Lebanon & Syria Country Outlooks for 2010
FROM THE ECONOMIST INTELLIGENCE UNIT
DOMESTIC POLITICS: In 2010-11 the political scene will remain uncertain, and will continue to be heavily influenced by developments elsewhere in the region. The government led by Saad Hariri, the prime minister, will make only slow progress on policymaking given the ideological and personal divisions between and within its two major factions. Mr Hariri’s “March 14th” movement and its allies, which hold the majority in parliament, are backed by the US, Saudi Arabia and France, whereas the opposition coalition, “March 8th”, is backed by Iran and Syria. Relations between the factions partly reflect relations between these external powerbrokers, which could deteriorate in the medium term. The president, Michel Suleiman, who is not aligned with either faction, will be a key powerbroker: five independent ministers that he appointed hold the casting votes in Mr Hariri’s power-sharing cabinet, which was formed in November 2009, five months after the parliamentary election. The results of the May local elections are likely largely to mirror the national power balance, but the electoral process could strain relations within the unity government.
INTERNATIONAL RELATIONS: There remains a risk of another confrontation with Israel in the medium term, and recent Israeli claims that Hizbullah, a Shia political-military movement that is part of March 8th, has received deliveries of Scud missiles have ratcheted up the tensions. However, neither Israel nor Hizbullah appears to have an appetite for another conflict in the near future, following the costly war in 2006, and the southern border is largely quiet apart from frequent Israeli overflights (which could eventually be a trigger or justification for escalation). However, the international response to Iran’s nuclear programme will have important ramifications for Lebanon. Although the dispute is likely to be addressed through political means, including sanctions, the risk of a US or Israeli attack on Iranian nuclear facilities cannot be ruled out. Under such a scenario, Hizbullah could be drawn into the conflict if Iran used the movement to threaten or retaliate against Israel, or if Israel sought to disable the group pre-emptively ahead of an attack on Iran.
POLICY TRENDS: The new government, formed in November 2009, should be able to make some progress with economic policymaking. However, efforts to rein in the fiscal deficit–largely driven by the hefty cost of servicing the massive public debt–will continue to encounter political obstacles. Corruption and patronage permeate the political system, and many politicians have their own interests in maintaining a bloated public sector. Privatising state enterprises will remain a highly sensitive issue owing to ideological differences and vested interests, and to questions about the likely transparency of any sales of state assets. Political divisions between March 14th, which controls the Ministry of Finance, and March 8th, which has the energy and telecommunications portfolios, will further complicate the debate. Long-discussed plans to sell the two state-owned mobile-phone operators and the heavily subsidised state-owned electricity provider, Electricite du Liban, may be deferred beyond 2011. Lack of progress on the reforms sought by donors is likely to delay further the disbursement of conditional aid pledged at the “Paris III” donor conference in 2007.
INTERNATIONAL ASSUMPTIONS: The global recovery is now well under way, but there are concerns about the likely effect of fiscal stimulus exit strategies and monetary tightening in many developed economies, and the Economist Intelligence Unit forecasts a softening of US growth in 2011. World oil prices are projected to rise in 2010-11, to an average of US$75/barrel (for Brent Blend). Lebanon is highly integrated into the regional economy, and will benefit from growth in the Middle East and North Africa region that is forecast to pick up to an average of 4.4% in 2010-11, although this is well below the average of 6% in 2005-08.
ECONOMIC GROWTH: Economic growth in Lebanon is closely correlated with trends across the Middle East, as services exports typically account for at least half of the small and open economy’s GDP. We forecast economic growth of 5.6% in 2010 and 5.3% in 2011, as a modest pick-up in regional growth boosts investment and demand for Lebanon’s exports, especially tourism. Although this is below the growth seen in 2007-09, it is still well above the long-term average since the civil war. Lebanon is still undergoing post-war reconstruction, but its long-term growth potential is constrained by political uncertainty and the high cost of financing for the domestic private sector (as banks extend most of their domestic credit to the government). Exports of goods and services are likely to remain the main drivers of growth, as Lebanon benefits from renewed economic expansion in the region. Domestic private consumption and investment growth will be constrained by the cost of credit, and government consumption growth will remain positive but will be curbed by the already large fiscal deficit.
