Lebanese forces Economic Brief Magazine issue No.2

Lebanese Forces Economic Brief

Issue N.2 / September 03 – September 18, 2018

CONTENT Turkey’s Lira crisis hits hard and likely to affect other economies .......................................................... 2 Impact on Lebanon contained but costs rise ............................................................................................ 2 Private Investments and Lending on a downward spiral ......................................................................... 3 National Refugee Policy still lacking ........................................................................................................... 3 Oil: a double edge sword ........................................................................................................................... 4 1

Lebanese Forces Economic Brief

Issue N.2 / September 03 – September 18, 2018

Turkey’s Lira crisis hits hard and likely to affect other economies

However, Lebanon is one of the countries that are most vulnerable to a sudden and sustained rise in the cost of debt if developments in the financial markets in Turkey take a dramatic turn. This is especially relevant in light of one of Moody’s recent reports about those countries running current account and budget deficits and seeing their economies getting worse by the Turkish currency crisis.

The Lebanese Eurobonds market, for instance, which has already been negatively affected by the US interest rate hike, took another beating after the Turkish Lira crisis knowing that two more US rates hikes are expected this year: a 25 basis points hike on September 26, and another 25 basis points by end of the year.

• The 10Y Lebanese Eurobonds yield increased by 1% from the 2-month low level of 9.11% posted on the 11 of July, to reach 10.145% on 29 August.

• The 5Y Lebanese Eurobonds yield increased from 9% on 11 July to reach 9.9% on 29 August.

• As for the cost of insuring debt, Lebanon’s five-year CDS spreads, contracted by 40 basis points in the last two weeks of August to decrease from 650 to 613 basis points, and by 120 basis points in the last 2 months, from a high 735 basis points posted on 3 July 2018.

The Turkish Lira, one of the world’s worst-performing major currencies, has lost more than 43% against the US dollar since the start of the year. The apparent reason, a political clash with the United States over an American jailed pastor, isn’t sufficient by itself to explain Turkey’s misfortune. Other factors are clearly in play.

Already running a large current account deficit with inflation growing at an annual rate of 15%, the Turkish economy has been particularly vulnerable to president Erdogan’s increasingly authoritarian bent and his unorthodox economic views. His opposition to raising the level of interest rates to fight inflationary pressure has fueled concerns about investment prospects and monetary stability and autonomy. His recent appointment of his son-in law as minister of treasury and finance has also made matters worse.

Turkey’s first two weeks of August 2018 have been particularly worrisome. The Turkish Lira depreciated by 30% against the US Dollar, rising from 5 to 7.2, but then recovering by 23% to stand at 5.85 as Qatar stepped in with pledges of $15 billion worth of investments. But $15bn represents a fraction of what Turkey needs to serve its dollar-denominated debt. In fact, the Turkish Bond yield (March 2027 US Dollar Bond) reached 9.3% on August 13, an 87% increase from the 5% level posted on January 2018.

With $300bn in foreign-denominated corporate debt, the financing cost of Turkey’s private sector is expected to rise, which will depress investments and most possibly lead to a recession. The foreign currency liabilities of Turkey’s non-financial companies exceed their foreign exchange assets by more than $200bn, and these companies now face repayment or the rolling over of $66bn in foreign currency debt. This and Turkey’s currency crisis risks spreading to other countries, including in the Eurozone and a number of emerging economies. The European Central Bank has already warned that the contagion could reach a number of banks in Germany, Spain, Italy and France.

Impact on Lebanon contained but costs rise Lebanese traders stand to gain from the depreciation of the Turkish Lira, given that they will have to pay less on their imports. In contrast, manufactures, especially in the food processing industry, will possibly see their competitive advantages challenged by their Turkish counterparts. On the banking sector front, the exposure of Lebanese banks to Turkish instruments and currency remains relatively contained; one major bank is known to have substantial operations in Turkey but is reportedly believed to have partly or fully hedged its currency risk.

