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Lebanon: 2019 Article IV Consultation—Press Release; Staff Report; Informational Annex; and Statement by the Executive Director for Lebanon

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
October 2019
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Context

1. Lebanon’s already difficult economic position worsened further in 2018. The country has long suffered from large fiscal deficits which have left public debt at around 150 percent of GDP, and large current account deficits that have brought external debt close to 190 percent of GDP. Growth has been low since the start of the Syrian crisis. Against a background of policy inaction due to the lack of an approved government after the May 2018 parliamentary elections, economic imbalances grew further in 2018. Economic growth effectively stalled, the budget deficit reached 11 percent of GDP, and the current account deficit exceeded 25 percent. The Banque du Liban (BdL) has skillfully maintained financial stability in difficult circumstances, often with unconventional measures, but the cost of these operations has grown, and the financial challenges Lebanon faces have intensified.

2. The new government formed in January 2019 has taken important first policy steps to help raise confidence among investors and donors. The parliament has approved a plan to reform the electricity sector and reduce its fiscal cost as well as a budget that aims to substantially reduce the overall fiscal deficit in 2019. Such reforms can encourage donors to disburse USD 11 billion in pledged concessional funding the authorities have secured for their Capital Investment Plan (CIP) at the CEDRE conference in April 2018. The CIP aims to upgrade Lebanon’s infrastructure while providing employment opportunities for communities hosting Syrian refugees as well as the refugees themselves.

3. The long path to reduce vulnerabilities and re-equilibrate the economy will need to involve further fiscal adjustment and radical structural reforms. The government needs to develop and decisively implement a comprehensive multiyear reform strategy to strengthen confidence and restore fiscal and external sustainability. Vulnerabilities in the Lebanese economy have increased significantly, and fundamental economic reforms represent the best path forward. The growth boost from the CIP can counteract the contractionary effect of the planned fiscal adjustment, especially if the authorities move quickly to improve the public investment management framework.

A Difficult Economic Environment

4. Economic activity slowed in 2018, and the slowdown appears to be continuing in 2019. Low confidence, high uncertainty, tight monetary policy, and a substantial contraction in the real estate sector are estimated to have reduced growth to 0.3 percent last year. Most high frequency indicators showed negative readings in the first half of 2019, including a decline of 16 percent in the value of cleared checks and 31 percent in the number of construction permits. The one notable exception is tourism, with tourist spending up 12 percent in the first half of 2019 relative to 2018. Average inflation reached over 6 percent in 2018 partly due to high prices of imported fuel but slowed down in the second half of the year and into 2019.

5. Social conditions remain difficult. Lebanon hosts approximately 1.5 million Syrian refugees (equivalent to a quarter of the population). Unemployment rate is estimated at about 20 percent with youth unemployment even higher at 30 percent. Already in 2010, before the influx of Syrian refugees, half of the labor force worked in the informal sector, without access to social insurance.

6. The budget deficit increased significantly, reaching 11 percent of GDP in 2018, up from 8.6 percent in 2017, with the primary balance worsening from 0.5 to -1.4 percent of GDP. The public debt-to-GDP ratio continues to be on an unsustainable path, reaching 151 percent of GDP (from 130 percent in 2012), although the pace was dampened last year by the higher-than-usual inflation, and thereby the relatively high nominal output growth.

7. A large part of the deficit increase was due to higher spending following the salary scale increase implemented in the second half of 2017. The new salary scale was more expensive than anticipated, as it also translated into higher pensions and a spike in lump-sum payments associated with early retirements. New hiring despite a hiring freeze further raised spending on personnel, underscoring the need to strengthen fiscal governance. Because of the large public debt, interest payments exceeded 9 percent of GDP. Tax revenues in 2018 were lower than forecast, with all tax revenue categories disappointing in the slow economy except taxes on income and profits.

8. In anticipation of an approved budget, the authorities made an effort to rein in spending in the first months of 2019, but this may have resulted in delayed payments. Expenditures through April declined by 28 percent year-on-year, which can be attributed to efforts to limit outlays in the run-up to the 2019 budget approval. However, there appears also to have been an accumulation of delayed payment orders, which were already above their usual level in 2018. There are numerous reports and statements from government officials and the private sector of arrears to the social security fund, hospitals, and suppliers. However, despite its request, staff has not received sufficient specific information on arrears and delayed payment orders from the authorities. On the revenue side, overall tax collections were 9 percent lower through April 2019.

9. The current account deficit remained largely unchanged at over 25 percent of GDP in 2018, accentuating external financing pressures. The trade deficit is estimated to have widened further in the first five months of 2019. The external position continues to be substantially weaker than the level consistent with medium-term fundamentals and desirable policy settings. Although standard models have limitations given weaknesses in Lebanon’s balance of payments statistics, the estimated overvaluation of the real effective exchange rate (REER) is significant (see Annex II).

10. BdL’s efforts to secure external financing have come under strain as deposit inflows have declined and the BdL’s gross foreign exchange reserves have fallen (see Box 1). The BdL has continued its financial operations to provide high returns on new USD deposits in an effort to attract and retain USD deposits in the banking sector and maintain a high level of foreign reserves. Yet deposit inflows have decreased, with deposit growth net of interest accrual turning negative. The BdL’s foreign reserves declined by USD 7.5 billion from their previous peak. At the same time, the financial operations contributed to very tight monetary conditions, in which private credit declined and non-performing loans increased.

11. Reflecting the weakening fundamentals and sentiment, Eurobond yields have increased, and Lebanon was subject to a ratings downgrade. Spreads with other emerging markets temporarily rose to record heights in January 2019. They subsequently dropped somewhat but remain volatile and above those seen in November 2017 during the crisis of Prime Minister (PM) Hariri’s temporary resignation. Moody’s downgraded Lebanon’s sovereign rating to Caa1 in January 2019 and Standard and Poor’s and Fitch changed the outlook to negative on their B- rating.

Lebanon-EMBI Spread

(Bps)

Source: Bloomberg.

Box 1.The BdL’s Financial Operations and their Impact on the Financial Sector

The BdL has continued to use unconventional financial operations to attract inflows and support the peg.1 The operations have provided high marginal returns in LBP and in USD on new bank USD deposits at the BdL. For example, for each new deposit at the BdL in USD, a bank would earn a 6.5 percent interest in USD and in addition have an opportunity to borrow a slightly larger amount in LBP at 2 percent and re-deposit it at the BdL at 10.5 percent for 10 years. These operations have boosted the BdL’s dollar holdings without affecting rates on older deposits at the BdL or on government debt. Until recently, effective combined yields in LBP and USD were approximately 17 percent on a 10-year placement. Starting in July 2019, an additional operation offers a higher total return on 3-year deposits. The latest operation also allows banks to record future profits from the operation upfront as long as the profits are retained as capital. The volume of these financial operations has been large in recent years: the operations in place since fall of 2017 have attracted over USD 24 billion from banks through February 2019 in sales to or deposits at the BdL.

Average Interest Rate on Deposits in Commercial Banks

(Percent)

Source: BdL.

Deposit Growth, year-on-year

(Percent)

Source: BdL.

Yet bank customer deposit inflows have slowed, and some deposits have been converted to dollars. Even though banks have partially passed the higher returns to higher deposit rates, total private deposits (including interest accrual) increased only by 3.4 percent in 2018, the slowest pace since 2005. Excluding accrued interest, deposit growth is estimated to have been slightly negative last year. The deposit growth rates declined further in the first six months of 2019. At the same time, deposit dollarization rose to over 71 percent.

Deposit Dollarization

Source: BdL.

Given the limited interest by banks and the private sector, the BdL financed most of the 2018 fiscal deficit. The banking system as a whole provided almost 12 percent of GDP of new financing to the government (more than the overall deficit since foreign investors reduced their Eurobond holdings), with about ¾ of the financing coming directly from the BdL.

Gross international reserves dropped by over USD 7.5 billion to around USD 36.5 billion, between their previous peak at the end of February 2018 and May 2019, declining below 90 percent of the ARA metric (see Annex II). The central bank accumulated foreign currency liabilities through its financial operations.

BdL’s operations also contributed to tight monetary conditions. The high rates bank can earn on USD deposits at the BdL have affected USD lending rates for bank customers, with the USD reference lending rate rising from around 7 percent in early 2018 to 9.7 percent in June 2019. These have in turn translated into higher LBP lending rates. In addition, the BdL has discouraged new lending in LBP by setting limits on the size of the LBP loan book relative to total bank lending. These limits have helped the BdL keep LBP liquidity tight in addition to the effect of its regular LBP products. As a result, lack of LBP liquidity at some banks has temporarily pushed overnight interbank LBP rates over 50 percent on several occasions.

Beirut Reference USD Lending Rate

(Percent)

Source: Association of Banks in Lebanon.

The higher lending rates combined with the challenging economic environment facing businesses led to a decline in lending to the economy. Private sector credit fell by 2.5 percent in 2018, and a further 5 percent by May 2019. The more recent sharp fall has been broad-based across the economy. Non-performing loans (NPLs) increased from 12.5 to 13.8 percent2 over the course of 2018, with a particularly pronounced increase from about 15 to 19 percent in construction loans.

The central bank operations also raised the banks’ combined exposure to the BdL and government to 69 percent of their total assets (more than 8 times Tier 1 capital) by May 2019, up from 62 percent at the end of 2017. The increase was largely due to the rise of banks’ deposits at the BdL. Banks thus earned an additional USD 2.7 billion in income from interest earned on their bank accounts, most of which are at the BdL, in 2018 relative to the year before. This produced stable net income of USD 2.2 billion in 2018 in an otherwise weak economy and despite higher taxes, rising NPLs and declining credit to the private sector.

Commercial Banks Consolidated Income

(MillionsofUSD)

Source: BCC.

Government and BdL Debt as Percent of Commercial Banks’ Assets

Source: BdL.

1 The de jure exchange rate arrangement is free floating, and the de facto exchange rate arrangement is classified as stabilized. Since October 1999, the BdL has been intervening to keep the pound around a mid point parity of LL 1,507.5 per USD 1, with a bid-ask spread of LL+/-6.5.2 Includes figures related to two banks under liquidation. Excluding these banks, NPLs increased from 9.2 to 10.3 percent.

