Socialist People’s Libyan Arab Jamahiriya: Staff Report for the 2004 Article IV Consultation
Author: International Monetary Fund
Publication Date:
08 Mar 2005
eISBN:
9781451823066
Language:
English
Keywords:
ISCR; CR; WEO oil price projection; General People's Congress; member Central Bank of Libya; government; Libya; Libyan authorities; money stock; government excl. SSF; General government operation; trade protection; Oil prices
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This 2004 Article IV Consultation highlights that the Libyan economy remains largely state controlled and heavily dependent on the oil sector. Since the lifting of the Libya-specific trade sanctions of the United Nation and United States in September 2003 and September 2004, respectively, the pace of economic and structural reforms has picked up somewhat, with the implementation of measures aimed at enhancing the role of the private sector in the economy. However, these reforms continue to be implemented in an ad hoc and nontransparent manner.

Abstract

This 2004 Article IV Consultation highlights that the Libyan economy remains largely state controlled and heavily dependent on the oil sector. Since the lifting of the Libya-specific trade sanctions of the United Nation and United States in September 2003 and September 2004, respectively, the pace of economic and structural reforms has picked up somewhat, with the implementation of measures aimed at enhancing the role of the private sector in the economy. However, these reforms continue to be implemented in an ad hoc and nontransparent manner.

I. Background and Recent Developments

A. Background

1. Libya is generously endowed with energy resources, but has one of the less diversified economies in the Maghreb region and even among the oil producing countries. In the early 1970s, Libya opted for a socialist state and a command economy. Investment was essentially state-driven and trade and price controls, along with subsidies, were widespread. Economic performance was severely constrained by stifling government interference in the economy and an unfavorable business climate. Economic conditions started to deteriorate in the mid-1980s with the fall in world oil prices, and worsened in the 1990s as a result of the UN economic sanctions, following the Lockerbie bombing. The authorities were reluctant to initiate any economic reforms when the country was subject to sanctions.

2. Since the freezing of the UN sanctions in 1999, Libya has been gradually implementing measures to reform and open its economy. But, it is only since the lifting of the UN sanctions and all U.S. Libya-specific trade sanctions in September 2003 and September 2004, respectively, that the pace of reform has picked up somewhat, with the implementation of measures aimed at enhancing the role of the private sector in the economy. These reforms continue, however, to be implemented in an ad hoc and nontransparent manner, and their pace and effectiveness are affected by serious human capacity constraints.

3. In recent years, Fund surveillance has focused on policies to overhaul the incentive and regulatory regimes, exchange rate and trade reforms, fiscal reform, monetary reform, as well as on improving the reliability of economic data. The authorities unified the exchange rate in 2002, and in 2003 eliminated exchange rationing and import licensing requirements. Progress in other areas, however, has generally been limited, mainly as a result of weak institutions.

4. The Libyan economy still remains largely state controlled and heavily dependent on the oil sector. Three quarters of employment is still in the public sector and private investment is low (2 percent of GDP). Private sector activities are hindered by a complex regulatory regime, restrictive labor market practices, and a legacy of policy reversals. In 1999–2003, the oil sector contributed about 50 percent of GDP, 97 percent of the country’s exports of goods, and 75 percent of government revenue. Libya’s social indicators are favorable by Middle East and North Africa (MENA) standards (Table 1).

B. Political Developments

5. A settlement related to the Lockerbie bombing was reached in August 2003, and in December 2003, Libya announced that it had agreed to reveal and end its programs to develop weapons of mass destruction. Libya’s relations with the U.S. have begun to normalize and ties with Europe and Asia continue to be strengthened.1

6. The authorities have renewed their commitment to open up and liberalize Libya’s economy. They have expressed strong interest in having the Fund and the World Bank take the leading roles in assisting them in formulating plans to reform the economy and they have requested technical assistance from both institutions in their areas of expertise. The appointment of reformist figures at key ministerial posts since 2002 indicates support for economic reform by senior decision makers.

II. Developments in 2003 and 2004

A. Economic Developments in 2003

7. Real GDP grew by an estimated 9 percent in 2003, reflecting a 28 percent rise in oil production and a modest 2.2 percent increase in nonhydrocarbon activities (Table 2,Figure 1). While activity picked up in the trade, service and transportation sectors (5 percent), gains in agriculture and utilities remained modest (2–3 percent), and manufacturing declined (-5 percent) mainly as a result of increased competition from private sector imports. Public works and construction decreased by 7 percent, consistent with the drop in public investment spending. Deflation, as measured by the official Consumer Price Index (CPI), decelerated to 2.1 percent from 9.9 percent in 2002, mainly as a result of the disappearance in 2003 of the effects of the appreciation of the special exchange rate on the price of private sector imports.2 Persistence of deflation in official statistics reflects in staffs view the fact that the current CPI, which according to the authorities is outdated and suffers from major shortcomings, covers essentially goods supplied by public enterprises whose prices have continuously declined in recent years as a result of increased competition from private sector imports.

