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Management Discussion And Analysis

3.0. Economic Environment

3.1. Domestic Operating Environment

In 2014, the Lebanese economy witnessed a relative improvement in performance, though much lower than its potential capacity, within a precarious domestic/regional environment. Real growth remained modest, as suggested by the average growth in the BDL coincident indicator which reported 3.2% in 2014, reflecting the average performance of main real sector indicators that were mostly on the upside throughout the year 2014.

It is worth mentioning that the official national accounts for 2012 and 2013 were released with a 2.8% real GDP growth rate in 2012 and a 3.0% rate in 2013, exceeding previous preliminary estimates. Such rates correspond to moderate acceptable growth given the spill over effects of the Syrian crisis on Lebanon’s real economy. This has driven the GDP value to USD 47.2 billion in 2013 and is thus set to exceed the USD 50 billion threshold in 2014.

At the monetary level, Lebanon’s foreign exchange market witnessed further resilience over the past year, with Central Bank reserves at a record high in absolute terms, covering close to 80% of LBP money supply and 22 months of imports. BDL’s foreign currency assets actually grew from USD 35.3 billion at year-end 2013 to USD 37.9 billion at year-end 2014. Notwithstanding gold reserves which had reached USD 11.0 billion at year-end 2014, leading to BDL’s foreign assets in excess of LBP money supply, which corresponds to a full currency board situation. The balance of payments closed the year 2014 with a deficit of USD 1.4 billion, following a deficit of USD 1.1 billion for the year 2013. Inflation remained in parallel contained at one of its lowest levels in the past decade, estimated at 3.5% by the IMF based on average prices in 2004 relative to 2013.

The year 2014 has seemingly reported a relative improvement for Lebanon’s public finances. Though remaining high in absolute and relative terms, the government’s fiscal deficit reported some improvement during the first eleven months of 2014, reversing a trend of deterioration that dominated in the past couple of years. The slight decline in total government expenditures, combined with a higher increase in total revenues, resulted into a contraction in the overall fiscal deficit. The latter dropped by 24% relative to the first eleven months of 2013, as a result of a 10% rise in public revenues coupled with a 1% contraction in public spending. As such, the public finance deficit to total expenditures ratio dropped from 31.9% in the first eleven months of 2013 to 24.3% during the corresponding period of 2014. The contraction in spending, which is partly related to the delay of some expenditures, actually comes despite a rise in debt service by 10% over the aforementioned period of 2014. As such, a primary surplus of 8.2% of expenditures was reported over the first eleven months of 2014, against a net primary deficit of 2.5% of expenditures over the same period in 2013.

Amidst this environment, the financial sector performance remained sound, confirming the sustained resilience of the banking industry. Within the context of financial inflows towards Lebanon amounting to circa USD 16.0 billion, the banking sector reported a satisfactory annual growth of 6.0% in deposits and 7.4% in loans by end-December 2014, while profitability stagnated at its previous year’s level. The past year reported in parallel a significant improvement in capitalisation. Shareholders’ equity recorded a growth of 10.8% in 2014, outpacing the growth in banking activity at large. As such, the equity to assets ratio rose from 8.6% in December 2013 to 9.0% in December 2014, outlining the banks' good coverage of all types of risks by their own funds. As a matter of fact, according to the latest estimate of the banks' capital adequacy ratio as per Basle 2, the latter stands at a sound 14.0%, well above regulatory requirements.

Domestic Operating Environment

111-month annualised figure for 2014.
Sources: Ministry of Finance, Central Bank of Lebanon, the concerned public and private organisms, Bank Audi’s Research Department.

Domestic Operating Environment

Sources: Central Bank of Lebanon, Bank Audi’s Research Department.

At the level of Lebanon’s capital markets, an improving activity was reported in their two components of equity market and fixed income market. Prices at the Beirut Stock Exchange rose by a mild 0.6% in 2014, yet on the back of stronger trading activity. The trading value surged by close to 80%, moving from USD 345 million in 2013 to USD 619 million in 2014, raising the annual turnover ratio from 3.4% to 5.9%, though still low by international standards. In parallel, Lebanon’s 5-year CDs spread closed the year 2014 at 394 bps, maintaining its level of the previous year’s closing, following a 57 bps contraction in 2013, underlining a relative improvement in credit risks at large.