Outlook and Risks

12. Against this precarious backdrop, the economic outlook depends critically on policy actions and reforms in the period ahead. The government’s fiscal adjustment efforts in 2019–20 and planned structural reforms aim at shoring up confidence, giving breathing space to the economy, and accelerating disbursements of concessional financing for the CIP committed at CEDRE. Higher public investment spending can stimulate growth in the near term and help a gradual recovery. Yet the fiscal adjustment in the budget will not suffice to bend down the public debt-to-GDP ratio and public debt will remain unsustainable. Likewise, structural reforms proposed thus far will not substantially reduce the current account deficit or lift growth to levels sufficient to reduce unemployment. Many of the benefits of government reforms are temporary in the medium-term projections. Growth begins decreasing by 2024 as the initial boost of the CIP and the fiscal stimulus of phasing out temporary fiscal measures disappear. Deposit growth declines and interest rates increase by 2023 as fiscal outcomes deteriorate and confidence declines.

13. Over the medium-term, some domestic and external events could provide an upside to this challenging outlook. Lebanon stands to benefit from a major reconstruction effort and the possible gradual return of refugees if the situation in Syria is resolved. Also, the potential discovery of a natural gas field in Lebanon’s territorial waters, where exploration just started, would boost growth and improve the country’s external balance.

14. However, risks are tilted to the downside in the short run and large vulnerabilities remain that threaten the baseline outlook (see Risk Assessment Matrix). Vulnerabilities have been growing with increasing domestic and external imbalances. The economy and the financial system in particular are highly vulnerable and moderate negative external or domestic events can precipitate a fall in confidence and potentially an economic and financial crisis. Possible domestic events include the government’s failure to achieve its fiscal targets and advance reforms, political infighting, and social tensions. On the external side, intensification of security risks in parts of the Middle East could have serious spillover effects in Lebanon.

Lebanon: Risk Assessment Matrix1
Nature/Sources of RiskRelative LikelihoodExpected Impact If RealizedPolicies to Mitigate Risks
Materialization of policy slippages or political risks, such that domestic political disagreements prevent the implementation of the budget, which can, at worst, lead to a conflict or security incidents.HighHigh
Could trigger a loss of confidence, lower deposits, higher financing costs, difficulties rolling over public debt, mounting exchange-rate pressure, falling reserves.Maintain a high level of reserves, implement sustainable fiscal policy adjustment and pass key legislation, to demonstrate a credible policymaking framework. Further strengthen banks’ capital and liquidity buffers.
Weaker-than-expected global growth (Europe). Weak foreign demand, Brexit, or concerns about some high-debt countries makes some EU businesses delay investment, while faltering confidence reduces private consumption. Inflation expectations drift lower, and the region enters a prolonged period of anemic growth and low inflation.HighHigh
Could lead to a slowdown in financial inflows and to significant funding pressure for both banks and the sovereign, increasing pressure on reserves.Maintain a high level of reserves and encourage improvement in domestic competitiveness to reduce reliance on foreign inflows.
Intensification of security risks in parts of Africa, Asia, Europe, Latin America, and/or the Middle East cause regional socio-economic and political disruptions, with potential global spillovers.HighHigh
Could lead to lower remittance and deposit inflows as well as inbound tourism income. Could also hurt confidence and lead to higher financing costs, increasing exchange-rate pressures, falling reserves.Maintain a high level of reserves and implement sustainable fiscal policy. Further strengthen banks’ capital and liquidity buffers.
Further economic sanctions could affect financial services, especially related to correspondent banking.MediumMedium
Could hurt cross-border payments, trade finance, and remittances.Continue to make progress to strengthen the AML/CFT and risk assessment framework. Continue to address identified gaps with regards to international tax compliance and exchange of information.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Policy Priorities

15. Decisive implementation of a strong reform program is critical to maintain confidence. Rebalancing the economy in the current framework of an exchange rate peg requires the steadfast implementation of a large and credible fiscal adjustment and ambitious structural reforms. These need to sharply reduce imbalances and significantly improve Lebanon’s business climate and governance as well as reduce corruption, which in turn can boost investment, growth and exports.

16. Regaining fiscal and external sustainability will require a consistent, multiyear effort. Bending down the path of the public debt-to-GDP ratio will require achieving primary surpluses of 4–5 percent of GDP and sustaining them for several years. Decreasing the debt ratio to 70 percent, the debt sustainability analysis (DSA) debt burden benchmark for emerging markets, will require maintaining such surpluses for about 20 years. This fiscal effort coupled with structural reforms will gradually improve the current account and allow a reduction of the economy’s reliance on deposit inflows. Bringing the current account deficit down further to its norm would require the realization of events that remain upside risks over the medium term, including development of gas fields and a resolution to the Syria conflict, or further structural reforms with an equivalent impact.

A. Front-Loaded and Sustained Fiscal Consolidation

17. Lebanon has no fiscal space. The scale of Lebanon’s debt burden and financing needs are putting Lebanon’s overall fiscal position under severe stress. The large budget and current account deficits are exacerbating the already-serious vulnerabilities.

18. The 2019 budget aims for a large adjustment. The budget approved by parliament in July, targets a deficit of 7.6 percent of GDP, aiming to reverse last year’s slippages and catch up with the path committed to under CEDRE. To deliver a 3½ percent of GDP adjustment in half a year, it relies on various revenue and expenditure measures, the most important of which are legislated to be temporary for three years, including: (i) increasing the tax on interest income from 7 to 10 percent; (ii) a 3 percent tax on imported goods which are subject to VAT, excluding fuel, industrial equipment and raw materials;1 and (iii) a freeze of public sector hiring and early retirement. Other measures include a tax on private electricity generators, license plate taxes and increased General Security fees (on work permits, visas, etc.).

19. IMF staff’s projection is that the budget measures will reduce the cash-basis fiscal deficit to around 9¾ percent of GDP. Staff projects a wider cash-basis overall deficit than the authorities due to more conservative assumptions about the speed of implementation of revenue measures, underlying revenue trends, the extent to which the budget constrains spending on a cash basis, and the level of nominal GDP. As noted earlier, there also remains uncertainty about the stock of arrears and outstanding payment orders and the process for their clearance which will affect the cash deficit for 2019. The projected deficit nonetheless benefits from temporary savings on interest payments due to the zero-interest BdL bridge loan (not included in the debt figures) covering a delay in Eurobond issuance.

20. The government has also adopted a new plan to eliminate the large subsidies to the electricity company, EdL The electricity sector plan (the third in the last 10 years) aims to reduce non-technical and technical losses, switch fuel to natural gas to reduce production costs at existing plants, increase EdL’s capacity to meet demand, and subsequently raise tariffs to eliminate electricity subsidies of about 2V2 percent of GDP by 2023. Thus far in 2019 the authorities have already increased electricity bill collections by about 0.2 percent of GDP and completed the high-voltage lines in Mansourieh which will reduce technical losses by 1 percent. Nonetheless, staff estimates regarding the plan’s impact based on discussions with World Bank energy experts are somewhat more conservative, suggesting that if the plan is fully implemented it could achieve 1.9 percent of GDP savings by 2025 (see Box 2).

21. The measures proposed in the budget together with savings from electricity sector reforms are projected to result in a primary surplus in 2020–22 but leave debt on a rising path. The full-year effect of revenue measures and budget reductions which IMF staff is aware of is estimated at just over 3 percent of GDP, which will help turn the primary balance slightly positive in 2020. In the medium term, the large projected savings from the electricity sector reform plan, if fully implemented, will replace some of the lost revenues and savings from the expiration of the temporary measures in the 2019 budget. However, without additional measures, the primary deficit will remain above its debt stabilizing level, and the already unsustainable public debt-to-GDP ratio will remain on an increasing path.

Government Debt

(Percent of GDP)

Source: IMF staff calculations.

Key Recommendations

22. It is critically important that a medium-term fiscal plan is announced based on credible and permanent measures that will yield a substantial primary fiscal surplus over the medium-term. IMF staff projects that a primary surplus of around 4–5 percent of GDP would be needed to noticeably reduce the debt-to-GDP ratio over the medium to long run. While achieving such surpluses is very ambitious and would depress growth in the short run, it is not unprecedented (e.g., Jamaica) and is essential given Lebanon’s level of public debt and vulnerabilities. Identifying and agreeing on the measures upfront to support such a plan would increase its credibility and help boost confidence. On current plans about 1 percentage point of GDP of the 2019 revenue measures will be permanent. The authorities’ current electricity plan can yield a further 2.7 percentage points of GDP in savings over the medium term. The authorities will need to identify and implement additional permanent fiscal measures to achieve the necessary primary position. They also need to ensure that the measures are sufficient to achieve the primary balance target without resorting to further build-up of delayed payments and arrears as well as allow for their expeditious clearance.

23. Revenue measures should include raising the value-added tax (VAT) and increasing fuel excises as well as efforts to increase tax compliance. Further raising revenue reliably and rapidly will require measures based on existing tax collection infrastructure, such as the VAT (which at 11 percent is relatively low) and fuel excises. Significant further revenue could also be raised by broadening the VAT base through the removal of exemptions on items such as foreign-registered yachts, diesel used for electricity generation, and road vehicles. The temporary increase of interest income tax in the 2019 budget could also be made permanent. The authorities should also make a decisive effort to improve tax administration, which could deliver meaningful additional revenue, including from those who currently evade taxes. Improving compliance would also help realize the revenue potential of VAT and other tax increases and limit tax evasion which might otherwise increase at higher rates. Better tax collection will, however, require concrete and sustained action. The recent decision by the BdL to require businesses to only use financial statements certified by the Ministry of Finance (as part of their tax return filing process) to obtain loans from banks, is encouraging in this regard. Successful improvement in the collection of existing taxes may reduce the necessary future increase in tax rates.

24. Eliminating electricity subsidies is the most significant potential expenditure saving. As previous plans have faltered and not been successful at addressing the problems in the electricity sector, the authorities need to ensure that the current plan is effectively implemented, notwithstanding resistance from vested interests. In this regard, it should incorporate a tariff increase that is sufficient to close EdL’s deficit under robust and realistic assumptions about the reduction of technical and non-technical losses. It is crucial to start increasing tariffs as soon as possible to generate fiscal savings, possibly targeting the largest consumers first.

25. The authorities should also conduct a thorough public expenditure review to identify potential areas for savings. This can build on their ongoing efforts to study reform options for the wage bill and pensions, which absorb a disproportionate share of revenue. Savings in current spending would also provide some space to increase expenditures on education, which are relatively low and may need to increase over the medium run to enable higher growth.

26. Fiscal tightening should also be complemented with scaled-up targeted transfers to the poor and vulnerable. Lebanon’s current social safety net (SSN) is limited. In order to cushion the impact of the needed fiscal adjustment including electricity tariff increases, the authorities should allow for an additional 0.5 percentage points of GDP in SSN spending. Most of it could be channeled through a scaled-up version of the existing National Poverty Targeting Program.

