Under Siege

As the conflict between Hezbollah and Israel rages, Massoud A. Derhally speaks to the key players who will decide Lebanon’s economic future.

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By  Massoud A. Derhally Published  July 30, 2006

|~|32-Ope-200.jpg|~|Ruined: Israel's attack on Lebanon has left 750,000 people dispalced. The country may have suffered permanent damage.|~|As the conflict between Hezbollah and Israel rages, Massoud A. Derhally speaks to the key players who will decide Lebanon’s economic future. Just days before the World Cup final, French flags hung from balconies, with hundreds of Lebanese football fans flocking to downtown Beirut to watch the game. Business there was good. The cafés and restaurants of the Solidere area at the heart of the city were packed. Tourists from Europe and the Gulf were making their way there, after a brief hiatus the summer before. Almost a year and half after the assassination of the country’s former premier Rafik Hariri, the country was on the rebound economically. But in an instant, when Hezbollah killed eight Israeli soldiers and kidnapped two others on July 12, the bustling and vibrant city of Beirut had reverted back to a war zone. As Israel retaliated, its bombs shattering Lebanon’s renaissance. Two weeks on, the unrelentless Israeli onslaught on southern Lebanon and the unleashing of over 2000 rockets by Hezbollah on northern Israel has brought the country to a standstill; stopping its recovery in its tracks. There have been three major implications for the Lebanon economy; firstly, the damage to the country; secondly, current foregone activity; and thirdly, the length of time it will take for the country to resume economic activity. That, according to Florence Eid, senior economist for the Middle East and North Africa region at investment bank JP Morgan, “is the most serious aspect in terms of the impact on Lebanon”. Over 70,000 foreigners have been evacuated since the outbreak of hostilities. The tourism industry, which is estimated to bring in as much as US$4 billion to the Lebanese economy, is now shattered. The country was expecting 1.6 million tourists in 2006, the highest number ever, and according to a recent report by Bank Audi, one of Lebanon’s leading banks, the number of tourists had risen 52% in the first five months of the year. Damage to the country’s infrastructure has also run into billions of dollars. Israel has destroyed nearly 60 bridges, making it all the more difficult for people in the southern part of the country to escape the carnage. The runways of Beirut’s airport have repeatedly been pounded by Israeli warplanes, while the main seaports have also been targeted. The Beirut Stock Exchange (BSE), which was closed for security reasons after the turmoil began to engulf the country, was down 14% on its last day of trading (July 17). In an effort to prevent a drastic nosedive in market capitalisation before its close, the exchange cut the daily limit for price fluctuations from 15% to 5%. More significantly, the crisis has set off a humanitarian crisis that seems to get worse by the hour. Israeli attacks on Lebanon have resulted in the loss of more than 400 lives and the wounding of more than 1000 civilians. Some 750,000 people are now refugees, according to the United Nations (UN) and international relief agencies. “It’s a very serious problem both in the short term, with the provision of food, supplies and medicine, and the long-term because of the complicated issues around the resettlement of the refugees,” Eid at JP Morgan tells Arabian Business. For many Lebanese and indeed the wider Arab and Muslim world, the dire situation in Lebanon can hardly be described as being the “birth pangs of a new Middle East,” as the US Secretary of State Condoleezza Rice described it on the eve of her trip to the region last week. The scale of devastation in Lebanon is colossal and immeasurable, according to Jihad Azour, the Lebanese minister of finance, who spoke to Arabian Business exclusively moments before boarding a plane to Rome, where regional and international players were meeting to try and resolve the crisis. “Nobody can give you now a quantifiable estimate of the damage, because the damage on infrastructure is changing on an hourly basis as a result of the destruction,” says Azour. “But one can clearly say that the magnitude of the Israeli war on Lebanon is huge, because in addition to the billions of dollars of destruction to the infrastructure you have houses that were destroyed, economic activity, bridges, roads, telecommunications facilities, water and other things that have been affected. The magnitude is huge. “There is also destruction of industries. A basic food factory and a factory for Proctor and Gamble and some other companies were subject to bombardment,” adds the minister. According the Lebanese Daily Star, damage to the manufacturing industry alone now comes in at over US$150 million. Intervention by Banque du Liban, the Lebanese central bank, has managed to quell some of the panic in the market as depositors rush to the banks to make withdrawals and buy dollars. The bank, according to a report by Bank Audi, had US$12.9 billion in foreign assets before the attacks, its highest level of reserves; equivalent to 74% of the Lebanese Pound Money Supply. Some banks have limited customer withdrawals to US$1000. “The economy is working at very low capacity today. It was expected to grow this year at 6% and lost a tourist season that was expected to be the best for 30 years,” laments Azour. “There