2ND QUARTER 2018 ECONOMICS LEBANON TABLE OF CONTENTS LEBANON ECONOMIC REPORT Executive Summary 1 A LACKLUSTER REAL SECTOR ACTIVITY YET COUPLED WITH PERSISTENTLY SOUND FINANCIAL AND MONETARY CONDITIONS Introduction 2 • Slowing down economic conditions in the first half-year While Lebanon has witnessed an active first half-year, underlined by the early adoption of a 2018 budget Economic Conditions 3 regularizing the State’s accounts, a number of successful international support conferences and free and orderly parliamentary elections, the country’s economy remains subdued, with the main growth drivers still sluggish on the overall. In fact, while private consumption has benefitted this year from the Real Sector 3 recent ratification of the public sector wage scale and its corollary impact on consumption spending of public servants, Lebanon’s investment framework continues to be adversely impacted by a mood of External Sector 5 cautiousness and uncertainty among investors. Within this environment, BDL has recently forecasted growth at 2% for 2018, against 2.5% last year. Public Sector 6 • A contracting trade deficit within the context of surging exports and declining imports Within the context of a 5% decline in trade deficit along with a 7% rise in financial inflows to Lebanon over the first five months of 2018 relative to the same period last year reducing the 2017 first half US$ Financial Sector 7 1.1 billion balance of payments deficit to a deficit of US$ 0.2 billion in the first half of 2018, a relative improvement in the external position was recorded over the period. The decline in the trade deficit comes within the context of a 9.9% growth in exports year-on year and a 3.0% retreat in imports over Concluding Remarks 11 the same period. • Monetary conditions persistently sound despite overall macroeconomic challenges Lebanon’s monetary conditions remained strong during the first half of 2018, despite overall macro- CONTACTS economic challenges, with the country’s defense lines at one of their most solid levels. The Central Bank of Lebanon’s foreign assets reached a new record high level in June, helped by BDL’s swap operations and continuous FC-to-LP conversions. They grew by US$ 2.2 billion during the first half of 2018 to reach US$ 44.2 billion at end-June. The Central Bank’s foreign assets-to-LP money supply coverage ratio rose Research from 80.0% at end-2017 to 81.8% of LP money supply at end-June 2018, which is two times the average Marwan S. Barakat of reserve adequacy in similarly rated countries (an average of 41%), outlining the Central Bank’s strong (961-1) 977409 capacity to defend the currency peg. [email protected] • Sound bank deposit growth yet coupled with lending contraction Jamil H. Naayem Lebanon’s banking sector witnessed healthy activity and earning growth in this year’s first half amid (961-1) 977406 sound deposit inflows on the back of increased capitalization, but lending activity remains slightly [email protected] contractionary year-to-date. Customer deposits, the traditional activity driver in the sector accounting for close to three quarters of banks’ balance sheets, progressed by US$ 4.7 billion in the first half of 2018, Salma Saad Baba in line with average first half growth of the previous five years, and reached US$ 173.3 billion at end- (961-1) 977346 June 2018. This has been favored by a pick-up in deposit collection as banks offered enticing returns [email protected] on deposits in local currency and amid higher interest rates cross-currencies in general following the further tightening of the US Federal Reserve’s monetary policy. Fadi A. Kanso (961-1) 977470 Capital markets under adverse price pressures during the first half-year [email protected] • Activity in Lebanon’s capital markets was tilted to the downside during the first half of 2018. The equity market, which suffers from a lack of liquidity and efficiency, registered price falls, increased Gerard H. Arabian price volatility and declines in total turnover amid lingering uncertainties over the cabinet formation. (961-1) 964047 [email protected] In parallel, the fixed income market saw downward price movements amid extended international offer that was accompanied by a low domestic bid, with Lebanon’s five-year CDS spreads seeing significant expansions over the first half of the year. This is actually well reflected in the 7.9% plunge Farah N. Nahlawi (961-1) 959747 in the stock price index year-to-date and the 202 basis points expansion in Lebanon’s five-year CDS [email protected] spreads, a measure of market perception of sovereign risk, to reach 723 basis points at end-June, before contracting back to 607 basis points at end-July 2018. 