Yield of Budget and Other Potential Fiscal Adjustment Measures(Lebanese authorities and IMF staff estimates, percent of GDP, full-year effect)
Revenue measures included in the 2019 budget 1/
Raising tax on interest income from 7 to 10 percent 2/1.1
3 percent tax on imports 2/0.3
License plate taxes0.3
Increased customs collection from reduced smuggling0.2
Exceptional revaluation of assets 3/0.1
General Security fees0.1
Other revenue measures0.4
Principal expenditure reductions in the 2019 draft budget 4/
Exceptional and emergency spending0.1
Equipment0.2
Buildings under construction0.3
Maintenance0.1
Total3.3
Medium-term savings from implementation of the authorities’ electricity plan2.0
Other potential measures recommended by IMF staff
Revenue
Increase VAT from 11 percent to 15 percent1.6
Increase VAT from 11 percent to 20 percent3.6
Remove most of VAT exemptions1.2
Increase total revenue from property taxes by 50 percent0.6
Increase the excise on gasoline by LL5,000 per 20 liters0.8
Expenditure
Fully eliminate subsidies to EdL 5/0.7
Scaled-up targeted transfers to the poor and vulnerable-0.5
Source: IMF staff calculations

Annualized IMF staff estimates, actual yields will depend on the number of months of collection.

To be cancelled after three years.

One-off revenues, with reduction in revenues in subsequent years due to claims for depreciation.

Compared with the 2018 budget and based on 2019 GDP. Staff does not have details of expenditure measures in the 2019 budget approved by Parliament.

Estimated savings under 2019 oil price assumptions.

Source: IMF staff calculations

Annualized IMF staff estimates, actual yields will depend on the number of months of collection.

To be cancelled after three years.

One-off revenues, with reduction in revenues in subsequent years due to claims for depreciation.

Compared with the 2018 budget and based on 2019 GDP. Staff does not have details of expenditure measures in the 2019 budget approved by Parliament.

Estimated savings under 2019 oil price assumptions.

Authorities’ Views

27. The authorities were confident that the measures incorporated in the 2019 budget would deliver their target deficit. In particular, they believed that many of the measures would begin yielding revenue and savings very soon after budget approval. They also stated that additional measures could be put in place to compensate for any possible fiscal underperformance. The authorities stressed the importance of the expenditure restraint embedded in the budget and already implemented before the budget approval, which achieved substantial savings on a cash basis in the first months of 2019. They also highlighted their commitment to work on and approve the 2020 budget during 2019. They intend to further reduce the overall deficit below the 2019 outcome as a result of the full-year impact of the 2019 measures, effects of the electricity plan and further fiscal reforms. They noted that any further adjustment would have to be more gradual so as not to threaten economic growth and focus first and foremost on addressing governance issues and wasteful spending.

B. Growth- and Export-Enhancing Structural Reforms

28. Fundamental structural reforms are key to boosting growth and improving external competitiveness. Lebanon has witnessed years of low growth and large current account deficits, both of which reflect a significant erosion of external competitiveness as well as the adverse effects of regional developments. The cost of doing business in Lebanon must be lowered to raise potential growth. Likewise, given the currency peg, deep export-enhancing structural reforms will be essential for external adjustment. Two priority areas for reforms are electricity provision, where the authorities have already approved a plan, and reducing corruption. In addition, the government’s own CEDRE vision provides specific ideas for reforms which need to be implemented. All these efforts are needed to resolve external imbalances even if some upside events are realized over the long run, including development of gas fields and a resolution to the Syria conflict.

Key Recommendations

29. The authorities should approve and implement legislation of key growth-enhancing reforms identified in its CEDRE vision. These initiatives aim to remove the various hurdles that businesses face today and thus reduce the effective cost of doing business. This includes accelerating implementation of already-approved reform laws such as the code of commerce and the law on judicial intermediation as well as the approval of a new customs law, regulation on closing a business, bankruptcy law, insolvency practitioner law and law on secured lending. The authorities should also resolve regulatory obstacles to development of industrial zones that could benefit from a possible Syria reconstruction.

30. In addition, the recommendations of the Public Investment Management Assessment (PIMA) technical assistance should be implemented ahead of execution of most of the CIP. It is crucial that the key improvements to the country’s public investment management framework are in place before the execution of most of the CIP projects to maximize the growth benefits of the planned investments. They include incorporating Council for Development and Reconstruction (CDR) spending in the budget and passing and implementing a public procurement law. The authorities should also improve the legal and institutional arrangements for the management of fiscal implications of public-private partnerships (PPPs), as recommended by a recent IMF technical assistance mission.

31. The electricity sector plan should be advanced without delay (see Box 2). Increasing electricity supply by the EdL to 24/7 would eliminate one of the biggest constraints to doing business in Lebanon, in addition to its positive effects on income distribution, the balance of payments, the environment and the fiscal deficit.

32. Further concrete steps must also be urgently taken to reduce corruption. The authorities should enact pending anti-corruption legislation in line with best practices, including the illicit enrichment and asset declaration legislation, and finalize and implement a prioritized anti-corruption strategy focusing on higher-risk areas. An effective fight against corruption requires full implementation of the legal framework, including operationalizing a strong and independent anti-corruption commission, investigating and prosecuting corruption cases consistent with Lebanon’s risks, and strengthening governance across a range of state functions (see Annex IV).

Box 2.The 2019 Electricity Plan

The electricity sector is highly inefficient in Lebanon and is imposing a significant economic and social cost. Electricité du Liban (EdL) is faced with three main issues: (i) installed capacity is well below consumers’ demand; (ii) losses (technical, non-technical and non-collection) represent 43 percent of production—i.e. only 57 percent of electricity produced is actually transmitted, billed, and collected; and (iii) electricity tariffs are subsidized, which imposes a heavy burden on the government budget.

Reforming the electricity sector is an important component of CEDRE’s commitment to reduce the fiscal deficit. In the past years, several reform plans have been produced but were never implemented—the most recent ones are the Policy Paper for the Energy Sector in 2010 and the Energy Sector Salvation Plan in 2017. The parliament has now approved an update of the 2010 Policy Paper. The plan has four objectives:

  • Reduce losses. There are two projects to reduce losses: (i) improve the Distribution Service Provider (DSP) framework and the distribution grid to reduce technical losses; and (ii) install smart meters to reduce non-technical losses. Based on cross-country experience, staff’s estimates suggest that a reduction of losses to 20 percent of production can be expected in the medium-term.
  • Increase capacity. Given that building new power plants takes at least two years, the authorities are planning to implement a temporary solution in parallel to reach a 24/7 supply in 2020. As a temporary solution is likely to be more expensive than a permanent one, combining the two in a Power Purchasing Agreement (PPA) would make it possible to backload the cost of the temporary solution. Staff’s estimates suggest that the increase in capacity could start by end 2020.
  • Reduce production costs. Using gas as input to electricity could bring substantial fiscal savings. The authorities are planning to negotiate a PPA to import LNG by ship, build three Floating Storage Regasification Units (FSRUs) and an underwater pipeline from ship to shore. Staff’s assessment suggests that gas could be used as input starting in 2022.
  • Increase tariffs. The goal is to raise average tariffs from the current level of USD 9.6 to USD 14.4 cents/kWh after increasing capacity and to adopt an automated fuel indexation mechanism. However, staff’s estimates suggest that a higher increase in tariffs to USD 16.2 cents would be necessary to close the primary deficit, accounting for both (i) capital expenditures; and (ii) a more realistic timeline for the plan implementation.

Based on a realistic assessment of the plan, it could start reducing EdL’s deficit by 0.1 percent of GDP in 2020 and 0.9 percent of GDP in 2021 (see Table). Then, savings would increase gradually as losses are reduced and achieve 1.9 percent of GDP in 2025.

The authorities should both increase tariffs and simplify the tariff structure. Consumers should pay electricity tariffs high enough for EdL’s budget to be balanced in the medium-term—including capital expenditures, the overall recovery cost is estimated at around USD 16.2 cents/kWh after the reforms. The tariff increase should take place as soon as possible, possibly targeting the largest consumers (industrials) first. As planned in the reform package, consumer tariffs should be indexed to the evolution of input prices once EdL’s budget is balanced. Finally, it is essential to both simplify the tariff structure to improve fairness and design it to incentivize consumers to reduce their consumption.

Table 2.Projected Savings under the Electricity Plan(In percent of GDP)
2019202020212022202320242025
1. Reduction of losses from 43 to 20 percent by 2025 1/0.00.10.20.30.40.50.5
2. Increase capacity to achieve zero outage by end 2020 2/0.0-0.1-0.8-0.8-0.9-0.9-0.8
3. Use of gas as input starting in 2022 3/0.00.00.00.70.70.70.7
4. Increase tariff from 9.6 to 14.4 cents/kWh in 20210.00.00.70.70.70.70.6
Electricity Plan – Total Savings 4/0.00.10.91.61.71.91.9
Memorandum items.
EdL’s primary deficit under unchanged policies 5/2.72.52.42.42.42.32.3
EdL’s primary deficit under the plan2.72.41.50.80.60.50.4
Source: IMF Staff estimates.

Non-technical losses are reduced from 21 to 10 percent, technical losses from 17 to 10 percent and non-collection losses from 5 to zero percent. These assumptions follow cross-country experience and represent a lower reduction than in the authorities’ plan in the medium-term.

Capacity is expected to be increased gradually to reach zero outage by end-2020. It is increased through a temporary solution (barges) over 2020–2022, while the permanent solution (new power plants) is expected to start producing electricity in 2023.

Gas is used as an input to power plants in 2022.

Savings of the four components of the plan do not sum to total savings because of significant interactions between the components.

The primary deficit excludes interest payments.

Source: IMF Staff estimates.

Non-technical losses are reduced from 21 to 10 percent, technical losses from 17 to 10 percent and non-collection losses from 5 to zero percent. These assumptions follow cross-country experience and represent a lower reduction than in the authorities’ plan in the medium-term.

Capacity is expected to be increased gradually to reach zero outage by end-2020. It is increased through a temporary solution (barges) over 2020–2022, while the permanent solution (new power plants) is expected to start producing electricity in 2023.

Gas is used as an input to power plants in 2022.

Savings of the four components of the plan do not sum to total savings because of significant interactions between the components.

The primary deficit excludes interest payments.

Authorities’ Views

33. The authorities highlighted the good progress they have made in implementing the various growth-supporting structural reforms identified in their CEDRE vision published in the spring of 2018. They are also confident that the electricity plan will be implemented without delays and have already achieved important first goals including the completion of the high-voltage lines in Mansourieh which reduces technical losses by 1 percent. The authorities also stressed their recent efforts to improve governance and announced the intention to join the Open Government Partnership.

