Lebanon’s GDP growth will remain sluggish at 0.7% in 2013 due to domestic political tensions and worsening security situation, which severely dented investment and tourism, the Institute of International Finance (IIF) said in a new report. The IIF’s forecast well undershoots the government’s optimistic 2.0% GDP growth forecast and the IMF’s 1.5%. The Lebanese economy is also suffering from the spillovers of the Syrian crisis with more than 1mn Syrian refugees currently in Lebanon, which is equivalent to nearly 25% of the country’s population. In case the Syrian turmoil ends, Lebanon’s GDP growth could rebound to 2.7% in 2014, the IIF forecasts.

Lower tax proceeds due to sluggish growth and rising public spending have negatively affected Lebanon’s public finances, the IIF warned. Based on the actual figures for the first eight months of 2013, Lebanon’s fiscal deficit will widen to 11.3% of GDP this year from 8.9% of GDP in 2012, the IIF forecasts.

The Lebanese banking system has shown “remarkable resilience to regional tensions and the continued weak domestic economic activity, thanks to loyal depositors and stable remittances from the large Lebanese Diaspora,” the IIF said.

Deposit growth has remained stable at 6% since early 2012 and credit growth to the private sector hovers around 8%. Despite the forecast government debt of 143% of GDP for 2013, Lebanon’s 5-year sovereign CDS spread stood at a two-year low of 390 bps in early October 2013, the IIF noted. The local currency also remains stable and, unlike other oil-importing countries in the region, foreign exchange reserves have continued to increase.

The IIF underscored that the potential for a strong recovery in tourism and investment is huge, due to the country’s strategic location, good climate, excellent entertainment services, and highly educated workforce. A stable political environment, structural reform (including addressing the chronic problems in the electricity sector), and the recent discovery of large recoverable oil and gas reserves could lift Lebanon’s economy to a sustainable higher growth path over the medium term and help bring government debt down to more sustainable levels.

The main political challenges facing Lebanon are to improve the security situation and form a new consensus government, the IIF said.