The reversal in economic fortunes between Lebanon and Syria over the past six years has been considerable. While in 2010 Lebanon’s nominal GDP was 60 percent of Syria’s, by 2015 the Lebanese economy was estimated to have become 3.5 times larger than the Syrian economy.

This development was mostly due to the collapse in economic conditions in Syria rather than significant growth in Lebanon, and will likely have repercussions both on the economic dynamics between the two countries as well as their future productive capacities. The reality is that the Lebanese economy is under severe strain and its external balances face multiple risks.

THE MASSIVE REFUGEE BURDEN

The Syrian conflict, which began in 2011, has led to a massive inflow of just over 1 million refugees, according to the United Nations High Commissioner for Refugees (with some figures showing a higher 1.5 million), and the closing of land routes to the Gulf, a major market for Lebanese exports. Annual real GDP growth has nosedived from 8–10 percent prior to 2011 to around 1–2 percent today, and is projected to remain at a modest 2–3 percent for the coming four years.

Isolating the direct effects of the Syrian crisis is not easy, however, as Lebanon’s economic difficulties also coincided with other challenges: a prolonged domestic political stalemate and unfavorable economic developments in countries hosting significant numbers of Lebanese expatriates, leading to a tightening in remittance and deposit flows.

What is clear is that the uncertainties caused by domestic and regional conditions converged to severely dent consumer and business confidence. They have slowed down activity in real estate, construction, finance, and tourism, all sectors that have traditionally driven growth. Public infrastructure is stretched and the quality of public services has deteriorated as protracted underinvestment has been exacerbated by a population expansion, due to the refugee presence, equivalent to that previously projected over the next 20 years. The consequent 30–50 percent increase in the labor force has doubled the unemployment rate to over 20 percent, with a disproportionate cost borne by unskilled youth.

Consumer confidence indices have improved lately and some evidence suggests that Syrians in Lebanon are supporting private demand through consumption and investment, albeit in the informal sector. However, the slowdown in growth has led to adverse government debt dynamics as public debt sharply rose to 157 percent of GDP in 2016, the third-highest level in the world, eliminating much of the progress made over the last decade after the ratio peaked at 185 percent of GDP in 2006. Additionally, debt servicing costs are estimated to have increased to over 50 percent of government revenue and are projected to rise further to 60 percent by 2021.

This reduces the government’s margin for maneuver at a time when efforts to kickstart growth are sorely required. To prop up the local economy, and in particular the real estate sector, the central bank has enacted quasi-fiscal schemes, including a loan subsidy program that has provided $4.4 billion since 2013. The economy’s reliance on financing its deficits by attracting foreign-deposit inflows has been brought into question as deposit growth has slowed since mid-2015, in part due to tightening financial conditions in the oil-exporting Gulf countries.

The slowdown in deposit growth has put further pressure on Lebanon’s sizeable foreign exchange funding needs. Those needs are mostly due to a large and persistent deficit in the current account (the trade balance in goods and services alongside net income payments and transfers).

In response to these stresses, in 2016 the central bank decided to bolster its foreign reserves holdings by engaging in a large-scale financial operation, swapping local currency-denominated bonds for Eurobonds newly issued by the Ministry of Finance and subsequently selling them to local banks. While the operation was successful in its stated aim of increasing the central bank’s foreign reserves, it came at a cost of creating excess local currency liquidity and offering banks substantial incentives to participate.

SYRIA’S WAR AND LEBANESE EXPORTS

It is plausible that risks to current account stability are going to continue for the foreseeable future. One element in which we can see the clear influence of the Syrian war is the decline in overland exports from Lebanon. Imports have fluctuated somewhat since 2011, but not as strongly as exports. In 2016, imports had risen by 4 percent compared to their 2010 value, standing at $18.71 billion, a relatively small change. Rather, the deterioration in the trade balance was driven by a reduction in exports.

In 2015, the war in Syria began to directly affect Lebanese export networks. The country has three border crossings with Syria—the Abboudieh crossing northeast of Tripoli, the Arida crossing along the Tripoli-Tartous highway, and the Masna‘ crossing along the Beirut-Damascus highway. Masna‘ has historically been by far the most important of the three, for example accounting for around 70 percent of all overland exports in 2013 and 2014.

Goods would flow through these crossings to access the lucrative Gulf markets. Exports were fairly consistent until April 2015, when rebels in southern Syria seized the last accessible border crossing out of Syria, the Nassib crossing with Jordan. The closure led to a dramatic 60 percent decline in exports that same month compared to April 2014, as shown in the first graph below.

Subsequently, overland exports declined by 75 percent between 2014 and 2016 and became dominated by Syrian demand. Excluding fuel exports and separating total annual exports by mode of transport (maritime, land, and air), we can see this development clearly through the convergence of “land exports” towards “Syria exports.”

What is notable about exports to Syria is that they did not decline in line with the general collapse in Syrian economic activity. This could be due in part to an ability among Lebanese producers to step in and replace production shortfalls within Syria. Exports in 2016 (excluding fuel) stood at around $200 million, only around 13 percent below their 2009 level.

Fuel exports have been excluded from the second graph due to their irregular frequency and outsize level, making them unreflective of the economic relationship between the two countries. Lebanon appears to have acted as an occasional stopgap for Syrian fuel demand. In 2012, fuel exports to Syria were valued at just over $60 million, while in 2013 that figure rose to over $300 million. This has mostly subsided, but appeared to pick up in 2017 when $25 million in fuel was exported in the first five months of the year, approximately the sum of the previous three years combined.

The recovery in air exports is partly accounted for by higher exports of precious metals and stones, especially unwrought gold, which tend to comprise the largest proportion of Lebanese exports (35 percent in 2011). These declined from around $1.5 billion in 2011 to $400 million in 2015, before recovering to $800 million in 2016. Over 99 percent of these exports go through Rafik Hariri International Airport, and their movements appear to be unrelated to the war in Syria.

Total exports in 2016 stood at 70 percent of their 2010 level, and about equal to their level in 2007. While this is a relatively tolerable decline, the potentially negative distributive effects resulting from the collapse in overland trade might be cause for concern. Much Lebanese agricultural and general food produce is exported by land. The decline in aggregate figures in these categories has been modest, at around 10 percent since 2014, but producers have had to incur adjustment costs related to finding alternative shipment routes. The improvement in precious stones and metals trading therefore masks a plausibly negative development in macroeconomic fundamentals.

On a more positive note, the resilience of exporters in the face of all these shocks is promising. Production declines have been relatively modest and can be expected to reasonably improve when a reliable land route out of Syria is eventually reopened. Lebanon is also increasingly positioning itself as the hub for Syria’s future reconstruction, expanding its special economic zone in Tripoli and attempting to channel international investors’ funds towards the adjacent port.

Needless to say, the success of these moves remains contingent on the dynamics of the Syrian conflict and the ability of reconstruction plans to stimulate inclusive growth that creates jobs for Syrian refugee returnees. The resulting virtuous growth cycle could potentially then encourage further job creation in Lebanon, and yield a much-needed windfall for the local economy and a healthy upswing in trading activity.