Tuesday, May 24, 2011

Can the utterly corrupt Lebanese Politicians Save The Economy?

Can the utterly corrupt Lebanese Politicians Save The Economy?

The Lebanese sovereign debt has the 7th highest CDS (credit default swap) in the world. That is not good....

Whenever a country is subjected to some turbulence; social political, economic or natural; its economic performance is bound to suffer. This has always been the case, all throughout history and it still is. Just witness the economic pain that was inflicted on the United States and on Europe as a result of the subprime problem, the failure of regulations and the extended leveraging indulged in by most actors. This has also been the case in Japan that suffered from the twin natural disasters of an earth quake and a tsunami when it was barely out of the “lost decade” debacle.
The Arab uprisings have not been more merciful. It has left in its wake a weakened Tunisian economy, an Egyptian economy that is caught in a painful down spiral, a Libya that is in the midst of a civil war and economic decline and a Syria that would most likely be hit by a severe economic contraction due to the ongoing social strife and the ensuing economic insecurity that accompanies it.

Lebanon appears to have escaped, so far, the political upheavals plaguing the region not because it is not in need of reform but because its citizens have freely chosen the reigning corrupt system of government that they are free; at least in theory; to change if they choose to do so. But the Lebanese do not have much to gloat about. The economy is not in shambles yet but it is, at best, in an unenviable position. Unemployment is high, social spending is meager, capital inflows are decreasing, the central governmental budget deficit is growing, exports are diminishing, the tourist sector projections are rather gloomy and the sovereign debt is growing both in absolute terms and as a percentage of the GDP.

In spite of all the above very few of our politicians devote much of their time to a serious discussion of the economic policies and priorities that Lebanon needs to adopt in order not to avoid falling into the economic abyss that the country is hurtling towards. The hubris of the politicians led them to build castles on the sand. They are all proud of the relative economic performance of the country in the last 2-3 years although that success is illusory and rests on very weak fundamentals.

Obviously the ability to finance the national debt is arguably the single most important issue facing the country. The lessons from the problems of Greece, Portugal and Ireland amongst many have not been learned by the Lebanese politicians whose expectations to manage the national debt are based on nothing else besides wishful thinking.

The easiest way to look at the burden created by the national debt is to determine its relative size to the GDP. Lebanon has the disadvantage of having an extremely high debt/GDP ratio which has increased recently. How difficult is it to project the size of this burden over the next decade? A detailed projection would require building a complicated macroeconomic model. But one can get a feel for what is likely to happen by simply looking at two variables, the average interest rate paid on financing the current debt and the average expected nominal rate of growth in the economy.

I have worked out for you three different scenarios. All what you have to do is choose the scenario that you think is most likely to occur.
My projections are based on a ten year cycle. This means that the following figures are projections for the year 2020 based on 2010. Another very conservative assumption is that the rate of interest paid on the debt will average only 7%. Most probably it will be much higher. Another starting assumption is that at the end of 2010 the GDP was 60,240 billion LL while the national debt amounted to 79295 billion LL. We will also assume that the Lebanese government will not be in a position to reduce the principal outstanding but will not borrow except to pay for the interest.

Sovereign Debt 2010:LL 79295 billion
Sovereign Debt 2020: LL 155,807 billion
GDP 2010:….LL 60,240 billion
GDP 2020…..LL142,500 billion (assumes annual average growth rate of 9%)
GDP 2020…..LL118,500 billion(assumes annual average growth rate of 7%)
GDP2020…..LL98,000 billion (assumes an annual average growth rate of 5%)

As you can see from the above it is crucially important for the economy to experience a nominal growth rate that is larger than the average rate of interest paid on the national debt. Any growth rate that falls short of the rate of interest is simply disastrous. Note that the 2010 Debt/GDP =132 and the rate will decrease to 109 if the economy can achieve an average rate of growth of 9% per annum but 159 if the average rate of growth is to be only 5% per annum. Obviously at an average rate of growth of 7% the ratio will not change.

For those that think that 9% or more is likely I have lovely plots of land for sale in the center of Beirut....

The Lebanese economy has hit the rough spot that I have been warning about for a while. All metrics are pointing south and the future does not look good.
It is next to impossible to envision a scenario where the Lebanese economy will grow at a faster rate than the rate of interest that has to be paid on the sovereign debt. This simply means that Debt/GDP will only grow and that there will never be any adequate funds to spend on the vast social needs of the country.
Lebanon needs to take some very painful economic measures if the country is to stand a chance of avoiding major dislocations. Unfortunately very few , if any, of our politicians have either the interest or the knowledge to tackle this most important of issues....


