud and the prime ministercould also have a serious impact, particularly if it led to a repeat of the1998 power struggle, which eventually forced Mr Hariri to resign (see Outlookfor 2000-01).

Should confidence fall, the key pressure point—as well as the possible triggerfor a wider crisis—is likely to be the Lebanese pound’s peg to the US dollar. Thepound has remained within a trading zone prescribed by the central bank ofL£1,501-1,514:US$1 since September 1998. Its stability has done much torestore faith in the currency, and has also become a symbol of the strength ofthe economy as a whole. The central bank remains committed to maintainingthe peg, and staunchly resisted pressure from the Hoss administration for aneasing of monetary policy, recognising that lower Lebanese pound interestrates would lead to a marked downturn in demand for the currency. However,despite maintaining high real interest rates—the benchmark two-year T-billoffers a yield of 14.64%—pressure on the pound built over the course of 2000,and the central bank was forced to intervene heavily to hold the currencybelow L£1,514:US$1. The trend is apparent from the breakdown of centralbank gross reserves over 2000, which fell from US$7.8bn (excluding gold) atend-1999 to US$5.9bn by November 2000—a decline of some 32%. Under-lining weak demand for the pound, central bank data show a shift in com-mercial bank funds from Lebanese to US dollar accounts, as confidence in thesustainability of the peg weakened. As a result of the shift to dollar accounts,the dollarisation of deposits increased from 62.8% at the end of the secondquarter to 66.7% by the end of October.

Pressure on the currency reached a peak in September and October, whenelection uncertainty was at its highest, with reserves falling by US$740m as thecentral bank intervened in the market on an almost daily basis. Money-marketdealers reported that the movement out of the local currency eased con-siderably in the last two months of 2000, after Mr Hariri was allowed to formhis government, and as he began to spell out his economic reform programme.IMF figures for November showed no rebuilding of official reserves, however,suggesting that confidence in the pound has yet to strengthen substantially.

The domestic economy

Economic trends

The absence of basic national accounts data continues to undermine efforts topresent an accurate picture of trends in the Lebanese economy. This long-standing data shortfall is surprising, given the ability of the Banque du Liban(the central bank) and the finance ministry to provide information on a rangeof other economic issues that is both more timely and more detailed than thatprovided in other neighbouring economies.

Central bank estimates zerogrowth for 2000

Lebanon 25


Nevertheless, a consensus on performance in 2000 has begun to emerge. In aninterview with the EIU, the central bank governor, Riyadh Salameh, said thathe expected real economic growth to have been close to zero over the full year.This figure—which concurs with our own assessment—was supported by astudy released by the UN’s Economic and Social Commission for Western Asia(ESCWA) in December, which also predicted zero growth for the year. In itsthird-quarter report on the economy, the Economic Analysis Unit of localBanque Audi found that GDP had contracted by an annualised 0.4% over thisperiod. It reported, however, that third-quarter activity was 0.1% higher thanthat in the second quarter, suggesting that the recession had begun to bottomout. Banque Audi noted that one factor behind the third-quarter increase wasspending associated with the parliamentary election campaign in August andSeptember, pointing to a 10% rise in the value of cheques cleared over theperiod. This appears to be borne out by the central bank’s “coincidentindicator”, which showed a sharp rise in August when the election campaignwas at its peak, before falling back in September.

Overall, the value of cleared cheques for the first ten months of 2000 (inforeign currency and Lebanese pounds) showed an increase of 1% on the sameperiod of 1999, with a steady upward trend apparent over the second half ofthe year. Associated with this rise in activity towards the end of the year, theconstruction sector—the main engine of growth in the early 1990s—saw anincrease in activity in the third quarter, although activity remained lower thanin the equivalent period of 1999. In the third quarter the number ofconstruction permits issued—a useful indicator of planned work—stood some16% above levels in the second quarter, although the work is seasonal, andactivity still stood more than 17% below the total for the third quarter of 1999.Figures for cement deliveries—a measure of work in progress—also offeredsome evidence of a slow recovery. Some 850,000 tonnes of cement weredelivered in the third quarter of 2000, up by 23% on the second-quarter figure,and 4.6% higher than the figure for the third quarter of 1999 (although thenine-month total remained some 12% down on the level of the previous year).

Selected economic indicators1999 2000 %1 Qtr 2 Qtr 3 Qtr 10 months 1 Qtr 2 Qtr 3 Qtr 10 months change

Construction permits (’000 sq metres) 1,689 2,211 2,368 6,910 1,543 1,685 1,960 5,667 –17.9

Cement deliveries ('000 tonnes) 618 789 813 2,505 417 693 850 2,219 –11.4

Value of cleared cheques (US$ m) 6,597 6,316 6,867 22,159 6,547 6,424 7,047 22,387 1.0

Coincident indicator (end-period) 189.2 184.0 183.5 189.7 198.8 188.8 194.7 198.0 –

Source: Banque du Liban.