C. Monetary Policy and Financial Stability

34. The BdL has been the linchpin of financial stability and protecting the peg, but at the cost of intensifying sovereign-bank linkages, which pose risks to banking sector stability, and weighing down its balance sheet while protecting banks’ profitability (see Box 1). The BdL’s latest operation aims, among other objectives, to build up banks’ capital buffers by letting them record future profits earned through the operation immediately as long as they are retained.

Key Recommendations

35. The BdL should gradually step back from quasi-fiscal operations and strengthen its balance sheet. The BdL is commended for not buying the T-bills with 1 percent interest rate whose issuance had been proposed by the government. There should also not be any pressure on private banks to purchase them instead. The BdL should step back from government bond purchases and providing other financing facilities including a zero-interest overdraft facility and bridge financing, and let the market determine yields on government debt. While immediate cessation of financial operations would increase risks, the BdL should gradually phase them out as fiscal adjustment and the subsequent decline in yields demanded by investors allow it to do so.

36. Action should be taken to continue building up banks’ capital buffers and strengthen deposit insurance. Gradually fully aligning risk weights placed on the banks’ holdings of BdL foreign currency denominated instruments with Basel III requirements represents a good mechanism to raise effective capital requirements.2 In line with the 2016 Financial Sector Assessment Program (FSAP) advice, the authorities should also increase deposit insurance coverage levels and provide for insured depositors’ preference under the creditor hierarchy rules applicable in resolution and liquidation of failed banks.

37. Continued effective implementation of AML/CFT measures is necessary to mitigate ML/TF risks and to ensure a positive MENAFATF AML/CFT assessment. The authorities have strengthened the AML/CFT framework and should continue making further improvements and focus on its effectiveness (see Annex IV). Failure to do so could lead to a negative MENAFATF assessment and adversely affect investment and banks’ continued access to correspondent banking relationships.

38. The authorities should review the tools available to cope with financial distress in systemic institutions. The Banking control Commission (BCC) has made progress in recovery planning. It should now proceed to identifying critical functions performed by systemic institutions that need to be preserved and develop bank-specific resolution plans.

Authorities’ Views

39. The authorities agreed that the BdL can step back from its financial operations once fiscal and structural reforms have reduced financing needs of the government and the economy. They highlighted that the banking sector is well-capitalized, with capital adequacy substantially above the minimum levels required by Basel III regulation. They argued that the risk weights on bank holdings of BdL debt are appropriate given the BdL’s placement of its reserves in safe assets. They also stressed that they received a positive MENAFATF AML/CFT assessment. They stated that they already meet the majority of criteria for a positive assessment under the revised FATF assessment methodology and are working address any remaining shortcomings in time for the next assessment.

Staff Appraisal

40. Lebanon has shown unique resilience in the face of long-standing economic challenges, but its vulnerabilities have continued growing and it is now at a critical moment. Over the years, Lebanon has time and again coped with external and domestic challenges that would have proved too large for many other countries. Yet by 2018 economic imbalances have reached exceptional levels, giving rise to acute financial challenges. The fiscal deficit rose over 10 percent of GDP for the first time in a decade, the current account deficit remains around 25 percent of GDP and the external position remains substantially weaker than the level consistent with medium-term fundamentals and desirable policy settings. Bank deposits inflows that used to finance the twin deficits have largely dried up. Lebanon’s difficult external economic environment and especially the ongoing Syria conflict have exacerbated Lebanon’s challenges. Economic growth has virtually stopped, and unemployment is high.

41. The new government has a narrow window to reverse the current unsustainable trends. The authorities understand that the room for maneuver has narrowed significantly and have embarked on fiscal and structural reforms to correct the course of the economy. The parliament has recently passed the 2019 budget with ambitious fiscal adjustment goals, but it is based on optimistic projections, and staff estimates that its effects will be more limited. Importantly, some of its key measures are temporary, when durable measures are necessary to underpin the needed adjustment. The government is also keen on improving Lebanon’s growth prospects through a set of structural reforms, including a new electricity sector plan.

42. Reducing the current imbalances and rebalancing the Lebanese economy will require further simultaneous actions on several fronts sustained over many years. The authorities’ efforts thus far are welcome first steps. Yet returning the country on a path towards sustainability demands stronger fiscal adjustment complemented by fundamental structural reforms that both raise growth and improve Lebanon’s external position. These efforts will need to be sustained for many years in order to return to fiscal and external sustainability and will require determined implementation and broad political and social support.

43. A multi-year fiscal adjustment is a key element of the necessary reforms. Lebanon needs a credible strategy to improve its primary balances to 4–5 percent of GDP in the next 2–3 years. The size of adjustment involved implies that reforms will have to include both substantial revenue and expenditure measures. Given Lebanon’s institutional capacity it would be hard to avoid a significant rise in the VAT rate and removal of exemptions as well as higher fuel excises. The authorities also need to implement tangible measures to improve tax collection across the economy. The electricity plan must not be delayed, including a price increase sufficient to eliminate subsidies to the EdL. This needs to be complemented by a thorough expenditure review to achieve sustained fiscal savings. A stronger safety net protecting the most vulnerable and the government’s CIP, financed on concessional terms, can help mitigate the contractionary effect of the adjustment on growth.

44. In addition, structural reforms are essential to revive growth and enable external adjustment. The implementation thus far of the electricity sector plan and legislative progress on the government’s CEDRE vision reforms are a good start. But Lebanon’s deep structural issues require many more far-reaching changes to remove growth bottlenecks and enable external adjustment in the context of the currency peg. In particular, the authorities must tackle the pervasive issue of corruption with great resolve.

45. The BdL has long protected the country’s economy and maintained financial stability but now it must also start rebuilding its own financial strength. The years of bearing the brunt of responsibility for the country’s economic stability have left its mark on the BdL’s balance sheet and have intensified sovereign-bank links. While the BdL may need to continue its financial operations for a while even if the underlying economic situation improves, it should limit its support to the government and place more importance on the strength of financial system, both in terms of its balance sheet and requiring commercial banks to build up their own buffers further. Effective implementation of AML/CFT measures should continue to mitigate ML/TF risks and to ensure a positive MENAFATF AML/CFT assessment.

Staff propose that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.Lebanon: Selected Economic Indicators, 2018–24
2018201920202021202220232024
Est.Proj.Proj.Proj.Proj.Proj.Proj.
Output and prices(Annual percentage change)
Real GDP (market prices)0.30.20.92.32.63.12.7
GDP deflator5.33.72.32.12.12.12.1
Consumer prices (end-of-period)4.03.42.42.42.42.42.4
Consumer prices (period average)6.13.12.62.42.42.42.4
Investment and saving(In percent of GDP)
Gross capital formation22.021.522.523.021.919.318.2
Government1.61.62.73.63.53.43.3
Nongovernment20.419.919.919.418.415.914.9
Gross national savings-3.3-4.0-3.2-2.3-2.6-4.9-5.4
Government-9.5-8.2-9.0-8.6-9.1-11.5-12.1
Nongovernment6.14.25.86.36.56.66.7
Central government finances (cash basis)(In percent of GDP)
Revenue (including grants)20.521.522.922.822.221.221.1
Expenditure31.531.234.434.934.736.036.4
Overall balance (including grants)-11.0-9.8-11.5-12.1-12.5-14.8-15.3
Primary balance (including grants)-1.4-0.30.30.20.5-1.3-1.2
Total government debt 1/151155162167172178185
Monetary sector(Annual percentage change, unless otherwise indicated)
Broad money 2/3.64.06.05.04.03.03.0
Deposit dollarization (level)70.770.068.068.069.070.070.0
Interest rates (period average, in percent)
Five-year Eurobond yield9.010.29.39.19.710.210.5
Five-year treasury bill yield6.88.08.08.08.08.08.0
External sector(In percent of GDP, unless otherwise indicated)
Exports of goods and services (in US$, percentage change)2.37.35.14.95.25.65.6
Imports of goods and services (in US$, percentage change)3.21.53.32.82.23.93.4
Balance of goods and services-24.3-21.8-21.2-20.1-18.6-17.7-16.7
Current account-25.6-26.4-26.3-25.6-24.5-23.9-23.1
Foreign direct investment2.43.03.84.64.64.13.5
Total external debt 3/191196207215219219219
Gross reserves (in billions of U.S. dollars) 4/36.531.730.229.127.023.419.2
In months of next year imports of goods and services12.910.910.19.58.57.18.7
In percent of short-term external debt 5/44.236.132.128.624.920.315.9
In percent of banking system foreign currency deposits29.625.023.121.218.615.412.3
In percent of total banking system deposits20.917.515.714.412.910.88.6
Memorandum items
Nominal GDP (in billions of U.S. dollars)56.458.660.563.166.169.673.0
Non-resident deposits (staff estimate, percent change)4.25.16.15.14.03.03.0
Commercial bank total assets (percent of GDP)443443455458455445438
Real effective exchange rate (annual average, percent change)2.2
Sources: Lebanese authorities; IMF staff estimates.

Does not include the bridge loan from the central bank.

Defined as currency in circulation plus resident and nonresident deposits.

Includes nonresident deposits.

Excluding gold and encumbered assets.

Short-term debt on a remaining maturity basis, including short-term nonresident deposits.

Sources: Lebanese authorities; IMF staff estimates.

Does not include the bridge loan from the central bank.

Defined as currency in circulation plus resident and nonresident deposits.

Includes nonresident deposits.

Excluding gold and encumbered assets.

Short-term debt on a remaining maturity basis, including short-term nonresident deposits.

Table 2a.Lebanon: Central Government Overall Deficit and Financing, 2018–24(In percent of GDP, unless otherwise indicated)
2018201920202021202220232024
Est.Proj.Proj.Proj.Proj.Proj.Proj.
Revenue and Grants20.521.522.922.822.221.221.1
Revenue20.521.522.922.822.221.221.1
Tax revenue15.015.716.916.916.415.315.2
Taxes on income and profits5.36.27.17.26.76.06.0
Taxes on property1.31.31.31.31.31.31.3
Taxes on domestic goods and services5.35.05.15.15.05.05.0
of which: VAT revenues4.54.24.24.24.24.14.1
Taxes on international trade 1/2.42.52.82.72.72.32.3
Other taxes0.70.70.70.70.70.70.7
Nontax revenue4.04.34.54.44.44.44.4
Other Treasury Revenue1.41.41.41.41.41.41.4
Grants0.00.00.00.00.00.00.0
Total Expenditure31.531.234.434.934.736.036.4
Current primary expenditure20.120.320.019.118.419.219.1
Personnel costs 2/11.411.511.511.511.512.512.5
Transfers to EdL 3/3.12.72.41.50.80.60.5
Other current 4/5.56.16.16.16.16.16.1
Interest payments9.69.411.812.312.913.514.1
Capital expenditure1.51.62.63.53.43.33.2
Overall balance-11.0-9.8-11.5-12.1-12.5-14.8-15.3
Primary balance-1.4-0.30.30.20.5-1.3-1.2
Net financing11.09.811.512.112.514.815.3
Banking system11.67.58.28.28.710.811.3
Government institutions0.60.50.60.70.81.11.1
Other-1.21.82.73.12.92.92.9
Memorandum items:
Total government gross debt 5/151.0155.1161.8167.0172.0178.2185.2
of which: foreign-currency denominated debt 5/59.462.065.767.768.969.670.5
Nominal GDP (Bil. LL)84,98188,28791,13795,18199,676104,934110,059
Sources: Lebanese authorities; and IMF staff estimates and calculations.

