The essential view "A quarter of a century at the helm"
Executive sat down with Riad Salameh, the governer of Banque du Liban (BDL) to discuss the prospects for the country’s GDP, the role of the central bank, and the external and internal challenges that lie ahead.
E Thank you for sitting down with Executive at this crucial time for Lebanon. I understand that you very recently discussed the country’s economic outlook and the positive impact of the elections on the financial situation with President Michel Aoun. In the current context, how do you see the perspectives for Lebanese GDP in the next two years, or perhaps even in the longer term?
Lebanon is a volatile country and there always are unforeseen events. The central bank has taken it as its policy not to announce estimates for growth prior to July of every year. In general, the Lebanese economy will profit from the implementation of the resolutions at the CEDRE conference. On one side, we estimate that the growth can increase—[in excess of] the normal growth of the country—by 1 percent on every $1 billion invested. On the other side we think that the reforms, which have been announced or promised by the government, will increase confidence and will therefore contribute to positive growth as the government has announced that it will decrease the deficit to GDP by 5 percent[age points] over the next five years.
E How about the risks related to the reforms in the current geopolitical environment, in which we have just seen the oil price go above $80, or if we look at the interest rate environment in the United States and many concerns about the Middle East in Europe and the US? How much of a risk exists that the reforms and fiscal discipline needed to reduce the deficit by 5 percentage points of GDP over five years would lead in the short term to negative developments in the economy, specifically in the perception of their situation by the people?
The challenges are true challenges, and we will be facing them whether the increase in interest rates because of the world increase in rates, [or] whether the higher oil prices. [It is also true that] geopolitical risks will be influencing the economy. But I believe that if there is realistic political will internally [in Lebanon] to undertake reforms, that these reforms will be executed. I don’t want to speculate. We have to wait to see the new government, and it will be their [responsibility].
E Some bankers expressed views that beyond GDP growth and employment creation because of the CEDRE inflows, it could also create a possibility to lower interest rates. Do you see any room for lower rates in Lebanon?
Interest rates are going to be stable. You cannot talk about lowering interest rates in a global environment where rates are going up. We have seen that emerging markets in the world are now practicing higher interest rates. The banks and the economy will have to adapt to this new level of interest rates. The only way to moderate this increase is to improve on the fiscal [situation], which will improve the rating of Lebanon and lead to an equilibrium in our market with lower spreads when we compare our rates to the international markets.
E So the risk premium on Lebanon could be reduced by measures of reform and fiscal discipline?
E Was there any reason for concern in the recent widening of spreads in Credit Default Swaps (CDSs) for Lebanon, which reflect the cost of insuring debt?
This is temporary and not linked to Lebanon as such. As yields on the 10-year [US treasury] bond went above 3 percent, we have seen a sell-off in all emerging markets. Lebanon also has seen its [bond] yields pushed higher, which normally pushes CDSs higher because of technical reasons. There are no new credit events in Lebanon from us which would justify any reaction.
E If we turn to looking at the role of the central bank in Lebanon, BDL has been, of course, the guardian of the monetary policy and of banking but also, especially in recent years to a large extent, of the entire economy, talking about the stimulus packages initiated by BDL. Do you see a possibility that under a reform paradigm, the economy could shift and see the government take a more determined role in fiscal policy?
We will welcome such a move. It is our hope and our aim to depart from non-conventional central bank activities, provided that the government fills the gap. During the past years, this [stimulus from BDL] was needed to maintain the stability in the economy and the social stability, but our main [area of] concern is the monetary stability and the banking sector, and also keeping Lebanon compliant with the international laws.
E Wouldn’t the government and specific ministries be hard-pressed in finding the cash to create incentive programs such as the housing loan incentive?
This will depend on the budget which [the government and Parliament] will adopt. Of course, all these initiatives need to be funded and need to be subsidized. Thus, if the policy of the government is to take over these activities, this will be shown in the next budget, because in the present budget there is no allocation for such subsidies.
E The story of BDL over the past 25 years cannot be separated from your story as its governor. When you were inaugurated on August 1, 1993, what was your expectation on how long you would be in this post?
At that time, I thought it would be a one-term operation, but events in Lebanon have put the central bank and my presence here as a matter of consistency for the country. Various governments have therefore decided that I should continue.
E With the effect that it looks today as if you might on one not too distant day, namely in about one year, enter the record books as the world’s longest continuously serving central bank governor of all times up to this point in history.
[Laughs] I don’t know what the terms of the other central bankers are, but I did not do it on purpose.
E As you have the benefit of being able, from personal experience, to review the challenges of the central banker’s role as they evolved over many years in the international development of the financial economy, how in your view does the current phase of 2017/18 compare to previous phases in the role of central bank governor of Lebanon?
