Economic growth is estimated to have reported slightly above 3% in real terms, its highest level since the year 1997. The growth was generated from both private demand and foreign demand. It is estimated that domestic private demand grew by 18.5% year-on-year driven by both its private investment and consumption components. In parallel, foreign demand grew by 23.9% in real terms over the same period.

Money Supply grew by 12.5% year-on-year, more than offsetting the contraction in the velocity of money (-5.4%), leading, within the context of an average price inflation of 2.2%, to the observed real improvement in output.

Construction permits grew from 4.0 million square meters during the first half of 2003 to 4.3 million square meters over the same period of 2004, thereby exhibiting a growth of 6.2%. Cement deliveries amounted to 1.23 million tons during the first half of 2004, rising by 6.2% relative to the same period of 2003.

The number of landing and departing aircraft at the Beirut International Airport (BIA), reached 18,173 planes during the first 6 months of 2004, a rise of 20.1% relative to the same period of the previous year. Similarly, the number of passengers displayed a growth of 28.8% from its previous year’s level.

The touristic sector has been performing exceptionally well this year. The total number of tourists reached 470,832 in the first half of 2004, up by 35.1% relative to the 2003 corresponding period.

The export to import coverage ratio fell from 21.5% during the first half of 2003 to 20.6% over the corresponding period in 2004, as result of a rise in imports (31.4%) higher than the increase in exports (26.1%).

Gross capital inflows dropped by around 26.6% over the first six months of 2004 reaching US$ 3,633 million. Net of Paris II transfers, private inflows are estimated to have increased by 25% year-on-year in the first half of 2004. Capital inflows more than offset the deficit in the trade balance, leading to a surplus in the balance of payments of US$ 265 million.

Domestic public debt in LP increased by 4.0% over the first half to LP 27,912 billion by the end of June 2004. The debt in foreign currency amounted to US$ 16,289 million at end-June 2004, increasing by about 4.6% relative to end-December 2003. In this context, gross public debt at the end of the first half 2004 amounted to LP 52,469 billion, up by 4.3% relative to end-December 2003.

Measured by total assets, banking activity grew by 4.7% over the first half of the year. The analysis of sources and uses of bank funds by currency, over the first half, shows an increase in LP loans by LP 177 billion, in FC loans by US$ 256 million, in LP deposits by LP 566 billion and in FC deposits by US$ 2,180 million.

The Lebanese eurobonds market has witnessed a sustained momentum since the beginning of 2004, extending the post-Paris II trend. The average spread on Lebanese papers tightened by 93 basis points over the first half, to record a new four-year historical low of 247 basis points, within the context of a rise in foreign benchmark rates

Economic conditions were underlined, in the first half of 2004, by a rising real sector activity, a slightly improving fiscal performance and a reinforced monetary and market situation. According to our estimates, economic growth reported slightly above 3% in real terms, its highest level since the year 1997, though still much below the potential of the economy characterized by a large cyclical output gap and quite below the requirements of a soft-landing scenario in public finance conditions. The growth was realized within the context of a 7% decline in public spending as a result of the reported delay in the ratification of the budget law, suggesting that growth been mainly driven by the private side of aggregate demand. At constant public spending, real growth would have registered circa 4% year-on-year in the first half of 2004.

Indeed, all first-half real sector indicators are in favor of such an upside. Among these, we mention the number of tourists (+35.1%), the number of passengers at the Airport (+28.8%), the imports of industrial machinery (+72.2%), the value of cleared checks (+7.5%), the size of exports (+26.1%), the value of property transactions (+26.8%), the permits for new construction (+6.2%), the number of containers at the Port (+22.8%), and finally imports at the mirror of aggregate demand in its consumption and investment components (+31.4%).