Crushing Sovereign Debt....

What is the single most important rationale for government? We agree to have a government and we endow it with many forms of power in the hope that it will maintain law and order, create even leveled fields in all areas, protect our intrinsic rights of congregation, freedom of speech and freedom of belief provided that its collective policies will produce a higher level of welfare than would have existed without it. Government appears when the members of society delegate to it the power to monopolize decision making in an effort to create an environment that is conducive to economic prosperity.

One can easily conclude from the above that ultimately it is the question of economic organization that determines the shape of society. Marx actually went further than this by stating that “history of society is a history of class struggle”. One does not have to be a Marxist to share the view that economic issues and the relations of production form the base upon which society is built.

If economics is so important then it behooves the Lebanese politicians to pay closer attention to the implications of the policies that they have subjected the country to over the past two decades. If they do not then the impending economic disaster will sweep away from the current current corrupt system at a great cost to the average citizen.

The world is rapidly coming to the realization that the monopoly power of government to borrow and spend by running deficits is not without its limits. Keynesian economics popularized the notion of an activist role for macroeconomics but it did not encourage profligate spending. Government has an important role to play whenever the economic Gods “conspire” to generate a level of output that is below the level of full employment but that does not mean that government can buy its way into prosperity through borrowing, inefficient spending, corrupt bureaucracies and badly thought investment projects. Those who thought that it is possible “to have a slice of cake and eat it too” have found out to their dismay that the price of exec and abuse is very high indeed. Just ask Argentina, Venezuela, Greece, Portugal and Ireland among others.

It is becoming increasingly clear that Lebanon will most likely be among the others although you would not know it from the Lebanese politicians or even the Lebanese press. What makes the Lebanese so sure that they are immune when they have violated practically every major macroeconomic metric? It is true that the civil war was costly both in blood and treasure. What civil war isn’t? But to feel that all what had to be done was borrow and spend without addressing the structural constraints has created one of the highest debt/GDP ratios in the world. A high debt ratio by itself might not be enough to indicate imminent problems but when that metric is added to high labour redundancies, dependence on capital inflows from expatriates attracted by artificially high interest rates coupled with an inability to service the national debt without additional borrowing then the outlook starts to become dire.

International capital markets are constantly evaluating the degree of risk that is to be associated with each of the different sovereign bond issues. The most common such a judgment is seen through what is commonly referred to as CDS, credit default swap. A CDS is essentially an insurance premium that the buyer of a risky issue is willing to pay to guarantee the principal involved. All of this dry and technical jargon is important because the professional global money markets have assigned to Lebanese debt the 7th highest CDS premium (the higher the premium the riskier the debt) Yes you heard it right, only six countries in the world have riskier debt than Lebanon and yet no one either at the Parliament, the Cabinet or MSM is talking about this.

Lebanese politicians have over the short life of this experiment called Lebanon moved from one political crisis to the next without ever dealing with the root cause of what ails the country. This will not work in economics, not when Lebanon has chosen to use the international capital markets. Denial will only make things worse. The Lebanese national debt has entered a new era of growth both in absolute and in relative terms. There is no way of stopping this trend without taking the bitter pill of debt restructuring. Lebanon is not the US, Japan< Greece or Portugal. Each of these countries can and will adopt an austere fiscal policy to get out of the hole that indebtedness has created but Lebanon cannot do this since there is not that much to cut anyway and since Lebanon cannot borrow at very low interest rates. The Lebanese debt will only grow and its burden will increase until the whole edifice comes crumbling down like a house of cards that it is. The matter is simple really, it is impossible for the Lebanese economy to grow at a faster rate than that used to finance its debt given the size of the debt and the realistic potential of the economy. Lebanon will be forced to restructure its debt, the sooner the less is the pain.

There is a moral dimension to this story. Those that are elderly have borrowed and possibly experienced some short term prosperity but they are leaving the future generation with an unsolvable problem that is reminiscent of Sisyphus. I pity the next generation....