Figure 1.
Figure 1.

Libya: Real GDP and Inflation, 1999–2005

(Annual changes in percent)

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities and Fund staff estimates.

8. The fiscal stance continued to be expansionary, with the non-oil fiscal deficit widening to 36 percent of GDP 3(Table 3, Figure 2). However, reflecting higher hydrocarbon revenues, which reached 47 percent of GDP, the overall surplus remained stable at about 10.5 percent of GDP. Non-oil revenue declined by 3 percentage points of GDP as a result of widespread tax evasion and low efficiency in tax collection. Capital expenditures were compressed to make room for the payment of one installment ($1.1 billion) of the Lockerbie settlement.4 However, current expenditure, excluding the Lockerbie payment, remained high (30 percent of GDP).

Figure 2.
Figure 2.

Libya: General Government Operations, 1999–2005

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities and Fund staff estimates.

9. Broad money increased by 9.4 percent (Table 4, Figure 3). As a result of the improved fiscal situation, net banks’ claims on the government declined sharply, whereas credit to nongovernment sectors increased by about 13 percent of end-2002 money stock, reflecting mainly credit extended to public enterprises.

Figure 3.
Figure 3.

Libya: Monetary Indicators, 1999–2004

(Annual changes in percent of beginning-of-the-year money stock)

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities and Fund staff estimates.

10. The favorable developments in the oil market contributed to a significant improvement in the external current account surplus, which reached about 15 percent of GDP. Oil export earnings increased by 47 percent to about $14.2 billion, and non-oil exports, mainly petrochemicals, also grew markedly. Imports declined by about 3 percent, consistent with lower capital expenditure and weak private sector demand growth (Table 5, Figure 4). Gross international reserves increased to about US$19 billion, equivalent to 22 months of 2004 imports.

Figure 4.
Figure 4.

Libya: External Sector, 1999–2005

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities and Fund staff estimates.

B. Policy Developments in 2003–04

11. Some progress was made on structural reforms in the last two years. Measures taken include trade liberalization, allowing foreign investment in some sectors, the removal of customs duty exemptions enjoyed by public enterprises, and the reduction in import tariff rates. In addition, a privatization plan was initiated in January 2004, which involves the sale of 360 economic units, but excludes the utilities, the oil and gas sector, and the air and maritime transportation sectors. Thus far, 42 small units have been privatized and sold to domestic investors.

12. In the money and banking area, banking supervision was strengthened. A new draft Law on Bank Reorganization, Currency, and Credit has been submitted for discussion to the Basic People’s Congress (BPC, Libya’s local councils).5 The draft law gives the Central Bank of Libya (CBL) greater responsibility in the conduct of monetary policy, including issuing its own securities. Also, the authorities have lowered interest rates across the board in an effort to encourage private sector demand for credit and developed a strategy to modernize the payment system.

13. An Anti-Money Laundering (AML) draft law is still being considered by the General People’s Congress (GPC, Libya’s Parliament). Meanwhile, the CBL issued guidelines on implementing AML measures including requiring banks to designate controllers to report suspicious transactions. A Financial Intelligence Unit was established at the CBL to ensure that commercial and regional banks comply with the requirement to file suspicious transactions reports and create internal AML units, which will disseminate information and delineate the procedures to be followed in this area.

14. The authorities passed a new tax law in March 2004. The new law reforms the general income tax, reduces the top marginal tax rate on wages and salaries, and increases exemptions. The corporate tax remains progressive, with rates varying from 15 to 40 percent, compared with 20 to 60 percent under the previous law.

15. Libya has taken steps toward regularizing its relations with external creditors, settling disputed claims with Italy’s export agency6 and creditors in Germany and the United Kingdom. Also, discussions are ongoing with other foreign creditors. These claims, on which no information has been made available to staff, pertain to disputed payments resulting from the imposition of UN sanctions on Libya. A new debt department has been recently established at the Ministry of Finance, with a view to developing an external debt database and strengthening external debt management procedures.