INFLATION: We estimate that consumer price inflation dropped sharply in 2009, mainly because of lower world commodity prices. Official data from the Central Administration of Statistics show that inflation averaged 1.2% in 2009, with a spurt in the last quarter, but there are serious questions about their reliability. In 2010-11 inflation is expected to pick up to an annual average of 3.9% as oil and some other world commodity prices rise.
EXCHANGE RATES: The Lebanese pound is expected to remain pegged to the dollar within a trading band of LP1,501-1,514:US$1. The dollar, and thus the pound, is likely to strengthen against the euro during 2010 owing to investor concerns about debt problems in Greece and to expectations of interest-rate rises. Banque du Liban (the central bank) is strongly committed to defending the peg, aided by its ability to influence interest rates, high levels of assets and strong support from local commercial banks–which, as the holders of the largest part of Lebanon’s foreign debt, have much to lose if the peg were to collapse. Nevertheless, in the longer term substantial imbalances in the public finances and external accounts could leave the peg vulnerable.
EXTERNAL SECTOR: Lebanon will continue to face a large, structural current-account deficit, which will be offset by strong inflows of capital. Despite the sharp drop in oil prices in 2009, the trade deficit widened slightly as spending on non-oil imports increased the import bill marginally and export earnings stagnated. However, it appears that very strong growth in tourism receipts offset the rise in the trade deficit in 2009, narrowing the current-account deficit to an estimated 6.1% of GDP from 10.2% of GDP in 2008. The current-account deficit is projected to widen again to 8.7% of GDP in 2010 as the rising import bill, especially for fuel, more than offsets the higher export earnings and remittances expected to result from the pick-up in global and regional growth. However, our projections assume that further export and tourism growth and lower oil prices in 2011 will narrow the current-account deficit to 7.1% of GDP. Lebanon’s current-account deficit in 2009 was more than covered by capital inflows, leading to a gross balance-of-payments surplus of US$7.9bn. The main concern is the risk of capital flight in the event of a major political shock, which could create financing difficulties–but under such a scenario, Lebanon would probably receive support from its external allies.
FROM THE ECONOMIST INTELLIGENCE UNIT
DOMESTIC POLITICS: The Syrian president, Bashar al-Assad, and his ruling Baath party are expected to retain a secure grip on the country, supported by key elements in the security services. The core of the elite is drawn largely from Mr Assad’s Alawi sect, and any move against him would risk endangering its hold on power. However, tensions within the regime persist, accentuated by external pressures such as the UN inquiry into the killing of Rafiq Hariri, a former Lebanese prime minister, the ongoing investigation by the International Atomic Energy Agency (IAEA) into allegations that Syria has a nuclear programme and accusations that Syria has been supplying the Lebanese militant group, Hizbullah, with long-range missiles.
INTERNATIONAL RELATIONS: After a period of considerable diplomatic isolation in 2005-07, Syria has been developing steadily better relations with many Western and regional states–notably France, Turkey and Saudi Arabia–and this process is expected to continue over the forecast period. One consequence is that the EU is now ready to sign its long-delayed Association Agreement with Syria, and talks to resolve some outstanding issues with the agreement are expected to be resumed soon. The catalysts for the improvement in relations include the more constructive role that Syria is playing in Lebanon and a desire by Western and other Arab countries to weaken Syria’s alliance with Iran. Syria would like to play the role of a bridge between Iran and the West, but this will be difficult if tensions increase further over the Iranian nuclear issue.
POLICY TRENDS: Syria is expected to continue the gradual liberalisation of its centrally planned economy, a process that has been led by the deputy prime minister for economic affairs, Abdullah al-Dardari. However, there remain influential officials who argue instead that socialist and protectionist policies should be retained, and these conflicting interests will inhibit the formulation and implementation of policy. There are also powerful members of the business elite who benefit from the current status quo and might resist certain changes that would threaten their advantages. The recent removal of Tayseer al-Reddawi as head of the State Planning Commission, apparently over public criticisms he made about policy implementation, indicates that the economic debate remains highly charged. The overriding policy challenge will be to offset the impact of the decline in oil production by developing other sectors of the economy, particularly those that can boost export earnings in the medium term, such as tourism. This will require making established state-owned and family businesses more dynamic and encouraging entrepreneurship and investment. Moves intended to increase domestic and foreign investment include expanding the Damascus Securities Exchange, relaxing foreign-currency restrictions and boosting bank lending.
