Lebanon’s financial firefighter
|Central bank governor of the year: |
Riad Salamé, Banque du Liban
The central bank governor has fought hard to achieve financial stability in recent years. Now, of course, that stability is being barely sustained by a narrow thread as the financial cost of the conflict between Hizbullah and Israel mounts up. The war might well push back Lebanon’s economic development several years. Up to now, though, the economic situation has not become as bad as it could have. There has been no financial markets meltdown, for example, or a run on the banks or a massive sell-off in the currency. That’s largely attributable to the foundations laid by the battle-hardened central bank.
The bank has, for example, built up its foreign currency reserves to $13 billion, equivalent to more than 18 months-worth of imports. This historically high level of reserves is acting as a safety net in ensuring that the Lebanese pound remains stable. Salamé says that there has been no need for strong intervention in the currency markets. Although the Lebanese currency is trading at the weak end of its official band, it has held up well in the circumstances. Salamé says the central bank is committed to supporting it and providing liquidity to the financial system.
Another boon is the banking system, which is solvent and liquid despite concerns that banks were limiting withdrawals of dollars. However, they were able to issue cheques and Lebanese pounds to depositors. If there is one consolation to take from the conflict, scant as it might be, it is that Lebanon’s financial institutions, just like Salamé, have experience of operating under the most intensely hostile conditions. Moreover, they are working closely with the central bank to ensure that any disruption is kept to a minimum. Banks’ consolidated balance sheets have grown 10-fold in the past decade – a sign of how far they have come. The banking system is weathering the storm even though Standard & Poor’s placed Bank Audi, Blom Bank and BankMed on negative watch following the outbreak of the conflict.
On the macroeconomic front there is uncertainty about the impact of the conflict on Lebanese growth this year. Salamé says he expects inflation to remain on target at about 4%. He is also confident that the government has enough money to continue to service its public debt repayments this year. Before the war broke out, Lebanon’s debt was already more than a staggering 180% of GDP; in the short term that ratio will rise. As far as the financial markets are concerned, though, the country’s debt dynamics are manageable. In the aftermath of the attacks, Lebanon’s bond and credit default swaps widened out considerably and the sovereign’s five-year CDS was even trading at a premium to Iraq. But at no point was there ever a risk that Lebanon would default on its debt, 80% of which is held by local banks.
From one crisis to another
Relatively favourable market sentiment is a testament to Salamé’s management of the financial system. The central bank president is without doubt the dominant financial figure in Lebanon. He gains respect for his ability to rise above the political fray – not easy in a country as political as Lebanon. And his skill in steering Lebanon’s economy to safer ground following a crisis is much admired. It is one of the bitter ironies of the war that it broke out just as Salamé had succeeded in restoring confidence in Lebanon’s economy following the shock of the assassination of former prime minister Rafik Hariri in February 2005.
The death of Lebanon’s most popular and iconic figure led to about $2 billion in deposits being withdrawn and another $5.5 billion being converted into dollars, according to the IMF. The Fund says: “Hariri’s assassination and the subsequent political crisis triggered significant financial turmoil and pressures on international reserves.” That a protracted crisis was averted was largely a result of action taken by the central bank. It absorbed some of the pressure through its international reserves. It also took other measures, as laid out by the IMF in its June Article IV report on Lebanon.
First, swap operations were undertaken, backed by higher interest rates and financial sweeteners, to lengthen the maturity of commercial banks’ claims on the government and the central bank.
Secondly, 10-year dollar certificates of deposits were issued, yielding 10% interest to attract and lock in some of the foreign assets of the commercial banks. In order to avoid a downgrading of banks’ ratings and its possible impact on confidence, incentives provided to banks included upfront cash payments to shore up profits. A sharp rise in interest rates on Lebanese pound deposits eventually contributed to a stabilization of the situation, until the effects of the political crisis waned.
By mid-year, concluded the IMF: “deposit inflows resumed at a high pace, accompanied by gradual dedollarization. The $750 million Eurobond issue of October 2005 was heavily oversubscribed, notably by international investors; by mid-March 2006 Eurobond spreads had declined to a record low of 180 basis points, broadly in line with the global emerging market index”.
The central bank’s intervention had paid off and the subsequent economic recovery was an important breakthrough for Lebanon, says Salamé. Speaking to Euromoney in his office the week before the Hizbullah conflict with Israel broke out, he said, almost prophetically: “As you know, our country is always arguing politically and can sometimes be exposed from a security point of view. The fact that we could separate the economy and the financial market from those realities is, I think, the major improvement.”
Carrying the burden
However, putting Lebanon back on track and continually financing the government comes at a price, says the IMF. It says that increased intermediation since 2002 had come at the expense of the central bank’s financial strength. “Its balance sheet has grown from $13 billion at end-2002 to $29 billion by end-2005, reflecting (below market) financing of the government and parallel sterilization operations, as well as efforts to replenish international reserves. The expansion of the balance sheet has been accompanied by growing losses that reflect these operations, as well as:
“1. The transfer to the government of unrealized capital gains on gold holdings
“2. The high cost of long-term dollar debt issued in the first half of 2005
“3. The favourable conditions accorded to commercial banks to protect their profitability in 2005.”
For his part, Salamé denies that the central bank’s finances have become weaker. Far from it. He says the bank is in healthy shape and points out the record level of foreign currency reserves as one example. In addition, the bank has about $6 billion in gold as well as shareholdings in key local companies, such as Middle East Airlines.
He does agree with the IMF report’s assessment of how big a role the central bank has had to play and still does in propping up Lebanon’s economy.
“The IMF report states that the central bank has been alone in carrying the burden of stability in the country and of managing the macroeconomic [situation],” says Salamé. “The report calls on the government to help share [the burden] on this issue. And we agree with that.”
He adds: “The fact that the central bank had to fund alone the government and the needs of the private sector and the banks, and to be present in the local currency market and foreign currency markets, was praised by the IMF. But at the same time it is a burden that should be shared. Nevertheless we are in good health.”
Never a dull moment
Once normality returns to Lebanon and the country begins to regroup, attention will begin to focus on how the central bank will perform when Salamé leaves office. Although he was re-elected for a further six years only last year, rumours abound that he might be in the running for the country’s presidency when the position comes due late next year. When asked about the future, he says enigmatically that while there are, theoretically, still five years left of his term in office at the central bank: “Only God knows what will happen.”
His final statement is the most poignant. “You don’t have one dull moment in Lebanon,” he says, when asked whether he still enjoyed being central bank governor. At the time, the statement was made half in jest. Right now, it is a sure bet that Salamé and his fellow countrymen would be craving for nothing more than that.
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