16.On September 2, 2004, the authorities informed staff that Libya’s participation in the HIPC Initiative failed to get the necessary political support for ratification. They also indicated that Libya is preparing its own debt relief plan, which they intend to discuss directly with HIPC.7

C. Economic Developments in 2004

17. Based on the latest World Economic Outlook (WEO) oil price assumptions, 8 large fiscal and current account surpluses are estimated to have occurred in 2004. Real GDP growth is estimated at about 4.5 percent, reflecting a deceleration in growth of oil production to 7.5 percent, and a real nonhydrocarbon GDP growth rate of about 2.5 percent. For the year as a whole, the authorities expected a deflation rate of about 1 percent. 9

18. The overall fiscal surplus is estimated to have reached about 19 percent of GDP. Oil revenue is estimated at 52.4 percent of GDP, reflecting significantly higher oil prices and production than in 2003. However, non-oil revenue is estimated to have declined by about 1 percentage point of GDP to 7 percent, partly owing to reduced tax revenue in connection with the new tax law provisions. Despite large increases in the wage bill (21 percent) and in capital expenditure (73 percent), total expenditure is estimated to have declined by 4 percent of GDP, mainly on account of a 7 percent of GDP drop in current extra-budgetary expenditure.10 The increase in the wage bill reflected mainly the new hiring of doctors and teachers.

19. Broad money is estimated to have increased by about 8.5 percent. Given the sustained improvement in the fiscal accounts, the government continued to be a net lender to the banking sector. Net claims on nonfinancial public enterprises and credit to the private sector are estimated to have increased only modestly. In May 2004, the government decided to use the foreign assets revaluation account at the CBL to buyback its outstanding domestic debt and part of the public enterprises debt to commercial banks.11

20. The estimated strong external current account—a surplus of about 26 percent of GDP—reflects a 10 percent increase in oil export volume and a 29 percent increase in oil export price. Nonhydrocarbon export growth is estimated to have remained robust, owing mainly to strong petrochemical exports. Imports are estimated to have grown by about 19 percent, consistent with import liberalization, a significant increase in capital expenditure, and high import prices.12 Official reserves are estimated to have reached $24.6 billion, equivalent to about 27 months of projected 2005 imports.

21. In view of the existing price rigidities, it is difficult to assess the appropriate exchange rate level for Libya. The authorities indicated, however, that the exchange rate market is functioning smoothly and no parallel market for the Libyan currency has developed since the unification of the exchange rate in 2002. Since the devaluation of the exchange rate in June 2003, 13 the Real Effective Exchange Rate (REER) has remained broadly stable and there has been no pressure on the exchange rate (Figure 5).

Figure 5.
Figure 5.

Libya: Exchange Rate Developments, 1999Q1–2004Q2

(End-of-Period)

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities; and Fund staff estimates.* In February 1999, the parallel market rate was legalized for some transactions and called the “special” rate. The exchange rate was unified in January 2002.

D. Medium-Term Outlook

22. Libya’s medium-term outlook remains favorable and does not raise any sustainability concerns, on the expectation that world oil prices will decline only gradually and oil production will increase steadily to about 2.15 million barrels per day by 2009 (Tables 6 and 7, and Figure 6). During 2005–09, both the fiscal and external current account balances are projected to continue to register large surpluses averaging about 18 percent and 30 percent of GDP, respectively. However, without corrective measures, the non-oil fiscal deficit is expected to remain relatively large over the period, averaging about 33 percent of GDP, and real nonhydrocarbon GDP growth is projected to range between 3–3.7 percent. Projected growth rates would not be sufficient to generate employment opportunities for the new entrants to the labor force, which are expected to grow by about 3.5–4 percent per year over the medium term, as the current pace of government reforms will fall short of generating a sustained increase in investment and output.14

Figure 6.
Figure 6.

Libya: Baseline Medium-Term Scenario, 1999–2009

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities and Fund staff estimates.

23. Although the medium-term outlook is based on historically high levels of oil price and production assumptions, the downside risks to the projected outlook are somewhat limited. Indeed, on the assumption of an oil price that is $5 a barrel below the WEO spot price trajectory, staff estimates indicate that the fiscal and external current account would still record large surpluses during the entire projection period—on average 12 and 25 percent of GDP, respectively (Figure 7).15 The build up of these surpluses reflects the limited absorptive capacity of the economy, particularly the projected low investment and growth levels resulting from the slow pace of reforms.

Figure 7.
Figure 7.

Libya: Sensitivity Analysis for the Medium-Term

(Oil Price lower by $5 every year), 2005–09

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 083; 10.5089/9781451823066.002.A001

Source: Libyan Authorities and Fund staff estimates.

III. Policy Issues and Discussions

24. Discussions took place at a time of an intense internal debate on how to reform the Libyan economy. The authorities agreed with the staff that higher growth rates and diversification of the Libyan economy could only be achieved through deregulation, a significant scaling down of the dominant role of the public sector, and the development of the private sector. They indicated, however, that given Libya’s political structure, their preferred approach to reform is a one-sector-at-a-time piecemeal one. They expressed strong interest in having the Fund and the World Bank take the leading roles in assisting them in reforming the economy. In this connection, they requested technical assistance from both institutions, including Fund’s long-term resident advisors to assist them in developing and implementing reform agendas in the fiscal, monetary, and banking areas.16 They are establishing an inter-ministerial economic team to coordinate policy design and reform implementation, and to follow up on Libya’s technical assistance needs.

