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Issue No. 154 Friday 7 - 20 July 2006

347-6-5

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ومالية مصرفية وماليةاخبار مصرفية اخبار

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INTEREST RATE DETERMINATION IN LEBANON

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Domestic foreign-cur-rency deposit rates

The spread between the interest rate on foreign-currency deposits (FCDs) and a benchmark rate such as LIBOR reflects bankingsector risk. Given the banking sector’s high exposure to the sov-ereign and the systemic risks aris-ing from sovereign risk, the same factors (public debt and interna-tional reserves) are expected to be key determinants of the inter-est rate spread. We also include other variables to measure risk factors. For country and banking system specific risks, we use thenet foreign assets of the bank-ing system, debt denominated in foreign currency relative to GDP, and the external current account balance.

To measure liquidity factors, we use excess banking sector re-serves held at the central bank, the deviation from trend of foreign-currency deposits, and the devia-tion from trend of broad money (M5). Since a majority of short term deposits in foreign currency are under one month (about 65 percent of FCDs as of end-2004), we consider the one-month inter-est rate as the dependent variable. For the benchmark, we use the one-month LIBOR rate to assess the pass-through from interna-tional rates to foreign-currency deposit rates in Lebanon. The independent variables are lagged one period to alleviate simultane-ity problems.

Domestic local-curren-cy deposit rates

The spread between interest rates on local currency deposits and those on foreign-currency de-posits reflects exchange rate risk.Risk perceptions should, in turn, be affected by reserve adequacy indicators and other monetary and fiscal policy variables. Otherthings equal, a higher level of for-eign currency reserves at the cen-tral bank should reinforce confi-dence that the exchange rate peg will hold under stress. However, one should be careful about mak-ing inferences on the direction of causality between international reserves and interest rates, since the central bank is likely to adjust interest rate policy in response to changes in the level of reserves, in which case causality would run from interest rates to reserves.

Exchange rate risk is also af-fected by sovereign risk since concerns about the government’s solvency can cause a shortfall in financing which increases therisks of an exchange rate depre-ciation. To measure sovereign risk, we use as independent vari-ables the debt to GDP ratio, and the debt in foreign currency to GDP ratio. As other risk factors, we also include the external cur-rent account balance, net foreign assets of the banking system, and dollarization. Causality between the degree of dollarization and the

exchange rate premium can go in either direction. A high spread vis-à-vis FCDs can encourage de-dollarization, but a high de-gree of dollarization may also reflect market perceptions aboutexchange rate risk which, in turn, require higher domestic currency interest rates. We lag independent variables one period to alleviate the endogeneity problem.

We use various indicators of liquidity conditions: deviation from trend of total deposits, the deviation from trend of LL de-posits, excess reserves at the cen-tral bank, and the spread between one-month FCDs and LIBOR.

Trends in Interest Rates

Panel A plots the yield on five-year Lebanese Eurobonds and that on (nearly risk-free) five-year U.S. paper. As mentioned above, the differential can be taken as a measure of sovereign risk. As such, sovereign risk fluc-tuated in the 2–5 percentage point range in 1995–99. In 2000, while rates on five-year U.S. treasuriesstarted falling, the Eurobond rate kept rising. The spread increased sharply starting from mid-2001, peaking at 10.9 percentage points in September 2002. During this period, the government was finding it difficult to finance itsdeficit as deposit inflows turnednegative, and gross international reserves declined. The unsustain-able situation was reversed by the Paris II donors conference in No-vember 2002 The promised sup-port to the government brought sovereign risk down sharply in the last quarter of 2002. Since then, spreads have come down to under 200 basis points, partly reflecting the overall decline inemerging market bond spreads.

The factors that could have potentially contributed to the in-crease in the spread in the period leading up to the Paris II confer-ence are: a weakening of under-lying macroeconomic fundamen-tals in Lebanon, a shortage of available liquidity, a lagged reac-tion of Lebanese interest rates to the drop in U.S. interest rates, or a less-than complete passthrough of U.S. interest rate changes. The latter could reflect a number offactors, including “home bias” and changes in investor prefer-ences not captured by our mea-sures of fundamental and liquid-ity factors.