Includes domestic excises, which are collected at customs and are classified as taxes on international trade.

Includes wages, salaries, related benefits, and pensions.

Excludes principal and interest payments paid on behalf of Électricité du Liban (EdL).

Includes transfers to the National Social Security Fund, hospitals, municipalities, Higher Relief Committee, Displaced Fund, Council of the South, bread subsidy, and the interest subsidy.

Does not include the bridge loan from the central bank.

Sources: Lebanese authorities; and IMF staff estimates and calculations.

Includes domestic excises, which are collected at customs and are classified as taxes on international trade.

Includes wages, salaries, related benefits, and pensions.

Excludes principal and interest payments paid on behalf of Électricité du Liban (EdL).

Includes transfers to the National Social Security Fund, hospitals, municipalities, Higher Relief Committee, Displaced Fund, Council of the South, bread subsidy, and the interest subsidy.

Does not include the bridge loan from the central bank.

Table 2b.Lebanon: Central Government Overall Deficit and Financing, 2018–24(In billions of Lebanese pounds, unless otherwise indicated)
2018201920202021202220232024
Est.Proj.Proj.Proj.Proj.Proj.Proj.
Revenue and Grants17,40218,95820,83821,70822,16222,20323,228
Revenue17,40218,95820,83821,70822,16222,20323,228
Tax revenue12,76513,89515,43416,12816,31816,05116,775
Taxes on income and profits4,4995,4526,4396,8226,6956,3106,618
Taxes on property1,1391,1841,1551,2071,2641,3301,395
Taxes on domestic goods and services4,5004,4524,6474,8265,0065,2445,468
of which: VAT revenues3,8413,7363,8563,9994,1404,3324,512
Taxes on international trade 1/2,0252,1812,5472,5992,6472,4232,513
Other taxes602626646674706744780
Nontax revenue3,4213,8004,0994,2194,4184,6514,878
Other Treasury Revenue1,2161,2631,3041,3621,4261,5021,575
Grants0000000
Total Expenditure26,75427,57531,35433,21734,58337,73440,086
Current primary expenditure17,04817,88418,25518,21218,31120,16821,000
Personnel costs 2/9,71910,12710,45410,91811,43313,08613,725
Transfers to EdL 3/2,6472,3452,2151,460768650528
Other current 4/4,6825,4125,5875,8356,1106,4326,747
Interest payments8,1568,30910,76811,70612,90214,11415,555
Capital expenditure1,3151,3822,3313,2993,3693,4523,532
Overall balance-9,352-8,617-10,516-11,508-12,421-15,531-16,858
Primary balance-1,196-307252197481-1,416-1,304
Net financing9,3528,61710,51611,50812,42115,53116,858
Banking system9,8796,5827,4657,8428,68311,34312,399
Government institutions4824105466928221,1221,234
Other-1,0091,6252,5052,9732,9163,0653,226
Memorandum items:
Total government gross debt 5/128,347136,964147,480158,988171,409186,939203,798
of which: foreign-currency denominated debt 5/50,49554,75559,83864,45268,69173,04777,618
Nominal GDP (Bil. LL)84,98188,28791,13795,18199,676104,934110,059
Sources: Lebanese authorities; and IMF staff estimates and calculations.

Includes domestic excises, which are collected at customs and are classified as taxes on international trade.

Includes wages, salaries, related benefits, and pensions.

Excludes principal and interest payments paid on behalf of Électricité du Liban (EdL).

Includes transfers to the National Social Security Fund, hospitals, municipalities, Higher Relief Committee, Displaced Fund, Council of the South, bread subsidy, and the interest subsidy.

Does not include the bridge loan from the central bank.

Sources: Lebanese authorities; and IMF staff estimates and calculations.

Includes domestic excises, which are collected at customs and are classified as taxes on international trade.

Includes wages, salaries, related benefits, and pensions.

Excludes principal and interest payments paid on behalf of Électricité du Liban (EdL).

Includes transfers to the National Social Security Fund, hospitals, municipalities, Higher Relief Committee, Displaced Fund, Council of the South, bread subsidy, and the interest subsidy.

Does not include the bridge loan from the central bank.

Table 3.Lebanon: Balance of Payments, 2018–24
2018201920202021202220232024
Est.Proj.Proj.Proj.Proj.Proj.Proj.
(in millions of US Dollars)
Current account (excl. official transfers)-14,406-15,452-15,913-16,191-16,186-16,654-16,889
Goods (net)-15,146-14,711-15,146-15,294-15,122-15,429-15,592
Exports, f.o.b.3,8474,2284,5494,8475,2105,5595,954
Imports, f.o.b.-18,993-18,939-19,695-20,140-20,332-20,988-21,546
Services (net)1,4381,9282,3242,5892,8383,0873,386
Credit15,74916,79617,54418,33519,17320,18821,237
Debit-14,312-14,867-15,220-15,746-16,334-17,101-17,851
Memo: Tourism (net)2,1462,4562,7622,9603,1483,4123,702
Income (net)-2,275-3,441-3,949-4,356-4,763-5,121-5,463
Credit3,1693,1983,1493,3003,3913,4273,437
Debit-5,444-6,639-7,098-7,656-8,154-8,548-8,900
o/w: Interest of government debt-680-661-945-1,061-1,178-1,249-1,308
Current transfers (net) 1/1,578772858869860809781
Official (net)27000000
Private (net)1,551772858869860809781
Capital and financial account5,15510,69614,36615,09714,16013,01312,726
Capital account (net)1,5511,5511,5511,5511,5511,5511,551
Direct investment (net)1,3791,7572,3162,9263,0452,8362,590
Portfolio investment, loans and other (net)2,2247,38710,49910,6209,5648,6258,585
Government (net)-1,2844642,1692,6652,0761,6741,392
BdL-11-10200000
Banks (net)1,3863,6534,3373,8313,2182,5102,585
Foreign assets of banks 2/-3,165-340-701-584-441-277-295
Nonresident deposits 3/4,5513,9925,0384,4153,6592,7872,880
Nonbank private sector (net)2,1333,3733,9934,1244,2704,4414,608
Errors and omissions5,077000000
Overall balance-4,175-4,756-1,547-1,094-2,025-3,641-4,162
Financing4,1754,7561,5471,0942,0253,6414,162
Official reserves (- increase)4,1754,7561,5471,0942,0253,6414,162
Use of Fund Resources0000000
Memorandum items2,2247,38710,49910,6209,5648,6258,585
Current account balance (in percent of GDP)-25.6-26.4-26.3-25.6-24.5-23.9-23.1
Goods and services balance (in percent of GDP)-24.3-21.8-21.2-20.1-18.6-17.7-16.7
Exports of goods (in percent of GDP)6.87.27.57.77.98.08.2
Export value, percent change-4.89.97.66.67.56.77.1
Export volume, percent change-7.57.95.35.46.15.45.6
Imports of goods (in percent of GDP)-33.7-32.3-32.6-31.9-30.8-30.2-29.5
Import value, percent change3.0-0.34.02.31.03.22.7
Import volume, percent change-3.71.43.71.90.42.31.5
Services credit (in percent of GDP)27.928.729.029.029.029.029.1
Services debit (in percent of GDP)-25.4-25.4-25.2-24.9-24.7-24.6-24.5
Gross reserves (excl. gold, year-end, in millions of US$) 4/36,46731,71130,16429,07027,04523,40419,241
External debt (in percent of GDP) 5/191.1195.7207.0214.7218.7219.0219.4
Government external debt (in percent of GDP)19.920.022.926.228.129.129.7
GDP (in millions of US$)56,37258,56560,45563,13966,12069,60873,008
Sources: Lebanese authorities; BIS; and IMF staff estimates and projections.

Excluding official budgetary transfers.

Net of non-deposit foreign liabilities.

Differs from banks’ reported data, to include estimated deposit flows by Lebanese nationals living abroad but classified as residents.

Excludes Lebanese Eurobonds and encumbered reserves.

Includes all banking deposits held by nonresidents, including estimated deposits of Lebanese nationals living abroad but classified as residents.

Sources: Lebanese authorities; BIS; and IMF staff estimates and projections.

Excluding official budgetary transfers.

Net of non-deposit foreign liabilities.

Differs from banks’ reported data, to include estimated deposit flows by Lebanese nationals living abroad but classified as residents.

Excludes Lebanese Eurobonds and encumbered reserves.

Includes all banking deposits held by nonresidents, including estimated deposits of Lebanese nationals living abroad but classified as residents.

Table 4.Lebanon: Monetary Survey, 2018–24
2018201920202021202220232024
Est.Proj.Proj.Proj.Proj.Proj.Proj.
(In trillions of Lebanese pounds)
Net foreign assets94.990.390.790.689.184.879.7
Banque du Liban70.965.364.162.860.154.948.9
Commercial banks24.025.026.527.929.029.930.8
Net domestic assets176.3191.7208.3223.2237.4251.5266.6
Net claims on public sector97.5104.7111.4117.9128.2142.3155.1
of which: Net claims on government95.9103.1109.8116.3126.5140.7153.5
Banque du Liban42.545.747.550.655.862.869.2
Commercial banks53.357.362.365.670.877.884.2
Claims on private sector78.578.581.084.688.693.297.8
Other items (net)0.38.515.920.820.616.013.8
Broad money (M5) 1/271.2282.0298.9313.9326.4336.2346.3
In Lebanese pounds83.788.9100.0104.9105.9105.8109.0
Currency in circulation5.05.25.55.86.06.26.4
Deposits in Lebanese pounds78.783.694.499.199.999.6102.6
Deposits in foreign currency187.4193.2199.0209.0220.5230.4237.3
(Year-on-year percent change)
Net foreign assets-6.7-4.90.40.0-1.7-4.8-6.0
Net domestic assets10.28.88.67.26.35.96.0
Net claims on public sector10.57.46.45.88.711.09.0
Claims on private sector-3.40.03.24.44.75.24.9
Broad money (M5) 1/3.64.06.05.04.03.03.0
In Lebanese pounds-2.16.112.55.01.0-0.13.0
Deposits in foreign currency6.43.13.05.05.54.53.0
Memorandum items(In trillions of Lebanese pounds, unless otherwise indicated)
Banque du Liban:
Foreign assets73.067.266.164.762.056.850.9
of which: foreign exchange49.041.839.537.934.829.323.0
of which: gold17.719.220.320.621.021.321.6
Claims on public sector (net)44.247.449.152.357.464.570.9
Claims on commercial banks26.826.826.826.826.826.826.8
Reserve money62.255.356.053.650.248.047.1
Gross international reserves (including gold, billions of USD) 2/48.244.443.742.841.037.533.6
Gross international reserves (excluding gold, billions of USD) 3/36.531.730.229.127.023.419.2
in percent of banking system foreign currency deposits29.625.023.121.218.615.412.3
in percent of total banking system deposits20.917.515.714.412.910.88.6
Share of foreign currency private deposits in total (percent)70.770.068.068.069.070.070.0
Sources: Banque du Liban; and Fund staff estimates and projections.

