Lebanon
Report on Performance Under the Program Supported by Emergency Post-Conflict Assistance
Author:
International Monetary Fund
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Publication Date:
17 Dec 2007
eISBN:
9781451943313
Language:
English
Keywords:
ISCR; CR; government; net; government net; Banque du Liban; authorities commitment; government's reliance; outgoing government; central bank; foreign currency; deposit inflow; government of Lebanon
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This report reviews Lebanon’s performance under the program supported by emergency post-conflict assistance. The 2007 program is broadly on track. Despite a difficult political environment, all end-September targets were met, except for the monitorable action on raising gasoline excises. Fiscal revenues were stronger than expected. Owing to strong deposit inflows, the central bank accumulated international reserves at a faster pace than targeted. The end-December monitorable action on inviting expressions of interest to participate in the privatization of two mobile phone networks was effectively met in November.

Abstract

This report reviews Lebanon’s performance under the program supported by emergency post-conflict assistance. The 2007 program is broadly on track. Despite a difficult political environment, all end-September targets were met, except for the monitorable action on raising gasoline excises. Fiscal revenues were stronger than expected. Owing to strong deposit inflows, the central bank accumulated international reserves at a faster pace than targeted. The end-December monitorable action on inviting expressions of interest to participate in the privatization of two mobile phone networks was effectively met in November.

I. Background and Recent Developments

1. The parliamentary majority and the opposition were not able to reach a compromise on a successor to President Lahoud, whose term came to an end on November 23. Constitutionally, the prime minister takes on the presidential responsibilities during this vacuum. Prime Minister Siniora has indicated that, until a new president is elected, his government would be acting in a caretaking role and refrain from taking new political initiatives. The ruling coalition and the opposition are engaged in discussions over the election of a new president who would then appoint a new prime minister and cabinet.

2. Notwithstanding political tensions and repeated security incidents, the economic recovery from the 2006 post-conflict trough has maintained momentum. Developments through July suggest that real GDP could grow by 2–3 percent in 2007 (Figure 1 and Table 1). Exports and imports have been buoyant in the first seven months of 2007, and it is expected that the trade and the current account deficits will widen relative to 2006. With rising international commodity prices and the depreciation of the U.S. dollar against the euro, CPI inflation has risen in the third quarter of 2007, and is projected to reach 5 percent in December 2007 (year-on-year). Inflows of external donor support of the government have continued to fall short of expectations, partly because negotiations have taken longer than envisaged; Paris III disbursements of budgetary grants and loans for 2007 are now projected at $0.8 billion compared with $2.0 billion assumed under EPCA (Text Table 1). Most of this inflow is expected to come in at the end of the year.

Figure 1.
Figure 1.

Lebanon: Recent Developments, January 2005–November 2007

Citation: IMF Staff Country Reports 2007, 384; 10.5089/9781451943313.002.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, 2003–07

article image
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.

Text Table 1.

Lebanon Paris: III Aid

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

article image
Sources: Lebanese authorities, and Fund staff estimates.

The financial terms of some loans are still uncertain.

Outright budget support plus 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.

3. Financial markets have weathered the political impasse and global financial market turbulence quite well. Partly in response to the global repricing of risks, spreads increased over the summer. However, the Eurobond market saw very limited trading, suggesting that investors are generally maintaining their positions pending a resolution of the political situation. Deposit inflows have continued at a sustained pace, with broad money growing at an annual rate of 11 percent. However, deposit dollarization has edged up slowly to over 76 percent. There has been little market reaction to the failure to elect a president by the November 23 deadline, as concerns that the outgoing president would name a second and parallel governments did not materialize.

II. Performance Under EPCA at End-September

4. The primary balance and net debt targets for end-September 2007 were met with significant margins (Table 2). The primary balance (cash basis, excluding grants as defined in the program) posted a small surplus of 0.3 percent of GDP, compared with a projected deficit of 2.8 percent of GDP. This substantial overperformance results from better than projected revenue collection (Value-Added Tax and telecom revenues in particular show a stronger trend than expected) and delays in the execution of capital expenditure as well as lower than expected transfers to the power utility, reflecting in part electricity rationing through power cuts. As a result, net debt was contained to below the target despite somewhat higher than projected interest payments. At the same time, it should be noted that the budgetary cost of higher fuel prices will be felt only in 2008 as much of the fuel supplies for Electricité du Liban are financed through letters of credit.