Well, the banking sector has improved, and the confidence in the currency has improved. Our concentrations and concern now are on the implementation of the new rules and regulations and accounting standards that have been decided through the Basel III agreements. Challenges that did not exist when we started are now important risk factors for the stability of the country, and I mention here what we have to face in terms of compliance and in facing the sanctions that are part of our daily business. The challenges have changed from the time when it was our objective to create the confidence in the currency, decrease dollarization, and strengthen the capital of banks. Of course, we have to keep these objectives, but we are now in another world of the added challenges that I mentioned.
E The IMF has recently used the term “unsustainable” in describing Lebanese debt to GDP ratios and the current account deficit, but one could argue that these ratios have, for many years, been far from positive and indeed worrying. Is Lebanon’s situation today worse than in previous periods?
We differ with the IMF with their estimate of growth for 2017, and these differences can influence all the feasibilities in projections that can come after. We think the growth in Lebanon was about 2.5 percent in 2017, and they put it at about 1 percent. The realities come from the market. Lebanon’s stability depends on confidence and on the inflows that come to Lebanon every year. This is what we look at more than at economic data, especially since, as you know, the GDP in Lebanon is undervalued as we are in an economy where not everything is really billed.
E What do you tell bankers, especially bankers from international markets, who would say that the Lebanese pound is overvalued?
You cannot maintain an overvalued currency for so many years. This is the best answer. We have seen a live stress-test [of the currency] in November when Prime Minister Hariri resigned. It created demand on the dollar where depositors were converting and it also created outflows. But the system remained stable and things reversed as the political event finished, which was a political and not a monetary crisis. That this reversal happened means that markets are looking at the value of the pound and being realistic. On the other hand, nobody in the world could really determine what the value of the pricing of a currency is. It is [determined by] supply and demand.
E It seemed from a recent conference sponsored by the Bank of International Settlements that the view on exchange rates in small open economies is shifting from a focus on such countries’ independent stances on monetary policy to greater understanding of inescapable dependencies through policy spillovers from globally dominant central banks. Research papers thus appear to put more emphasis for central banks to know if their currency is close to its long-run equilibrium value rather than using other metrics for assessing the real exchange rate, which seems to indicate that that the impact of external influences on small economies and your positions on the exchange rate are increasingly being validated.
Yes, and our policy is derived from the realities of Lebanon. We have a dollarized economy in Lebanon today, and there is no value added to this economy if we do not maintain a peg on the pound. On the contrary, the peg on the pound creates demand for consumption and also stable purchasing power, thus social stability.
E But from your perspective, how could the competitiveness of the Lebanese economy be increased vis-à-vis strong manufacturing nations which have exchange rates that make their products more competitive in global markets, when looking for example at regional behemoth Turkey where the exchange rate just this spring reached 4.6 TRY to the USD, down from about 3.5 a year ago and from 2 in 2014?
The higher costs that are linked to production in Lebanon are essentially due to the absence of a proper infrastructure. Once you have this infrastructure, you are going to be able to produce and be competitive. Cost is on the other hand also due to lack of efficiency, which means that you need a more serious approach at work[places] in terms of working hours and having fewer holidays. This would also help increase salaries in the private sector by way of an increase in demand [for labor].
Lebanon is competitive in many sectors, but our infrastructure is today really very backward. We are talking here not only about roads and transportation, but also about the environment, about fighting pollution [and] exploiting the sea. The resolutions of the Paris conference are important to create a base for a productive [and] competitive economy, and the internal reforms are important for effectiveness. Our view is that the public sector growth as share of GDP should stop, and we should encourage the growth of the private sector to have a greater part in our GDP. That will turn out to give leverage to Lebanon.
E Which brings us back to the CEDRE process and the importance of international support for Lebanon. One of the issues in this regard is the refugee issue that was the main topic at the Brussels conference held in April. Is the drain on the Lebanese economy and society from your perspective a component that needs more international humanitarian and development assistance, beyond what was pledged in Brussels or at earlier such refugee aid conferences?
[The refugee issue] is a cost on Lebanon and has been stated as such by the World Bank and the United Nations. [In the presence of] such a cost, whatever reforms you do, there will be pressure on the government. The increase in the security forces, for instance, and the cost of that increase is due to the fact that you need more people to assume security [functions] when you have such a number of refugees. And so on.
On another side, the Syrian war also has hurt Lebanon because residents from the Arabian Gulf countries are not visiting Lebanon as before and because our exports are almost impossible to achieve. So whatever you do in terms of [improving] productivity, whatever you do in terms of [achieving] reform, these [economic restraints due to the refugee issue] are realities and currency devaluations are not going to solve these realities.
But returning to the relation between competitiveness and the exchange rate, I take you to the Italian example, where [Italy] used to devalue the lira to improve the economy [before the EU’s establishment of the economic and monetary union]. They realized that [this approach] was not working and that is why they joined the euro, which is a stable currency. The currency can play as long as it does not create inflation.