The growth was generated from both private demand and foreign demand. It is estimated that domestic private demand grew by 18.5% year-on-year, raising its share from 63% to 68% of the aggregate demand for goods and services, driven by both its private investment and consumption components. In parallel, foreign demand grew by 23.9% in real terms over the same period, showing that the sustained market diversification efforts by domestic producers over the past few years are actually bearing fruit. Exports now account for more than 7% of aggregate demand, against less than 4% a couple of years ago.

The positive private consumption growth of 17.9% year-on-year was realized despite the negative impact of lower interest rates on interest income this year and ultimately on private consumption. Within the context of a marginal propensity to consume of 0.8, the net impact of the decrease in interest rates (by an average of 3.3% on FC deposits and an average of 1.3% on LP deposits) on private consumption was negative, estimated at LP 320 billion for the first half-year. It was yet compensated by a strengthened confidence factor on behalf of those domestic consumers, in addition to a significant growth in consumption demand by tourists. It is estimated that the additional touristic consumption stands at close to LP 400 billion in the first half, based on the significant growth in the number of tourists and a slight improvement in the average spending by tourist. The estimate of private consumption growth is also supported by the increase in the Value-Added Tax receipts by 35% year-on-year, mainly due to the growth in aggregate private spending much more than an improvement in tax collection.

The positive growth in the economy is likewise supported by the basic equation of the quantity theory of money. As the Money Supply grew by 12.5% year-on-year, more than offsetting the contraction in the velocity of money, which fell by 5.4% over the same period. In parallel, a real output growth of 3.0% was generated, which, within the context of a 2.2% price inflation, lead to a nominal growth in output of 5.3%. The contraction in the velocity of money is related to the significant growth in the average bank deposit base by 13.6% year-on-year, within the context of a lower (but still high) 7.5% growth in the total value of cleared checks in the banking system.

At the fiscal level, it looks like the year 2004 is heading towards a stability in public finance ratios. With this year’s deficit expected to be in line with budget targets, the debt to GDP ratio should revolve within the 184%-188% range all throughout 2004, triggered by lower debt growth and strong economic expansion. It is not that such a stability is sufficient to provide the comforting signs for markets and investors, but at least, it is an encouraging step ahead on the road of public finance soft-landing, after geometric growth rates for more than a decade. It might suggest that the economy has not yet fallen into a debt trap and that the opportunities for exit still do exist if drastic and timely adjustment measures are enforced.

At the monetary level, activity remains positive, with balanced net conversions on the foreign exchange market despite the lousy political climate through the first half. Net FX reserves rose by US$ 350 million between December and June to reach US$ 2.6 billion and US$ 10.2 billion when including the banks’ FX deposits at the Central Bank. Central Bank’s foreign assets reached US$ 12.2 billion, the equivalent of 70% of Money supply in Lebanese Pounds (91% when including gold), reinforcing markets immunity at large. Interest rates dropped by a further 19 basis points extending the 213 basis points contraction observed in 2003, to bottom at a new 20-year low in June. The balance of payments reported a surplus of US$ 265 million over the first half, despite a 33% growth in trade deficit, suggesting that capital inflows were on the upside by circa 25% year-on-year (adjusted to Paris II transfers in the first half of 2003).

At the banking level, the significant growth in activity observed last year was extended to the first half of 2004. The banking sector saw its assets rising by 4.7%, driven by the growth in customer deposits which grew by LP 3,860 billion, 10.7% above last year’s corresponding period figure and more than double the average growth of the first half of the past five years. The main growth characteristic this year is that it was accounted for by foreign currency deposits to the extent of 85%, contrary to the trend witnessed last year. As such, deposit dollarization slightly increased from its 3-year record low of 66.2% at end-December to 67.1% at end-June. The significant growth in banking activity generated an important quantity effect that offset the persistently contracting price effect as a result of declining spreads and margins.

A detailed analysis of the above developments in the real, monetary, government and foreign sectors of the economy follows. The concluding part of the report addresses the current socio-economic conditions and the requirements for enhancing the social component of economic growth.