The Socialist People’s Libyan Arab Jamahiriya
2005 Article IV Consultation: Staff Report; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund
Publication Date:
10 Apr 2006
eISBN:
9781451823073
Language:
English
Keywords:
ISCR; CR; government; Libya; net creditor position; oil revenue; financial situation; reform effort; privatization strategy; relief plan; General government operation; divestiture strategy
Download PDF (1 MB)

This 2005 Article IV Consultation underlies that in 2004, Libya’s macroeconomic performance was satisfactory, owing mainly to higher oil prices and increased oil output. Real GDP grew 4½ percent while consumer prices declined. The favorable developments in the oil market contributed to a significant improvement in the external current account surplus, which reached some 24 percent of GDP. In 2005, macroeconomic performance remained relatively strong. Real GDP growth was about 3½ percent, and inflation low. In contrast to previous years, economic growth is estimated to have been generated mainly in the non-oil economy.

Abstract

This 2005 Article IV Consultation underlies that in 2004, Libya’s macroeconomic performance was satisfactory, owing mainly to higher oil prices and increased oil output. Real GDP grew 4½ percent while consumer prices declined. The favorable developments in the oil market contributed to a significant improvement in the external current account surplus, which reached some 24 percent of GDP. In 2005, macroeconomic performance remained relatively strong. Real GDP growth was about 3½ percent, and inflation low. In contrast to previous years, economic growth is estimated to have been generated mainly in the non-oil economy.

I. Introduction and Recent Developments

1. Overcoming the long legacy of centralized economic management, excessive reliance on the public sector, and heavy dependence on oil poses a formidable challenge for Libya. Since the lifting of international sanctions, which lasted more than ten years, Libya has decided to undertake comprehensive structural reforms and accelerate its transition to a market economy.1 While progress has been made in recent years to liberalize the economy, the latter remains largely state controlled and not diversified. Three quarters of employment is still in the public sector, private investment is minuscule (2 percent of GDP), and the oil sector remains dominant.2 Libya’s social indicators are favorable by Middle East and North Africa (MENA) standards (Table 1).

Table 1.

Libya: Demographic, Social, and Human Development Indicators, 1998–2003

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Sources: World Bank World Development Indicators, 2005 and UNDP’s Human Development Report, 2005.

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.

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

Literacy rates are for 2002.

Human Development Indicators measures average achievements in basic human development in one simple composite index. Its value ranges from 0 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.

2. In 2004–05, Fund surveillance focused on the need to overhaul the incentive and regulatory regimes, reform trade, fiscal and monetary policies, restructure banks; and improve the reliability of economic data. During these years, the authorities passed new tax and banking laws, partially liberalized interest rates, streamlined the customs tariff, significantly improved business application procedures, and broadened the privatization program and the scope of foreign direct investment.

3. Fund relations with Libya have been stepped-up recently. Following the Executive Board’s decision in early 2005 to support Libya’s request for technical assistance from the IMF in support of the country’s economic and financial reform efforts, several IMF missions visited Tripoli to assess the country’s reform requirements and provide economic and financial advice.3

4. In July 2005, a staff team met with Libya’s Leader Qadhafi who stressed Libya’s determination to reform and modernize its economy, and praised the enhanced relationship with the IMF.

5. Libya’s cooperation with the World Bank has proceeded more slowly than was expected. However, prospects for resumed cooperation appear to have improved recently.4

II. Developments During 2004–05

A. Economic Developments in 2004

6. In 2004, Libya’s macroeconomic performance was satisfactory with strong economic growth and large fiscal and external current account surpluses, reflecting higher oil prices (31 percent) and increased oil output (5.6 percent) (Table 2, Figure 1). Overall, real GDP grew an estimated 4½ percent, with a 4 percent increase in the non-oil sector’s value added. Growth in the construction, utilities, and mining sectors reached 5 percent, boosted by increased government spending. Also, major gains were registered in the trade and service sectors (5–6 percent) as a result of the liberalization of external trade and the marked resumption of foreign tourism. According to official data, consumer prices declined by 2.2 percent (Table 2).5

Table 2.

Libya: Basic Economic and Financial Indicators, 2001–06

(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.

Previously the parallel market. It was legalized for some transactions in February 1999.

Figure 1.
Figure 1.

Libya: Real GDP and Inflation, 1999–2006

(Annual changes in percent)

Citation: IMF Staff Country Reports 2006, 136; 10.5089/9781451823073.002.A001

Sources: Libyan Authorities; and Fund staff estimates.

7. The fiscal stance continued to be expansionary, with a non-oil fiscal deficit of 33½ percent of GDP (Table 3, Figure 2). However, reflecting high oil revenues (about 51 percent of GDP) the overall fiscal surplus rose to about 17½ percent of GDP. Non-oil revenue increased by about 1 percentage point of GDP, owing to strong collections by customs, in conjunction with increased imports, and improvements in revenue administration. Total expenditure and net lending declined by ½ percent of GDP, as the surge in capital expenditure (8 percent of GDP), due to the implementation of a number of public projects,6 was more than offset by a sharp drop in extrabudgetary current expenditure.

