The role of public debt in the Lebanese economy

Prepared by the researcher : JAMMAL, Naji.¹, AHMAD, Mayada.²

• ¹(Faculty of Economics and Business Administration, Lebanese University, Lebanon)
• ²(Doctoral School of Law, Political, Administrative and Economics Sciences, Lebanese University, Lebanon)

Democratic Arabic Center

Journal index of exploratory studies : Tenth Issue – September 2023

A Periodical International Journal published by the “Democratic Arab Center” Germany – Berlin

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Abstract

Background: The article delves into the crucial role of public debt in the Lebanese economy, highlighting its record levels and impact on the country’s economic and financial stability. While public debt holds the potential to stimulate economic growth through investments, excessive debt can result in high interest rates and solvency deterioration. The current economic and financial situation in Lebanon, marked by a multidimensional crisis and poor financial management, underscores the significance of analyzing the role of public debt. The article reviews existing literature, presents a mathematical model, and suggests strategies to mitigate the adverse effects of public debt on the Lebanese economy.

Materials and Methods: In our study, we employed a combination of statistical methods including simple regression, correlation analysis, and sensitivity assessment to effectively pinpoint the role of public debt within the Lebanese economy. By utilizing these techniques, we aimed to gain a comprehensive understanding of the relationship between public debt and GDP, shedding light on how changes in public debt might impact the economic dynamics of Lebanon. This multifaceted approach allowed us to uncover insights that contribute to a more nuanced comprehension of the intricate interplay between public debt and the broader economic landscape of the country.

Results: The researcher discovered a notable inverse relationship between “public debt” and “economic growth.” Additionally, the findings unveiled a weak correlation between these two factors, implying that alterations in “public debt” exhibit only a faint connection to shifts in “GDP.” Furthermore, the analyst detected a modest sensitivity, underscoring that minor fluctuations in public debt yield restricted repercussions on “GDP.”

Conclusion: The analysis underscores that public debt assumes a prominent role within consumption-driven sectors rather than productive ones, a distinction vividly evident in the pronounced negative correlation between public debt and GDP. This association highlights that the impact of public debt predominantly resonates within domains reliant on consumer spending, indicating its potential influence on consumer behaviors and market dynamics. On the other hand, the link between public debt and productive sectors appears less pronounced, suggesting that the influence of public debt on these sectors might be comparatively modest.

1. Introduction

                Public debt is a very important topic in many countries, including Lebanon. The country has a high public debt, which has increased over the years, and represents a significant burden on the government and the economy in general. This has raised concerns about its impact on financial and economic stability. It is often seen as a necessary tool to finance public expenditure, but it can also represent a significant burden on the economy. In the case of Lebanon, public debt has reached record levels, rising from 35% of GDP in 2010 to more than 170% in 2020, according to World Bank data, making it one of the highest in the world, which has had significant repercussions for the country’s economic and financial stability (World Bank, 2020).

The role of “public debt” in the Lebanese economy is complex and has important implications for the country’s economic future. “Public debt can be used to finance infrastructure projects and investments that stimulate economic growth” (World Bank, 2019). However, excessive public debt can also cause interest rates to rise, which in turn can affect economic growth and lead to a deterioration in the country’s creditworthiness  (Reinhart, C. M., & Rogoff, K. S., 2010).

Lebanon is currently facing a multidimensional crisis in its economic and financial context. Since 2019, the country has been facing a severe financial crisis, which has led to a rapid depreciation of its national currency, the Lebanese pound, and a significant increase in the prices of basic necessities. This crisis is largely due to high public debt as tax revenues have fallen and public spending has increased to meet urgent humanitarian and economic needs. The situation is also aggravated by corruption (Transparency International, 2020) and poor management of public finances.

Amidst this situation, it becomes vital to analyze the role of “public debt” in the Lebanese economy and assess its impact on key financial variables such as monetary policy, financial stability, and central bank foreign exchange reserves. Many studies have been conducted on this subject, but it is important to continue exploring this issue given the crucial importance of “public debt” for the Lebanese economy. From this point on, the question of the role of public debt in the Lebanese economy is a controversial but fundamental subject due to its economic and financial impact. Lebanon’s difficult economic and financial situation has raised a central question:

“What is the effect of public debt on the Lebanese economy and what is its relation to GDP?”

This article therefore proposes to evaluate the role of “public debt” in the Lebanese economy by focusing on its impact on key financial variables and evaluating the different possible approaches and strategies to reduce its negative impact. To do this, the researcher first reviewed the existing literature on this subject, citing the most relevant authors. Next, a mathematical model is presented to illustrate the impact of public debt on the Lebanese economy and analyze the results. Finally, a proposal of some strategies to reduce the Undesirable consequence of “public debt” on the Lebanese economy and a conclusion on the implications for the country’s financial policy.

