Lebanon
Report on Performance Under the Program Supported by Emergency Post-Conflict Assistance
Author:
International Monetary Fund
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Publication Date:
30 Nov 2007
eISBN:
9781451822724
Language:
English
Keywords:
ISCR; CR; Banque du Liban; deposit; June; financing; donor disbursement; end-June monitorable action; BdL's balance sheet; liabilities of the central bank; market condition; monitorable action
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This report on Lebanon’s Performance Under the Program Supported by Emergency Post-Conflict Assistance analyzes the economic situation and financial system. The economic situation continues to be overshadowed by the political stalemate and episodes of violence. The recent turbulence in international financial markets has not had a significant impact on Lebanon. It is important to restore promptly the revenue source, which constitutes a key measure in the authorities’ fiscal adjustment strategy. The ongoing work by the new cash management unit to establish a cash flow plan is encouraging.

Abstract

This report on Lebanon’s Performance Under the Program Supported by Emergency Post-Conflict Assistance analyzes the economic situation and financial system. The economic situation continues to be overshadowed by the political stalemate and episodes of violence. The recent turbulence in international financial markets has not had a significant impact on Lebanon. It is important to restore promptly the revenue source, which constitutes a key measure in the authorities’ fiscal adjustment strategy. The ongoing work by the new cash management unit to establish a cash flow plan is encouraging.

I. Background and Recent Developments

1. There are as of yet no signs of a solution to Lebanon's political deadlock, which stems from both deep internal divisions over power sharing and geopolitical tensions. Mediation attempts by the Arab League and France have so far failed to produce a compromise. Parliament is expected to be convened on September 25 to elect a new president, but absent a quorum (if the opposition stays out) the process will possibly stretch out until President Lahoud's term ends on November 25. Failure to elect a president could result in the formation of two parallel governments—the governing coalition could remain in power, while the outgoing president could appoint a new prime minister. While all parties have vowed to refrain from violence, the security situation remains tense.

2. The economic situation continues to be overshadowed by the political stalemate and episodes of violence, including the assassination of an MP and the armed confrontation between the army and Islamic militants in the North. In this environment, economic activity, including tourism, remains subdued, and real GDP is expected to rebound only slowly to achieve a moderate increase of about 2 percent in 2007, somewhat higher than envisaged in the program (Figure 1 and Table 1). Following price pressures in the summer of 2006 arising mainly from the conflict with Israel and the ensuing blockade, CPI inflation declined through mid-2007 and, on current trends, should fall to around 2 percent by year's end.

Figure 1.
Figure 1.

Lebanon: Recent Developments, January 2005–July 2007

Citation: IMF Staff Country Reports 2007, 371; 10.5089/9781451822724.002.A001

Sources: Lebanese authorities; J.P. Morgan; Bloomberg; and Fund staff calculations.1/ Coincident indicator is a composite indicator of economic activity monitored by the central bank.2/ Defined as gross international reserves minus principal and interest due over the next 12 months on all foreign currency liabilities of the central bank to entities other than the government of Lebanon. Excludes long-term foreign exchange liabilities of the central bank.
Table 1.

Lebanon: Selected Economic Indicators, 2003–08

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Sources: Lebanese authorities; and Fund staff estimates.

Defined as cash in circulation plus resident and non-resident deposits.

Short-term debt on a remaining maturity basis.

3. The financial system remains resilient to the political uncertainty. Owing to moderate capital inflows (and slow deposit growth), as well as limited donor disbursements, gross international reserves declined by $300 million to $11 billion in the first quarter. However, deposit growth has accelerated since then, and by end-June broad money was already 4½ percent higher than prior to the conflict with Israel, with international reserves recovering to $11.6 billion. Still, the economy is highly vulnerable to swings in confidence, and the political deadlock has increased risks, as reflected by Eurobond spreads (459 basis points as of August 29) and deposit dollarization (at around 76 percent), which remain substantially higher than prior to the 2006 conflict. The recent turbulence in international financial markets has not had a significant impact on Lebanon. While spreads have increased by around 80 basis points between mid-July and mid-August, there has been no pressure on the currency, and deposit inflows have remained robust though at a more moderate pace than in the second quarter.