Table 3.

Libya: Consolidated Fiscal Operations, 2001–06

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

The difference between total oil revenue and the ORF allocations represents the budgetary oil revenues.

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 1,404 million, respectively.

Corresponds to operations (net) not accounted for.

Figure 2.
Figure 2.

Libya: General Government Operations, 1999–2006

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 136; 10.5089/9781451823073.002.A001

Sources: Libyan Authorities; and Fund staff estimates.

8. Broad money grew 9.2 percent(Table 4, Figure 3). As a result of the improved government financial situation, the government’s net creditor position with the banking system was about 50 percent of GDP. Overall credit to the economy declined by 1 percent,7 resulting in the credit-to-GDP ratio declining to 21 percent from 28 percent in 2003.8 The CBL kept its refinance rate at 4 percent, but the economic relevance of monetary policy instruments, including interest rates, remained very limited, as lending and deposit rates were largely administered.

Table 4.

Libya: Monetary Survey, 2001–06 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.

9. The favorable developments in the oil market contributed to a significant improvement in the external current account surplus which reached about 24 percent of GDP. Oil export earnings increased by 41 percent to about US$20 billion, and non-oil exports, mainly petrochemicals, also increased markedly. Reflecting higher capital expenditures, imports grew 22 percent to US$8.8 billion. Overall, gross international reserves reached about 24 months of 2005 imports (Table 5, Figure 4).

Table 5.

Libya: Balance of Payments, 2001–10

(In millions of US dollars unless otherwise specified)

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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 US$1,076 million and US$1,080 million, respectively.

Figure 3.
Figure 3.

Libya: Monetary Indicators, 1999–2006

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

Citation: IMF Staff Country Reports 2006, 136; 10.5089/9781451823073.002.A001

Sources: Libyan Authorities; and Fund staff estimates.
Figure 4.
Figure 4.

Libya: External Sector, 1999–2006

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 136; 10.5089/9781451823073.002.A001

Sources: Libyan Authorities; and Fund staff estimates.

B. Economic and Policy Developments in 2005

Economic developments

10. In 2005, macroeconomic performance remained relatively strong. Real GDP growth was about 3½ percent, and the fiscal and external current account surpluses are estimated at 32½ percent and 41 percent of GDP, respectively. For the first time since 1999, official data show positive consumer inflation of about 2.5 percent.

11. Contrary to previous years, overall economic growth in 2005 is estimated to have been generated mainly in the non-oil economy (4½ percent). While activity in the oil sector grew only 1½ percent due to output capacity constraints, pick-up in the nonhydrocarbon sector’s activity was essentially the result of increased government expenditure. The main sectors that registered strong growth include trade, hotels, and transportation (7 percent); and construction and services (5 percent). Gains in agriculture remained modest (2.5 percent), but the manufacturing sector registered its first positive growth in five years (1.8 percent).

12. Based on preliminary data, oil revenues reached 68 percent of GDP. Non-oil revenue is estimated to have declined by about 15 percent because of the nontransfer of the interest on the Oil Reserve Fund (ORF) balances by the CBL, and lower collections by customs and local governments, partly reflecting the downside effects of the new tax law and customs tariff.9 Excluding the payments for the Lockerbie settlement, government spending increased by about 33 percent, reflecting a sharp increase in the wage bill (25 percent) and an improved execution of the development budget. The non-oil fiscal deficit widened to 35 percent of GDP.10

13. Monetary developments were characterized by strong broad money growth (29 percent). Both money and quasi-money grew markedly, by 33 percent and 20 percent, respectively. These developments reflected a remonetization of the economy consistent with improved domestic economic conditions and increased public confidence following the lifting of sanctions, and the sharp increase in credit to public enterprises (23 percent).11 Overall, the commercial banks remained highly liquid and increased their excess reserves with the CBL.12 With the sustained improvement in the government’s financial situation, the government’s net creditor position with the banking system reached 70 percent of GDP. While bank credit to the private sector grew only modestly (about 3 percent), most of the private sector credit needs were met by the government through specialized banks.13

14. On the external side, the widening of the current account surplus reflects mainly strong hydrocarbon exports, which increased by 48 percent to about US$29 billion. Imports grew 24 percent to some US$11 billion, boosted by increased domestic demand. Overall, gross international reserves rose to about 32 months of 2006 imports.

15. Since January 2002, the Libyan dinar has been pegged to the SDR. Reflecting the movements in the U.S. dollar/Euro rate, the exchange rate of the Libyan dinar depreciated by a cumulative 4 percent against the US dollar in 2004–05. During the same period, the Real Effective Exchange (REER) based on the official CPI rate declined by 7 percent (Figure 5).

Figure 5.
Figure 5.

Libya: Exchange Rate Developments, 1999Q1–2005Q3

(End-of-Period)

Citation: IMF Staff Country Reports 2006, 136; 10.5089/9781451823073.002.A001

Sources: 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.

