BEIRUT: Lebanon is likely to see pressure to reduce interest rates to support the budget, a senior official at Merrill Lynch told The Daily Star Thursday, playing down the impact of the European crisis on the country, saying it is more exposed to the GCC region.

Bill O’Neill, chief investment officer for Europe, Middle East and Africa at Merrill Lynch, also said the global economy would most likely avert recession in 2012 but experience weak growth.

“The interest rate in Lebanon is at a very high level. My sense here is that … reducing the interest rate would be important in terms of budget support,” he said in an interview.

Despite the fact that Lebanon’s public debt is still relatively high, it is well covered in terms of foreign reserves, and the country is less exposed to the eurozone and more to the MENA and GCC, O’Neill added.

“If the Gulf region puts up a better year than we except that gives at least an upside risk … for Lebanon what is important is the resilience of GCC and the GCC demand.”

The mounting pressure of financial markets on MENA and Gulf countries poses a key challenge, according to O’Neill, who said political crises sweeping the Middle East have been less significant than some expected but nevertheless kept foreign direct investments away.

The real estate market in the Gulf would be influenced by both domestic activity and financial markets, O’Neill said, adding that external pressure was forcing rapid leveraging of public sector and government debt by the banking sector, as is also the case in Lebanon.

“The key issue is to contain the effect of external market pressure to reduce debt. This is the key element defining whether the local financial system could continue to support real estate. As European banks exit the Gulf, local players will have to fill the gap,” O’Neill added.

“If local players fail to fill the gap you will see a contraction in credit.”

While mature economies face the pressing need to reduce debt, a quick move by the European Central Bank to monetize sovereign and bank debt could improve the EU region’s outlook, he added.

“Having just emerged from a recession less than three years ago, mature economies could re-enter a mild recession at some point in 2012, which has been worrying the market for the last six months,” O’Neill said.

O’Neill added that government borrowing came to a limit in terms of supporting the economic recovery.

The global economy will be looking at a growth rate of 3.7 percent in 2012, compared to 4 percent in 2011, while growth would stand just above 1 percent in developed countries, O’Neill said.

Among the major issues threatening Europe is “continued policy paralysis, pressure on banks to restrict borrowing and raise its cost as well as a potential contagion to other regions from eurozone deleveraging,” O’Neill said.

“A persistent failure to address the systematic issue in the euro debt crisis means Europe will see a contraction in activity in 2012.”

While the ECB is expected to cut interest rates to 0.5 percent, it will need to print money in some form to offset a loss of confidence, austerity and a credit crunch, O’Neill said, consequently weakening the euro throughout the year, he added.

Concerns of a global recession leave investors with an emphasis on capital preservation, O’Neill said.

“The task of ensuring diversification in investment portfolios is more complicated by a shrinking set of safe havens,” he added.

Investors should prefer credit to high-priced sovereign investments with a preference for U.S. companies and should particularly avoid sovereign and bank exposures in peripheral eurozone economies, O’Neill said.

Stressing the importance of yield, quality and growth in selecting equities, O’Neill recommends U.S. large capitalization with strong cash flow and growing dividends as the top pick.

“Investors are taking risks in a very selective way with emphasis on security of income and quality of balance sheets … as for clients who are more inclined to take risks, we think equity markets will have a better year in 2012 provided that the European situation does not deteriorate,” he said.

O’Neill said preferred sectors include those with exposure to emerging market consumers, information technology and global infrastructure.

While eurozone equities are cheap, O’Neill said it is too early to invest in the region due to its high risk.

“IF EU members take the appropriate measures, the market response would be very fast, but I agree with German Chancellor Angela Merkel that stabilizing the situation would take two to three years.”

A fully functional and stable monetary and to some degree fiscal union would probably take near a decade to achieve, particularly for economies like Greece, Ireland and Portugal, O’Neill said.

The fundamental position of peripheral economies would not probably see improvement before two years when they reach a sustainable level of debt, he added.

Expectations of lower inflation would reduce appeal to commodities in 2012 with gold and oil unlikely to replicate the returns of 2011, O’Neill said. While supported by very low real interest rates, gold is likely to be held back by the U.S. dollar’s strength, he added.

However, aggressive quantitative easing programs – when central banks purchase financial assets from banks and other private sector businesses while printing money – could lead to a considerable move higher in gold price that could break above $2,000 but not hold, O’Neill added.

As for crude oil, tight control of supply and inventories would limit a possible fall in price, O’Neill said.