Panel B, shows the spread be-tween one-month U.S. dollar deposits and LIBOR of a corre-sponding maturity. As one might expect, the FCD rate exceeds the LIBOR rate throughout, except for a brief period in 2000, when LIBOR rose rapidly. The spread began rising in 2001, as inter-national dollar interest rates fell faster than domestic dollar rates. This observation does not imply that the widening of the spread has caused the faster dollar inter-

est rate reduction, as underlying risk factors may have been in-creasing at the same time.

The spread between pound-de-nominated deposits and FCDs, a measure of exchange rate risk, is plotted in.1 Panel C. This risk fluctuated substantially over1995–2003. A spike was recorded in late 1995, reflecting a period ofheightened political tension relat-ed to the extension/renewal of the president’s term. Excluding this episode, exchange rate risk re-corded a trend decrease until late 2000 (4.3 percent for onemonth deposits). It then crept up again to 6.9 percent in mid-2002, decreas-ing again thereafter. The pattern since end-2000, follows that of sovereign risk and is likely to re-flect the fact that public financedynamics constitute a dominant factor for the credibility of the exchange rate anchor.

3 plots spreads on dollar depos-its over LIBOR and LL deposits over dollar deposits against gross reserves and deviations from trend in broad money. In 1995–96, broad money was below trend due to the tensions regarding the renewal of the president’s term, and dollar deposit spreads were rising (Panel B). Then, money growth picked up but no discern-ible pattern was seen in spreads. Starting from late 2000, increas-ing financial market stress led torising FCD rates and spreads, and a slowing down of money growth. In addition, liquidity conditions in world markets became tight in 2001, after the technology bust in the United States and Europe. The more relaxed monetary con-ditions in the United States and Europe starting from 2001, fol-lowed by an easing of domestic financial tensions after Paris II,led to declines in spreads. Depos-it growth resumed in late 2001 in-spired by the confidence effects ofParis II. Since then, broad money growth has been sustained, while spreads have fallen. The figure,therefore, suggests that deviations from trend in broad money can be taken as a good indicator of the availability of liquidity, and that there is a negative relationship with spreads, more discernibly since late 2000.

Panel C plots spreads on LL deposit rates over dollar deposits, and gross international reserves. Until mid-2001, gross reserves were generally increasing while spreads were falling. Financial stress in 2001–02 led to falling reserves, while spreads increased. Since Paris II, foreign exchange reserves have risen markedly, while spreads have come down considerably. A similar pattern is observed in Panel D with respect to broad money. Thus, the panels suggests a negative relationship between reserves and deviations from trend in broad money on the one hand, and spreads on LL de-posits on the other.

ResultsEurobond yields We ran equa-

tion as a Vector Error Correction model to determine the long-run relationship between Eurobond yields, a benchmark rate proxied by the interest rate on five-yearU.S. T-bills, and sovereign risk captured by foreign exchange re-serves and foreign-currency debt. We used monthly data from May 1995 to January 2005.

The results suggest that an in-crease of 100 basis points in the U.S. T-Bill rate would result in an increase of 70 basis points in Eu-robond yields. At the same time, a one percent increase in the foreign currency debt (about $75 million based on the average value over the period) would increase yields by 1.4 basis points, while a one percent increase in international reserves (about $65 million based on the average value over the period) would reduce Eurobond yields by 6.5 basis points.

Foreign-currency de-posit rates

Overall, our results suggest that there was a pass-through of about 40 percent from LIBOR to FCDs over the period November 2000 to January 2005. An increase in M5 from trend by one percent leads to a reduction in FCD rates by 0.1 basis points. A one percent increase in international reserves leads to a decrease of 0.6 basis points, while an increase of 1 per-centage point in the dollarization ratio decreased FCD rates by 7.7 basis points. All other variables related to banking sector risk and liquidity were not significant, andare not reported here.

Domestic currency interest rates

The dependent variable is taken to be the rates on 1-month deposits in Lebanese pounds, as a majority of deposits are under

1 month. In this case, the bench-mark rate is taken to be the equiv-alent FCD rate. For consistency with the previous equation, the estimates are based on the same sample period of November 2000 to January 2005.