Policy developments

16. In 2005, the authorities continued to implement measures to reform and open up the economy. The government significantly streamlined the customs tariff, and eased restrictions on external trade by downsizing the negative import list from 31 items to 17 items. The new tariff schedule has only two rates (10 percent for tobacco products and 0 percent for all other products), but all imported goods are now subject to a 4 percent service fee. In the meantime, the production and consumption tax was increased to 25–50 percent for imported goods and reduced to 2 percent for domestically produced goods.14 Also, the government created an investment fund (IF) to manage part of the government’s oil revenues.

17. In the monetary and banking area, the authorities passed: (i) a new banking law which reinforces the independence of the CBL and gives it authority to allow foreign banks to operate in Libya; and (ii) an Anti Money Laundering (AML) law. As of August 2005, banks were granted autonomy to determine freely interest rates on deposits and to set lending rates within a band of 250 basis points above the discount rate (currently at 4 percent). In practice, owing to high bank liquidity, deposit rates remained generally low, in the order of 1–1½ percent, while there were no pressures on lending rates. Also, the CBL issued a number of decrees to improve the operations of commercial banks, launched the privatization of Sahara Bank, and recapitalized three of the five commercial banks it owns.

18. As regards structural reform, major progress has been made in simplifying business application procedures in order to facilitate and accelerate business creation. In particular, a one-stop window has been established and a 30-day limit for application approval set with the obligation for the administration to notify any refusal through a notary public. The privatization program and foreign investment’s scope of activity have been broadened to include downstream activities in the oil, health, transportation, and insurance sectors. Also, joint ventures between Libyan and foreign investors are now permitted to benefit from the incentives of Law 5.15 Overall, a total of 216 enterprises have been slated for privatization and 144 are to be liquidated. Thus far, 66 small enterprises have been sold.

19. Concerning external debt, Libya has taken steps toward regularizing its relations with external creditors. In 2004–05, disputed claims with creditors in Germany, Spain and the United Kingdom have been settled. Discussions with other foreign creditors are ongoing. These claims pertain to disputed payments resulting from the imposition of UN sanctions on Libya.

20. Following its withdrawal from the HIPC Initiative, Libya has developed its own debt relief plan. By end-2005, rescheduling agreements were reached with a number of HIPC countries including Uganda, Tanzania, and Benin, and negotiations with Nicaragua were ongoing. The authorities provided staff with detailed information on Libya’s claims on other countries. They indicated that Libyan law does not allow the government to cancel the principal of any outstanding loan. Because of this limitation, the authorities’ relief plan relies on various modalities, including debt to equity/real estate swaps, rescheduling of principal and interest cancellation.

III. Report on The Discussions

A. Medium-Term Outlook

21. Macroeconomic policy discussions focused primarily on the need to reform the economy and strengthen capacity building in order to set the stage for sustainable growth of the non-oil economy and increase job creation. While the authorities did not elaborate on their medium-term economic development plan, which is at an early stage of preparation, they reaffirmed their determination to implement structural reforms and enhance the role of the private sector in the economy.

22. Staff agreed with the authorities that Libya’s financial outlook for the medium term does not raise any sustainability concerns, owing mainly to the projected favorable developments in the oil sector. However, it stressed that the economic outlook—mainly the expansion of the non-oil economy and job creation—will depend largely on the reforms that would be implemented by the authorities. Staff pointed out that continuation of current policies characterized by uncoordinated reform measures is likely to result in subdued economic growth over the medium term. It argued that the growth of the non–oil economy in recent years was mainly driven by fiscal stimulus and is not sustainable if not supported by comprehensive structural reforms, which remain the best recipe for increased investment and sustained economic growth.

23. Staff presented its macroeconomic projections based on the continuation of current policies, which indicate that during 2006–10, real GDP growth would be about 4.5 percent per year on average, reflecting an average annual growth rate of about 7 percent in the oil sector and modest growth in the non-oil economy of 3¼ percent per year on average.16 Annual CPI inflation is projected to stabilize at 3–4 percent, assuming there is no slippage in the fiscal stance. Both the fiscal and external current account balances will continue to register large annual surpluses, averaging about 35 percent and 41 percent of GDP, respectively. The build-up of these surpluses reflects the limited absorptive capacity of the economy, particularly the projected low investment and growth levels (Table 6).

Table 6.

Libya: Illustrative Medium-Term Scenario, 2001–10

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

24. Although the medium-term outlook is based on historically high levels of oil price and production assumptions, the downside risks are somewhat limited. Indeed, on the assumption of an oil price that is US$15 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 22 percent and 27 percent of GDP, respectively (Figure 6).17

25. Staff stressed that the projected trends underscore an increase in Libya’s already high dependency on oil, with large non-oil fiscal deficits (about 29 percent of GDP on average), and very modest non-oil private investment (2 percent of GDP). It noted that the projected levels of growth and investment in the non-oil sector are among the lowest in neighboring countries and other oil countries, well below the country’s potential, and not sufficient to generate enough employment opportunities for the rapidly increasing Libyan labor force (about 4 percent per year).18

Figure 1.
Figure 1.