II. Performance Under EPCA

4.All the quantitative targets for the first and second quarters of 2007 were observed, with the exception of the end-March ceiling on government borrowing from the Banque du Liban (BdL) (Table 2). Difficult market conditions in the first months of 2007, with commercial banks reluctant to roll over maturing securities, led the government to rely more on financing from the BdL, thus exceeding the end-March target, albeit by a small margin—the outcome was LL 106 billion ($70 million) above the LL 903 billion ($602 million) flow targeted for the first quarter. All end-June targets were met by ample margins:

Table 2.

Lebanon: Quantitative Indicative Targets Under the Program Supported by Emergency Post-Conflict Assistance, March–December 2007

(Billions of Lebanese pounds unless otherwise indicated; end-of-period) 1/

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Source: Lebanese authorities.

At program exchange rates.

In millions of U.S. dollars. Defined as Banque du Liban's foreign exchange deposits abroad, foreign exchange holdings (including SDRs), gold and holdings of liquid foreign currency-denominated securities, less encumbered foreign assets.

Includes the accounts of the Center for Reconstruction and Development and the Higher Relief Council maintained at the Banque du Liban.

Includes a decline in net borrowing of LL2380 billion on account of the gold revaluation transfer which took place in the second quarter of 2007.

  • The BdL was able to meet the reserve target with a margin of $1.4 billion due to the pick up in deposit inflows and the absence of any pressures in the foreign exchange market;

  • The primary fiscal balance (excluding grants) through end-June is estimated at 0.6 percent of annual GDP, some 3 percentage points of GDP better than programmed, owing to a stronger than projected revenue collection on income and VAT taxes (partly due to the higher growth and to VAT carry-overs from 2006), better performance and earlier-than-expected receipt of non-tax revenue, and lower foreign-financed capital expenditures;

  • The target for net government debt was also met despite a higher than expected interest bill in the second quarter;

  • Despite additional BdL direct financing of the government in the primary market, overall central bank credit to the government at end-June came out significantly below the program target because of central bank sales of government paper in the secondary market. Credit to the government turned out lower than its end-March level, even after accounting for the cancellation of treasury bills held by the BdL, which was financed through a June operation involving the transfer to the government of the BdL's unrealized gold valuation gains. This operation does weaken the BdL's balance sheet.

5. The end-June monitorable actions (structural reform measures under the program) have been mostly completed, despite some delays and except for a minor technical aspect.1 At the same time, one action has become redundant (Table 3):

Table 3.

Lebanon: Monitorable Actions for the Period March–December 2007

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  • The draft 2007 budget was submitted to parliament on June 13. The budget is consistent with the EPCA primary deficit target and—as envisaged under the program—includes the operations of two extrabudgetary funds and does not allow for budget carryovers;

  • The audit plan of the electricity company (Electricité du Liban, EdL), finalized with a small delay on July 13, envisages completing the audits of the 2002–04 accounts by the end of the year and the 2005–06 accounts by mid-2008. Moreover, for the first time in some years, EdL provided financial results for the first half of 2007, a key input into the finance ministry's fiscal projections. In August, the 2001 audit report was posted on the EdL and ministry of finance websites;

  • The auditor for the National Social Security Fund (NSSF) was appointed on June 12, and the audit plan through 2005 was finalized on August 6. The audits of the 2001–02 accounts are expected to be completed in early 2008. Subsequent audits will cover more recent years. Because the books have not yet been closed, an auditor has not yet been appointed to audit the 2006 accounts, but the authorities considered that extending the current contract to cover 2006 would be a simple formality.

  • Based on a legal opinion rendered by the ministry of justice, the authorities consider that the law for the sale of the fixed assets of the two state-owned mobile phone operators is no longer necessary, making the corresponding end-June monitorable action of seeking parliamentary approval redundant. On this basis, the government expects that invitations for expressions of interest for the two companies would be issued before the end of 2007.

