This 2007 Article IV Consultation highlights that economic developments in Lebanon in 2006 were significantly affected by the July–August conflict with Israel. Real GDP is estimated to have been flat, with strong growth in the first half of the year offset by the disruptions during and after the conflict. Inflation increased, mainly reflecting supply shortages during the conflict and the ensuing blockade. Executive Directors have welcomed the authorities’ success in containing the primary fiscal deficit in the first half of 2007.
1. This statement reports on most recent developments and their impact on the economic outlook and the staff appraisal. It complements information contained in the Staff Report for the 2007 Article IV Consultation and in the Report on Performance Under the Program Supported by Emergency Post-Conflict Assistance (IMF Staff Country Report No. 07/371).
A. Recent Developments
2. The parliamentary majority and the opposition are still in discussion over the choice of a compromise presidential candidate. The current president’s term comes to an end on November 24, 2007, and the presidential election (by parliament) has been postponed to October 23. The security situation remains tense in the wake of the latest assassination of a member of the parliamentary majority on September 19. Main military operations at the Nahr al-Bared Palestinian refugee camp were successfully completed. The authorities estimate the cost of rebuilding the camp and the surrounding communities at $300-400 million. They will be seeking additional donor assistance to fill this need.
3. The latest economic activity indicators are consistent with the earlier projection of 2 percent real GDP growth for 2007 (IMF Country Report No. 07/371). The economic recovery in the first half of 2007 was relatively modest (economic activity remained well below the very strong first half of 2006), and is unlikely to pick up momentum in the second half given the unsettled political and security situation. CPI inflation decelerated to below 2 percent year-on-year in July, consistent with the end-year inflation projection of 2 percent or lower.
4. Financial markets have weathered relatively well the domestic political uncertainty and the recent global financial turbulence. The Eurobond market has reportedly been very quiet with hardly any trading, suggesting that investors are maintaining their positions and waiting for the political situation to evolve. Eurobond spreads stood at 492 basis points on September 27, or 120 basis points higher than in mid-July. Deposit inflows have continued at a sustained pace, with broad money growth of 7 percent since the beginning of the year. Deposit dollarization is broadly unchanged at 76 percent.
5. Despite the strength of monetary growth, commercial banks provided no new net financing to the government in July and August. In the absence of fresh donor support, the government turned to central bank financing. Still, riding on the strength of capital inflows, gross international reserves increased by $300 million in July-August to $11.9 billion. Gross government debt stood at $40.2 billion at end-August.
6. Government revenue and expenditure performance through July is in line with annual program objectives, but the authorities have not yet taken steps to increase gasoline excises to the level agreed for end-September (monitorable action under the program). At current international prices, the excise rate has declined to near zero, and reaching the target rate of $0.20 a liter would require a 30 percent increase in gasoline retail prices. Such an increase would yield about 0.5 percent of GDP over three months. The authorities have indicated that they expect to meet the primary deficit target for 2007 even without this measure, thanks to over performance on other revenue items and lower expenditures, related in part to delays in capital spending.
7. The authorities have requested technical assistance from the IMF’s Fiscal Affairs Department to prepare for the removal of various subsidies and the liberalization of gasoline prices, and to advise on the final stages of preparation of the General Income Tax (GIT). Preparations for a staff mission are underway, awaiting receipt of information on a household expenditure survey. The GIT is still under review before its submission to the Cabinet for approval. The law would have to be approved by parliament this year, if it is to come into effect in 2008 as planned. However, this deadline remains challenging as considerable preparatory administrative work is still needed to meet this objective.
8. Disbursements of Paris III budget support this year are likely to fall significantly short of program assumptions. Since June, the authorities have received a U.S. budgetary grant of $75 million, and a $100 million World Bank Development Policy Loan is in the process of being disbursed. They are also expecting the disbursement of $300 million in budgetary loans from the United Arab Emirates. However, out of total outright budgetary support (loans and grants) of around $1.6 billion projected for 2007, only $0.6-0.9 billion is likely to be disbursed this year, mainly on account of technical and administrative reasons. Moreover, the Paris III program was premised on the expectation that a significant portion of project loans would be converted into indirect budget support (by financing existing or planned government capital projects), but negotiations on this are still under way.
9. A safeguards assessment of the Banque du Liban is currently in progress with respect to Lebanon’s Emergency Post-Conflict Assistance. A mission visited Lebanon September 10-17, and a draft report is being prepared for the authorities comments prior to completion of the assessment.
B. Changes to the Outlook and Implications for the Staff Appraisal
10. Recent developments do not alter the thrust of the staff appraisal of the Article IV Staff Report:
Relative to the projections underlying the Article IV Staff Report, deposit inflows have been stronger than expected, which should enable the government to increase its reliance on domestic market financing at a time when donor support appears to be falling short of program assumptions. However, as noted in the staff report, tapping the market will likely require an upward adjustment in domestic interest rates, particularly given the authorities’ commitment to rely on central bank credit only as short-term bridge financing.
The upward revision in oil prices relative to those assumed in the Article IV report will adversely affect the financial position of the loss-making power utility (EdL). However, the budgetary impact is likely to be felt only starting in 2008 because of lags in the financial support provided by the government to EdL.
The 2007 budget target remains achievable. Early action to increase the gasoline excise would enhance the chances of meeting the target, and is also key to meeting the authorities’ medium-term fiscal objectives, as spelled out in the Paris III program.
While a resolution of the political impasse is expected to lower Eurobond spreads, Lebanon’s financing costs are likely to have increased on account of the global re-assessment of risk. The adverse impact on debt sustainability reinforces the need for a prompt implementation of the adjustment and reform measures planned for 2008. Realizing the expected privatization receipts and securing donor disbursements will be important to meet projected foreign currency debt service payments of over $4 billion in 2008 (of which $3.6 billion for Eurobond debt service).