Broad money (M5) is defined as M3 (currency + resident deposits) + nonresident deposits.

Defined as all official foreign currency assets, less encumbered foreign assets.

Defined as all official foreign currency assets, less encumbered foreign assets and gold.

Sources: Banque du Liban; and Fund staff estimates and projections.

Broad money (M5) is defined as M3 (currency + resident deposits) + nonresident deposits.

Defined as all official foreign currency assets, less encumbered foreign assets.

Defined as all official foreign currency assets, less encumbered foreign assets and gold.

Table 5.Lebanon: Financial Soundness Indicators for the Banking Sector, 2015–18(In percent, end of period)
2015201620172018
Capital
Regulatory capital to risk-weighted assets* (consolidated basis)15.116.617.116.6
Regulatory Tier 1 capital to risk-weighted assets* (consolidated basis)13.914.815.314.8
Total capital/Total assets (Individual Basis)9.39.29.18.4
Asset quality
Nonperforming loans net of provisions to capital 1/6.88.711.613.1
Nonperforming loans to gross loans 1/10.811.112.513.8
Asset concentration
Claims on public sector (BdL excluded) to total assets19.416.514.213.2
Placements with the BdL to total assets36.442.145.450.8
Foreign assets to total assets12.310.910.410.0
Profitability
Efficiency ratio 2/57.760.553.653.3
Return on assets (after tax)1.00.91.20.9
Return on equity (after tax)11.410.713.99.7
Liquidity 3/
Deposits to total liabilities88.987.985.476.2
Liquid assets to total assets18.118.714.314.1
Liquid assets to short term liabilities28.129.722.827.2
FX exposure 3/
Foreign-currency-denominated loan to total loans74.671.368.869.9
Foreign-currency-denominated liabilities to total liabilities64.063.964.460.1
Net open FX position to regulatory capital14.116.116.611.8
Sources: Lebanese authorities and Financial Soundness Indicators (FSI).

As of September 2018

Non performing loans definition covers loans to financial and non-financial sector. Figure related to the two banks under liquidation are included, thus materially affecting the gross NPL Ratio (around USD 1.9 bn exposure including interest is added to the gross exposure). The Non-performing loans to gross loans ratio is calclauted based on Banque du Liban Centrale Des Risques Data.

It represents non-interest expense to sum of net interest income plus non-interest income. Profitability indicators have been revisited following banks’ submission of annual audited financial statements

These indicators are computed following FSI guide.

Sources: Lebanese authorities and Financial Soundness Indicators (FSI).

As of September 2018

Non performing loans definition covers loans to financial and non-financial sector. Figure related to the two banks under liquidation are included, thus materially affecting the gross NPL Ratio (around USD 1.9 bn exposure including interest is added to the gross exposure). The Non-performing loans to gross loans ratio is calclauted based on Banque du Liban Centrale Des Risques Data.

It represents non-interest expense to sum of net interest income plus non-interest income. Profitability indicators have been revisited following banks’ submission of annual audited financial statements

These indicators are computed following FSI guide.

Annex I. Status of the Article IV 2018 Recommendations

Recommendations

1. The 2018 consultation called for a fiscal consolidation plan with front-loaded fiscal adjustment, embedded in a credible budget. Concretely, the consultation called for an adjustment package that combines both revenue and spending measures. It also called for strengthening the public investment management framework to improve Lebanon’s public investment capacity before implementing large investment projects.

2. The 2018 consultation called for more conventional interest rate policy instead of financial engineering operations. It also noted that banks should continue strengthening buffers, align treatment of NPLs with international best practices, and enhance liquidity regulations. The consultation also advised the authorities to strengthen the crisis management and AML/CFT frameworks.

3. The 2018 consultation stressed the importance of structural reforms—particularly electricity sector reform and eradicating corruption—to improve competitiveness and boost growth. The consultation recommended that the authorities expand electricity capacity and fully eliminate subsidies. It also called for rendering the anti-corruption regulatory framework effective.

Progress

4. In the fiscal sector, the authorities passed the 2019 budget—which aims for a large fiscal adjustment. The budget includes various revenue and expenditure measures; however, the most important of which are for three years only. These measures include increasing the tax on interest income from 7 to 10 percent, a tax on imported goods, and a freeze of public sector hiring and early retirement. Other recommended much-needed fiscal measures including an increase in VAT and the reinstatement of gasoline excises and fuel taxes were not proposed by the government. In the monetary sector, the BdL continued to employ financial operations rather than more conventional interest rate policies but plans to phase them out as fiscal adjustment proceeds. It also remained active in the T-bills and Eurobonds primary markets, even though it only provided financing for the payment of wages and the debt service. There is still need for continued building up of capital buffers and fully aligning the risk weights placed on the banks’ holdings of BdL foreign currency denominated instruments. On structural reform, the authorities approved the electricity sector plan but have yet to increase power supply and raise tariffs and simplify their structure. The authorities passed the Access to Information Law, initiated work on an anti-corruption strategy and prepared a draft of a modern public procurement law. Further steps are still needed to reduce corruption and improve governance.

Annex II. External Sector Assessment

The external position of Lebanon in 2018 is substantiaiiy weaker than the level consistent with medium-term fundamentals and desirable policy settings. External debt was unsustainable at 190 percent of GDP in 2018, while the current account deficit stood at over 25 percent of GDP. Gross international reserves were at 90 percent of the IMF’s ARA reserve adequacy metric, falling short of 100 percent—the level considered to be adequate—for the first time in 10 years. Substantial fiscal and external sector adjustments are needed to strengthen the external position and reduce the need to attract non-resident deposit flows. Fundamental structural reforms are needed to improve Lebanon’s external competitiveness and help further reduce the economy’s savings-investment imbalance.

1. In 2018, the net international investment position (IIP) continued to deteriorate and is estimated at about -128 percent of GDP in 2018. Net external debt position stood at -98 percent of GDP, net FDI position at -97 percent of GDP, and gross FX reserves at 65 percent of GDP. About 40 percent of external gross liabilities (125 percent of GDP) was FDI-related and predominantly invested in real estate which has been stagnant over the past six years. The remainder (185 percent of GDP) comprised of debt liabilities which, for the first time in 10 years, saw a decline compared to the previous year. Government debt accounted for about 20 percent of the external debt liabilities, while the remaining majority comprised short-term non-resident deposits.1 The trajectory of external debt and gross financing needs continue to rise, and external debt is assessed to be unsustainable (see Annex VI). On the asset side, debt securities held by the banking system, FDI assets, and gross reserves together account for 190 percent of GDP.

IIP Composition, by Instrument, 2010–18

(in percent of GDP, based on IIP data from EWN database)

Source: Lane and Milesi-Ferretti’s External Wealth of Nations Dataset, IMF WEO.

2. The current account deficit remained around 25 percent of GDP in 2018, comprising of a trade deficit of 24 percent of GDP and interest payments of 4 percent of GDP, offset by 3 percent of GDP in net inflows in current transfers, the lowest level seen in more than a decade. This was primarily driven by a decline in inbound current transfers (14 percent of GDP in 2018 after peaking at 20 percent in 2014). Surplus in service trade has also reached decade lows over the past two years and reached 2.6 percent of GDP, compared to a 10-year average of 7.4 percent of GDP. However, the lifting of travel bans of Gulf nationals is expected to restore inbound tourism in 2019 and beyond. Based on economic fundamentals, the current account approach to assessing the external sector balance suggests that the current account norm in 2018 was -5.6 percent of GDP, implying a current account gap of 20.3 percent of GDP. In turn, the external sustainability approach suggests a current account norm of -8.3 percent of GDP and a CA gap of 15.8 percent of GDP in 2024.

Components of Current Account, 2010–18

(In percent of GDP)

Source: Banquedu Liban and Staff calculations.

3. Financing conditions are challenging. The government has not placed Eurobonds in the market since 2017. The May 2018 Eurobond issuances were underwritten by the BdL, some of which have been off-loaded in the secondary market at a discount. Maturing Eurobonds and all external interest payment obligations have been paid by the BdL on behalf of the government. The counterpart to these transactions has been a negative government FX cash balance (overdraft) at the BdL and a bridge loan at zero percent interest rate. The gross growth of official non-resident deposits increased in 2018 to almost 9 percent but should be compared to ever-increasing interest rates. In 2018, the BdL continued to engage in financial operations offering high yields to non-resident depositors, but nonetheless ended the year with a loss of about USD 4 billion in reserves. Non-resident deposit inflows slowed in 2019.

Financing of Current Account, 2010–18

(In percent of GDP)

Source: Banque du Liban and Staff calculations.

4. The IMF’s EBA-light methodology suggests that the real effective exchange rate is significantly overvalued. The very high negative net foreign asset position, with high levels of short-term debt suggests that the external sustainability approach is the most relevant measure for Lebanon. It suggests a 50 percent overvaluation if net foreign assets were to be stabilized at the 2018 level of-128 percent of GDP. In turn, the exchange rate is overvalued by 66 percent if the net foreign assets were to be brought down to -100 percent of GDP by 2024. The current account approach suggests a real exchange rate gap of 63 percent in 2018 (compared to 45 percent estimated in 2017). As in previous years, the IREER approach suggests a much smaller REER gap of 9.1 percent2 The REER has appreciated over 30 percent since the lows in 2008. The appreciation trends are consistent with the higher domestic inflation rates in Lebanon in the past year and appreciation of the nominal effective exchange rate.

Real and Nominal Effective Exchage Rate, 2010–18

(Index, 2010)

Sources: Information Notice System; and IMF staff calculations.

