Economic Analysis - Recovering, But No Boom Ahead - NOV 2017

BMI View: The Lebanese economy will see some improvements over the coming years, as falling political risk boosts business confidence and as external conditions brighten. That said, the pace of growth will remain modest, owing to structural weakness in the business environment , poor public finances prompting austerity measures, and the return of inflation.

We maintain our view for the Lebanese economy to experience a modest uptick in growth in 2017 and the following years, after having bottomed in 2015-2016. Continued improvements on the political front will support confidence in the economy, which will also benefit from improving external conditions. As such, we forecast growth to accelerate from an estimated 1.5% in 2016 to 2.3% in 2017 and 2.5% in 2018. That said, given structural weaknesses in the Lebanese economy, the introduction of tax hikes, and the return of inflation, growth will remain insufficient to make a notable difference to living standards and to engineer a return to boom years.

Gradual Recovery For The Lebanese Economy
Lebanon - Real GDP Growth & GDP Per Capita
e/f = BMI estimate/forecast. Source: UN, BMI

Confidence Boost And External Conditions Supporting The Recovery...

Falling political risk in Lebanon will be the main factor underpinning the growth recovery. Since October 2016, we have seen significant progress in addressing the country's institutional crisis, with the election of a new president, the formation of a new government, and most recently, the adoption of a new electoral law in July 2017, a precondition for the organisation of legislative elections in 2018. This will facilitate the policy-making process and give greater clarity to investors. For instance, the government has revived efforts to develop the oil and gas industry in the country, with the promulgation of two decrees in January delineating exploration blocks and approving the tender protocol mechanism ( see ' Major Attraction To Offshore Tender ' , May 2 2017). While a taxation law has yet to be announced, these progresses will drive foreign investors' interest in the sector. Illustrating recovering business sentiment, Lebanon's Purchasing Managers Index readings have improved following the election of Michel Aoun - although they remain below the 50 threshold which separates expansion from contraction.

Some Improvements Since October 2016, But Still Below 50 Threshold
Lebanon - Purchasing Managers' Index
Source: BLOM Bank, PMI

We also expect some notable improvements in external conditions, which will in turn have a positive impact on the crucial tourism sector and on exports. Exports of goods have benefited from the weakness of the US dollar (to which the Lebanese pound is pegged) and from the relative stabilisation of the security situation in Iraq and Syria, which has enabled the reopening of some trade routes. As such, goods exports expanded by 11.1% y-o-y in the first half of 2017. This has been compounded by a gradual recovery of the tourism sector, benefiting from the return of tourists from the Gulf, owing to the removal of the ban imposed in 2016 by the Gulf Cooperation Council on its citizens to travel to Lebanon, and by improving perceptions of security conditions.

Return To Positive Growth, But Vulnerabilities Still At Play
Lebanon - Monthly Exports, 3-month moving average
Source: Lebanese Customs Department, BMI

... Structural Challenges Preventing Return To Boom Years

These modest improvements will not be sufficient for the Lebanese economy to return to the boom years seen between 2007 and 2010, when the economy expanded by an annual average of 9.2%. The Lebanese economy still faces a number of challenges, including the dire state of public finances, which will force the government to limit spending and will particularly weigh on public investment. This has for instance pushed the government to hike the corporate tax rate from 15% to 17% earlier in August 2017, which will limit business confidence improvements.

Weak Business Environment A Major Deterrent
MENA - World Bank Ease Of Doing Business Rankings
Source: World Bank, BMI

Lebanon's weak business environment will also constrain the country's growth prospects over the coming years. Lebanon ranks 126th out of 190 economies in the World Bank's Ease of Doing Business for 2017, down from rank 122nd the year before. For the pace of economic growth to sharply accelerate, we would need to see ambitious reforms adopted. One measure that has long been mooted by various multilateral agencies is the restructuring of loss-making state energy company Electricite du Liban - transfers to the company accounted for around 4% of GDP before the slump in oil prices. Measures to tackle corruption and reduce red tape would also likely be necessary to improve the business environment. However, given continued fragmentation in the political life, we see limited room for structural reforms to be implemented over the coming years.

Inflation And Tax Hikes Holding Consumption Back

We still expect private consumption to be the main driver of growth over the coming years, benefiting from the recovery in the tourism sector and by stimulus packages of Banque du Liban (BdL). BdL has actively subsidised loans over the past few years, driving demand for credit in the economy, and we expect this trend to continue. Meanwhile, salary raises in the public sector, adopted by the government in August 2017, will also be positive for consumption. Nonetheless, we caution that private consumption growth will be held back by the increase in the value-added tax rate from 10% to 11%, and by other tax hikes on tobacco and alcohol among others. In addition, households will be negatively impacted by the return of inflationary pressures in 2017, after two years of deflation. We forecast inflation to average 3.9% in 2017 and 3.0% in 2018, up from -0.8% in 2016, owing to recovering energy prices and dollar weakness ( see 'Inflation Uptick To Continue In Coming Months ' , August 25 2017). This will limit the upside from private consumption.