Lebanon in 2017: Cautious Optimism

Lebanon

Lebanon is finally gaining positive political and economic momentum. After a two-and-a-half-year vacancy in Baabda Palace, Michel Aoun was elected president in the fall of 2016. President Aoun appointed Saad Hariri as Prime Minister, who subsequently formed a new unity government. This political breakthrough represents a significant step forward for Lebanon as it has struggled with five years of sluggish growth, weighed down by spillover from the Syrian conflict and its own political impasse. The new government is already showing signs of efficiency; efforts to open up the oil and gas sector for exploration have begun and the cabinet approved a US$ 15.8 billion draft budget for the first time since 2005.

As the outlook seems to brighten, these are the things businesses should be paying attention to in Lebanon: 

  1. Gradual pace of recovery

The market has responded seemingly well to the political breakthrough. Consumer confidence levels soared in Q4 2016, the Coincident Indicator (the composite indicator of economic activity in Lebanon) has been on the rise, PMI (purchasing managers index that records private sector activity) began to decelerate at a slower pace than it had been over the past year, and real estate and construction activity started to pick up in the beginning of 2017.

Despite these positive figures, executives should manage expectations for rapid improvement and maintain cautious optimism for the market. While the retail index increased gradually throughout 2016, Q4 2016 still witnessed a 1% YOY contraction. The index shows that consumers are still prioritizing purchases of basic needs and goods, and are hesitant to spend on non-essential items. The lack of growth over the past five years and the influx of Syrian refugees into the labor market have stagnated, or even weakened, the purchasing power of Lebanese households. Thus, businesses must carefully assess plans to raise targets in this environment that still exhibits slight uncertainty.

  1. Rising costs

Both businesses and consumers are likely to face rising costs in 2017 through higher taxes and higher inflation. The 2017 budget discussions include several proposals for tax hikes. Some of these included an increase in the VAT rate from 10% to 11% and an increase in corporate income tax from 15% to 17%. The purpose of the tax increases is to fund an increase in public sector salaries, which is estimated to cost around US$ 800 million. Although there is public opposition to these measures, they are likely to pass as the government urgently needs to expand its revenues. Lebanon’s budget deficit in 2016 stood at 28.32% of total expenditure.

An expected rise in inflation will also drive costs higher for businesses and consumers. Although the recent increase in inflation is partially demand-driven, it is also driven by the rise in energy prices. In January 2017, inflation stood at 4.7% YOY, with inflation in utilities and fuels jumping 18.4% YOY.

For B2C firms, rising costs will likely translate into ongoing hesitance in consumer spending, especially for non-essential goods. B2B firms may also see limited growth in demand for expensive products, as domestic firms may not be able to increase their investments significantly amidst higher costs.

  1. Electoral law reform

An important test that will determine whether the government can sustain the recent positive momentum is if it can pass a new electoral law and successfully hold legislative elections this year. Although the deadline was February 21, debate is ongoing to replace the 1960 electoral law, which represents a majoritarian system. President Aoun, Hezbollah, and the Amal movement are advocating for a proportionality system, while Prime Minister Saad Hariri and the Lebanese Forces are advocating for a hybrid law or the continuation of the majoritarian system.

Delays in passing the electoral law and holding legislative elections would once again highlight the deep divisions among Lebanon’s political class and prevent the country from sustaining the boost in confidence witnessed from the election of President Aoun. For businesses, the delay would likely result in the continuation of weak private investment that has been a factor weighing down economic growth.

Should Lebanon successfully pass a new electoral law and hold elections, businesses should expect another boost in consumer and investor confidence, along with more certainty in government capabilities for foreign investors.

With significant changes occurring in the market this year, it will be increasingly important for businesses to monitor the relevant developments, both domestically and in the region. Many factors will dictate the trajectory of Lebanon’s outlook, including the status of the Syrian conflict, the status of relations between Lebanon and Gulf states, and of course domestic politics. However, for the time being Lebanon has gained significant momentum that should shift executives’ muted expectations to one of cautious optimism.


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