[LCM Articles] Lebanon—The Economic Consequences of the Conflict

[Saad Shakhshir]

Taken from the IMF's Regional Economic Outlook Report (Sept. 2006).  Full
report here:
http://www.imf.org/external/pubs/ft/reo/2006/eng/02/mreo0906.pdf

Lebanon—The Economic Consequences of the Conflict

The conflict with Israel will result in lower productive capacity and
disrupted demand, and entail large
reconstruction and rehabilitation costs.

The conflict has had devastating economic consequences for Lebanon. Initial
estimates put the damage to infrastructure at about $3½ billion, including
the international airport and major roads and bridges. Although financial
markets weathered the crisis relatively well, economic activity and the
fiscal situation were severely affected by the conflict.

Real GDP is expected to contract in 2006, despite a strong showing in the
first half, when developments were consistent with growth of about 5 percent
for the year as a whole. The conflict resulted in substantial disruption on
the demand side, with the regional demand for tourism and financial services
as well as for other business services having fallen dramatically. Recovery
in these sectors will depend on a return of confidence and on improved
security, both of which may take time. The destruction of physical capital
and the displacement of a large part of the population will also contribute
to the contraction of output in 2006, and could significantly lower
medium-term growth. The reconstruction effort is expected to support
domestic demand and eventually restore Lebanon's physical capital stock, but
it remains to be seen whether the large number of professionals who have
left the country will return, and how long it will take before Lebanon's GDP
recovers to its pre-conflict level.

The fiscal outlook is very difficult, both in the short and in the medium
term. During the conflict, government revenues slowed to a trickle, and
spending was limited to wages and essential services (emergency relief,
hospitals, and the army). The government was able to draw down its deposits
with the banking system to finance these operations. Following the cessation
of hostilities, there is an urgent need to accommodate substantial relief
and reconstruction expenditures, but it is unclear how fast expenditure
execution and revenue collection capacity can be restored. Thus, the primary
deficit is expected to increase in 2006 and possibly also in 2007. Given
Lebanon's already high debt burden (175 percent of GDP at end-2005), it is
important that there be substantial donor support to rebuild the economy
without a further increase in the debt-to-GDP ratio. A donors' conference in
Stockholm at the end of August generated $940 million in pledges for the
immediate recovery effort.

Financial stability was maintained during the conflict because of the
central bank's strong gross international reserves position, with most
depositors and investors adopting a wait-and-see approach. Nearly 4 percent
of deposits left the banking system immediately after the outbreak of
hostilities, and deposit dollarization rose to about 75 percent; the pace of
withdrawals has since slowed considerably. The liquidity cushion maintained
by the central bank and commercial banks played an important role in
preserving depositor confidence and the exchange rate peg, with the central
bank intervening in the market to meet temporary pressures on the currency.
A significant added boost to confidence was given by Saudi Arabia's and
Kuwait's deposits with the central bank of $1 billion and $0.5 billion,
respectively, on top of $500 million and $300 million in grant pledges by
the two countries. Eurobond spreads doubled over the first three weeks of
the conflict, but declined to about 340 basis points by end-August, or about
140 basis points above the pre-conflict level. The stock market was
temporarily closed during the conflict, and lost about 20 percent of its
value, but by end-August had recovered 15 percent relative to the trough
during the conflict.
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