Libya: Sensitivity Analysis, 2005–10

Citation: IMF Staff Country Reports 2006, 136; 10.5089/9781451823073.002.A001

Sources: Libyan authorities; and Fund staff estimates.1/ Overall fiscal balance is close to zero.2/ External current account surplus is close to zero.

26. In order to address the above challenges and improve the country’s economic prospects, staff recommended the development of a comprehensive reform program. To that effect, it submitted for the authorities’ consideration a draft Medium-Term Strategy (MTS) to reform the economy that it had prepared at their request. The MTS’s various components constituted staff’s core recommendations (Box 1).

27. The authorities were in broad agreement with staff’s assessment, but did not indicate whether and when they will start implementation of the proposed reforms. Staff agreed with the authorities that given the magnitude of the challenges and social constraints faced by Libya, prioritization and sequencing of reforms and technical assistance support were key for the success of the proposed strategy.

B. Fiscal Policy

28. The authorities highlighted their relative spending restraint in recent years, stressing that high oil prices have not led to spending booms. Staff concurred with the authorities’ assessment, and welcomed their decision to eliminate extrabudgetary spending from the ORF.19 However, it emphasized the need to strengthen the budgetary process which continues to suffer from lack of transparency, the persistence of netting-out operations, and the absence of medium-term planning. In this context, the authorities indicated their strong resolve to address the netting-out issue in 2006.

29. The authorities indicated that their import tariff reform of August 2005 has been well received by the private sector. Staff noted that while this reform is expected to boost trade and economic growth, it could also result in short-run revenue loss that would add to the shortfalls already expected from the new tax law. The possible revenue loss would need to be partly offset by broadening the tax base and increasing efficiency in revenue collection.20 Consequently, staff encouraged the authorities to implement staff’s recommendations on strengthening tax policy and revenue administration. The authorities indicated that they have already started to implement staff’s recommendations on revenue administration and requested follow-up TA in this area.

30. Staff reviewed progress in the implementation of the government’s LD 3 billion multi-year lending program financed with ORF resources through the specialized banks.21 Staff reiterated its recommendation that this operation be undertaken through the commercial banks and that any interest rate subsidy be granted through the budget. The MoF agreed with staff, but pointed to the CBL’s reluctance to have the commercial banks finance this program as the main reason for its undertaking through the specialized banks.22 The CBL argued that because of the lack of collaterals and guarantees, the commercial banks would not be able to recover these loans. Staff urged the CBL and the MoF to work out a mechanism that would allow the commercial banks’ participation in this program.

31. Staff reviewed a summary of the draft current and development budgets for 2006, which point to an increase in expenditure of about 17 percent. It agreed with the authorities on the need to increase public expenditure in order to start addressing the population’s considerable social needs. To that effect, it recommended that the large part of this increase be dedicated to raising education and health standards, developing physical infrastructure, funding greater targeted social outlays, and clearing all government arrears.23 Staff stressed, however, that because of the economy’s limited absorptive capacity, due attention should be given to the potential inflationary impact of the proposed increase in government spending. Also, staff emphasized the need to (i) increase the execution rate of the government’s investment program; and (ii) improve the quality of spending by streamlining project preparation and selection, and enhancing monitoring of project execution. Staff projects that for 2006 the overall fiscal surplus will reach about 38 percent of GDP, with a non-oil fiscal deficit of about 29 percent of GDP.24

Libya: Proposed Medium-Term Economic Reform Strategy 25

The Medium-Term Strategy (MTS) to reform Libya’s economy proposed by staff aims to maintain macroeconomic stability and rationalize the use of the country’s oil wealth, accelerate the transition to a market economy, and establish a solid basis for the development of the non-oil economy. It could be implemented over a 5–6 year period in two phases of 2–3 years each.

I. Phase I (2006–08): During this phase, priority should be given to accelerating the transition to a market economy by (i) consolidating public finances and streamlining budgetary management; (ii) developing indirect monetary instruments and enhancing the role of the central bank; (iii) removing remaining external trade restrictions; (iv) completing price liberalization and rationalizing the subsidy system; (v) implementing a vigorous and coherent privatization program; and (vi) improving the business climate. The main recommended reforms include:

I.1. Public finance

  • Develop a unified consolidated budget under the responsibility of the ministry of finance (MoF); establish a stabilization and savings fund; modernize the treasury system; strengthen budgetary procedures; develop medium-term expenditure frameworks, reform the procurement code; and strengthen preparation and monitoring of the public investment programs.

  • Simplify the tax system; develop tax payment arrangements for corporations; reduce tax rates; limit exemptions; restructure the tax and customs departments; establish a large taxpayer unit; upgrade controls; strengthen human resource development; and upgrade office buildings and equipment.

  • Undertake a census of the civil service and a study of the social security system.

I.2. Monetary reforms and bank restructuring

  • Terminate directed credit allocations; fully liberalize interest rates; put credit subsidies on budget; issue CBL bills; and allow commercial banks to issue CDs.

  • Upgrade on-site and off-site supervision; improve the accounting and financial reporting systems; strengthen credit risk assessment; strengthen the prudential supervisory framework and include specialized banks; and develop capacity building and staff training.