5. The reserves adequacy metrics now point to a reserve shortfall. Although gross reserves continued to be large at 65 percent of GDP at end-2018, they stand at 90 percent of the Fund’s Assessing Reserves Adequacy (ARA) metric. In 2018, the BdL intervened in the foreign exchange market to support the fixed exchange rate peg while keeping the domestic liquidity tight in order to control speculative foreign exchange transactions. Together with challenges in attracting non-resident deposits, the BdL lost 7.4 percent of GDP in reserves in 2018, some of which is attributed to BdL’s paying Eurobond principal and coupon on behalf of the government. The ARA metric is also projected to fall to 70 percent by end-2019.

Reserve Adequacy 2010–24

(USD billion)

Sources: National authorities; and IMF staff calculations

Annex III. Adjustment Scenario

1. Macroeconomic implications of staff recommendations across fiscal, structural as well as monetary and financial policies are integrated in an adjustment scenario. The table below presents selected economic indicators in this scenario.

2. In particular, the adjustment scenario incorporates additional fiscal adjustment over the medium term, delivering a primary balance of 4.6 percent of GDP by 2022 through a front-loaded fiscal adjustment. This in turn stabilizes the level of the debt-to-GDP ratio at 166 percent by 2022. The ratio then begins declining, reaching 163 percent in 2024. The additional fiscal adjustment combined with deeper structural reforms improves the current account deficit, which declines to about 20 percent of GDP by 2024. The government’s continued reform drive also raises investor and depositor confidence over the medium term, which is reflected in higher growth of deposits and slightly lower interest rates. These developments in turn stabilize the BdL’s foreign reserves, which begin substantially increasing by 2022. Growth in the adjustment scenario is lower than in the baseline through 2022 due to the contractionary impact of the additional fiscal tightening.1 By 2024, however, growth reaches almost 4 percent, the long-term level it can then sustain as a result of higher investment and confidence as well as fundamental structural reforms, which boost it relative to the baseline forecast.

Table 1.Lebanon: Selected Economic Indicators, 2018–24 (Adjustment Scenario)
2018201920202021202220232024
EstProj.Proj.Proj.Proj.Proj.Proj.
Output and prices(Annual percentage change)
Real GDP[market prices)0.30.20.31.42.23.33.8
GDP deflator5.33.72.32.02.12.12.1
Consumer prices (end-of-period)4.03.42.42.42.42.42.4
Consumer prices (period average)6.13.12.62.42.42.42.4
Investment and saving(In percent of GDP)
Gross capital formation22.021.522.523.523.423.323.2
Government1.61.62.73.63.53.43.3
Nongovernment20.419.919.919.919.919.919.9
Gross national savings-3.3-4.1-3.0-1.10.31.01.6
Government-9.5-8.2-7.2-5.3-4.4-4.2-3.9
Nongovernment6.14.04.24.24.75.35.6
Central government finances (cash basis)(In percent of GDP)
Revenue (including grants)20.521.524.425.926.627.026.9
Expenditure31.531.234.234.634.434.634.0
Overall balance (including grants)-11.0-9.6-9.5-8.7-7.5-7.4-7.1
Primary balance (including grants)-1.4-0.12.03.24.64.64.7
Total government debt 1/151155161165166165163
Monetary sector(Annual percentage change, unless otherwise indicated)
Broad money 2/3.64.06.07.07.07.07.0
Deposit dollarization (level)70.770.068.067.066.065.065.0
Interest rates (period average, in percent)
Five-year Eurobond yield9.010.29.07.66.97.07.0
Five-year treasury bill yield6.88.08.08.07.57.57.5
External sector(In percent of GDP, unless otherwise indicated)
Exports of goods and services (in USS, percentage change)2.37.15.15.35.96.97.2
Imports of goods and services (in USS, percentage change)3.21.52.41.71.03.33.9
Balance of goods and services-24.3-21.9-20.9-19.3-16.9-15.2-13.7
Current account-25.6-26.5-26.1-24.7-22.7-21.4-20.3
Foreign direct investment2.43.54.35.66.67.17.6
Total external debt 3/191197212226237246253
Gross reserves (in billions of U.S. dollars) 4/36.532.833.235.439.845.352.2
In months of next year imports of goods and services12.911.411.312.013.014.215.9
In percent of short-term external debt 5/44.237.435.434.635.737.339.7
In percent of banking system foreign currency deposits29.625.925.425.727.329.531.8
In percent of total banking system deposits20.918.117.317.218.019.220.6
Memorandum items
Nominal GDP (in billions of U.S. dollars)56.458.660.162.264.968.472.5
Non-resident deposits (staff estimate, percent change)4.25.17.27.17.17.17.1
Commercial bank total assets (percent of GDP)443443458474487494499
Real effective exchange rate (annual average, percent change)2.2
Sources: Lebanese authorities; IMF staff estimate.Note: The adjustment scenario does not incorporate arrears clearance due to lack of information regarding the stock of arrears.

Does not include the bridge loan from the central bank.

Defined as currency in circulation plus resident and nonresident deposits.

Includes nonresident deposits.

Excluding gold and encumbered assets.

Short-term debt on a remaining maturity basis, including short-term nonresident deposits.

Sources: Lebanese authorities; IMF staff estimate.Note: The adjustment scenario does not incorporate arrears clearance due to lack of information regarding the stock of arrears.

Does not include the bridge loan from the central bank.

Defined as currency in circulation plus resident and nonresident deposits.

Includes nonresident deposits.

Excluding gold and encumbered assets.

Short-term debt on a remaining maturity basis, including short-term nonresident deposits.

Annex IV. Governance

1. There is evidence of governance weaknesses and a high level of corruption in Lebanon. According to the World Bank’s Business Enterprise Survey (2013), 61.4 percent of firms identify corruption as a major constraint compared to 49.1 percent in the MENA region. Furthermore, corruption is identified as a major constraint by the highest number of firms in Lebanon, followed by electricity which is reported as a constraint by 55.1 percent of firms.

2. Over the years, Lebanon recorded modest progress in improving its governance framework, including in the fight against corruption. In 2017, the Parliament approved the Access to Information Law after a decade of deliberations while work on an anti-corruption strategy was initiated. More recently, a draft public procurement law has been prepared with assistance from the World Bank. An Anti-Corruption Law, which allows for the establishment of a national anti-corruption commission, and whistleblower protection legislation have also been adopted.

Major Constraints to Businesses in Lebanon

(in percent of firms)

Source: Enterprise Survey, 2013.

3. The main areas for reducing corruption and improving governance are:

  • Anti-corruption framework. Further concrete steps should also be urgently taken to reduce corruption. Existing legislation should be promptly and effectively implemented, including by the appointment of an independent, sufficiently empowered and resourced anti-corruption commission, and supplemented by the enactment and urgent implementation of the pending illicit enrichment and asset declaration legislation in line with best practices. Other priorities include the adoption of an anti-corruption strategy and undertaking corruption investigations and prosecutions to obtain a number of corruption convictions and confiscations commensurate with risks. The latter will also be important for the upcoming MENAFATF AML/CFT assessment (see below).
  • Fiscal governance can be improved along several dimensions:
    • (i). Better monitoring of the use of public funds, including in public employment (around 5,000 people were illegally hired after the hiring freeze of the 2017 salary scale law). Spending by the Council for Development and Reconstruction (CDR) should be included in the budget.
    • (ii). Passing a public procurement law to ensure that public funds are appropriately disbursed in preparation for the CIP.
    • (iii). Stronger management of core tax functions, with reforms to the Tax Identification Number (TIN) system, compliance risk management and collection of tax arrears.
    • (iv). Better oversight of tax administration through establishment of an independent internal audit unit and improving transparency of external reporting.
  • Regulatory framework and the rule of law. The doing business framework should be improved, beginning with decreasing delays with construction permits and contract enforcement. Border procedures can be streamlined to facilitate trade. At the same time, the authorities should solicit comments from the general public on proposed regulations.
  • Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT). The high-level awareness among the authorities and private sector of ML/FT-related risks, such as from domestic proceeds of corruption and non-resident deposits, is encouraging. Over the past years, the authorities have strengthened the AML/CFT legislative framework, and report to have undertaken two national risk assessments (NRA). The Special Investigative Committee’s (SIC) focus on supervision and its leadership in improving the Lebanese AML/CFT system are also important positives.
    • Continued legislative improvements and effective implementation of AML/CFT measures are needed to mitigate intrinsic ML/TF risks and ensure a positive future MENAFATF AML/CFT assessment. A negative assessment could adversely affect investment and banks’ continued access to correspondent banks. To this end, the authorities are urged to continue improving the AML/CFT system, including by i) sharing the outcomes of the national risk assessments with private and public sector stakeholders; ii) improving risk-based supervision and ensuring the effective application of preventive measures (including those related to politically exposed persons) among all financial institutions and designated non-financial businesses and professions; iii) ensuring the timely availability of accurate beneficial ownership information; iv) improving targeted financial sanctions requirement;, and v) increasing the numbers of prosecutions and convictions for ML, commensurate with risks.
    • Plans by the BdL, supported by the Association of Banks in Lebanon, to fully abolish numbered/secret accounts are commendable and should be implemented without delay. Authorities have committed to abolishing numbered or secret accounts, notably because their continued use reflects negatively on the Lebanese banking sector. Likewise, it is crucial that the authorities modernize banking secrecy provisions to allow timely and direct access to financial information held by financial institutions by law enforcement and judicial bodies. This would help support investigations and prosecutions against money laundering, corruption and other financial crimes.1
Annex V. Public Debt Sustainability Analysis

With public debt already above 150 percent of GDP and gross financing needs of over 30 percent of GDP, Lebanon’s public debt is unsustainable under the baseline scenario. Debt and gross financing needs will continue to rise as a share of GDP, reaching 180 percent and 37 percent, respectively, by 2024. In addition, debt dynamics and financing needs are highly vulnerable to a range of shocks. Decisive policy actions to bring the debt path on a downward trend are thus urgently required.

1. Baseline scenario projection assumes the following:

  • Real GDP growth is projected to pick up slowly assuming the government implements the planned reforms which would unlock funding for its Capital Investment Plan (CIP). Starting at 0.2 percent in 2019, growth is projected to pick up in 2021 and peak at 3.7 percent in 2023.
  • Inflation (measured by the GDP deflator) is projected to ease from 5.3 percent in 2018 to 2.1 percent in 2021.
  • The primary deficit is estimated at 1.4 percent of GDP in 2018; it is projected to narrow in 2019 before turning into a small surplus in 2020, thanks to corrective fiscal measures. However, these measures are expected to be temporary and their reversal is projected to lead to a primary deficit again by 2023.