3.2. Operating Environment in the MENA Region

Within this environment, the performance of the MENA region in 2014 is even more mixed, and in some cases, more disappointing. According to the IMF, the region as a whole is set to grow by 2.6% in 2014, but this average masks a big difference between the high-income and developing countries of MENA. The former has a projected growth rate of 4.9%, while the latter’s growth rate is expected to grow at 0.7%, a bit faster than the previous year’s 0.4% as per the World Bank.

The weak performance of developing MENA this year is due to two ongoing phenomena in the region. The first is the violent conflicts, including the civil war in Syria, now in its fourth year and its attendant effects on its neighbours; the recent dramatic security developments in Iraq since mid-last year; a devastating war in Gaza in June-July 2014, and ongoing insurgencies in Libya and Yemen. The second is the political transitions in Egypt and Tunisia, as well as political openings in Morocco and Jordan which, accompanied by large macroeconomic imbalances and a huge and unfinished reform agenda, have kept these economies’ output well below potential.

It should be mentioned that, while the high-income countries in MENA (all hydrocarbon exporters in the Persian Gulf), have been growing at a rapid clip, they also face structural problems that may constrain their growth. Given current projections for the price of oil in the aftermath of the recent drop, budget surpluses are expected to disappear in most oil producing countries, probably affecting the expansionary stance in those countries.

At the banking level, the MENA region has been reporting a satisfactory performance on the overall. The annualised growth rates in deposits of 7.8% and in loans of 7.8% by December 2014 remain sound. But such a banking sector growth in the MENA region is mainly driven by oil exporters, while most oil importers barely saw their deposit and loan bases growing. Not less importantly, the latter’s net banking profitability remained under pressure within the context of relatively tough operating conditions in their respective economies, underlined by narrowing net interest margins, growing provisioning requirements and slow fee income growth generation at large.

Operating Environment in the MENA Region

Sources: central banks, Bloomberg, Bank Audi’s Research Department.
Figures in italic are the latest available.

In Egypt, the main regional country of presence for Bank Audi, the economy has begun to recover after four years of slow activity. Policies implemented so far, along with a return of confidence, are starting to produce a turnaround in economic activity and investment. On the back of a 6.8% growth in the third quarter of 2014, triggered by manufacturing, construction and the Suez Canal, the IMF is projecting growth will reach 3.8% in FY 2014/2015. While the economy is still operating way below potential output, it is closing part of its cyclical output gap with its output growth now exceeding its population growth at large.

Improved confidence on the political and economic course underpinned by a “Road Map” with well-defined landmarks, combined with the large financial support from the GCC countries, has shored up investor sentiment in Egypt. The equity market continues its rally, bond spreads have narrowed, and capital inflows have started to recover. Consumer confidence in Q3 of 2014 increased by four points (as compared to the previous quarter) to an index of 85. Tourist arrivals increased by about 30% in Q3 of the current year, as compared with the same period of last year. There are also signs that foreign investors are returning to the Egyptian market, as indicated by the positive net purchases of Egyptian equities in recent months, with the stock market index surging by 32% in 2014. In parallel, five year CDs spreads contracted by 323 bps from year-end 2013 to reach 282 bps at year-end 2014, outlining an improvement in market perception of country risks at large.

At the monetary level, conditions were relatively stable on the overall over the past year in Egypt. The year 2014 ended with an exchange rate of 7.15 Egyptian Pound per USD, a slight depreciation of 2.8% per annum. The year did not witness pressure on the gross FX reserves, which barely moved from USD 17.1 billion in December 2013 to USD 15.4 billion in December 2014, representing 8.2% of LE money supply and 2.8 months of imports. Still, the IMF thinks that a more flexible exchange rate policy focused on achieving a market-clearing rate and avoiding real appreciation would improve the availability of foreign exchange, strengthen competitiveness, support exports and tourism, and attract foreign direct investment.