25. Staff indicated that Libya could benefit from the experience of other countries that succeeded in their transition from a centrally planned to a market economy. These experiences stress that proper planning, coordination, and sequencing of policies are essential for the success of the reform efforts. In addition, the sustainability of reforms requires public support, which could only be achieved through a constructive dialogue with the civil society.

26. Given the complementarity of structural reforms, staff recommended putting in place a comprehensive and well-sequenced macroeconomic and structural reform program that could serve as a blueprint to reforming the Libyan economy. Staff suggested that in the short term, the authorities could focus on developing market-based monetary instruments, restructuring the banking system, liberalizing prices, strengthening budgetary management and procedures, and moving from price subsidies to a cash subsidy system. Preparatory work for these measures is at an advanced stage and the Fund has already provided technical assistance in the monetary reform area. More profound structural measures that require significant technical preparation and consensus building could be gradually implemented at a later stage (Box 1).

A. Fiscal Policy

27. Fiscal policy continues to be shaped by the availability of oil revenues and the need to support employment and finance the subsidy system. Several factors have markedly reduced the capacity of the authorities to conduct an effective fiscal policy. These include a lack of transparency of the budget process, considerable netting out of expenditure items, extra-budgetary revenues and expenditures, rigid rules, and the absence of medium-term planning. In addition, widespread tax exemptions continue to weaken the non-oil tax base.

28. Staff stressed that a prudent fiscal policy will remain key to maintaining macroeconomic and financial stability. It urged the authorities to avoid extra-budgetary spending and strengthen expenditure management and control in the period ahead. Staff recommended that the significant projected increases in oil revenues over the medium term be largely saved or allocated to finance structural measures to reform the economy, such as public enterprise and civil service reforms, and reform of the subsidy system.

29. While staff has not had the opportunity to comment on the 2005 draft budget, 17 it recommended that the authorities avoid extra-budgetary spending and that any budgeted increase in spending be directed to improve human capital and infrastructure, which have deteriorated significantly under the sanctions. Also, increased spending on health and education should be accompanied by reforms in these sectors. The authorities were advised to seek technical assistance from the World Bank in this regard.

Libya: Required Economic Reforms

Phase 1 (1–12 months): Objective: Maintain macroeconomic stability, implement monetary reforms, finalize the plan to restructure public banks, establish appropriate relative prices, and improve overall transparency in economic management:

  • Anchor the transition on macroeconomic stability by adopting a medium-term budget framework underpinned by sound management of the Oil Reserve Fund (ORF). Also, there is a need to develop an official law or decree, which clearly states the rules, purpose, and objectives of the ORF.

  • Lift sectoral credit restrictions and allow interest rates to determine credit allocation. Gradually liberalize interest rates. Implement IMF’s recommendations on improving the conduct of monetary operations and banking supervision.

  • Finalize the plan to restructure public banks.

  • Reassess the privatization strategy.

  • Replace price subsidies by cash payments.

  • Improve the economic database.

Phase 2 (12–36 months): Objective: Establish the institutional foundations for the efficient functioning of a modern economy:

  • Accelerate the process of building up a sound investment climate, with strong institutions to support open markets and a level playing field for all investors. Measures include simplifying business entry, opening protected services to domestic and foreign investors, reducing regulatory ambiguity, strengthening the rule of law, and land reform.

  • Restructure public enterprises and implement the privatization program.

  • Restructure public banks and start to modernize prudential regulations and banking supervision in line with international best practices. Privatize public banks.

  • Strengthen the social safety net to protect the vulnerable groups most affected by structural reforms.

  • Consolidate and harmonize import duties and other taxes levied on imports. The number of tariff rates should be reduced from the current 20 to no more than five.

  • Implement a comprehensive civil service reform.

  • Develop an active money market with reliance on indirect monetary instruments

30. Although the fiscal position is projected to remain comfortable over the medium term, the structure of the budget needs to be rationalized through streamlining of expenditures and improving the efficiency of the tax system. On the revenue side, staff recommended that the authorities amend the new tax law approved by the GPC in March 2004, in line with FAD’s recommendations (Box 2).

Libya: Recommended Tax Reforms

FAD recommended a strategy aimed at simplifying the tax system, in order to improve its efficiency and make it more stable, transparent, and equitable. The strategy, which should be supported by tariff reforms and a reform of the tax and customs’ administration, aims to:

  • reform the general income tax; reduce the individual exemptions; and limit the rate schedule for individuals to three brackets: 15, 25, and 35 percent;

  • simplify the corporate tax with a 35 percent flat rate, base corporations’ payments on last year’s income, and allow corporations to exclude domestic dividends from income;

  • abolish the social solidarity tax, the Jihad tax, and the investment contribution tax;

  • allow banks a tax deduction equivalent to the additional loan loss provision required by the central bank.