INTERNATIONAL ASSUMPTIONS: The Economist Intelligence Unit forecasts that world real GDP growth (at purchasing power parity exchange rates) will be 3.9% in 2010–this is up from 3.8% previously as a result of a number of positive indicators, particularly in China, India and Russia–and 3.5% in 2011 as the effect of government stimulus packages fades. The benchmark dated Brent Blend is forecast to average US$75/barrel in 2010-11. Syrian crude, most of which is heavy, will trade at a discount to this, averaging about US$66/b.
ECONOMIC GROWTH: We have revised up our estimate of 2009 real GDP growth to 3.6%–as new expenditure data suggests government consumption was higher than expected. We forecast that real GDP growth will average 4.1% in 2010-11. Foreign investment into Syria is likely to rise because of Syria’s increasing economic openness and improving international relations, although it will be held back in the short term by the ongoing global squeeze on credit–Groundstar Resources of Canada, for example, relinquished an oil-development contract in September 2009 because of problems securing financing. Government consumption growth will be steady in 2010-11 as the fiscal stimulus is sustained but will slow slightly. Fixed investment will strengthen in 2010-11. Private consumption growth will pick up in both years, although if there is a significant improvement in security in Iraq (not our core scenario) following its election and the planned withdrawal of most US troops by late 2010, a sizeable number of the 1m or so Iraqi refugees in Syria may return home, thereby depressing consumption. Imports will pick up after contracting in 2009.
INFLATION: Consumer price inflation is expected to increase over the forecast period, as global commodity prices recover slightly, government subsidies on fuel are reduced and value-added tax (VAT) is finally introduced. We forecast that annual average inflation will be 6.7% in 2010-11, up from just 2.6% in 2009, but well below the peak of 15.7% in 2008. If Iraqi nationals were to return home in greater numbers, this would have a deflationary effect, particularly on urban rents. However, this will only happen if security conditions in Iraq improve markedly.
EXCHANGE RATES: The Syrian pound is projected to strengthen slightly against the US dollar in 2010-11, to an average of SP45.7:US$1, as the world economy moves out of recession and Syria’s current-account deficit narrows slightly. The pound has been pegged to a basket of currencies based on the IMF’s special drawing rights since October 2007 and, although this new regime is less rigid than the previous peg to the dollar, the authorities are unlikely to let the pound float freely, because they place a high priority on exchange-rate stability. The dominant position of the state-owned banks and the Central Bank’s control over foreign-currency transactions (even as some laws are relaxed) mean that the regime is well placed to control the value of the currency. The Central Bank’s foreign-exchange reserves are relatively healthy, at US$4.7bn (around four months of import cover) at end-November 2009. (The Commercial Bank of Syria also holds some foreign reserves.)
EXTERNAL SECTOR: We forecast that export earnings will recover in 2010-11, to an average of US$11.7bn, below the oil-price-related peak of 2008. In recent years, drought has seriously constrained production and therefore exports of cotton and textiles. The drought has now eased, and our core scenario is that it will continue to do so in the 2010/11 season, although climatic trends are hard to predict. Oil production is increasing at a number of small fields but declining at the larger, mature fields, with the net effect that total production will be roughly flat, averaging around 377,000 barrels/day in 2010-11. The net impact of changes in oil prices on the trade balance is limited, because Syria’s imports of refined products are about equal in value to its exports of crude oil. A domestic factor affecting the trade figures is the relaxation of foreign-exchange controls, which has led to more non-oil exports moving out of the black economy and being officially recorded. Overall, the trade deficit will widen slightly to an average of US$2.8bn in 2010-11, although as a proportion of GDP it will fall to an average of 4.6%.