Resilient Lebanon Defies Odds In Face of Global Crisis

• Author: Harald Finger and Carlo Sdralevich
• Position: IMF Middle East and Central Asia Department

But while many emerging market countries are deeply embroiled in the global economic crisis, the Lebanese economy could this year grow substantially faster than our recent conservative projection of 4 percent.

Twelve months ago, this rosy scenario seemed unlikely. A fragile national unity government was focusing mainly on maintaining short-term macroeconomic stability and preparing for parliamentary elections-which many saw a possible source of domestic violence-and was in no position to implement major reforms. Then the global financial crisis erupted, and the storm sent Lebanese Eurobond spreads briefly to above 1,200 basis points in October 2008.

With one of the highest government debt-to-GDP ratios in the world, a large and highly dollarized banking system with a significant exposure to the government, and a peg to the dollar, Lebanon has long looked highly vulnerable, and by the time the U.S. investment bank Lehman Brothers failed, Lebanon seemed a prime candidate for a textbook emerging market financial crisis.

Economic resilience

But once more, Lebanon has mocked the doomsayers. Lebanon's ongoing economic resilience bolstered the banking system, with deposit inflows now growing at nearly 20 percent annually (see Chart 1), and the central bank quickly accumulated international reserves, up 60 percent within a year to the equivalent of almost 70 percent of GDP.

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While this resilience is remarkable, it is not the first time in recent years that Lebanon has defied the odds in the face of a severe shock. In 2005, former prime minister Rafik Hariri was assassinated, triggering civil unrest that led to the withdrawal of Syrian troops. In 2006, Hezbollah engaged in a brief but bloody war with Israel. In 2007-08, the country was paralyzed by a political crisis that involved a Hezbollah tent city in downtown Beirut surrounded by armed soldiers, tanks, and barbed wire.

The country was left without a functioning parliament for more than a year. Brief but intense street fighting among opposing militias in May 2008 took the country to the brink of another civil war. And yet Lebanon managed to thrive, an astonishing resilience explained by a combination of structural and contingent factors.

At 160 percent of GDP, Lebanese government debt is staggering, but the government's structural...