The sector that has offered the strongest signs of recovery is tourism. Before the1975-1990 civil war this sector accounted for some 20% of Lebanon’s GDP,with the bulk of spending coming from the arrival of Gulf Arabs in the

Construction activityincreases towards end-2000

End of southern war givestourism a boost

26 Lebanon


summer months. Since the end of the war tourism numbers have slowly begunto rise, but growth has been held back by the poor state of Lebanon’s tourisminfrastructure. The intermittent escalation of hostilities with Israel have alsolong been a barrier to any real revival. The summer of 2000, coming soon afterthe Israeli troop withdrawal from south Lebanon in May, was the first time fora quarter of a century that there was no fighting in Lebanon. Encouragingly forthe sector, tourist numbers reacted positively.

Tourist arrivals1999 20001 Qtr 2 Qtr 3 Qtr 9 months 1 Qtr 2 Qtr 3 Qtr 9 months % change

Tourists 107,460 185,905 253,258 546,623 107,018 197,294 292,387 596,698 9.1

Passenger arrivals 194,674 287,978 350,408 833,060 222,221 285,130 383,450 890,801 6.9

Aircraft arrivals & takeoffs 6,283 6,803 7,971 21,057 6,967 7,201 8,513 22,681 7.7

Sources: Banque Audi; Banque du Liban.

During the third quarter—the peak tourism period—some 290,000 touristsarrived in Lebanon, an increase of 15.4% over the same period of 1999, withthe total for the first nine months of the year reaching almost 600,000. TheMinistry of Tourism reported that for the month of August alone around120,000 tourists arrived, up by 36.7% on August 1999. The ministry’s estimatesare supported by data from Beirut International Airport, which show a year-on-year increase of 9% in passenger arrival numbers in the third quarter, with an-ecdotal evidence suggesting that the strong performance continued in Octoberand November. The government’s new “open skies” policy (see Economicpolicy) looks likely to accelerate the upward trend over the course of 2001,especially as the construction and rehabilitation of four- and five-star hotels inBeirut and elsewhere continues. While the bulk of visitors to Lebanon arrive byair, figures for the first eight months of 2000 indicate that the city may also beresuming its role as a stopping-off point for Eastern Mediterranean cruise ships.Over this eight-month period the number of passengers arriving at Beirut portincreased by almost 33% year on year, although the number of arrivals re-mained below 30,000.

Infrastructure

The lull in Israeli airstrikes against Lebanese infrastructure targets since the endof the occupation in May has afforded the government the opportunity topress ahead with repair and rehabilitation work. The Jamhour power stationnear Beirut, which was put out of action by Israeli airstrikes in February 2000,was refurbished and renewed by Egyptian technical staff, with the work com-pleted in October. Meanwhile, the World Bank announced that it would fin-ance the upgrading of Bsalim substation, which was last bombed in May 2000.The US$19.5m contract was awarded in November to the Swiss-based ABBHigh Voltage Technologies, which will install new switch gear to replace equip-ment destroyed in the May raids.

Lull in airstrikes giveschance for repair work

Lebanon 27


The restoration of generating capacity will ease pressure on the network, whichfailed to cope with peaks in demand during the summer of 2000. Over thelonger term, power supply should also be boosted by an agreement betweenSyria and Lebanon to rehabilitate a branch of the Iraqi-Syrian oil pipeline,which used to carry Iraqi oil through Syria to a refinery in Lebanon’s northerncoastal Mediterranean city of Tripoli. The section of pipe has been closed sincethe mid-1970s, and the plan to reopen it follows a rapprochement betweenSyria and Iraq, which is believed to have led to the resumption of oil flowsbetween the two countries in late 2000. The cost of the rehabilitation of thepipeline is projected at up to US$3m, while Iraq has reportedly offered to fundthe rehabilitation of the disused Tripoli refinery, which formerly had a capacityof some 20,000 barrels/day. The Lebanese government, however, is said toprefer construction of a new refinery in Tripoli with a capacity of 150,000 b/d,at a cost of some US$100m. Unconfirmed rumours have suggested that the oilwill be supplied to Lebanon on concessionary terms, bypassing—and probablyviolating—the UN oil-for-food programme.