III. Prospects for the Remainder of 2007 and Preparations for 2008

6. Policy performance in the first half of 2007 bodes well for the achievement of the program's end-year quantitative fiscal targets. In particular, the strong revenue collection should allow the authorities to contain the primary deficit below the program ceiling. However, not adjusting domestic gasoline prices to match the recent rise in international oil prices has eroded excise revenues to near zero since May. Looking forward, it is important to restore promptly this revenue source, which constitutes a key measure in the authorities' fiscal adjustment strategy. As a first step, the program envisages raising the gasoline excise to at least LL300 per liter by end-September 2007, which is expected to generate about ½ percent of GDP in 2007. This measure is expected to be politically difficult, but its implementation does not require parliamentary approval.

7. Donor disbursements have been lower than expected. So far in 2007, actual disbursements of pledges committed at the Paris III (Text Table 1) and Stockholm conferences have been disappointing, as the finalization of many agreements is taking significantly longer than expected, owing mostly to technical and administrative reasons. During the first six month of 2007, the shortfall was moderate because disbursements had been programmed to take place mainly in the second half of the year. Unless an acceleration takes place during the remainder of the 2007 in line with Paris III pledges, disbursements are likely to fall short of the projection under EPCA. As it is difficult to foresee where there would be scope for further fiscal adjustment to offset such a shortfall, the government would be forced to borrow the difference at market interest rates.

Text Table 1.

Lebanon: Paris III Aid

(In millions of U.S. dollars, unless otherwise specified)

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Sources: Lebanese authorities, and Fund staff estimates.

The financial terms of some loans are still uncertain.

Includes project loans and grants that support the existing expenditure envelope.

Based on a discount rate of 7.45 percent, Lebanon's average projected rate for U.S. dollar market financing.

8. The end-year quantitative indicative targets for gross international reserves and central bank credit to government should be achievable. A reallocation of the assets of the NSSF from bank deposits to treasury bills covered much of the government's domestic financing need in the first half of the year. As this one-off portfolio reallocation comes to an end, the availability of liquidity in the banking sector should enable the government to rely to a greater extent on market financing, thus limiting recourse to central bank credit to below the program's ceiling. However, greater interest rate flexibility may be needed to tap the financial markets, particularly if donor disbursements do not materialize as projected in the second half of the year. Looking beyond 2007, the current global repricing of risk could increase Lebanon's financing costs, though spreads, so far, have been primarily driven by domestic politics and may well decline if the political crisis is resolved.

9. The budget law and other fiscal legislation for 2008 are under preparation, but the presidential election and its aftermath are likely to delay their approval to end-2007, at the earliest. The 2008 budget process is at its initial stages, and so far only limited information is available. The authorities' indicated that the draft Global Income Tax law is near completion and should be ready for submission to parliament by end-year, as planned under Paris III. Parliamentary adoption and completion of the necessary administrative measures before end-2007 would allow the law to be introduced in 2008. Work is also proceeding on a new tax code that harmonizes tax procedures and on a new risk-based tax audit strategy. Meanwhile, there is scope to advance on administrative reforms that do not require parliamentary action. In this regard, ongoing work by the new cash management unit to establish a cash flow plan is encouraging, and further progress is expected in implementing a public financial management reform plan that was developed with assistance from the Fund's Fiscal Affairs Department. Improvements in these areas are key to prepare the ground for more effective budgeting, monitoring, and control in 2008.2

1

No monitorable actions were envisaged for end-March.

2

A forthcoming FAD technical assistance mission will focus on the distributional impact of reducing subsidies.

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Cover IMF Staff Country Reports
Lebanon: Report on Performance Under the Program Supported by Emergency Post-Conflict Assistance
Author:
International Monetary Fund
Volume/Issue:
Volume 2007: Issue 371
Publisher:
International Monetary Fund
ISBN:
9781451822724
ISSN:
1934-7685
Pages:
12
DOI:
https://doi.org/10.5089/9781451822724.002
Figure 1.

Lebanon: Recent Developments, January 2005–July 2007