This relationship can be inter-preted as reflecting a combinationof market arbitrage and the central bank’s reaction function. Higher reserves and higher liquidity are associated with lower pound de-posit rates, while an increase in the FCD rate has a positive impact on pound deposit rates, albeit less than one. Because an increase in dollar interest rates has a large adverse effect on public finances,one would expect that it would also undermine confidence in theexchange rate peg, with a result-ing increase in the exchange rate risk premium. We find, however,that controlling for the effects of gross reserves and deviations from trend of broad money, a unit increase in FCD rates causes a less than unit increase in local currency rates.

ConclusionsThis study shows that, al-

though global benchmark interest rates are an important element in the determination of interest rates in Lebanon, the pass-through is lower than unity, which is at odds with the findings in some stud-ies for other emerging markets. For example, Arora and Cerisola (2001) find that for nearly allemerging markets in their sam-ple, a unit change in long-term U.S. rates causes a higher than unit increase in sovereign bond rates. Given the openness of the capital account and the presumed sophistication of large deposi-tors, the degree of pass through is surprisingly low—0.7 for Euro-bond rates, 0.4 for FCD rates, and

slightly less than unity for LL de-posits. This result could be driven by unobserved changes in risk premia and investor preferences over this period that are not cap-tured by our data on fundamen-tal risk factors. It could also be attributed to a home-bias effect resulting from a dedicated Leba-nese investor base which does not trade actively across asset class-es. This explanation seems to be validated by the fact that the pass-through is greater for Eurobonds than for FCDs: although market Eurobonds are for the most part held by domestic banks, they are also traded on international mar-kets, and are more likely to be held by non-Lebanese investors. One would therefore expect ar-bitrage on Eurobonds to be more active than on FCDs.

Despite the absence of a full pass-through in the period un-der consideration, the impact of changes in international interest rates on the government’s bor-rowing costs remains substantial. Given the relatively short aver-age maturity of the debt, an up-ward shift in the U.S. yield curve would have a relatively quick and substantial negative impact on the budget.

This study also confirms thatinterest rates in Lebanon are af-fected, as one would expect, by market liquidity conditions, as well as measures of government solvency and central bank liquid-ity. The negative relationship be-tween international reserves and interest rates can help shed some light into the debate about the optimal level of international re-serves, which depends on balanc-ing the holding cost of reserves against the benefits deriving fromlower exposure to shocks (as re-flected in lower spreads).Source: IMF Country Report No. 06/200

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Lebanese International Bond Issues

DEBT INSTRUMENTS Maturity YTM MidPrice ($)

Sovoreign Debt

Beirut Stock ExchangeM.Cap.($mil)**

Over - the - Counter

Lebanese Treasury Bonds

R. Lebanon 10 1/2 Aug- 06 2.09% 100.40 Lebanon Euro 8 7/8 Oct-06 4.56% 100.63 R. Lebanon 6 1/2 Feb- 07 5.69% 100.25 R. Lebanon 8 5/8 Oct-07 6.14% 102.50 R. Lebanon 7 3/8 Jun- 08 6.55% 101.00 R. Lebanon 10 1/8 Aug- 08 6.60% 106.25 R.Lebanon Euro 7 1/4 May-09 5.51% 104.00 R. Lebanon 10 1/4 Oct-09 6.85% 109.25 R. Lebanon FRN (libor+3.25%) Nov- 09 7.00% 105.00 R. Lebanon 7 Dec-09 6.83% 100.13 R. Lebanon 7 1/8 Mar-10 6.96% 100.00R. Lebanon 7 7/8 May-11 7.24% 102.25 R. Lebanon 7 3/4 Sep-12 7.34% 101.63 R. Lebanon 8 5/8 Jun-13 7.46% 105.88 R. Lebanon 11 5/8 May-16 7.92% 124.50 Central Bank of Lebanon 10% Apr- 15 7.63% 114.63

Private Issues

Credit Libanais 6 3/4 Jul-06 1.53% 100.10 Ciment Libanais 10 Jul-06 0.76% 100.15 B. Mediterrannee 6 3/8 Oct-06 4.42% 100.25 First National Bank 6 7/8 Jan-07 5.08% 100.50 B. Mediterrannee 6 1/4 Aug-07 5.77% 100.00 Fransabank 8 1/2 Dec-07 6.10% 102.75

