ACI – The Financial Markets Association is due to hold its 43rd World Congress in Lebanon in September and as part of the build up to the Congress, Profit & Loss spoke to Riad Salameh, the Governor of Banque du Liban, the country’s central bank, about his outlook for the local economy and recent events in the country’s economic history.
The story of Lebanon in the modern era has been traumatic; the country was wracked by a civil war for 15 years which destroyed much of the country’s infrastructure. Whilst the physical rebuilding process is continuing apace, economically speaking there is still much work to be done, although recent advances have given the local markets a sense of optimism.
Riad Salameh, governor of the country’s central bank, Banque du Liban, acknowledges that much work needs to be done as the country seeks to return to the position of regional influence that it held throughout the 1960s and early 1970s. “Lebanon has always practiced a free market since independence, thus encouraging the free movement of capital,” he says. “We are sensitive to providing the environment necessary for the markets to operate efficiently and to international standards.
“After the war, we had to create a programme to rebuild the infrastructure and to upgrade the income and social standards for the people. During the war, people got poorer and the currency weakened. Our challenge now is to complete the rebuilding of the country.”
Inflation has been at the centre of the process, according to the governor, who explains, “Keeping inflation under control was a difficult task, but we ensured that it remained our major target and since 1996 we have achieved price stability. In 1991/1992 inflation was over 100%, but we have managed to hold it under 5% which has also helped us maintain a stable exchange rate.”
A key element of the economic recovery was what the governor terms, “the re-enhancement of the financial markets”, with a focus on the banking sector. He points out that the banking sector was weakened during the war as capital left the country. “It was a major effort to rebuild confidence and reconstitute the capital base as well as to build a large base of deposits. Lebanon is rare in the fact that it has a deposit base almost two and a half times GDP. This deposit base came from the confidence we were able to create in the regulatory environment and our desire to let the market function normally.”
The regulatory environment referred to by Salameh has seen banks in Lebanon adopt internationally recognised principles and accounting standards set by such institutions as the Bank for International Settlements and the International Monetary Fund. Reinforcing this was the establishment of a legal framework to fight money laundering.
The increased deposit base has also helped the readjustment process and supported the country’s deteriorating balance of payments situation. “During the readjustment process, the country received no aid and developed a large deficit,” says Salameh. “This meant we had to keep interest rates high and led to a series of downgrades by the international rating agencies over the past 10 years.
“We were also impacted by the series of emerging markets crises such as those in Russia, Asia and Latin America,” he continues. “Our profile was assimilated with those markets, therefore an atmosphere developed wherein we were waiting for the next crisis. This affected the markets and pressured rates and the budget deficit, so we had to break the cycle by our own means.”
Notwithstanding the problem of the budget deficit, the Banque du Liban managed to achieve a degree of exchange rate stability – it currently maintains a 1500-1515 range to the US dollar – as well as the reconstitution of the banking sector. More than 30 banks were merged into other organisations during this process, Salameh stresses that no depositor lost money, and what he terms “a stronger banking system” emerged which has a mixture of domestic, offshore and blended ownership.
With the soundness of the banking system assured, the task of the central bank then moved to other areas, specifically the large debt built up during the initial reconstruction process. “The level of interest rates was not sustainable,” explains Salameh, “Therefore the French government, at the request of Lebanon, prepared the Paris II meeting which prepared an aid package for the country and gave the domestic market a great confidence boost.”
The package consisted of 15-year loans worth $4.5 billion to Lebanon at low rates. Salameh breaks down the figures as follows: $3.1 billion directly to the budget to reduce the deficit, and $1.4 billion to fund regeneration projects. The execution of the loans started in early 2003 when $950 million was received and Eurobonds issued against that tranche.
“Paris II boosted confidence as the market recognised that it would bring down interest rates without jeopardising the currency or the banking sector,” says Salameh. “It was very important that we did this quickly and we were successful. Two-year secondary rates fell from 16-18% to under 10%, Eurobonds were trading at a discount of 20-30% but have rallied to sell at a premium and yields in dollars fell from 14-18% to a maximum of 10%. This gave us the conditions for better financial government, and will enable us to cover principal and interest payments in the future.”
To reinforce the benefits of the Paris II agreement, the Banque du Liban and the government also agreed terms of a groundbreaking deal with the banking sector. The banks had received windfall profits during the upheaval of the previous decade, so they were approached to help restructure the government’s debt. The banks subscribed $4 billion in loans at zero per cent to reinforce the Paris II funds, meaning, says Salameh, very important savings in the country’s debt servicing programme. “These deals mean that in two to three years, the next Lebanese government will be able to balance the budget,” he adds.