was a lot of investment that was expected this summer, the stock market was hit, and add to this other sectors like Middle East Airlines. The hotel industry; that was also hit. The government also lost revenues and its expenditures increased. Last but not least, many opportunities [have been] lost because Lebanon was regaining its place as a regional centre and this was a big hit.” Lebanon is a “cursed” country, its prime minister Fouad Siniora said in the past weeks. Before the showdown between Israel and Hezbollah, the country’s debt had swelled to nearly US$40 billion. Beirut had planned to have a follow up conference to the Paris I and Paris II meetings, which saw 18 Arab and Western countries as well as eight financial institutions convene in the French capital in 2001 and 2002 to help alleviate the woes of the country's soaring debt. The planned meeting, known as Beirut I, aims to provide a framework of support to the government in its reform initiatives along fiscal, structural, institutional and administrative lines. “If there is a cessation of hostilities over the course of the coming weeks, then a Beirut I conference can be put together quickly. The international community is meeting in Rome to consider a humanitarian and reconstruction package. Today there is little agreement on anything with respect to this conflict, except that the humanitarian crisis is reaching alarming levels for everybody, and that the reconstruction of Lebanon needs to be financed by players outside of the country,” says Eid of JP Morgan. With the escalating violence and the onset of negotiations in Rome on July 26, the issue of Lebanon’s debt burden is certainly not as grave an issue as that of the country's immediate humanitarian and relief needs. It is also unlikely to negatively impact the country’s fiscal standing at the moment. The situation is not catastrophic, says Eid, because the Lebanese banking sector is “well capitalised and in a position to continue to roll over Lebanese debt. This is due to the banks’ diversification strategies, where since the past couple of years, Lebanese banks and their clients are no longer concentrated in Lebanon. On the back of petrodollar flows, but also because of consolidation and diversification strategies started in the mid-1990s, Lebanese banks now have operations throughout the region, and in many countries in Europe, and some in Latin America and Africa.” The turmoil in Lebanon has also transcended the country’s boundaries, affecting regional countries and emerging markets both negatively and positively. The Mediterranean island of Cyprus has once again become host to fleeing tourists and refugees. Ironically, Syria, which is loathed by the vast majority of Lebanese because of its 30-year era of tutelage over Lebanon, has also become a haven for over 150,000 people fleeing the mayhem. As always, markets react to uncertainty and fluidity, and as the situation in Lebanon imploded, investor sentiment was naturally affected. That effect, however, according to investment banks and analysts, has so far been measured. “[In terms of the] regional impact, initially of course there was an impact not just on Lebanon, but all markets in and outside the Middle East region, including the Eastern European foreign exchange and as far down as South Africa. All markets were shaken in the first 48 hours of the conflict,” says Eid. Joe Kawkabani, a fund manager at Shuaa Capital in Dubai, agrees. He believes that market sentiment is initially reactive but if a situation persists for a certain period of time, markets become insulated and volatility decreases. “The initial reaction was a panic in the market, which was natural given the situation, [because] at the beginning no one knew if the situation would be contained between Lebanon, Israel and Palestine or if it would spread to involve, for example, Iran, which would be dangerous for the whole region including the GCC,” Kawkabani tells Arabian Business. But with time, Kawkabani says there was an adjustment. “Afterwards, markets started behaving more normally once they realised that the conflict was contained in Lebanon, and there would be no consequences or anything happening in the GCC. They started focusing on their own news and now, they are not really reacting to any news from Lebanon, whether it is positive or negative. Going forward, if the situation escalates again, then definitely they are going to react. “Everyone is worried and in the back of their mind is the big Iran issue, which would have a big impact on the region.” If that doesn’t escalate, Kawkabani says there are likely to be similarities between markets' reaction to the current situation and that of the unabated violence in Iraq. “Before the war, at every announcement, either by the United Nations or president Bush, you would have a market reaction. If they were going to invade the market would go down, if they were going to postpone the market would go up. “There was a lot of volatility, but as soon as they went into Iraq the market went up and now it has stopped reacting at all to what is happening in Iraq. The situation is far from settled but markets aren’t reacting at all.” He continues: “I think Lebanon is going to be the same case. If we distance ourselves from it and then it proves to be contained to Lebanon, it won't be an event because the market will have already priced everything in, because what the markets hate is uncertainty. When you have certainty, then it is priced in and there is no effect. If anything, the Gulf countries are benefiting from high