  • ensure that tax incentives are not subject to administrative discretion, and that incentives for investment are not used as tax holiday;

  • introduce the VAT by 2007; and

  • facilitate privatization, by introducing appropriate rules for tax neutral corporate restructuring.

31. On the expenditure side, the authorities were encouraged to reassess the 70/30 rule, and strengthen expenditure management and control. 18 Staff recommended alternative approaches that could target specific sectors such as education or health without distorting the overall budget allocation. It stressed that further rationalization of spending, including within the context of reforming the civil service and the subsidy system, are needed to improve the efficiency of government spending. The authorities agreed with the staff that the 70/30 rule introduces a measure of rigidity into the budget process, particularly in view of the country’s limited absorptive capacity.

32. The authorities also agreed with the staff that the operations of the ORF should be reviewed to increase its transparency and accountability (Box 1). 19 Also, there should be regular and frequent disclosure and reporting on its inflows, outflows, and the investment of its assets, and the fund’s accounts should be audited by an independent agency. The authorities agreed with staff’s recommendations and stressed that the ORF should have both saving and stabilization functions.

33. The authorities were in general agreement with staff’s assessment of and recommendations on fiscal policy. To that effect, they requested a Fund resident advisor at the Ministry of Finance that would help them develop an agenda for fiscal reform. FAD is of the view that a first step in this process would be to send a fact-finding mission to Libya to assess this request.

B. Monetary Policy and Financial Sector Developments

34. Staff welcomed the authorities’ intention to implement monetary and banking sector reform. It stressed that current policies of direct controls on credit and interest rates are inefficient and make monetary policy increasingly ineffective in influencing macroeconomic goals. Even though progress is not yet tangible, the authorities are keen to develop a market-oriented monetary policy. While interest rates were reduced across the board in February 2004, the first change since 1994, rates are still controlled by the CBL. Furthermore, the current interest rate structure with a range of unchanged and low ceilings on lending rates reduces banks’ ability to price in risk and discourages their lending activity. The authorities are concerned that, if they liberalize lending rates, interest rates would increase and adversely affect economic activity.

35. Staff stressed the importance of further easing interest rate controls, with the aim of full liberalization. It emphasized that the current weak demand for loans and the abundant bank liquidity offer a window of opportunity for initiating gradual interest rate liberalization without leading to higher lending rates. At the same time, directed credit allocation should be phased out. Without these reforms, financial markets will not be able to deliver efficient allocation of credit, which is needed to jump-start private sector activities and increase the overall efficiency of the economy.

36. Staff urged the authorities to continue implementing the recommendations of the 2001 and 2004 MFD technical assistance missions on banking supervision and monetary policy operations (Appendix IV). With the intended move toward indirect monetary management, it recommended the establishment at the CBL of a monetary policy committee responsible for key policy decisions, and the strengthening of daily monetary policy management.

37. The authorities agreed with staff on the urgent need to reform the predominantly state-owned banking system. They indicated that they have stepped-up efforts to improve banking supervision and arrange workouts of nonperforming loans, which stood at 26 percent of total loans at end-August 2004. They are aware that a more efficient and market oriented banking system is needed if Libya is to succeed in reforming its economy. They intend to restructure and privatize public banks, and allow foreign banks to operate in Libya, and have asked the Fund and the World Bank to assist them in this endeavor.

38. Staff discussed with the authorities the main features of the draft law on bank reorganization, currency, and credit, currently under preparation. The draft law, which is intended to give the CBL greater responsibility in the conduct of monetary policy, raises issues that are a source of concern, mainly the composition of the proposed Board of the CBL, which would comprise representatives of three ministries with voting rights. Moreover, the draft law does not remove existing interest rate ceilings. Staff stressed that these provisions are not consistent with the principle of central bank autonomy. The authorities are reviewing the comments sent to them by MFD and LEG.

39. staff recommended that the authorities proceed with the planned reforms in the area of AML/CFT and encouraged the implementation of AML/CFT measures in line with international practice in order to address vulnerabilities to money laundering and terrorist financing. The authorities were urged to seek staff’s comments on the draft AML/CFT law before its adoption by the government.

C. Exchange Rate and Article VIII Issues

40. Staff discussed with the authorities the importance of continued assessment of the level of the exchange rate. It stressed that adjustments to the peg should occur as needed to absorb shocks and avoid a sustained real appreciation that would be harmful to competitiveness. Given the current features of the Libyan economy, in particular, the absence of well-developed financial markets, including a formal exchange market and the lack of adequate monetary instruments to manage liquidity, staff believes that the current exchange regime is appropriate. However, the exchange rate level and regime will need to be monitored as structural and macroeconomic reforms progress.