This year and next are going to be very pivotal for Lebanon.... It does not take a genius to figure out that when your debt is larger than the GDP and when you finance that debt by paying an interest rate that is above 7% that the Debt/GDP will grow when the GDP increases by only 1.3% in 2011....
The sooner our utterly corrupt and subservient politicians and public realize that we have no choice but to restructure the better. Postponing the inevitable will only make things much worse.
The only way for Lebanon to escape this debt trap is to have a group of countries agree to forgive a major chunk of debt. There is no other way since we cannot inflate ourselves out of this mess even if we wanted to. The higher is our inflation then the larger would be the rate of interest demanded to finance the debt. I wish the Lebanese public will become more aware of this issue in order to push the crooked CIA/politicians and the Hariri Mafia to find the least painful option soonest....

Some things are preordained and I do not mean only philosophically. There is often a strong rationale that predetermines an outcome once a certain sequence of events is unleashed. Once the trigger of a loaded hand pistol is pulled then a bullet is released and if that hand pistol was directed to ones leg then that leg would be seriously wounded. It cannot be otherwise. Such logical conclusions always follow from certain actions and therefore these consequences cannot be considered to be accidental since they were designed to follow once an act is committed. To exceed the speed limit by passing a highway patrol is to expect a speeding ticket just as to fail to present a research paper on time is to earn a failing grade. This is not any different than to expect to borrow if the level of expenditures is to exceed the flow of income and this is exactly what is happening to the ability of some countries, such as Greece, to carry successfully their debt burden. The same exact logic applies to Lebanon. Lebanon has over borrowed and must face the consequences. The logic of default is just as impeccable and straight forward as that of pulling the trigger while aiming at a leg.

Historically, the Greeks were the first to develop the concept of tragedy. They even developed a particular genre where the events become totally complicated and appear to defy any solution when out of the blue a divine solution is presented through outside forces. This solution became known as Deus Ex Machina, a resolution by divine powers unrelated to the actual dynamics of the problem. I mention this in order to stress that in the Greek current debt crisis and to a larger extent in the case of Lebanon we do not have the right to depend on such an irrational and highly unlikely solution. Deus Ex Machina just does not exist in the real world. Lebanon has borrowed beyond its capacity to service these loans and the longer we persist in our denial then the bigger the problem will become.

I am not interested in asking why we borrowed and whether the decisions were proper or not. I am obviously not interested also in whether the borrowed funds were put to good use or not. All of these are academic issues that are not significant at this phase. We need to devise a way to manage the debt problem so that it will not crush us and crush all the hopes of the next generation. We have to look at the numbers objectively and allow these numbers to tell the extent of our financial woes. The details might overwhelm some but the logic is quite simple.

A country, any country, passes an annual budget that shows its planned expenditures and its planned revenue stream. Whenever the expenditures exceed the projected revenue then the deficit represents the amount that is borrowed. The sum of these annual deficits makes up the national debt.

With that in mind let us take a look at Lebanon. Each and every year for decades to come the projected level of expenditures exceeds that of revenue. The current level of annual deficit is almost $3 billion and that figure will rise every year if for nothing else but for the fact that our national debt will have to rise and consequently the required level of interest needed to service that debt. Almost 40% of all expenditures are allocated to debt service. This means that only 60% of our expected expenditures go to pay wages and run the basic government services. This relatively small figure carries great implications, it simply means that Lebanon is already running a very austere budget, there is no room for any additional cuts, and Lebanon has already cut to the bone. But some will point out to the fact that as the level of national debt rises every year so does the GDP and therefore the burden could stay the same. That would be true if the GDP is to grow at a faster rate than the rate of interest used to finance the debt. Lebanese debt, in general, carries an average interest rate of around 7%-7.5% although our growth rate cannot be expected to average even 4%. This growth rate might even be excessive given the potential for political instability and war in the region not to mention the lowered economic growth expectations worldwide.

So where are we and what should we expect? The Lebanese Debt/GDP ratio is approximately 137% and it is expected to grow every year for as far as the eye can see. One rather conservative scenario projects a growth of this ratio to about 163% by 2020 when the level of sovereign debt is expected to have ballooned to over $90 billion with an interest burden of about $6.7 billion or about 12 % of the GDP. That is unconscionable and is a ticket to perdition. The Lebanese people deserve better.
There is only one painless solution for those who believe in dreams; A Deus Ex Machina where a wealthy Western country and/or a group of Arabian officials ride down in the basket from the sky to write off a substantial portion of the Lebanese national debt, our Scarlet letter.....

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