  • Transfer public banks’ ownership to a bank restructuring agency; consolidate the 48 regional banks into one entity; complete the due diligence process; start the restructuring/privatization process of the state-owned banks; and develop a plan to open up the banking sector to external competition.

  • Reform existing legislation on accounting and bookkeeping, and bankruptcy, in line with international standards; and complete the modernization of the payment system.

I.3. Structural reform

  • Abolish remaining state import monopolies; replace nonreligious and non-health-related import bans with import tariffs; simplify customs procedures; and bring institutions, laws, and regulations related to international trade and investment in line with international standards.

  • Remove the remaining controls on price and profit margins; put all subsidies on budget and develop a plan to gradually reduce them over time.

  • Strengthen the independence of the privatization agency, and enact a privatization law.

  • Amend the foreign investment law: use a negative list; streamline the approval process; regroup all tax incentives in the tax code in order to harmonize tax incentives across all investors; and replace tax holidays or exemptions by tax credits, tax allowances, or accelerated depreciation.

  • Develop a plan to reform the education and health systems; undertake a study on poverty; and develop a social safety net for the segments of the population most affected by structural reform.

  • Create a national statistical council; establish a national statistical agency; and prepare a multi-year statistical work program, including a multi-year recruitment and training program.

II. Phase II (2008–10): During this phase, the focus will be on consolidating the reform process by (i) advancing economic diversification and promoting sectoral reforms in the agricultural, industrial, and services (including tourism) sectors; (ii) reforming the civil service and the social security system; (iii) further strengthening the social safety net; and (iv) improving governance. As several of these reforms require major technical work and large consensus building, preparations should start early in the reform process, so that implementation begins before the end of the first phase of reforms.1/

II. 1. Economic diversification and sectoral policies

  • Build up a sound investment climate; complete the privatization program; complete the restructuring of the banking system and develop financial markets; develop a land reform plan and revamp the existing legal framework for industrial land; reform the labor code; improve government services in the agricultural sector, and improve rural infrastructure.

II. 2. Civil service, social sectors, and governance

  • Initiate a reform of the civil service; implement comprehensive reforms in the education and health sectors; and develop a reform package to restructure and strengthen the social security system.

  • Strengthen the institutional framework by establishing a strong and independent audit agency and an efficient judiciary.

III. Implementation of the MTS, Fund technical assistance and other

  • Implementation of the MTS will require its decomposition into annual programs, including the required technical assistance for the implementation of the recommended reforms and a performance monitoring system.

  • Regarding the provision of Fund TA, available options include (i) the placing of short and long-term resident advisors; and/or (ii) frequent visits from the Fund’s functional departments and METAC staff. Libya would have to cover most of the cost of the TA arranged/provided by the Fund.

  • The establishment of a High Inter-Ministerial Economic Team (HIT) to coordinate the government’s reform efforts is key to the success of the MTS. The HIT could be aided in its task by a technical committee responsible for data collection and analysis, and technical policy formulation.

  • The sustainability of the reform process requires that the government establish a permanent and constructive dialogue with civil society, including the business community, in order to explain and, hence, increase adherence to and effectiveness of its policies.

1 Given that many of the reforms in Phase II (and some in Phase I) fall in the World Bank’s areas of expertise, the authorities are encouraged to seek the Bank’s assistance for their design and implementation.

32. The authorities agreed with staff that the establishment of a Stabilization and Savings Fund (SSF) to replace the ORF and the IF, is key to strengthening management of the country’s oil wealth and maintaining macroeconomic stability.26 They argued, however, that establishing the SSF by law would take up to two years, as this would require that the draft law be discussed by the country’s Basic People’s Congresses (BPCs), before it is sent to the General People’s Congress (GPC).27 Also, they disagreed with staff’s recommendation not to allow the SSF to invest domestically. Staff argued that all public investment should be channeled through the budget. In addition, investing the SSF’s resources abroad would be consistent with the government’s divestiture strategy and could be justified by the need to sterilize these resources in order to avoid the transmission of oil-revenue volatility to the economy. Staff noted that the two draft decrees on the SSF prepared by the MoF and the CBL needed significant revisions in order to meet the requirements for a successful SSF.28 It reiterated the need to establish an SSF along the lines it recommended. In particular, the law establishing the SSF should state the nature and source of its resources and the rules governing the accumulation and use of these resources; and stipulate guidelines for the establishment of operating and asset management regulations.29

33. Finally, staff discussed the medium-term fiscal outlook, and expressed its concern that the authorities continue to use the civil service to reduce unemployment. Also, it stressed that while the government’s overall fiscal position is projected to remain comfortable, mainly as a result of strong oil revenues, the structure of the budget needs to be rationalized and fiscal policy geared toward maintaining macroeconomic stability. To that effect, three categories of reforms are required, including measures to (i) bring total control of fiscal policy under the responsibility of the ministry of finance and improve transparency in government operations; (ii) enhance the quality of government spending and broaden the non-oil tax base; and (iii) improve the management of the country’s oil wealth in order to reduce the overall fiscal vulnerability to oil shocks. The authorities agreed with staff’s recommendations, and recognized the need for a comprehensive reform of the civil service. They indicated that working groups would be established to implement the recommended measures.30