At the banking sector level, the banking system has been resilient amidst a tough operating environment. Banks operating in Egypt posted an activity growth of 17.6% in local currency terms between end-2013 and end-November 2014 (+14.3% in USD terms). Deposits and loans were up by 15.8% and 12.4% (+12.5% and 9.2% in USD terms), respectively. Deposits in foreign currency increased by 6.5% during the first 11 months of 2014 compared to a growth of 18.6% in local currency deposits over the same period, contracting deposit dollarization from 23.8% in December 2013 to 21.9% in November 2014, which mirrors the relaxed activity on the foreign exchange market. The aggregated net profits of eleven listed banks of the sector rose by 15% in USD terms during the first nine months of 2014, suggesting a reinforcement of banking sector profitability at large.

3.3. Operating Environment in Turkey

The Turkish economy has grown significantly well in recent years. The economy recovered promptly from the global financial crisis and unemployment reached its lowest level in the last decade. Lately, Turkish authorities effectively contained the fallout from heightened domestic uncertainty and financial market volatility. But low national savings and competitiveness challenges are constraining investment and exports, contributing to considerable external imbalances that expose the country to the risks associated with international capital flows.

Economic growth has indeed continued this year, although it has contracted from the previous year amidst the effects of US tapering and domestic uncertainties. All in all, it is expected that growth would average 3% in 2014, yet below the four year average growth rate of 6%. As a matter of fact, domestic demand slowed relatively as high domestic interest rates, coupled with uncertainty due to international developments, prevailed. The largest contribution to growth is coming from exports of goods and services and contracting imports (mirroring weak domestic demand), which translates into a strong net export contribution to growth.

External sector indicators appear to be mixed this year. Exports have increased by 3.9% in 2014, driven by the gains in competitiveness in the aftermath of currency depreciation. Foreign direct investment in Turkey dropped by 11.8% in 2014 relative to the previous year. The number of foreign tourists rose by 5.5% in 2014. Last but not least, Turkey’s BOP reported a deficit of USD 0.5 billion in 2014, against a surplus of USD 10.8 billion over the previous year.

At the monetary level, inflation continues to be considerably higher than the Central Bank’s target of 5%, reflecting the exchange rate pass through, high food inflation and partly premature monetary easing. That being said, in December, consumer prices reached an annual inflation rate of 8.2% year-on-year.

At the banking sector level, Turkish banks continue to post a relatively sound growth with good financial soundness indicators. When expressed in TL terms, assets grew by 15.1% in 2014 (5.6% in USD terms), and loans grew by 18.5% in TL terms over the period (8.8% in USD terms). Capital adequacy ratios are high, with an average ratio of 16.3% at end December 2014. Asset quality remains satisfactory with a NPL ratio of 2.8% of gross loans and a loan loss provision ratio of 73.8% of non-performing loans. Last but not least, profit ratios have contracted this year but remain acceptable with a ROAA of 1.3% and a ROAE of 12.2%.

Operating Environment in Turkey

Sources: IMF, Central Bank of Turkey, Bank Audi’s Research Department.

3.4. Operating Environment in West Europe

The Western Europe region had a rather tough year in 2014, marked by a mostly faltering economic momentum. The global financial crisis legacies, particularly still elevated public and private debt levels, along with high unemployment, continued to weigh on the economic recovery. Consumer and corporate confidence remains fragile in some areas, mirroring a few lingering uncertainties about the recovery of the private sector economy. Corporate investments remain somewhat constrained and capacity utilisation has still not renewed with pre-crisis levels. At the same time however, fiscal consolidation efforts on behalf of authorities have had positive spill overs on indebtedness ratios which have more or less stabilised, and headwinds to economic momentum from fiscal restraint have eased. Along the same lines, inflation rates have remained very low in the absence of demand-side price pressures across the region.

Within this environment, monetary authorities have maintained exceptionally accommodative policies throughout the year to prop up economic activity in its consumption, investment and trade components. The European Central Bank has announced a series of measures to tackle low price pressures, such as a reduction in key interest rates, targeted liquidity provisions, and outright purchases of covered bonds and asset-backed securities. While such steps are bound to continue providing markets with liquidity, banks’ lending activity has remained constrained by their recapitalisation efforts in abidance with new regulations and ongoing deleveraging efforts, despite the successful completion of the ECB’s asset quality review and the move to place the largest banking institutions under single supervision. The still subdued quantity effect, along with tight spreads in a low interest rate environment, and dampened fee income generation in a low growth context, have weighed on banks’ bottom lines during 2014.