Global Arab Network | IMF: Lebanon’s economy expansion continues at a fast pace

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IMF: Lebanon’s economy expansion continues at a fast pace

Global Arab Network - - Ammar Shikhani

Friday, 15 October 2010 17:08

The expansion of Lebanon’s economy continues at a fast pace. Real GDP rose 9 percent in 2009 backed by a confidence rebound and large capital inflows, which fueled activity in the construction, tourism, commerce, and financial services sectors, reports Global Arab Network according IMF publications.

The output gap has substantially narrowed or even closed and momentum carried into 2010, with growth now expected to reach at least 8 percent.

Inflation has risen since the fall of 2009, driven partly by energy prices. Real estate prices have also increased at a rapid pace. In view of the Lebanese pound’s peg to the U.S. dollar, the weak euro should help keep inflation in check in the coming months provided that there is no further build-up of price pressures in the non-tradable sector, which could be a risk if the economy accelerates further.

The current account deficit is set to widen in 2010, mainly reflecting domestic-demand driven growth. The current account deficit remained stable in 2009, as rebounding tourism inflows and lower prices for energy imports helped offset the effects of rising domestic demand. The current account will likely deteriorate this year as imports receive an additional boost from buoyant domestic demand and a partial rebound of oil prices.

Capital inflows remain robust despite some moderation in recent months. Non-resident inflows surged last year as political and security risks declined and the authorities kept domestic interest rates high while global rates dropped. As a result, commercial bank deposits grew by more than 23 percent in 2009 and deposit dollarization declined.

This allowed the BdL to increase international reserves to over $29 billion, while sterilizing much of the impact on the domestic money supply through the issuance of CDs. Deposit inflows moderated in the first half of 2010, following a series of interest rate cuts, but remain healthy overall at an annualized growth rate of about 11 percent. Sovereign and CDS spreads have increased somewhat in recent weeks, broadly in line with emerging market averages.

The banking system has remained sound, but credit growth has picked up recently as banks are seeking to reverse falling interest margins. Lebanon’s banks have weathered the global crisis well, thanks to relatively conservative funding and asset structures, which reflect prudent banking regulation and supervision. Supported by the strong economy, the banking system remains profitable and well-capitalized, highly liquid, and exhibits low and still falling NPL ratios.

Exposure to Dubai was very limited, and is virtually non-existent with regards to Southern Europe. However, falling interest rates are putting pressure on bank profits, challenging the traditional business model that relied on intermediation of private deposits to the government and the BdL.

Banks are responding by seeking new growth opportunities outside of Lebanon and expanding domestic credit to the private sector, which has accelerated to 21 percent y-o-y growth in April.

Near-term risks to the economic outlook are mainly linked to the political and regional security situation.
The risk of a relapse by opposing party blocks into political deadlock or spillovers from a sudden spike in regional tensions remains latent, and exposes Lebanon to the possibility of a sudden negative confidence shock.
While there has been little fallout from Greece so far, an adverse shift in global market sentiment could lead to a repricing of sovereign risk, which would hurt the debt dynamics and could put pressure on international reserves.

To some extent, this risk is mitigated by Lebanon’s limited exposure to external government debt markets and its loyal depositor base. However, future shocks could be different in nature and expose vulnerabilities more strongly than past crises.

Against this broadly positive backdrop, economic policy still faces a number of challenges.

In the near term, the key issue is to manage the buoyant economy cautiously, avoiding overheating risks, such as excessive pressures on non-tradable prices and the external current account.

This requires, in the first place, a prudent fiscal policy stance. In addition, monetary and prudential policies have to be adapted to the post-global crisis environment to temper deposit inflows and avoid potential risks that could emerge in the future if property prices continued to rise rapidly, or from the regional expansion of local banks.

The main medium-term challenges are to address the country’s sizeable remaining macrofinancial vulnerabilities and implement growth-enhancing structural reforms. The key issue here is to avoid complacency and instead take advantage of the positive momentum to achieve debt reduction and re-launch long-delayed structural reforms, which could jointly help entrench stability and maintain high and sustainable rates of growth.

The authorities’ short-term policy focus is increasingly shifting from bolstering the economy in the face of a global recession toward managing its rapid expansion. Fiscal policy seeks to reconcile plans for a substantial increase in infrastructure investments with the need to safeguard macroeconomic stability and debt reduction.

The challenge for monetary policy, in turn, is to slow deposit inflows to a pace that can be absorbed without excessive credit growth or international reserves accumulation and associated sterilization costs. Finally, banking sector regulation and supervision is increasingly focusing on potential vulnerabilities emanating from high credit growth, sharply rising real estate prices, and the regionalization of domestic banks. (IMF)

Global Arab Network

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