41. With regard to Libya’s acceptance of the obligations of Article VIII, Sections 2(a), 3, and 4 of the Fund’s Articles of Agreement, the standard review, by MFD and LEG, of Libya’s exchange system is currently underway. Staff stressed that, should the review identify any exchange restrictions, the authorities will need to eliminate them.

D. Trade Reform

42. Staff welcomed the recent simplifications in Libya’s trade regime, including abolishment of licenses, lowering of tariff protection, and elimination of import duty exemptions granted to public enterprises. However, despite these measures, effective trade protection remains relatively high (Box 3).

43. WTO accession negotiations will place a high demand on administrative resources. In this connection, the authorities have formed a working group to undertake a thorough review of all laws, regulations, and policies that affect international trade and investment, and to prepare the Memorandum of the Foreign Trade Regime before the start of the negotiations for full membership in 2005. Staff recommended that, in order to speed-up the process, Libya could seek technical assistance from the World Bank, whose experts have prepared similar documents in other countries.

Libya’s Trade Regime

Libya’s trade regime remains among the most restrictive in the world. In 2003, the simple average tariff rate was 21.8 percent, with tariff rates ranging between zero and 425 percent, and there is a substantial dispersion of tariffs within product categories. Besides import tariffs, the trade protection system includes a discriminatory consumption tax (between 10 and 50 percent) on goods that are consumed but not produced in Libya (while a production tax on local production ranges between 2 and 5 percent); and a regional and social solidarity tax of 15 percent of the import tariff. In addition, there are import bans on 31 items.

Some progress was made in 2004 to liberalize Libya’s trade regime. Tariff rates were reduced—the maximum rate to 100 percent—resulting in a decline in the simple average tariff to 17.8 percent, and some state import monopolies were eliminated. The authorities intend to keep the import bans only for religious, health and ecological reasons, which would involve less than ten products, and replace the remaining bans by tariffs.

Further action is needed to improve Libya’s trade regime. The consumption tax and regional and social solidarity tax should be integrated into the tariff rate structure, tariff protection should be limited to few items and reduced gradually overtime, and the number of tariff bands should be reduced from the current 20 to no more than five. Also, the remaining state import monopolies should be phased out and customs procedures should be simplified and made consistent with international standards.

E. Pricing and Subsidy Policies

44. The authorities described their plans to reform the subsidy system, the cost of which has increased by about 85 percent in 2004 to about 3.5 percent of GDP. 20 Staff recommended that the authorities’ plan to replace the current price subsidy system with cash subsidies be accelerated, and that the latter be well targeted and limited to the vulnerable segments of the population. While agreeing with staff’s recommendation, the authorities indicated that, for political reasons, the subsidy amount would be distributed equally among all Libyans.

45. Staff noted that implicit subsidies would also need to be addressed. They are sizable and are channeled to the economy mainly through fixed low consumer prices, in particular for petroleum products and electricity. In this connection, staff welcomed the increase in electricity prices in July 2004, and encouraged the authorities to increase gradually domestic petroleum product prices. Staff recommended that all implicit subsidies be budgeted and gradually reduced over time.

F. Deregulation and Privatization

46.The pace of reforms has progressed recently. Obstacles to private sector activity that were in effect for a long time are gradually being lifted. Staff welcomed the liberalization of foreign investment in some sectors and the creation of the Libyan Foreign Investment Board, acting as a one-stop-shop for foreign investors. However, while the state has begun to withdraw from economic activity, the regulatory and institutional framework that supports the transition to a market economy suffers from major deficiencies.

47. staff welcomed the reduction in the number of state import monopolies. State-owned companies now face competition from the private sector, which can freely import or produce goods that were previously under public monopoly. While price and profit margin controls still remain in a number of markets, the authorities stressed that enforcement of these controls is almost non-existent; accordingly, they were urged to abolish them. A limited number of goods, which the authorities feel are not sufficiently exposed to competition, could remain under a temporary pricing formula; however, the number of these goods should be gradually reduced and eventually eliminated.

48. The authorities are committed to privatizing most state-owned public enterprises. However, their strategy remains constrained by two main objectives: (i) protecting employment; and (ii) broadening the ownership base to avoid concentrated ownership. In this connection, staff encouraged the authorities to reassess their strategy and implement measures along the lines recommended by the World Bank. The latter include, among other things, (a) enacting a privatization law that would give the privatization agency an independent legal existence and an explicit mandate, and allow investors to acquire a significant share of capital and have corporate control over the privatized companies; and (b) basing the sale process on competitive bidding.

