Lebanon: Rebuilding all over again (page 2 of 2)

Higher investment spending linked to the reconstruction process is expected to drive real GDP growth of 12.0% in 2007. The majority of the rebuilding will initially be financed by either donor support or government and private Lebanese initiative.

For example, Lebanese individuals and private companies have donated funding for the reconstruction of 12 of the 80 bridges destroyed. With regards to donor support, the Saudi and Kuwaiti governments have donated USD 500m and USD 300m respectively in grants for the rebuilding and the international community pledged USD 940m in aid in a donor conference held at end-August. It will take a longer period of peace for foreign investment to return to Lebanon.

With regards to the government, emphasis has shifted from the reform program, which focused on reducing fiscal imbalances, to the reconstruction of the country. The parliamentary Commission for Public Works, Energy and Water has devised a 6-step plan to tackle the reconstruction. Beirut had made it clear to potential donors it wants to lead its own reconstruction effort.

In another positive development, the authorities have continued in managing the stability of the currency. Breaking of the currency-trading band against the US dollar would have increased the cost of servicing and repaying external debt, which accounted for 51.3% of total government debt in May 2006.

Supporting the Lebanese pound

The greatest demand for the US dollar was at the initial stages of the conflict and the central bank had to intervene by drawing down its FX reserves. However, the central bank indicated the intervention required was less than following the assassination of ex-Prime Minister Rafiq Hariri. The domestic currency was partly supported by the record high FX reserves held at the central bank; reserves stood at USD 12.9bn at mid-July.

Confidence in the Lebanese pound increased following Saudi Arabian and Kuwaiti's announcements that they will transfer USD 1bn and USD 500m to Lebanon's central bank respectively. By the fourth week of the conflict, the central bank barely had to intervene in the currency market. Importantly, FX reserves only fell to USD 12.6bn by 15 August, following the USD 1bn Saudi deposit; this figure excluded the USD 500m pledged from Kuwait.

Debt support required

As in previous crises, the yields on government Eurobonds increased owing to the higher risk premium. However, the government is unlikely to default on its sovereign debt in the short term due to the combination of the composition of investors and the Gulf support highlighted. The bulk of the government debt (including foreign) is held by Lebanese banks, which alleviates massive exists at times of crisis.

Credit ratings agency Standard & Poor's said the Gulf pledges are helpful for the country's near-term rating prospects and would help bolster depositor confidence in the Lebanese banking system, although the agency placed Lebanon's 'B-' long-term sovereign rating on credit watch with negative implications. Meanwhile, Fitch cut Lebanon's credit rating outlook to stable from positive.

Donor support also remains vital for managing the already high debt positions. Prior to the conflict, government debt amounted to USD 38.7bn, equivalent to over 175% of GDP. Debt levels will increase going forward with the rebuilding process and international grants will be central in limiting the increase in debt. Importantly, the crisis has hastened the convening of the delayed meeting to 31 August in Sweden.

This will be followed by a meeting in Beirut to address longer-term economic needs. However, for Lebanon's debt position to reach a sustainable long-term level, a significant level of debt forgiveness is required, rather than just restructuring and grants.