E Could then inflationary pressures on Lebanon arise from the CEDRE inflows of money, if the equivalent of more than 20 percent of the country’s GDP in one year are to flow in over the course of five years?
The investments are spread over 10 to 12 years, so the issue of inflation can be mastered.
E And the central bank will play a strong role in this?
E If we turn to the banking sector, where you mentioned the need to comply with international rules and also apply new accounting standards. One of the goals of the unconventional measure initiated by BDL in 2016—often called the swap—was to enable banks to build up profits that they would retain for the purpose of switching to the more demanding International Financial Accounting Standards, or IFRS 9, if I understood correctly. The migration to IFRS 9 was mandated for the first quarter of this year. Can you tell us anything about how it was achieved, if it was smooth or if there were any hitches?
It was smooth. It has delayed the publishing of our usual statistics by two weeks, but, as of now, all banks are taking IFRS 9 as the reference in reporting. There are also other circulars which were considered positive like the issuance of the liquidity cover ratio. One can say today that the banks are properly capitalized because when we did the engineering [of 2016] and we also asked the banks to have a solvency ratio of 15 percent, based on Basel III. Today, they are at over 15 percent [solvency].
E Is this the case all throughout the sector?
It is the average of the sector. You always have one or two banks which are behind, and we follow their cases, but you have to admit that what we are asking [of Lebanese banks] is beyond any level of what is required worldwide.
E As one always hears rumors about new developments and pairings in the Lebanese banking industry, is there any change in the BDL policy on mergers of banks in the top tier of now 15 banks, the so-called Alpha group with deposits of over $2 billion each?
We have not introduced any change so far. We are, of course, flexible, and will adapt to the realities, adapting our policies to what is required to be able to keep Lebanon financed properly. For the time being, we do encourage mergers but not among the top 12 banks. We think that the consolidation that has happened by market forces has also improved the confidence in the banking sector in Lebanon.
E If I may ask in this context about another financial sector, namely insurance. Insurers have spoken for some time about having appealed to you for subsidized soft loans from BDL that would encourage consolidation in this industry which according to the World Bank’s Financial Sector Assessment is beset with over-crowdedness and unhealthy competition on pricing. Is there any outlook for the insurance sector to get soft loans from the central bank or any other form of support toward consolidation?
The insurance sector is not in our jurisdiction. It is controlled and regulated by the Ministry of Economy [and Trade]. We have no project for putting any subsidized loans [at the disposal of] the insurance companies in the country.
E What can we expect for 2018 as far as Circular 331 and its process, as far as the Beirut Stock Exchange (BSE), and as far as the electronic trading platform (ETP) and the transformation of the current capital markets environment?
On 331, we are committed to pursue implementation of this circular as we believe that it is going to contribute to the creation of a productive sector for Lebanon, productive like we see it in the modern world, and that would play an important role in improving efficiency and competitiveness in the country. [Regarding the BSE], we are still waiting for the government to designate board members so that the process of privatization of the Beirut Stock Exchange can be pursued as the law requires. On the electronic platform, we are getting there. It is a matter of one or two months that we will have the clearing system in place. We are presently testing it and want to operate [the ETP], even if we will not sell it for the time being because we are waiting to sell it at the same time as the Beirut Stock Exchange. We believe [the ETP] will create liquidity in the country.
E Is it correct that an ETP is usually especially beneficial for the trading of government securities on basis of certain volumes?
Such a market gives you the freedom to list all types of papers after getting the approval of the [Capital Markets Authority]. There are no restrictive measures such as on a classic stock exchange. We anticipate seeing trading not only in government securities [but also] in currencies, except for the Lebanese pound, [and] in shares when these shares cannot be listed on the stock exchange. We hope that [the ETP] will [provide] exits for startup companies and funds, and also hope to see commercial paper and debt paper traded there. Trading should be possible from all over the world, so this is another way to integrate the Lebanese diaspora with the local economy.
E How about things like bonds for financing parts of the PPP projects in infrastructure? Would the ETP be a possible avenue for trading such bonds as financial papers with small minimum tickets in Lebanon?
The idea of CEDRE is to fund the projects with international funds, not local funds. Therefore, apart from certain exceptions, this should not be a place to use in order to fund these projects.
E When multilateral institutions such as World Bank and European Bank for Reconstruction and Development, which have committed to roles in the financing of Lebanon’s infrastructure projects, will come to Lebanon, will BDL have an advisory role on the evaluation of projects or in some other form sit at the table when projects are being negotiated?
The central bank has no role in this. These are international funds, and the follow-up should be done by international bodies. [The process of discussing the infrastructure investments] is between the government and the lending institutions or countries, but whenever our contribution is required we will not hesitate because we think that the project is beneficial for Lebanon.