G. Other Issues

49. Staff expressed its regrets that Libya will not be participating in the HIPC Initiative under a multilateral framework which is providing considerable debt relief to HIPC, and urged the authorities to reconsider their decision. The authorities are aware that the comparability of treatment clause in Paris Club debt relief agreements requires the debtor country to seek from all other official bilateral and commercial creditors debt relief terms comparable to those obtained under the Paris Club. However, they indicated that the legislative structure in Libya requires approval from the BPC before Libya’s participation in the HIPC Initiative could be considered for ratification. The authorities informed staff that the BPC did not support Libya’s participation in the Initiative and, for that reason, decided to withdraw from it and are preparing their own debt relief plan instead.

50. The authorities agreed with the staff that a concerted effort is needed to address data deficiencies in Libya (Appendix III). Staff discussed with the authorities how the fundamental flaws of the Libyan data system can be addressed, and recommended that Libya participate in the General Data Dissemination System (GDDS) and appoint a national coordinator to that effect. The authorities reiterated their request (made during the annual meetings in October 2004) for a multi-sector technical assistance mission from the Fund’s Statistics Department. 21

IV. Staff Appraisal

51. Since the freezing of the UN sanctions in 1999, Libya has been implementing measures to reform and open its economy, but progress in developing a market economy has been slow. In 2003–04, Libya’s macroeconomic performance was strong, with large fiscal and external surpluses reflecting the favorable developments in the world oil market. While staff welcomes the adoption of measures aimed at encouraging foreign investment and enhancing the role of the private sector in the economy, the pace and effectiveness of these reforms remain limited in part because their implementation is done in an ad hoc and nontransparent manner. Staff encourages the authorities to speed up the transition to a market economy, by easing government control on the economy and shifting progressively the economic decision-making to the private sector, while allowing free competition on a level playing field.

52. Staff believes that the authorities’ one-sector-at-a-time piecemeal approach to reform would limit the pace and efficiency of the envisaged reforms. Libya needs strong and sustained economic growth to meet the demands of its rapidly growing labor force, which requires high investment in both physical and human capital, as well as an efficient use of available resources. This can only be achieved through the implementation of a comprehensive and well-sequenced reform program.

53. Priority structural reforms that could be launched in the short run could focus on monetary and financial reforms, price liberalization, budgetary management and procedures, and subsidy system reform. Further reform steps to create a conducive environment for economic activity, including a vigorous privatization program and the building-up of a sound business climate, that require significant technical preparation and consensus building could be implemented at a later stage. In this context, the authorities are urged to reassess their privatization strategy and implement measures along the lines recommended by the World Bank.

54. Improving budgetary management and control and implementing a prudent fiscal policy are key to maintaining macroeconomic stability. There is a need to strengthen the budget system and integrate extra-budgetary operations in a consolidated budget under the responsibility of the Ministry of Finance. In view of the large non-oil fiscal deficit, it is important to broaden the non-oil tax base and streamline spending. To achieve this objective, the authorities need to strengthen tax policy as recommended by staff and reassess the 70/30 rule to better take into account the country’s absorptive capacity and avoid procyclical expenditure. Given the human capacity constraints at the Ministry of Finance, Libya will need substantial technical assistance to undertake these reforms.

55. The authorities’ plan to replace the current price subsidy system with a cash subsidy should be accelerated. Staff recommends that the new subsidy be well targeted and limited to the vulnerable segments of the population. It is also important that the authorities tackle the issue of the implicit subsidies. Staff welcomes the recent increase in electricity prices and encourages the authorities to increase gradually domestic petroleum product prices.

56. staff strongly urges the authorities to increase transparency and accountability in the operations of the ORF. This should be done through the enactment of a law that clearly states the ORF’s rules, objectives, and the agency that controls it. Also, the ORF’s accounts should be regularly reported and audited by an independent agency.

57. It is crucial that the authorities carry through their stated intention to reform the monetary and banking sector. For that purpose, the authorities are urged to incorporate in the new law on bank reorganization, currency, and credit MFD and LEG comments. In particular, the new law should clearly give the CBL full autonomy in the conduct of monetary policy. In this regard, urgent steps are needed to develop indirect monetary policy instruments, including the gradual liberalization of interest rate and the elimination of directed credits. It is also important to strengthen bank supervision and to ensure adequate asset classification and provisioning, in line with international best practices. Staff strongly supports the intention of the authorities to restructure and privatize public banks, allow foreign banks to operate in Libya, and their request for technical assistance from the Fund to reform Libya’s financial and banking sector.

58. Determining the proper exchange rate for the Libyan dinar is difficult in the current economic conditions. However, the relatively modest increase in the demand for foreign exchange and the absence of pressures on the exchange rate following the implementation of current account convertibility and the increased liberalization of the external trade are indications that the current rate of the Libyan dinar is broadly appropriate. Nevertheless, the authorities should be prepared to revalue the peg as necessary in response to market forces, while taking into consideration the need to preserve the economy’s competitiveness. Also, exchange rate policy will need to be kept under review as structural and macroeconomic reforms progress.