C. Monetary Policy and Financial Sector Development

34. Staff welcomed the CBL’s recent partial liberalization of interest rates as an important first step in the CBL’s progressive move to indirect monetary management. In view of the success of this first phase, it advocated a swift shift to full interest rate liberalization, stressing that the banks and the MoF would need to work out a mechanism to address the issue of interest rate subsidies. Staff encouraged the CBL to press ahead with other market-based monetary reforms, starting with the issuance of CDs, and the reactivation of the interbank money market as a first step toward the development of open market operations. It also recommended that the CBL reinforce its daily monetary management, and improve its economic monitoring capabilities. The CBL agreed with staff’s recommendations and reiterated its request for the posting of a long-term advisor to support its reform efforts. Also, it requested Fund TA to develop a CD market.

35. The CBL noted the progress made in implementing its plan to strengthen banking supervision developed with the assistance of the Fund’s Middle East Technical Assistance Center (METAC). It expressed its satisfaction with METAC’s TA and requested that it be maintained in 2006. The CBL’s plan aims to upgrade and improve the on-site and off-site inspection systems, develop new key prudential regulations in line with Basel requirements and international best practice, and strengthen capacity building. Achievements so far include developing a new set of financial statements consistent with International Financial Reporting Standards; upgrading loan classification and provisioning, and credit filing; and improving liquidity risk management.

36. On bank restructuring, the CBL indicated that its decision to recapitalize some of the commercial banks and tackle the nonperforming loans issue aims to strengthen the banks’ balance sheets and enhance their attractiveness for privatization. Staff argued that these actions should have been part of a more diligent restructuring program. To that end, it urged the authorities to reconsider their overall approach, stressing that the lack of interest by the private sector in the privatization of Sahara Bank is already an indication that this approach is not appropriate.31 Accordingly, staff recommended that the restructuring/privatization of the state-owned banks be done along the lines of the strategy developed by the MFD TA mission on bank restructuring of June 2005.32 In particular, staff stressed that the establishment of an independent bank restructuring agency that would take over ownership of public commercial banks is a critical condition for the success of the proposed strategy. In view of the above, staff recommended that the privatization of Wahda Bank, currently at an advanced preparation stage, be delayed.

37. The authorities were appreciative of the IMF’s comments on Libya’s recently passed AML law. They indicated their intention to request Fund TA in order to amend the law along the lines recommended by staff.

D. Exchange Rate and Article VIII Issues

38. Staff agreed with the authorities that the current exchange rate regime is serving Libya well, and the current rate of the Libyan dinar is broadly appropriate; the fact that non-oil exports are currently low reflects mainly lack of structural reform and investment, rather than an overvaluation of the exchange rate. This view was shared by the Chairman of the Chamber of Commerce who confirmed the absence of a parallel exchange rate market, or any delay or restriction on access to foreign exchange for current account transactions.33 Staff recommended, however, that the authorities closely monitor the dinar’s exchange rate and be prepared to change the level of the peg as necessary to absorb shocks and avoid real appreciation. To that effect, staff stressed the importance of developing better data on the non-oil economy, in order to better assess its competitiveness.

39. For the medium term, as structural and macroeconomic reforms progress and the non-oil economy starts to develop, staff recommended that the authorities consider the feasibility of switching to a more flexible exchange rate regime. This would give them more room to maneuver in response to sharp changes in oil prices and better accommodate the development of the non-oil economy. To keep the authorities’ options regarding the exchange rate regime open, staff advised them to start developing the needed institutions, including in foreign exchange markets and risk management and intervention policies, that will allow them to move to a more flexible exchange rate regime.

40. 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, LEG and MFD are awaiting the necessary clarifications from the authorities before the review can be completed.

E. Trade Reform

41. Staff welcomed the progress that has been made in reforming and simplifying the trade system. It encouraged the authorities to take advantage of the country’s strong balance of payments to further liberalize external trade and terminate the remaining state import monopolies. In particular , staff argued that the recent increase in the consumption tax on imported commodities exacerbates the discriminatory nature of this tax and raises protection, while reducing transparency in import duties and probably aggravating governance problems by limiting competition and encouraging smuggling. Staff stressed that this tax was not consistent with the national treatment under the WTO basic principle, and recommended that it be integrated into the tariff rate structure, and gradually eliminated at a later stage.34 Also, staff recommended that competition be allowed in key sectors, including telecommunications and transportation.

42. The authorities are aware that WTO accession discussions will place a high demand on administrative resources. In this connection, they have formed a working group to undertake a thorough review of all laws, regulations, and policies that affect international trade and investment, and prepare the Memorandum of the Foreign Trade Regime. In order to speed-up this process, staff encouraged the authorities to seek technical assistance from foreign experts, including World Bank experts, who have helped other countries in similar processes.