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Lebanese Forces Economic Brief

Issue N.2 / September 03 – September 18, 2018

National Refugee Policy still lacking Lebanon is home to the highest number of refugees per capita worldwide, which is weighing heavily on its already crumbling infrastructure, straining its public finance and posing a myriad of political and economic challenges. A consensual-based National Refugee Policy has yet to be developed, as Lebanon’s relationship with the international community lacks clarity and consensus on how to move forward. In addition, the absence of proactive responses from international stakeholders has fueled concerns in Lebanon about whether the country can absorb the demographic and economic burden without being significantly affected.

Already, a total of $559.3m in funding has been made available to implement activities under the Lebanon Crisis Response Plan, despite the government appeal for $2.68bn. A recent Blominvest Bank report indicates, “The advent of an unprecedented number of Syrian refugees into Lebanon since 2011 carried economic, social, and humanitarian spillovers on the Lebanese economy.” The report adds that the Syrian workforce totals 384,000 persons and may have dis-employed 270,000 Lebanese; youth unemployment jumped to 34% while Syrian workers compete on the low-skill jobs in the services and other sectors; and the work informality rate in Lebanon rose by 10 percentage points from the 44% recorded pre-crisis.

Solutions, if any, should in no way be forced repatriation; rather, policy should focus on creating the right socio-economic and political conditions that ensure a voluntary, safe, and dignified return for the refugees.

Above all, policy should be creative and crafted in a way to ensure a triple-win solution: a decent return for the refugees to Syria, the least impact possible for the Lebanese, and a halt of migration toward Europe.

Private Investments and Lending on a downward spiral Despite Lebanon’s adoption of a 2018 budget, the recent parliamentary elections and international support conferences, economic growth remains sluggish, projected to average 1.5% in 2018 according to our estimates.

Tourism and private consumption continue to drive growth in the first half of 2018, with real estate and construction lagging behind due to the uncertainty surrounding housing loan subsidies. High borrowing costs are expected to depress private investments, weighing heavily on investor sentiments and growth, despite private consumption picking up after the enactment of the public sector salary scale.

The banking sector’s first half results showed that banks were able to attract an additional $4.7bn in deposits thanks to higher rates, with deposits in Lebanese pound and US dollars almost equal. Lending, however, posted a negative growth of about $100m for the first time in many years, reflecting high borrowing costs and negative investor sentiments. The results of the six commercial banks listed on the Beirut Stock Exchange show that their aggregate net profits increased by 7.1% compared with the same period of last year, reaching $687.9m in the first half of 2018.

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Lebanese Forces Economic Brief

Issue N.2 / September 03 – September 18, 2018

Oil: A double edge sword The rise in oil prices usually leads to an increase of capital inflows to Lebanon, including FDI, remittances and tourist arrivals – provided official travel warnings from the Gulf States are lifted. This will help cover Lebanon’s financing needs, but besides fueling consumption and growth, it does not help in fixing the country’s longstanding structural problems, or provide incentives to the productive sectors of manufacturing and agriculture.

The recent rise in oil prices will make it more expensive for Lebanon to finance its imports, which will further widen the current account deficit. It will also increase its fiscal deficit due to the state’s subsidies to EDL, knowing that electricity tariff rates have last been adjusted in 1996 and are based on an oil price of $21 per barrel. Estimates from the IIF reveal that an $18/barrel rise will lead to an increase in the country’s current account deficit of 2.9% of GDP. In terms of the increase of the transfers to EDL, IIF estimates that it will rise from 2.5% of GDP in 2017 to 3.1% in 2018, resulting in the fiscal deficit to reach about 9% of GDP. Our estimates, however, show that the deficit will exceed the 9% level, as revenues are expected to drop because of the slowdown in economic activity.

LF Economic Policy & Research – Email LFEB@lebenese-forces.com, Prepared by RS; Reviewed by RB. Disclaimer: The content of this report is provided as general information only and should not be taken as an advice to invest or engage in any form of financial or commercial activity. Any action that you may take as a result of information in this publication remains your sole responsibility. We consider that we have no liability for its content and makes no warranty, representation or guarantee as to its accuracy or completeness 4