59. Despite the recent simplifications in Libya’s trade regime, effective trade protection remains high. The required reforms include the integration in the tariff rates of the taxes levied on imports, the streamlining of the tariff structure, gradual reduction in tariff rates, and the abolishment of the remaining state import monopolies.

60. Staff urges the authorities to reassess their decision to withdraw from the HIPC Initiative. It stresses that the success of the HIPC Initiative will require the participation of all creditors, including Libya.

61. The authorities need to increase their efforts to improve Libya’s statistical database, whose shortcomings seriously affect the capacity of the government to assess economic and financial conditions and the ability of staff to conduct effective surveillance. Staff encourages the authorities to look to the GDDS as a framework for statistical development and appoint a national coordinator to that effect.

62.In the period ahead, staff intends to intensify policy dialogue with the authorities with a view to assisting them in the development and implementation of an economic reform program. In this regard, staff will develop a technical assistance program in support of Libya’s economic reforms.

63. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

Glossary

AML

Anti Money Laundering

BPC

Basic People’s Congress

CBL

Central Bank of Libya

CPI

Consumer Price Index

FAD

Fiscal Affairs Department

GDDS

General Data Dissemination System

GDP

Gross Domestic Product

GPC

General People’s Congress

HIPC

Heavily Indebted Poor Countries

IBRD

International Bank of Reconstruction and Development

IFC

International Finance Corporation

IMF

International Monetary Fund

LEG

Legal Department

MCD

Middle East and Central Asia Department

MENA

Middle East and North Africa region

MFD

Monetary and Financial Systems Department

MIGA

Multilateral International Guarantee Agency

OPEC

Organization of Petroleum Exporting Countries

ORF

Oil Reserve Fund

PDR

Policy Development and Review Department

REEF

Real Effective Exchange Rate

TA

Technical Assistance

WEO

World Economic Outlook

WTO

World Trade Organization

Table 1.

Libya: Demographic, Social, and Human Development Indicators, 1997–2002

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Sources: World Bank’s World Development Indicators, 2002 and UNDP’s Human Development Report, 2002.

Middle East and North Africa (MENA) (16 countries): Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Jordan, Lebanon, Libya, Morocco, Oman, Saudi Arabia, Syria, Tunisia, West Bank and Gaza, and Yemen. 21 Population under the age of 15 and over the age of 65 as a share of the total working-age population.

Population under the age of 15 and over the age of 65 as a share of the total working-age population.

Human Development Indicators measures average achievements in basic human development in one simple composite index. Its value ranges from zero to 1.

The MENA region for HDI and GDI refers to 16 countries: Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, the UAE, and Yemen.

Gender Development Index (GDI) measures achievements in the same dimensions and uses the same variables as the HDI does, but takes account of inequality in achievement between men and women.

Table 2.

Libya: Basic Economic and Financial Indicators, 2000–05

(Quota = SDR 1,123.7 million)

Population (million):5.6 (2003)

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Sources: Libyan authorities and Fund staff estimates and projections.

Growth rates are related to GDP at factor cost.

Up to 2002, data reflect the authorities’ estimates, which in staff view could be over-estimated. For 2003 onwards, data are staff estimates and projections.

At official exchange rate prior to 2002.

The previous parallel market, and was legalized for some transactions in February 1999.

Table 3.

Libya: Consolidated Fiscal Operations, 2000–05

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Sources: Ministry of finance; and Fund staff estimates and projections.

Net of income taxes and includes the contributions to the social security fund.

ORF expenditure for 2003 and 2004 includes payments for the Lockerbie settlement of LD 1,388 million and LD 2,095 million, respectively.

Includes current and capital expenditures.

Data for 2004 do not include the government’s debt buyback operation.

Table 4.

Libya: Monetary Survey, 2000–05 1/

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Source: Central Bank of Libya.

Data include the local (“regional”) banks.

In 2004, data reflect the government’s debt buyback operation.

Table 5.

Libya: Balance of Payments, 2000–09

(In millions of US dollars; unless other indicated)

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Source: Central Bank of Libya; and staff estimates and projections.

Includes foreign partners’ oil share.

Includes partner’s profit remittances from oil investment.

For 2003 and 2004, includes payments for the Lockerbie Settlement of $ 1,076 million and $ 1,624 million, respectively.

Table 6.

Libya: Illustrative Medium-Term Scenario, 2000–09

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Sources: Libyan authorities; and Fund staff estimates and projections.
Table 7.

Libya: Indicators of External Vulnerability, 2000–05

(In percent of GDP; unless otherwise indicated)

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Sources: Libyan authorities; and Fund staff estimates.

The exchange rate was unified in January 2002.