F. Pricing and Subsidy Policies

43. Staff confirmed that state-owned companies now face competition from the private sector, which can freely import or produce goods that were previously under public monopoly.35 It urged the authorities to officially abolish the price and profit margin controls which still remain in a number of markets but are not enforced. Staff agreed with the authorities that a limited number of goods which are not sufficiently exposed to competition could remain under a temporary pricing formula, but recommended the establishment of a timetable for the gradual elimination of this pricing option.

44. Staff encouraged the authorities to gradually streamline the subsidy system (Box 2).36 It recommended that the energy and water subsidies be tackled by first undertaking a comprehensive study to assess their size and distribution by main recipients; and at a later stage, implementing a plan to reduce them over time. Staff agreed with the authorities that given its political sensitivity, the reduction of these subsidies could only be gradual and in conjunction with the development of a social safety net. As a first step in that direction, the authorities raised prices of domestic petroleum products in 2005 by 22 percent on average. As regards food subsidies, staff advised the authorities to continue their campaign to garner public support for their plan to replace the current system with a cash subsidy, which was rejected by the BPC in early 2005. The authorities indicated that they remain confident that, as the public debate develops, there will be more support for their proposed reform.

G. Privatization and Foreign Direct Investment (FDI)

45. Staff stressed that encouraging private sector development, and in particular strengthening Small and Medium Enterprises (SMEs), is key to promoting economic diversification, an objective that will require long and sustained efforts. To that effect, it recommended that priority be given to enhancing the government’s privatization strategy, removing all the remaining monopolies and other impediments to economic competition, and attracting foreign investment.

46. As regards the strengthening of the government’s privatization strategy, staff stressed the need for (i) enacting a privatization law that would give the privatization agency a legal existence and an explicit mandate; (ii) allowing investors to acquire a significant share of capital and have corporate control over the privatized companies; and (iii) basing the sale process on competitive bidding.

Quasi-fiscal Deficit in the Energy Sector, 2004

Libya is endowed with considerable energy resources, with proven oil and natural gas reserves estimated at about 39 billion barrels and 1.5 trillion cubic meters, respectively. Because energy prices are very low, energy consumption remains high, and is among the highest in the Maghreb countries.

There is a large quasi-fiscal deficit in the electricity sector, as measured by the difference between the cost recovery price-value of energy delivered to users and actual revenue.1/ It includes commercial losses due to nonbilled consumption, nonpayment, and technical losses. The collection rate is 59 percent, and technical losses are 11 percent. The government increased electricity prices in June 2004 for the first time in seven years; the increase on average was 30 percent for households and 45 percent for businesses and municipalities. For other sectors, prices remained unchanged.

The quasi-fiscal deficit for natural gas and petroleum products measures the difference between domestic prices and international prices.

Quasi-Fiscal Deficit in the Energy Sector, 2004

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Sources: The Libyan authorities; and staff estimates.

Based on a cost of US 17 cents per kwh.

47. Staff welcomed the authorities’ decision to broaden the scope for FDI, but warned that the impact of this reform would be limited if not supplemented by additional key reforms to improve the business climate and encourage foreign investment and technology. The latter include (i) removing the US$50 million floor on foreign investment, a requirement that disqualifies most foreign investments in the non-oil sector; (ii) replacing the current system of a positive list with a clear negative list; (iii) simplifying procedures and speeding-up the approval and registration process; and (iv) promoting a more competitive business environment by fostering easier access to land and strengthening bankruptcy laws.

H. Strengthening the Statistical System

48. Libya’s statistical system remains weak, which requires the development of an effective long-term program of reforms to strengthen the institutional framework and build-up a strong and reliable statistical system. Key reforms recommended by staff include (i) establishing a National Statistical Council that would ensure coordination among data producing agencies, discuss and approve the national statistical work program, and monitor progress in building a high quality statistical system; (ii) creating a National Statistical Agency with the authority to produce and disseminate official statistics and coordinate the national statistical work program; (iii) increasing financial resources devoted to statistical activities and strengthening human resource development and training; and (iv) participating in the IMF’s General Data Dissemination Standards (GDDS), and using the latter as a framework for statistical development. The authorities agreed with staff’s recommendations and requested a resident advisor on national income accounts.37 In February 2006, they officially announced their participation in the GDDS and appointed a national GDDS coordinator.

I. Other Issues

49. The authorities informed staff that they have started to implement their own debt relief plan for Libya’s poorest debtors, including HIPC countries. They restated their position that they could not bypass the BPC’s decision to reject Libya’s participation in the HIPC Initiative. Staff reiterated its recommendation that Libya reconsider its withdrawal from the HIPC Initiative and integrate its debt relief plan in the multilateral framework of the latter.

50. The authorities informed staff that they intend to participate in the financing of the Exogenous Shocks Facility (ESF). Staff provided the authorities with the additional information they requested on this facility.

51. Staff reiterated its earlier recommendation to establish a high inter-ministerial oversight committee that will be in charge of coordinating the government’s reform efforts. Such a committee will help clarify the reform responsibilities of the CBL and the MoF and ease the current tensions between these institutions.