2. The baseline assumptions are plausible in historical and cross-country context. Lebanon’s forecast track record is not systematically biased. The median forecast errors for growth, inflation, and the primary balance during 2008–16 are broadly in line with those observed in other countries.

3. The deteriorating debt outlook is mainly driven by the projected positive interest rate-growth differential. The public debt-to-GDP ratio is forecast to increase from over 150 percent in 2018 to 180 percent in 2024. Over the forecast horizon, economic growth is not expected to reach levels high enough to offset adverse dynamics from real interest rates, even considering the concessional loans expected from the CIP. Although the gross financing needs-to-GDP ratio is forecast to fall through 2022, it is projected to rise again to 37 percent of GDP in 2024. The increase in financing needs in 2022 and beyond is primarily driven by the debt maturity profile of around five and seven years, for domestic and foreign debt, respectively.

4. The debt and financing needs projections are highly sensitive to a range of shocks:

  • Growth shock. Slower growth remains one of the principal risks to debt sustainability. If growth were to decline by one standard deviation in 2020 and 2021, the debt-to-GDP ratio would reach almost 200 percent and financing needs would exceed 40 percent of GDP in 2024.
  • Real exchange rate shock. A 50-percent real exchange rate shock, based on the standard MAC DSA inflation pass-through coefficient of 0.25, would affect the debt-to-GDP ratio to a similar extent as a growth shock, because, under these standard assumptions, the effects of higher foreign currency debt would be largely offset by the impact of inflation in eroding domestic debt.
  • Interest rate shock. Higher interest rates also pose a significant risk to debt sustainability. A shock to the interest rate would result in financing needs reaching almost 40 percent of GDP in 2024. Interest rates on domestic and foreign bonds have recently been rising and may continue doing so, and the potential rate increase could be even higher than assumed in this scenario if investor confidence evaporates.1
  • Macro-fiscal shock. If shocks to growth, the interest rate, and the primary balance occurred simultaneously, the debt-to-GDP ratio would exceed 250 percent at the end of the projection horizon. Financing needs would rise to close to 50 percent of GDP.
  • Contingent liability shock. In the absence of concrete estimates of contingent liabilities, a standardized shock of 10 percent of financial sector assets is used to reflect the significant size of Lebanon’s banking sector relative to the size of its economy and to represent a hypothetical realization of such contingent liabilities. In this scenario, the debt-to-GDP and financing needs-to-GDP ratios would reach 218 and 43 percent by 2024, respectively. This does not assume any feedback on GDP growth and interest rates due to the contingent liability shock.

5. The fan figures show significant uncertainty around the baseline. The width of the symmetric fan figure, estimated at around 60 percent of GDP, illustrates the degree of uncertainty for equal-probability upside and downside shocks.

6. Lebanon’s debt profile reveals substantial weaknesses. Despite the relatively long average maturity of government debt, projected public GFNs are very high and generate significant rollover risks, reflecting the level of debt and large fiscal deficits. External financing needs are almost 12 times the upper risk-assessment benchmark, bond spreads have been rising and now exceed the upper risk-assessment benchmark by 242 basis points, and public debt in foreign currency is about halfway between the lower and upper risk-assessment benchmarks.

7. There are additional risks from public sector liabilities that not currently captured in the DSA. The coverage of debt in the DSA is limited to the central government and does not capture the stock of government expenditure arrears, the exact magnitude of which is uncertain. Beyond the central government, the liabilities of public enterprises and the BdL also pose risks to public debt sustainability, with the latter having accumulated foreign currency liabilities over the last decade.

Figure 1.Lebanon: Public DSA Risk Assessment

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.

4/ EMBIG, an average over the last 3 months, 01-May-19 through 30-Ju l-19.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Figure 2.Lebanon: Public DSA—Realism of Baseline Assumptions

Source: IMF Staff.

1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Not applicable for Lebanon, as it meets neither the positive output gap criterion nor the private credit growth criterion.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Figure 3.Lebanon: Public Sector Debt Sustainability (DSA) Analysis—Baseline Scenario

(In percent of GDP, unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as central government.

2/ Based on available data.

3/ EMBIG.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r -π(1 +g) – g + ae(1 +r)]/(1+g+π+g-π)) times previous period debt ratio, with r = interest rate;π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π(1+g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 4.Lebanon: Public DSA—Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Figure 5.Lebanon: Public DSA—Stress Tests

Source: IMF staff.

Annex VI. External Debt Sustainability Analysis

1. Lebanon’s external debt is unsustainable. External debt is estimated at about 190 percent of GDP in 2018. The current account deficit excluding interest payments is high at 20 percent of GDP, and although this is projected to decline over the projection period, the interest-growth differential on account of high and growing external debt will continue to weigh against the positive developments in the non-interest current account deficit. The increase in external debt is somewhat dampened by the draining of foreign exchange reserves. All else equal, the non-interest current account deficit will have to reach 5.9 percent to stabilize external debt over the long term at the 2024 level (214 percent of GDP).

2. External debt mainly comprises of non-resident deposits. 77 percent of the external debt is non-resident deposits, most of which are short-term with maturities less than one year.1 Government debt only accounts for about 10 percent of total external debt, with only about a third of the outstanding Eurobond estimated to be held by foreign investors. The remainder of the external debt is debt owed by the BdL, bank non-deposit liabilities, and non-bank liabilities.

3. Gross external financing need stood at 174 percent of GDP in 2018 and financing it is becoming increasingly difficult. Non-resident deposits have proved more difficult to attract to Lebanon in 2018 compared to past years. The political impasse in 2018 and fiscal slippages have heightened the risk aversion of non-resident depositors and increased the risk premium required to attract them. In 2018, the government did not issue any Eurobonds in the market. Instead, they were issued to the BdL, which then re-sold part of them to the market at a discount to attract foreign exchange.

4. The scenario analysis demonstrates Lebanon’s sensitivity to an exchange rate shock. A real depreciation shock of 30 percent would increase external debt to over 300 percent of GDP. The sensitivity to of the debt dynamics to this shock highlights the importance of reducing external imbalances and relying on external financing. Growth shock, non-interest current account shock, and combined shock lead to an external debt that exceeds 220 percent of GDP by 2024.

5. To restore external sustainability, a decisive external adjustment is needed. Over the medium term, structural reforms, particularly in the energy sector that would shift the inputs from oil to gas, can yield gains from production efficiencies and reduction of losses. Potential extraction of gas inside Lebanon can help to reduce the demand for expensive fuel imports, including diesel.

Table 1.Lebanon: External Debt Sustainability Framework, 2014–24(In percent of GDP, unless otherwise indicated)
ActualProjections
20142015201620172018201920202021202220232024Debt-stabilizing non-interest current account 6/
Baseline: External debt166.6166.6182.0189.4191.1195.7207.0214.7218.7219.0219.4-5.3
Change in external debt5.40.015.47.51.64.611.37.74.10.30.40.0
Identified external debt-creating flows (4+8+9)20.110.916.017.112.822.720.516.114.313.113.60.0
Current account deficit, excluding interest payments24.715.518.320.419.418.618.117.115.715.214.45.3
Deficit in balance of goods and services25.223.928.025.419.618.519.919.319.118.618.1
Exports39.939.737.335.934.835.936.536.736.937.037.2
Imports65.163.665.361.354.454.456.456.055.955.655.3
Net non-debt creating capital inflows (negative)-3.3-2.7-3.0-1.4-2.8-3.3-4.2-4.9-4.9-4.4-3.8-3.8
Automatic debt dynamics 1/-1.3-1.90.7-1.8-3.87.46.63.93.52.22.9-1.5
Contribution from nominal interest rate3.53.74.85.56.27.88.28.68.88.78.78.7
Contribution from real GDP growth-2.9-0.7-2.6-1.0-0.4-0.4-1.6-4.6-5.3-6.5-5.7-5.7
Contribution from price and exchange rate changes 2/-1.8-4.9-1.5-6.4-9.6-4.5
Residual, incl. change in gross foreign assets (2–3) 3/-14.7-11.0-0.6-9.7-11.1-18.1-9.2-8.4-10.3-12.8-13.20.0
External debt-to-exports ratio (in percent)417.8419.9488.3528.0549.7545.1566.4584.7593.1592.1589.1
Gross external financing need (in billions of US dollars) 4/76.477.684.189.798.099.0104.8111.0118.7126.2132.8
in percent of GDP158.1155.3164.1168.0173.910-Year10-Year169.1173.3175.8179.5181.3181.9
Scenario with key variables at their historical averages 5/195.7197.9200.7201.9200.9199.7-12.4
Key Macroeconomic Assumptions Underlying BaselineHistorical AverageStandard DeviationFor debt stabilization
Real GDP growth (in percent)1.90.41.60.60.22.93.40.20.92.32.63.12.72.7
GDP deflator in US dollars (change in percent)1.13.00.93.65.33.93.13.72.32.12.12.12.12.1
Nominal external interest rate (in percent)2.22.33.03.23.42.60.54.24.34.34.34.24.24.2
Growth of exports (US dollar terms, in percent)-7.82.9-3.70.32.3-1.28.47.35.14.95.25.65.6
Growth of imports (US dollar terms, in percent)7.61.15.2-2.2-6.48.112.94.07.03.84.54.64.4
Current account balance, excluding interest payments-24.7-15.5-18.3-20.4-19.4-19.13.9-18.6-18.1-17.1-15.7-15.2-14.4
Net non-debt creating capital inflows3.32.73.01.42.84.43.43.34.24.94.94.43.8

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 1.Lebanon: External Debt Sustainability—Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2020.

1

The detailed list of goods is yet to be prepared by the Cabinet.

2

Risk weights are currently set at 50 percent for foreign currency denominated BdL debt, below the 100 percent as per Basel Capital Accord.

1

IMF estimates of non-resident deposits differs from banks’ reported data and include estimated deposit flows by Lebanese nationals living abroad but classified as residents.

2

These numeric results should be treated with caution in light of concerns regarding the quality of Lebanon’s current account data (including very large positive errors and omissions in 2018 equivalent to about 10 percent of GDP) and the impact of the Syria conflict on Lebanon’s balance of payments.

1

The projections use a fiscal multiplier of 0.6 with 0.4 in the same year and 0.2 the following year.

1

Note that some of the banking information, which cannot be shared domestically, is shared with foreign authorities as a result of the implementation of FATCA/CRS and FATF’s cross border wire transfer transparency requirements.

1

The Interest Rate Shock scenario―as defined in the public DSA―assumes that the interest rate increases by difference between average real interest rate level over projection and maximum real historical level, or by 200bp, whichever is larger.

1

IMF estimates of non-resident deposits differs from banks’ reported data and include estimated deposit flows by Lebanese nationals living abroad but classified as residents.

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