1. Literature Review

Numerous studies have been carried out regarding the involvement of public debt in the economy, particularly in Lebanon. According to  (Safieddine, A., & Daouk, H., 2014), public debt is an important source of financing for the Lebanese government, but it can also have negative consequences on the economy, particularly in terms of increasing interest rates and reducing private sector investment. Similarly, according to  (Alameddine, 2017), Lebanon’s high public debt has an impact on the trade balance, balance of payments, and foreign exchange reserves.

2.1-Impact of public debt on monetary policy

“Public debt” can have a considerable impact on a country’s monetary policy, with noteworthy repercussions on its overall economic and financial dynamics. Research has demonstrated that “public debt” can have a substantial influence on the decisions concerning monetary policy. According to a study by (Reinhart, C.M. et Rogoff, K.S., 2010), high public debt can limit monetary policymakers’ room for maneuver by forcing them to keep interest rates low to reduce the debt burden.

Another study conducted by (Afonso, A. et Sousa, R.M., 2012)  showed that “public debt can affect monetary policy decisions by altering the transmission of monetary policy”. Specifically, the results showed that “high levels of public debt can reduce the effectiveness of monetary policy by reducing the ability of central banks to influence short-term interest rates”.

      In addition, some studies have shown that public debt can affect central bank credibility in monetary policy. For example, a study by (Bohn, H. et Inman, R.P., 1996) found that high levels of public debt can reduce central bank credibility in monetary policy due to debt sustainability concerns.

Moreover, other studies have indicated that elevated levels of public debt can influence financial stability. For example, a study conducted by (Aizenman, J. et Hutchison, M.M. , 2010) showed that high levels of “public debt” can increase the risk of financial crises by making countries more vulnerable to external shocks.

Speaking of the case of Lebanon, for example, high public debt can raise interest rates, which can make private sector investment more expensive and reduce overall economic activity. According to (Barakat, A., & Alameddine, M. , 2018), public debt can also affect money market liquidity, which is a key element of monetary policy. According to (Harb, 2015) “public debt” has had a detrimental effect on economic growth by reducing public investment and increasing the cost of borrowing for the private sector. The author also pointed out that public debt has led to fiscal imbalances and macroeconomic instability.

Similarly, (Saba, 2019) showed that public debt had negative effects on foreign trade by increasing import costs and reducing export competitiveness. He also pointed out that public debt has reduced the government’s ability to meet social needs, such as health and education.

2.2- Impact of public debt on financial stability

“Public debt” can also have an impact on a country’s financial stability. In Lebanon, high public debt can affect “the central bank’s foreign exchange reserves”, which can lead to lower investor confidence and increased capital outflows. According to (Obeid, N., & Sakr, N., 2016), high public debt can also lead to increased credit risks for the government and banks. “Public debt” can also exert a substantial influence on both monetary policy and financial stability. In a context of high public debt, the central bank may be forced to maintain high interest rates to maintain the attractiveness of public debt securities and thus attract investors. This can lead to a reduction in the demand for credit, which can harm economic growth. In addition, government debt can affect money market liquidity and central bank foreign exchange reserves  (Amos O. Arowoshegbe & Ademola O. Ariyo, 2016). Specifically, government debt can reduce central bank foreign exchange reserves.

2.3-Impact of public debt on the central bank’s foreign exchange reserves

Foreign exchange reserves consist of foreign currencies held by the central bank, serving as a means to ensure exchange rate stability and fulfill the country’s foreign currency requirements (Krugman, P., & Obstfeld, M., 2021). In the event of high public debt, the central bank might need to utilize a portion of its foreign exchange reserves to repay the debt. This can reduce the “foreign exchange reserves” available to support the country’s exchange rate stability and trade  (García-Herrero, A., & Koivu, T., 2013).

According to (Cheung, Y.-W., & Qian, X., 2017), high public debt can reduce the central bank’s foreign exchange reserves, as it can affect the confidence of foreign investors. This confidence can translate into capital outflows, which can reduce central bank foreign exchange reserves and affect financial stability. (Pilbeam, 2018) also pointed out that public debt can affect the balance of payments and foreign exchange reserves. High public debt can lead to an increase in the cost of borrowing for the government, which can reduce the confidence of foreign investors and lead to capital outflows. This can reduce the foreign exchange reserves available to support the country’s exchange rate stability and trade.