PBR06 E

PER 06 E

YTDClosingPrice$

Stock

Solidere (A) 22.03 22.5% 22.3 1.7Solidere (B) 22.18 23.4% 22.5 1.7

3,644.7

BLC Bank 10.26 46.4% 21.2 8.6 413.7Banque Audi GDR 66.85 11.7% 15.3 1.8 2,190.4Bank of Beirut-Listed shares 13.75 38.9% 17.4 2.4 558.3Bank of Beirut-Pref.Call.Class B 11.7 -3.3% NA NA 35.1Bank of Beirut-Pref.Call.Class C 25.75 0.0% NA NA 75.2

Byblos Bank-Priority shares 2.24 -2.6% 11.2 1.3Byblos Bank-Pref. Call.-listed 108 -2.7% NA NA 108.0

Byblos Bank-Listed shares 2.22 -5.9% 11.1 1.3916.6

BEMO Bank -listed 5 42.9% 13.6 1.5 80.0BLOM Bank GDR 73.1 9.9% 9.7 1.6 1,571.7Rymco 1.1 -1.8% 18.3 0.7 27.5Holcim Liban 2.34 30.0% 24.0 2.3 548.0Ciments Blancs Bearer 2.14 71.2% 4.7 2.1 19.3Ciments Blancs Nominal 1.3 -13.3% 2.9 1.3 11.7Uniceramic Nominal A 1.3 -7.0% 10.5 2.1 16.7Uniceramic Bearer C 1.59 -9.1% 12.8 2.5 20.5Beirut Interbank Fund 105 -1.9% NA NA 21.0Beirut Global Income Fund 102 -3.0% NA NA 34.7Beirut Lira Fund* 106,500 -1.8% NA NA 29,288Beirut Golden Income * 109,000 -2.4% NA NA 44,690

Stock YTD PER06 E

PBR06 E

M.Cap.($mil)**

MidPrice

Solidere GDR 25.7% 22.3 1.7 3,630.022Casino du Liban 20.3% NA NA 255.6355Fransabank 50.0% 13.5 1.7 708.845

Sibline 30.0% 11.2 1.0 100.91.3SGHL 0.0% NA NA 96.06

R. Lebanon 8 1/2 Jan-16 7.75% 104.63

Audi Investment Bank 10.75 May-10 6.98% 112.00 B. Mediterrannee 7 5/8 Jul-10 7.33% 100.63

Although all data is based on information deemed to be reliable,FFA takes no responsibilities for any decision based on it.

The closing prices as of 30 - 06 - 2006*Price and all calculations quoted in Lebanese Pounds**The Market Capitalization and other ratios reflect all categories of outstandingordinary shares at end of period

Months IssuingDate

MaturityDate

Circular DiscountRate (%)

Yield(%)

Months IssuingDate

MaturityDate

Circular Yield(%)

Value(L.L)

6 29/6/06 28/12/06 248 6.99 7.24

12 22/6/06 21/6/07 247 7.19 7.75

24 22/6/06 19/6/08 247 8.50 10,000

36 22/6/06 18/6/09 247 9.32 10,000

CAC40 YTD:5.32% S&P YTD:1.78% NIKKEI YTD:-3.76% FTSE YTD:3.83%

FINANCIAL

FUNDS ADVISORS

INTERNATIONAL S.A.L

TEL: 00961 1 985195 FAX: 00961 1 985193Web Site: www.ffa.com.lb - e-mail : [email protected]

Arab MarketsCompany Name Last YTD

Saudi Basic Industries Corp.Saudi Telecom Co.Saudi Electricity Co.Al Rajhi BankSamba Financial GroupRiyad Bank

National Bank of Kuwait

Kuwait Finance HouseThe Public Warehousing Co.

Mobile Telecommunications Co.