52. Staff discussed the issue of Libya’s TA needs and their financing, and informed the authorities about the two available options: (i) the TA provided by the IMF would be on reimbursement basis; or (ii) Libya could establish at the IMF a TA-sub-account that would be used to finance the TA provided and/or arranged by the IMF. The authorities agreed to cover most of the cost of the country’s required TA needs, and indicated that they will inform staff about their preferred option at a later stage.

IV. Staff Appraisal

53. There have been some encouraging developments in Libya since the freezing of the UN sanctions in 1999. Macroeconomic performance has been increasingly strong, aided by a favorable external environment, and various reform measures to liberalize the economy have been implemented. Progress in developing a market economy has been slow and discontinuous nonetheless, and the government has yet to clearly break from past shortcomings in policy formulation and implementation.

54. Libya’s economic and financial conditions are expected to remain favorable in the short to medium run, owing mainly to positive prospects in the world oil market, but the outlook for the non-oil economy remains mixed. While the projected expansion of the oil sector is expected to impact positively on the rest of the economy, the latter will, however, continue to operate below its potential if the weaknesses of the government’s reform approach are not redressed.

55. Prospects for far-reaching economic reform in Libya have improved significantly since the 2004 Article IV consultation. However, overcoming the long legacy of centralized economic management and heavy dependence on oil poses a formidable challenge to the government, requiring a well calibrated reform strategy, strong technical capacity, and enhanced intra-governmental coordination—all requirements that Libya has yet to meet. To that effect, the authorities are urged to adopt the measures to reform Libya’s economy proposed by staff in the MTS. To avoid overstretching the already limited administrative capacity, prioritization and sequencing of reforms, better intra-governmental coordination, and a comprehensive technical assistance program in support of the recommended strategy are needed.

56. In the fiscal area, improving budgetary management and control and implementing a prudent fiscal policy are key to maintaining macroeconomic stability. To that effect, control of fiscal policy should be brought under the responsibility of the ministry of finance by unifying the government’s budgets and officially abolishing all extrabudgetary operations. Given that very large fiscal surpluses are being generated at the same time that basic social needs have not been met adequately, staff supports an increase in public expenditure on basic infrastructure and social services, taking into account absorptive capacity. At the same time it is crucial to promptly eliminate all outstanding government arrears, including arrears toward the social security fund and the electricity company. Also, it is important to bolster institutional capacities and accountability in order to ensure increased spending efficiency. In particular, budget preparation, execution, and monitoring need to be considerably reinforced, and budgetary discipline enhanced.

57. As part of the proposed reform strategy, the ORF and the IF need to be replaced by a Savings and Stabilization Fund (SSF), with strict rules governing its revenue and expenditure policies. Such rules need to be fully enforced, and assessment of performance would need to be done periodically.

58. The CBL’s partial liberalization of interest rates is welcome as an important first step in the CBL’s gradual move to indirect monetary management. Staff encourages the authorities to fully liberalize interest rates and to press ahead with other needed monetary reforms, including eliminating directed credit, issuing CDs, and reactivating the interbank money market. It is also important to continue to strengthen bank supervision and to ensure adequate asset classification and provisioning, in line with international best practices.

59. The authorities’ bank restructuring approach needs to be reconsidered in light of the recommendations of the June 2005 MFD TA mission on bank restructuring. In particular, the establishment of an independent bank restructuring agency that would take over ownership of public commercial banks is a critical condition for the success of the proposed reform strategy.

60. The current exchange rate regime is serving Libya well and 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.

61. Progress continues to be made in reforming the trade regime. However, additional reform measures are needed, including terminating the remaining state import monopolies, and integrating all taxes and fees on imports in the tariff rates and undertaking a gradual reduction in the latter. In order to speed up preparations for WTO accession discussions, the authorities are encouraged to seek technical assistance from outside experts, including World Bank experts, who have helped other countries in similar processes.

62. Promoting economic diversification remains an objective that will require long and sustained efforts. Priority should be given to enhancing the government’s privatization strategy and attracting foreign investment. Also, it is necessary to enact a privatization law, and, for foreign investment, use a clear negative list and remove the US$50 million floor.

63. Libya’s statistical system is in need of a thorough restructuring. In this process, priority should be given to the establishment of a National Statistical Council to improve coordination among data producers, and the creation of a National Statistical Agency with the authority to produce and disseminate official statistics. While data provision is adequate for overall surveillance purposes, data shortcomings remain in some key areas.

64. There is an urgent need to establish a high inter-ministerial oversight committee that will be in charge of coordinating the government’s reform efforts. This committee will be key for the successful implementation of the recommended reforms.

65. Staff welcomes the authorities’ intention to participate in the financing of the ESF and encourages them to make their decision official. Staff reiterates its recommendation that Libya reconsider its withdrawal from the HIPC Initiative and integrate its debt relief plan in the multilateral framework of the latter.

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

APPENDIX I Libya: Fund Relations

(As of December 31, 2005)

I. Membership Status: Joined 09/17/58; Article VIII

II. General Resources Account:

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III. SDR Department:

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