Finally, (Melvin, M., & Norrbin, S. C., 2017) also pointed out that public debt can have an impact on monetary policy and financial stability. In a context of high public debt, to uphold the appeal of public debt securities, the central bank might be compelled to maintain elevated interest rates, which can reduce the demand for credit and harm economic growth. Additionally, public debt can reduce the government’s ability to meet social needs such as health and education  (Serven, L., & Solimano, A., 1992).

In sum, studies show that “public debt” can have a significant impact on central bank “foreign exchange reserves, financial stability, monetary policy, and economic growth”. Policymakers should therefore be aware of these potential impacts when making decisions about public borrowing and debt management.

2.4- Impact of public debt on GDP:

 Several studies have examined the impact of “public debt” on “GDP”. According to (Reinhart, C. M., & Rogoff, K. S., 2010), “public debt” can have a negative effect on “economic growth”. They found that when public debt exceeds a certain threshold, typically around 90% of GDP, economic growth slows significantly.

In contrast, other studies have shown that there is no clear correlation between “public debt” and “economic growth”. For example, (Aizenman, J., & Marion, N. , 2011) studied the impact of “public debt” on “economic growth” using data from a sample of 38 developing countries. They concluded that high “public debt” has a detrimental influence on “economic growth”, especially in developing countries that have weak institutions and increased vulnerability to external shocks.

Other studies have suggested that high “public debt” can also have positive effects on “economic growth”. For example, (Alesina, A., & Ardagna, S., 1998) have shown that debt-financed government spending can boost short-term “economic growth”.

(Cecchetti, S. G., & Mohanty, M. S., 2011) also studied the impact of “public debt” on “economic growth” using a sample of 18 OECD countries. They concluded that high “public debt” has a negative impact on long-term “economic growth”, especially when the debt is financed by high taxes.

In sum, the literature review shows that high “public debt” can have negative effects on “economic growth” and long-term development. These results underscore the importance of prudent “public debt” management and effective fiscal policies to ensure sustainable “economic growth”.

In order to properly respond to the problem, it is important to clearly specify the epistemological positioning and the methodology of the research, where there is an elaboration of the hypotheses to be tested and the methods that are the basis for the verification of these hypotheses, in order to initiate well-adapted solutions and recommendations.

• Material and Methods

Epistemology, as a philosophical discipline, is considered the basis of all sciences. It is the study of the formation of valuable knowledge (Piaget, 1967). It involves reflection on the production and justification of knowledge. Research work is based on specific conceptions of knowledge, uses different research techniques, relies on appropriate validity criteria, and leads to results aimed at describing, interpreting, or conceiving an existing reality or transforming it. In this study, the objective is to describe the observed facts, formulate and test hypotheses using adequate validity criteria.

The mathematical model is built based on the facts observed during the research missions. This approach combines empirical and theoretical aspects.

The hypotheses are formulated based on the existing literature and tested in order to obtain logical results and formulate laws. The causal relationship between variables is established through observation.

The empirical methodology involves investigating the function of public debt in the Lebanese economy by examining the relationship between “public debt” and “economic growth”. A specific research question serves as the guide for the adopted hypothetic-deductive methodology.

The research approach is mainly quantitative, using data on the relevant variables for the period from 2000 to 2021, taking the Lebanese economy as the population.

3.1- Elaboration of hypotheses:

Within the framework of the literature review concerning the involvement of “public debt” in the economy, including its impacts on financial stability, monetary policy, and central bank foreign exchange reserves, as well as its influence on GDP, the following main research hypotheses are formulated:

H1: The increase in the level of public debt leads to a decrease in economic growth in Lebanon.

H2: Public debt and GDP show a low correlation in Lebanon.

H3: Public debt in Lebanon shows low sensitivity to variations in gross domestic product (GDP).

Once the literature review has been carried out and the hypotheses formulated, it is relevant to recapitulate our entire approach by means of a diagram.

3.2- Research methodology:

In order to verify the hypotheses mentioned above, our methodology is based on the following steps:

3.2.1- Simple regression between public debt and economic growth in Lebanon

First, the researcher performed a simple regression to study the relationship between public debt and economic growth in Lebanon. This analysis will allow us to assess the impact of public debt on the country’s economic performance. The researcher considered the public debt as the independent variable and economic growth as the dependent variable. The objective is to determine if a significant relationship exists between these two variables. The statistical technique used is simple linear regression. The data used for this analysis comes from official sources and covers a specific period.

Simple regression is “a statistical technique that allows you to study the relationship between two variables: an independent variable (X) and a dependent variable (Y). It seeks to determine the equation of a straight line that best represents the linear relationship between these two variables”  (Kutner, M. H., Nachtsheim, C. J., Neter, J., & Li, W., 2004).