In December Lebanon’s new prime minister, Rafiq al-Hariri, concluded the firstphase of an agreement with Egypt and Syria to build an underseas gas pipelinefrom Egypt to Lebanon, at a cost of US$1bn. The pipeline will initially supplyLebanon, and later Syria, Jordan and Turkey with Egyptian natural gas. Startingat Arish in northern Egypt, the pipeline will run under the Mediterranean Seabeyond Israeli territorial water to Lebanon, and then overland to Syria, Turkey,and Jordan. Under the terms of the agreement, two firms will be set up by thethree countries to build and run the pipeline. Costs are estimated at aroundUS$800m for the sea pipeline and US$200m for the land pipeline. Financing isstill being discussed, with a syndicated loan seen as the most likely option,although few other details have been released.

Financial and other services

The fall in interest rates on government Treasury bills has continued to promptthe main commercial banks to expand their retail and fee-based bankingservices. At the end of September 2000 the ratio of earnings from non-interestsources of income—largely commission and fee-earning income—stood at23.2% of all income from the top 12 banks. This compares with 21.2% over thefirst nine months of 1999, according to Banque Audi’s third-quarter report. Atleast part of the gain will have been a product of falling interest income,however, as well as reflecting new fee-based work. Highlighting another aspectof change in the banks’ portfolios, reports in late 2000 pointed to a sharpincrease in credit and debit card numbers, as the banks have sought to expandtheir retail base. The most recent figures indicated that the total number ofdebit and credit cards issued in the country by the end of June 2000 stood atover 293,000, an increase of 9.2% on the total at the end of March, and a riseof more than 41% year on year, according to the Banque du Liban (the centralbank). The number of automated teller machines (ATMs) also rose by 4%between the first and second quarters of 2000.

Iraqi crude deal signed toreduce energy costs

Lebanon joins regional gasagreement

Shift towards retailbanking continues

28 Lebanon


The Lebanese banks are also looking to take advantage of opportunities offeredby the economic reform process in neighbouring Syria. In late 2000 five bankswere granted licences to establish operations in Syria’s free zones. Several havealready established offices there, and although their activities are currentlyrestricted to dealings with the few businesses that are also working in the freezones, the banks are confident that over time they will be allowed to operate inSyria itself. Their expectations were encouraged by a decision from the BaathParty regional command in late December which announced that permissionwould be given for the establishment of private banks in Syria—the first sincethe sector was nationalised in 1963. While Syria is far from being a wealthystate, the market for a whole range of retail and corporate banking services isvirtually untouched, convincing many within Lebanon of the potential Syriaoffers in terms of expanding their franchise value. Given their expertise andknowledge of the local market—many Syrian businesses and wealthy individ-uals have long been using banks in Lebanon to meet their financing needs—Lebanon’s leading commercial banks would be well-placed for involvement inthe development of private banking in Syria, probably in association with alocal partner.

The general sluggishness of the economy has continued to affect the equitymarket, with slack bourse activity exacerbated by uncertainty over the 2000parliamentary election. The Beirut Stock Exchange (BSE) share index eased by0.6% between June and September 2000, while market capitalisation fell by7.2% year on year, to US$2.6bn. Underlining the lack of confidence amonginvestors, and the broader liquidity problems that have beset the market overthe past two years, trading volumes on the bourse declined by 8.5% year onyear in the third quarter as a whole. The average daily trading value in the first11 months was less than US$300,000, down by almost 90% on the volumes ofUS$2.5m reached at the peak of the Lebanese equity boom in 1997. There issome muted optimism that the government’s economic reform programmewill re-inject life into the market if growth accelerates, while the mooted priva-tisation process and sale of mobile telephone licences is expected to lead tosome new listings—the first for two years. The BSE itself has also begun tointroduce reforms designed to boost interest in the market, shifting to a con-tinuous trading system in October, although traders confirmed at end-2000that this had failed to raise the level of activity.

Foreign trade and payments

Lebanon's traditional heavy reliance on imported goods, and its narrow ex-porting base, has continued to push the trade account heavily into deficit.Over the first ten months of 2000 import spending totalled US$5.16bn, almostthe same as the value of imported goods over the corresponding period of1999, according to figures from the Banque du Liban (the central bank). Thetotal disguises a rising trend, however, which saw import expenditure increaseover the year from a low of US$1.43bn in the first quarter to US$1.64bn in thethird. A slight recovery in domestic demand may account for part of the

BSE slump continues

Trade deficit remains high

Syrian economic reformsoffer scope for expansion

Lebanon 29


increase in the second half of the year, but data showing that imports of in-dustrial machinery continued to fall suggests that confidence remained weak.Instead, the bulk of the additional expenditure probably reflected higher oilspending, after low stocks forced the purchase of additional volumes for powergeneration, and as petroleum derivative prices continued to rise. Addingweight to this assessment, traffic volume at Beirut port—the country’s principalshipping gateway—stood some 17% below its 1999 level in the third quarter,while the number of containers passing through the port also fell.

