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IMF gives Lebanon glowing marks for financial resilience.

Byline: Daily Star Staff

Summary: Lebanon's financial system has displayed a unique resilience to shocks, the International Monetary Fund (IMF) said in a "working paper" published on Monday. "Lebanon's ability to navigate rough waters is not fortuitous. Despite the large debt overhang and external vulnerabilities, investors and depositors.

BEIRUT: Lebanon's financial system has displayed a unique resilience to shocks, the International Monetary Fund (IMF) said in a "working paper" published on Monday. "Lebanon's ability to navigate rough waters is not fortuitous. Despite the large debt overhang and external vulnerabilities, investors and depositors, at present, are comforted first and foremost by the perception of an implicit guarantee from donors, but also by Lebanon's track record of zero default, and the country's large liquidity cushion," the IMF said in the paper.

It added that a benign global environment may have also helped Lebanon manage financial pressures in 2005 and 2006.

"And while the policy challenges are very daunting, there is a belief that a soft landing is still possible and that Lebanon can, over time, grow out of its financial problems. All of this keeps investors interested," the IMF said.

The report argued that local banks play a key role in maintaining stability.

"On the one side, they hold the bulk of government paper and have no incentive to liquidate their position abruptly even during severe crisis as this would be self-defeating. On the other side, they mobilize strong and continuous deposit inflows from a dedicated client base that provides the necessary net financing for the government and the balance of payments," the report said.

Underlying Lebanon's resilience to financial shocks, the paper's authros added, is a growing tension between worsening solvency indicators and ample short-term liquidity.

"This good equilibrium will remain stable as long as a sufficiently large share of investors and depositors believe that the equilibrium's key pillars, including the perceived guarantee by donors, remain intact," the report said.

Accordingly, the failure of one or more of these pillars could throw the economy off this "good" equilibrium.

"While Lebanon is certainly unique in many aspects, it holds interesting lessons for other countries. First and foremost, Lebanon's experience could be interpreted as validating the notion that markets recognize good behavior and are willing to give countries more leeway if they have never defaulted in the past. Second, a strong local banking system that intermediates inflows can be a contributor to market stability in as much as it creates a more stable investor base - this said, stability is ultimately only as good as the stability of deposits," the report said.

It added that another factor is building on special circumstances to cultivate a dedicated investor and depositor base that helps insulate, to some degree, financing flows from general market trends.

"Having said that, it is unlikely that many countries could, or even should try to, replicate the Lebanese experience," the paper said.

In this sense, the paper points to the limitations of standard models of debt sustainability and financial crises and the need to complement such models with country-specific financial and institutional factors to determine resilience to shocks and risks of financial crises.

The IMF also noted that while public debt is mostly held domestically, the country as a whole has a high external debt to GDP ratio.

Domestic banks hold the majority of government paper, playing a larger role than in most peer countries.

Banks fund their positions from deposits, which reached 267 percent of GDP in 2006, a large part of which is held by non-residents.

"This is reflected in the relatively low government debt to broad money ratio. Individual deposits tend to be highly concentrated, suggesting that high net-worth individuals make up the bulk of deposits," the report said.

It added that deposits have a very short average maturity, and deposit dollarization is very high.

"With the average maturity of deposits (less than one month) being much shorter than that of government paper (just over one year for Treasury bills (T-bills) and around six years for Eurobonds as of August 2007), the banking system - and therefore the country - is exposed to a very significant rollover risk," the report said.

In addition, the high degree of dollarization introduces exchange-rate risk borne by the state and private debtors (and transferred to creditors in the form of credit risk).

The IMF stressed that Lebanon has maintained a perfect record of meeting its debt obligations, even during very difficult times. Research has shown "that a country's history of default impacts the market's risk perception today. As a result, countries which have defaulted in the past have lower debt levels than countries who have a history of never defaulting," the IMF said. It added the authors call this "debt intolerance," and, using this labeling, Lebanon then seems to exhibit "debt tolerance."

"There have been no defaults, not even during the [1975-1990 Civil War], nor during the times of financial pressures in 2005 and 2006," the IMF said. As one market participant noted, in Lebanon, there is not even talk of a default from either the government or the opposition.

"With a large share of government debt being held domestically and ultimately by depositors, the costs of default in Lebanon would be very high, thus making the option of defaulting to address the large public debt overhang very unattractive," the IMF said.

It added that this "no default" record sets Lebanon apart from many of its peers who have taken recourse to defaulting on several occasions.

The IMF also underlined the importance of the cash injection from several Arab countries in boosting the investors' confidence on Lebanon.

During the summer 2006 war with Israel, for instance, " Saudi Arabia and Kuwait announced that they would deposit $1 billion and $500 million respectively with the [Banque du LIban], and provide an additional $500 million and $300 million [respectively] in aid. The impact on confidence was prompt, with certificate of deposit spreads narrowing immediately, and Eurobond spreads starting to narrow about one week after the announcement," the IMF said.

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Publication:The Daily Star (Beirut, Lebanon)
Date:Feb 5, 2008
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