The simple regression equation is usually represented as: Y = a + bX

Or:

Y is the dependent variable: public debt measured by the change in GDP.

X is the independent variable: economic growth measured by the change in public debt

a is the y-intercept (intercept).

b is the slope of the regression line (regression coefficient).

Once the coefficients a and b are estimated, the regression equation enables the prediction of Y values corresponding to various X values. The slope (b) of the regression line represents the average alteration in the dependent variable (Y) for every unit change in the independent variable (X). These values will be detected using SPSS software.

3.2.2-Correlation between public debt and GDP

Second, the researcher studies the correlation between “public debt” and “gross domestic product (GDP)” in Lebanon. This analysis intends to assess the relationship between these two key economic variables. The researcher calculates the correlation coefficient to measure the strength and direction of this relationship. Furthermore, the researcher used official data on public debt and GDP and adopted the appropriate method to calculate the correlation coefficient. The objective is to ascertain the presence of a significant correlation between public debt and GDP, and to provide an economic interpretation of the findings.

Correlation is a statistical measure that quantifies the relationship between two continuous variables. It illustrates the degree to which changes in one variable are linked with changes in another variable.

The typical way to express correlation is with a correlation coefficient “that ranges between -1 and 1. Values close to -1 indicate strong negative correlation, values close to 1 indicate strong positive correlation, and the value 0 indicates no linear correlation”  (Montgomery, D. C., Peck, E. A., & Vining, G. G. , 2012).

The interpretation of the results is done using the SPSS software, and then a relevant analysis is presented to find the correlation between the variation of the debt and that of the GDP.

3.2.3- Sensitivity of public debt in relation to GDP

Next, the researcher assesses the sensitivity of public debt to GDP. This analysis allows us to understand how public debt reacts to variations in GDP.  Furthermore, the researcher utilized official data on public debt and GDP to make this calculation. The objective is to assess the impact of GDP on public debt and interpret the results obtained.

Sensitivity analysis ( β ) is “the study of how the uncertainty of the output of a code or system (digital or otherwise) can be attributed to the uncertainty in its inputs”  (Saltelli, 2002).

β =

With:

X: growth rate of public debt

Y: GDP growth rate

Cov (X, Y) = [ (∑(X*Y)] – [ * ]

Var(X)= [ (∑ (X ²)] – [ ²]

The hypothesis is verified by calculating the value of β in the three periods (from 1993 to 2022) of 1993–2002, 2003–2012, and 2013–2022.

This study is based on data from the Lebanese Ministry of Finance, the Central Bank of Lebanon, and the World Bank. The researcher utilized financial data from the period 1992–2022. Due to the lack of financial information for the second half of 2023, this study stops at the year 2022. By following this methodology, the researcher is able to analyse the relationship between “public debt” and “economic growth”, assess the correlation between “public debt” and “GDP”, and study the sensitivity of “public debt” to “GDP”.

1. Result

In this section, the researcher analyses the results of this study entitled “The Impact of Public Debt on GDP in Lebanon”. The results are presented based on a simple regression to explore the relationship between “public debt” and “economic growth” as well as the correlation between “public debt” and “GDP”. Next, the researcher aims to examine the sensitivity of “public debt” to “GDP”.

  4.1- Simple regression between public debt and economic growth in Lebanon

This model allows us to determine the impact of the increase in public debt on economic growth.

The simple regression equation is usually represented as: Y = a + bX

According to SPSS, the following results were found:

Table 1: Model significance table.

a Predictors: (Constant), Debt

b Dependent Variable: GDP

Source: computed by the researcher using SPSS

This table shows the results of Fisher’s test. The last column shows a significance of 0.000, which is smaller than 0.05, so this means that the model is globally significant.

Table 2: Table showing the coefficients of the independent variables.

a Dependent Variable: GDP

Source: computed by the researcher using SPSS

So, after obtaining the coefficients, the model will be:

The table above shows the influence of the independent variable on the dependent variable. Based on the values of the p-values of each variable, the author can deduce that the two variables are significant, having a significance of 0.000 less than 0.05.

But, as is clear in the equation obtained, the variable “Public debt” shows a negative coefficient, which means that as the public debt increases by one unit, the economic growth represented by the GDP decreases by 0.372 units.

This sheds light on the inverse relationship between public debt and economic growth in Lebanon.

Table 3: Performance Indicator Table

a Predictors: (Constant), Debt

Source: computed by the researcher using SPSS

This table shows the performance indicator R-Square: It is 0.341, which implies that the independent variable explains 34.2% of the variation of the dependent variable.