The Gulf BankThe Commercial Bank of Kuwait

Emaar Properties Co.Emirates Bank InternationalNational Bank of Abu DhabiNational Bank of DubaiEmirates Telecommunication Corp.Shuaa Capital

Industries Qatar Co.Qatar TelecomQatar National BankQatar Gas Transport Co.The Commercial Bank of QatarDoha Bank

Bahrain Telecommunication Co.Al Ahli United BankInvestcorp BankArab Banking CorporationGulf Finance HouseNational Bank of Bahrain

182 -4.21%122.5 -18.33%24.25 61.67%

169.75 -19.17%350.5 -16.55%

99.5 -28.93%

2000 -9.91%2840 -19.32%2040 -14.29%

1360 9.68%1860 -35.86%

1180 5.36%

11.4 -50.97%13.55 -28.80%24.55 -45.54%

17 -25.04%10.55 -48.79%

4.56 -55.73%

93.8 -35.31%217.5 -6.81%215 -27.41%

113.9 -27.02%22.4 -55.73%

114.2 -65.04%

0.85 -6.39%0.94 0.00%2359 -0.04%

2.54 -16.45%1.14 -3.39%

0.84 -16.17%

Saudi SE 13434 -19.62%

Kuweit SE 9920 -13.35%

DUBAI FM 425 -58.43%

DOHA SM 7646 -30.83%

BAHRAIN SE 2021 -7.95%


R. Lebanon 8 1/4 Apr- 21 8.25% 99.50

Dr. Lionel VaironDepuis le lancement des réformes

économiques en Chine au début des années quatre-vingt, le système ban-caire chinois – public – est confronté à une équation extrêmement délicate, comment soutenir le secteur indus-triel public non solvable sans pour au-tant affronter un krach majeur ? Dans les années quatre-vingt, confronté à l’absence de rentabilité de nombreuses entreprises industrielles d’Etat écrasées par le nombre de leurs employés, leur faible productivité et leur dispersion dans des secteurs qui n’auraient pas dû relever de leurs attributions (éduca-tion, logements sociaux etc.), le gou-vernement chinois a choisi d’engager des restructurations pour des centaines d’entreprises, qui se sont traduites par des licenciements massifs, en particuli-er dans le bastion industriel traditionnel du pays, le Nord-Est. Afin de limiter lacasse et d’agir progressivement, l’Etat a parallèlement contraint les banques publiques à accorder des prêts à d’autres entreprises non solvables pour limiter l’ampleur des conséquences sociales de ces restructurations et attende des jours meilleurs. Le poids des créances douteuses de ces banques – qui s’est alourdi pour certaines banques avec des crédits accordés à des particuliers dans des conditions peu transparentes – a pris une ampleur qui a depuis dix ans conduit les analystes occidentaux à prédire l’effondrement rapide du sys-tème financier chinois et la faillite ensérie de ces banques d’Etat. Respectant les engagements pris au moment de son adhésion à l’OMC en 2001 et souci-euse désormais d’assainir ce secteur, la

Chine a lancé l’ouverture du capital de ses banques publiques à des investis-seurs privés et étrangers à hauteur de 20% maximum du capital. Les résultats défient à ce jour toutes les analyses cat-astrophistes. L’introduction début juin à la bourse de Hong Kong de la Bank of China, la seconde banque publique chinoise, qui a levé 9,725 milliards $, confirme le succès de cette entrepriseet l’erreur des analystes occidentaux. Introduite à 2,95 HK$, le titre clôturait le jour de son introduction à 3,40 HK$, soit 15,25% d’augmentation dans un contexte général hongkongais morose (-1,34%). En octobre 2005, la China Construction Bank avait remporté le même succès avec 9,28 milliards $ levés. La prochaine, l’Industrial and Commercial Bank of China, devrait les suivre cette année. Ces trois banques ont vu affluer quelques 60 milliards $destinés à les renflouer alors que descentaines de milliers $ étaient trans-férés vers des sociétés de défaisance. Les banques occidentales ont engagé une lutte acharnée pour l’entrée dans le capital de certaines banques, parmi elles Merrill Lynch, Bank of Ameri-ca ou la HSBC britannique. Le taux élevé d’épargne des Chinois et la for-midable croissance économique qui perdure depuis un quart de siècle, les excellents profits réalisés en 2005 parles banques chinoises, et en dépit des faiblesses de gestion actuelles, incitent les experts à voir en la Chine le seul pays qui pourra connaître dans les dix à vingt prochaines années un rythme soutenu de croissance, en particulier si les banques se débarrassent de leurs mauvaises habitudes.

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