oil prices and economic activity is still fine,” says Kawkabani. Though foreign capital is always wary of instability, there is also little sign that investors are planning to pull out of Lebanon. The consensus among observers is that investors will wait and see how the situation evolves over the coming weeks, with particular focus on how the crisis will be brought to an end. Lebanon’s largest foreign investors are Arabs from the oil rich Gulf, who are estimated, by one financial industry expert in Abu Dhabi, to have over US$25 billion in vested interests in the country. If there was any indication of how badly the Gulf region wants stability in Lebanon, it came on the eve of the failed conference in Rome, when Saudi Arabia, the main architect of the Taif agreement that ended Lebanon’s civil war, announced it had sent Lebanon US$500 million to help the country in its relief and reconstruction efforts, and deposited US$1 billion in the Banque du Liban. The UAE has also pledged US$20 million in aid. Sarmad Zok, chief executive of Kingdom Hotel Investments, a leading hotel and resort investment company, of which Prince Alwaleed bin Talal Al Saud is a majority shareholder, has no plans to scale back the company's Lebanese investments, which include the Movenpick and Four Seasons Hotels, as a result of the crisis' escalation. “My prospects on Lebanon in the short term…are that I have concerns about Lebanon, but over the medium and long term I am optimistic because I think eventually something will come out of this and hopefully it will be lasting stability for the overall region. This business, as proven in many other instances, is a very resilient business and one that has a tendency to launch back once events unfold,” Zok tells Arabian Business. “Our hotels have not been impacted. They are not physically damaged. The Movenpick hotel in Beirut has very aggressive profit protection planning programmes. We experienced in the first few days a drop in occupancy but that was followed by a slight recovery because we have a lot of news media agencies staying at our hotel.” Eid at JP morgan says, “In general, Gulf investors tend to buy and hold assets. Foreign Direct Investment (FDI) is very lumpy and difficult to move, so once decisions are made and implemented it is very difficult to unwind. Investors would rather wait to see what happens before they begin to unwind." “The most important point here is that the component of investment in Lebanon by those companies is minor compared with the overall portfolio. We are not seeing a rapid flight in capital or unwinding of FDI from Gulf investors.” She adds: “Gulf capital in Lebanon is not really foreign capital. It was there at the worst of times and was the first to go in the early 1990s. Foreign capital will be the last to get out, considering the tremendous increase in liquidity in the Gulf.” Nassib Ghobril, a prominent economist based in Beirut says “The resilience of the market will depend on how long the conflict lasts and what kind of solution comes out of it.” But he points out that traditionally, Gulf investors have predominantly put their money into real estate in the Lebanon and liquidating such assets takes time. Nasser Chamma, chairman of Solidere, a US$3.6 billion firm that manages the reconstruction of Beirut’s central business district, is understandably upset by what is happening in Lebanon, but he is unfazed and confident his company and other firms will weather the storm. “When this dust settles and there is a more solid political platform, I believe then the economic situation in Lebanon will pick up in a big way. But what is important is that we have a permanent solution to these problems that keep coming up and we are optimistic that something of this sort will materialise," Chamma tells Arabian Business. “I [will be] optimistic and very upbeat if we have a political resolution that presents a solid foundation whereby we don't not have these surprises again. Solidere is a company that has really solid foundations because it has no debt and it has this huge inventory of land and the land will be there for many years.” As Arabian Business went to press, the prospects for Lebanon were largely dependent on the outcome of the international conference in Rome. The conference did not produce the desperately needed ceasefire. The issues at the core of this conflict go beyond the Israeli soldiers that Hezbollah killed and the two others it kidnapped. They involve Iran and Syria, the backers and financiers of the Shiite group, as well as the prospect of a settlement between Syria and Israel that would return the occupied Golan Heights to Damascus and provide Israel with its security needs. There is also the final demarcation of borders between Lebanon and Syria, in addition to the protracted Israeli-Palestinian conflict that extremists capitalise on time and again. Perhaps most important of all is the issue of Lebanon’s confessional system, which while a symbol of the rich heritage of the country, has proved a fundamental obstacle to its progress. It’s a tall order for a small nation. But if it manages to emerge out of the debris of this war as it did out of the ashes out its 15-year civil war, Lebanon may once again become the “Paris of the Middle East”. Just remember, says Kawkabani, “after Rafik Hariri died a lot of investment came back to Lebanon, there was a real estate boom, and the stock market went up by 50% alone in January 2006. A lot of people are willing to invest in Lebanon.”||**||

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