Exports, meanwhile, reached US$585m by the end of October 2000, marking a7.6% improvement on earnings over the same period of 1999. Much of theincrease appeared to reflect strengthened demand in the Gulf economies,where rising oil prices boosted local demand. However, Lebanese manu-facturers have also been required to shift the focus of their marketing activitiesabroad to compensate for the weakness of the local economy over the pasttwo years. It is possible that the downturn in exports in September andOctober (earnings fell 12% below their 1999 total) might have been a productof a slight upturn in local consumption, which left a smaller surplus for export.Even with the stronger export performance, however, earnings over the firstten months of 2000 amounted to just 11% of import spending, leavingLebanon with a trade deficit of US$4.57bn.

Balance of payments(US$ m)

1999 20001 Qtr 2 Qtr 3 Qtr 10 months 1 Qtr 2 Qtr 3 Qtr 10 months % change

Exports (fob) 135 154 179 544 163 174 185 585 7.58

Imports (fob) –1,541 –1,492 –1,618 –5,150 –1,429 –1,533 –1,638 –5,158 0.16

Trade balance –1,406 –1,338 –1,439 –4,606 –1,266 –1,360 –1,453 –4,573 –0.72

Net transfers & capital flowsa 1,803 1,228 1,547 5,251 1,136 1,345 1,575 4,484 –14.62

Balance of payments 397 –110 108 645 –130 –14 122 –90 –

a Including bonds.Source: Banque du Liban.

Despite the large trade deficit, the overall balance of payments for the first ninemonths—measured as a product of changes in commercial and central banknet foreign assets—was close to balance, showing a deficit of just US$22m. Asever, little data is available for any of the non-trade flows, making it impossibleto offer a breakdown of net capital inflows, services earnings and transfers.What does seem clear, however, is that the profile of the inflows has continuedto change. During the boom years of the post-war period the bulk of capitalinflows into Lebanon were direct investment flows, as expatriates and otherssought to participate in, and profit from, the reconstruction process. As thisexpansionary process drew to a close, net equity flows weakened, with debtinflows playing an increasingly important role in holding the overall balanceof payments in check.

Balance of payments showsnarrow deficit

30 Lebanon


Public-sector debt inflows alone reached an all-time high of US$1.8bn in 2000,as the government sold Eurobonds to meet its fiscal borrowing needs. The saleslifted the outstanding stock of public-sector Eurobonds to US$5.1bn by end-2000, twice the value of the stock at end-1998. While the sales ease the short-term pressure on the balance of payments, they store up interest and principalrepayment liabilities, which will place Lebanon’s external accounts undergrowing pressure in the medium term. Repayment obligations are modest in2001 and 2002, for example, but the state is already committed to makingprincipal repayments of some US$3.3bn over 2003-05.

The fact that a large proportion of the government’s “external” debt is ownedby the domestic commercial banks reduces some of the pressure repaymentsplace on the overall balance of payments, as does the ease with which the gov-ernment has been able to continue marketing fresh debt at competitive inter-national prices. Despite a downgrade from the credit risk ratings agencyStandard & Poors in mid-2000, from BB– to B+ for unsecured sovereign debt,and a series of credit warnings from the other agencies, Lebanon was able toissue a four-year US$400m Eurobond in December, with a 9.5% coupon. Thespread of 410 basis points over comparable US Treasuries is far lower than anyother similarly rated sovereign could expect to have received—if they couldhave sold a bond at all—and is all the more remarkable for being sold only afew weeks after the new prime minister, Rafiq al-Hariri, came to power andbegan to outline his reform programme. There has also been widespread spec-ulation that Mr Hariri’s return to office and his strong links with the Arab Gulfstates have re-opened financing links with this area. Rumours in late 2000 sug-gested that Saudi Arabia had agreed to transfer a new deposit to the centralbank to assist the government’s efforts to support the Lebanese pound. Thedeposit would be similar to a previous US$600m deposit transferred by SaudiArabia in 1997, and to two Kuwaiti and UAE deposits, totalling US$300m,received in 1998. All three deposits, which were offered at subsidised interestrates, were due to mature at end-2000, but Mr Hariri is said to have negotiateda rollover, and reportedly an increase in the value of the deposits.

Gulf loans are set to berenewed

lebanon€¦ · rafiq al-hariri, to impose his government’s plans on the state’s fractious...

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