In terms of the problems still facing the country, aside from the regional issues over which it has little control, Salameh pinpoints economic growth as a key factor in the long term recovery plans. “The economy witnessed low growth – it has probably been running at around 2% on an annual basis – however we think 2002 will be lower than that as there was less activity. We are confident that 2003 will see a better rate of growth and that we will witness significantly higher rates of growth in 2004 as other sectors of the economy reinforce the activity generated by the financial services sector,” he says.
The areas expected to reinforce the recovery are, the governor suggests, predominantly in the service sector, such as tourism and medical services. “Even industry has doubled exports over the past two years,” he adds, reinforcing the positive outlook for the country. “Which is a value-add because we possess few raw materials and mostly rely upon services.”
“Technology also played a key role in the development of the banking system,” the governor continues, “Lebanon has a payments system similar to those in Europe and the US. It is also important for a country with large capital movements – a lot of our economic activity comes from external activities – to have the technology to facilitate the movement of capital.”
Alongside the economic regeneration, the political renaissance continues. Lebanon recently joined the EuroMed group of countries and is part of the Arab Common Market. Salameh also reveals that the country is in the throes of preparing its World Trade Organisation (WTO) entry bid.
Underpinning the recovery effort is Lebanon’s total belief in the market economy. “Our policy is clearly that we have open markets – there are no restrictions on ownership of Lebanese companies for example,” he notes. “By following this path, we can attract further investment and operating companies to our country. We reinforce this with a sophisticated banking sector which adheres to international standards and is fully transparent.”
Although the war in Lebanon drove many of its citizens abroad, sufficient skill sets still exist within the country and are being built upon as confidence and many of the exiles, return. “Our biggest asset is our people,” opines Salameh. “They are well-educated and their skills can help improve the economic situation through the implementation of technology.
“We have done enough on the regulatory side – we have created a market approach that can push interest rates lower and help prop up the economic recovery,” he continues. “We can now look to leverage off our peoples’ skills to export our banking services, especially to the Arab countries.”
The economic recovery plan relies heavily on one aspect beyond the control of the central bank or the market – the government’s willingness to adhere to what is in effect a voluntary programme. “The government has committed to a programme of reorganising the country’s debt maturities that will help push interest rates lower,” notes Salameh. “For this to be a success however, the government needs to maintain the pace of the budget deficit reduction through the programme of privatisation and securitisation of certain parts of its income.
“We also have to acknowledge the reduced role the government will take in the economy and that the private sector has to create enough liquidity for employment and economic growth,” he adds. “Difficulties could arise if the government delays its objectives or if there is not sufficient follow-through from the private sector. Although we are hopeful of the recovery, it has to be recognised that it will take time.”
As noted earlier, the Banque du Liban has been able to maintain exchange rate stability; a factor the governor notes “will always be important” for the country. “Perhaps the most important element of our strategy is the stable exchange rate,” he explains. “This generates confidence which is very important for capital flows. A weakening exchange rate can create negative sentiment and we rely to a great extent on international capital flow.”
The central bank has been intervening regularly on both sides of the market in recent years, an element of its activities that builds a deeper relationship with the market. “By maintaining a managed – as opposed to fixed – exchange rate regime, we have been able to create a relationship based on trust with the market,” says Salameh. “The market may not always agree with what we are doing, but thus far it has. Our policy will continue to target the attraction of investment and capital flows, controlled inflation and a stable exchange rate.
“There is no advantage in a more competitive exchange rate for Lebanon, because of the dollarisation of our economy,” he continues. “Such a move would only pressure interest rates higher and while the yield differential is still important to attract investment, we have to ensure it is not overstated.”
Although the dollar remains dominant in Lebanon, the country is closely aligned historically and empathetically with France, which raises the question of whether the euro will have an impact on the local economy. Salameh is reluctant to predict a role for the fledgling currency, suggesting the market will decide. “The euro may well have played a bigger role had it not declined so steeply in its early period,” he suggests. “But as it recovers there is a chance that it could play a bigger role. It has to be recognised, however, that the market relationship remains in dollars, so even if the euro is to play a bigger role it will take some time.
“The euro is a good currency,” he adds. “And we will encourage ‘euro-isation’ in the local economy. We already clear euro cheques and have issued Eurobonds in the currency, so we are seeing an impact.”
Looking closer to home, the subject of the recently announced Gulf Currency Union along the lines of the euro project arises (see Profit & Loss, November/December 2002). “The currency union is an important initiative,” Salameh says. “And looking ahead, if we have built even closer relationships with those taking part, we will look at entry favourably – I think the currency union is a very good approach for this region to take.”
All things considered – and there is still the very important matter of regional stability to consider – Lebanon appears to have a bright future. This is an opinion shared by the governor, who expounds the need for a considered approach. “Lebanon has an international standard legal environment, a truly open market approach to its economy and is seeing a strong improvement in its economic fortunes. It also has the communication and culture to sustain a market economy. If we continue to be prudent and take safe steps – all the while maintaining momentum – Lebanon can become a major player in the global markets,” says Salameh.