After this relevant analysis, the researcher can say that public debt has a negative impact on economic growth in Lebanon and therefore verify the first hypothesis:

H1: The increase in the level of public debt leads to a decrease in economic growth in Lebanon.

  4.2- Correlation between public debt and GDP

Table 4: Correlation between the studied variables

Source: computed by the researcher using SPSS

The table above shows a significance of 0.000, which is smaller than 0.05, so this means that the model is globally significant.

A correlation of -0.060 indicates a very weak and close to zero correlation between the two variables studied:

• Correlation close to zero: A correlation of -0.060, being close to zero, suggests that there is no correlation between the two variables. In other words, variations in public debt have no impact on variations in GDP.
• Low correlation: A correlation of -0.060 is considered very low. This means that there is practically no relationship between the two variables studied.

This verifies the second hypothesis:

H2: Public debt and GDP show a low correlation in Lebanon.

  4.3- Sensitivity of public debt in relation to GDP 

This entails calculating sensitivity indices that measure the impact of an input or a group of inputs on the output.

β =

By calculating the value of β in the three periods (from 1993-2022)

The researcher found that:

• β (X, Y) from 1993-2002= -0.14
• β (X, Y) from 2003-2012= 0.15
• β (X, Y) from 2013-2022 = -0.17

Looking at these values, the researcher observed a negative or almost low sensitivity between the public debt and the GDP, which means that the public debts do not contribute to the GDP, and therefore this explains the consumerist nature of the Lebanese economy, where the funds from these debts are used in consumption projects or in direct consumption.

This allows the researcher to verify the third hypothesis:

H3: Public debt in Lebanon shows low sensitivity to variations in gross domestic product (GDP).

1. Discussion

In this study, the researcher investigated the role of “public debt” in the economy of Lebanon using statistical methods such as simple regression, correlation, and sensitivity that elucidated the relationship between “public debt” and “GDP”. The results obtained allowed us to draw important conclusions about the relationship between these two key variables.

First, the researcher identified a significant negative relationship between “public debt” and “economic growth”. This relationship suggests that when “public debt” increases, “economic growth” tends to decrease. It is important to emphasize that the regression provided us with significant coefficients, thus reinforcing the reliability of our results.

Then, the results revealed a weak correlation between these two variables. This indicates that changes in “public debt” are only weakly associated with changes in “GDP”. It is therefore necessary to consider other economic factors and mechanisms that can influence the Lebanon’s “economic growth”.

Moreover, the researcher found a low sensitivity, which means that small variations in public debt have a limited impact on “GDP”. However, this should not overshadow the importance of carefully monitoring the evolution of “public debt”, as even small changes can potentially have longer-term economic consequences.

1. Conclusion

      In summation, a comprehensive examination of the role of public debt within the Lebanese economy paints a clear picture of its predominantly detrimental impact on economic growth. The robust negative correlation between public debt and economic growth signals a significant association, substantiating the notion that escalating public debt can hinder the country’s economic advancement.

     Moreover, the revealed weak correlation and limited sensitivity between public debt and GDP further illuminate the nuanced nature of this relationship. This signifies that the traditional assumption of public debt fueling economic expansion through productive sectors might not hold true in the Lebanese context. The data strongly suggest that public debt’s influence leans more heavily towards consumption-oriented domains, indicating that its effects are more pronounced within these segments.

    In connection with these considerations, Lebanon’s “foreign exchange reserves,” primarily comprising foreign currency deposits, foreign debt securities, and gold assets, have been significantly impacted by the dynamics of public debt. The outflow of capital has led to a reduction in foreign currency deposits, undermining the Central Bank’s capacity to uphold the Lebanese Pound’s value. Simultaneously, escalating foreign debt obligations have escalated the expenses tied to public debt management, with the gold holdings proving insufficient to counterbalance pressures on other reserve elements. The mounting public debt creates a cascade of strains on foreign exchange reserves, posing a direct threat to the nation’s financial stability.

    In conclusion, our results underscore the crucial importance of managing “public debt” responsibly and prudently to preserve and sustain “economic growth” and maintain financial stability in Lebanon. The negative correlation and low sensitivity between “public debt” and “GDP” raise concerns about the potential effect of a high level of indebtedness on the country’s economy. Thus, balanced fiscal policies and strategic financial reforms can play a pivotal role in the search for sustainable and stable growth. These findings should prompt policymakers to take informed steps to strengthen financial stability and promote an environment conducive to economic prosperity for all Lebanese citizens.

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