2nd Quarter 2018 1 Bank Audi sal - Group Research Department - Bank Audi Plaza - Bab Idriss - PO Box 11-2560 - Lebanon - Tel: 961 1 994 000 - email: [email protected] 2ND QUARTER 2018 ECONOMICS LEBANON While Lebanon has witnessed an active first half-year, underlined by the early adoption of a 2018 budget regularizing the State’s accounts, a number of successful international support conferences and free and orderly parliamentary elections, the country’s economy remains subdued, with the main growth drivers still sluggish on the overall, as witnessed by the lackluster performance of a number of real sector indicators. Out of 11 real sector indicators, 4 are up and 7 are down in the first six months of 2018 relative to last year’s corresponding period. Among indicators with positive growth, we mention total exports with an increase of 9.9%, the number of passengers at the Airport with an expansion of 9.3%, , electricity production with a rise of 5.3% and the number of tourists with a growth of 3.3%. Among indicators with negative growth, we mention construction permits with a fall of 17.8%, value of property sales with a contraction of 14.0%, merchandise at the Port with a fall of 7.9%, new car sales with a decline of 5.4%, cement deliveries with a decrease of 4.1%, imports with a drop of 3.0%, and cleared checks with a downtick of 2.5%. Consequently the coincident indicator of the Central Bank of Lebanon, a mirror image of real sector activity in the country, reported 314.5 over the first five months of 2018, i.e a growth of 2.5% year-on-year. Such a growth is below the one reported over last year’s same period (4.6%) and over the same period of the past three years (3.3%). It seems the real economy is slowing down this year, yet without falling into a recessionary trap. BDL has recently forecasted growth at 2% for 2018, against 2.5% last year. In fact, while private consumption continues to be sound, private investment is adversely affected by the wait-and-see attitude among investors. Private consumption has benefitted this year from the recent ratification of the public sector wage scale and its corollary impact on consumption spending of public servants. On the other hand, Lebanon’s investment framework continues to be adversely impacted by a mood of cautiousness and uncertainty among investors as witnessed by the decline in bank loans to the private sector amid scarce lending opportunities. At the external level, within the context of a 7% rise in financial inflows to Lebanon over the first five months of 2018 relative to the same period last year reducing the deficit in the balance of payments, a relative improvement in the external position was recorded over the period. Financial inflows, which had been lagging in recent years behind the trade deficit, almost offset it year-to-date. Financial inflows to Lebanon rose from US$ 6,647 million over the first five months of 2017 to US$ 7,090 million over the first five months of 2018. In parallel, a 5.2% decline in the trade deficit is witnessed amid a 9.9% growth in exports year-on-year, and a 3.0% retreat in imports over the same period. Amid a slight increase in financial inflows, banking activity was sound, with satisfactory deposit growth but with negative lending growth. Deposit growth reported US$ 4.7 billion over the first 6 months of 2018, close to the same period last year, while the lending portfolio reported a net contraction of US$ 0.1 billion for the first time in recent years. Unlike last year when all deposit growth was driven by FX deposits, this year’s deposit growth was evenly broken down between LP and FX deposits, leading to a slight retreat in dollarization from 68.7% at end-December 2017 to 68.4% at end-June 2018. The overall economic sluggishness over the first half-year was accompanied by adverse capital markets developments. At the equity market level, the BSE price index contracted by 7.9% over the first six months of 2018, amid a 47.3% decline in the trading volume year-on-year. At the fixed income level, the 5-year CDS spreads, a measure of the markets perception of sovereign risks, rose from 521 bps at end-December 2017 to 723 bps at end-June 2018, i.e a deterioration of 202 bps, before relatively improving in the month of July. The developments in the real sector, external sector, public sector and financial sector for the first half of 2018 will be analyzed thereafter while the concluding remarks are left to an in-depth assessment of the requirement to fight fiscal evasion as a prerequisite for public finance softlanding.