Table 2.

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

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

article image
Source: Lebanese authorities.

At program exchange rates. Figures reflect data revisions as of November 6, 2007.

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.

5. The program targets on international reserves and government net borrowing from the BdL were also met comfortably. Given the continued deposit inflows, and in the absence of foreign exchange market pressures, the BdL was able to increase its gross international reserves (excluding gold) by $400 million during the third quarter to $12 billion by end-September 2007, somewhat higher than expected, and despite significant shortfalls in donor support relative to program expectations.1 Despite the ample liquidity in the system, commercial banks were reluctant to roll over government paper at t-bill offer rates which have remained unchanged since early 2005, and the government had to rely on financing from the BdL again during the third quarter, though still below the end-September ceiling.

6. The government did not introduce a floor (of $0.20 per liter) on gasoline excises by end-September as previously envisaged (Table 3). The increase in international oil prices since May 2007 has been absorbed largely by lowering gasoline excises, which are thus yielding minimal revenue at current oil prices. As such, the planned introduction of a floor on gasoline excises would have required an increase in the retail price of around 30 percent. The authorities did not consider this to be feasible in the current very difficult political circumstances and were also concerned about the possible inflationary impact. However, they did raise retail prices by 2½ to 3 percent in November to prevent the excises from becoming negative. In 2007, the overperformance on other revenue sources is expected to more than offset the resulting shortfall from excises (around 1/2 percent of GDP in the last quarter). However, raising gasoline excises remains an important pillar of the Paris III fiscal adjustment objectives.

Table 3.

Lebanon: Monitorable Actions for the Period March–December 2007

article image

7. Progress has also been made on structural reforms. The global income tax law was approved by Cabinet in November. The law significantly improves the tax system, though it leaves important details to be specified by ministerial decrees. Introduction of the global income tax will likely be delayed to 2009—one year later than planned under Paris III—given the technical work still needed on the related administrative measures. On the expenditure side, the new cash management unit is in the process of designing a cash flow plan, while work on multiyear budgeting in pilot ministries is continuing. With respect to the power sector reforms, the authorities expect to switch some production from fuel oil to gas by mid-2008 which should lower production costs significantly. However, the installation of remote meters to improve billing, and thus its budgetary cost, are likely to be delayed into 2008.

III. Outlook for the Remember of 2007 and 2008

8. Given the strong performance through September, fiscal targets for 2007 appear achievable with an ample margin. The authorities expect revenue overperformance through the first three quarters of the year to compensate for the shortfall in excises. In addition, spending is likely to be lower than projected under the program, as the authorities now expect lower transfer payments and low execution of foreign financed capital expenditures. In all, the authorities expect significant overperformance on the primary fiscal balance (excluding grants). This should more than offset the somewhat higher interest spending relative to that projected under EPCA, so that government net debt would also come out below the program ceiling, adjusted for the significant shortfall in budget grants.

9. The target on international reserves is also achievable. Provided the political situation remains manageable, financial inflows are expected to continue at a sustained pace through the remainder of the year, which should allow the BdL to maintain international reserves at their current level or realize a modest further build-up.

10. The challenge in the fourth quarter is to reduce government net borrowing from the BdL as envisaged under the program. In this regard, the exchange of LL 1 trillion ($667 million) in certificates of deposits for treasury bills effected in October was an important step to reduce the government’s reliance on BdL financing in as much as it facilitated the government’s ability to tap the market, by raising implicit yields well above the t-bill offer rate The authorities commitment to the end-year financing target will require deliberate efforts to mobilize additional market financing.

11. The privatization process of the two mobile phone networks has been initiated ahead of schedule. On November 2, the government issued a request for applications to participate in the auction for two thirds of the two existing mobile phone licenses, assets, and contracts, thus effectively meeting the end-December monitorable action under EPCA. The auction is scheduled for the first quarter of 2008, and the transfer of ownership is expected to be completed during 2008. The remaining one third will be sold on the stock exchange through an initial public offering.

12. The authorities restated their commitment to the 2008 objectives outlined in the Article Iv staff report, and the mission did not discuss an updated 2008 projection with the authorities. At this stage, policy plans are still too uncertain in regard to key revenue and expenditure issues to provide the basis for a solid projection. Although the outgoing government has adopted a draft 2008 budget, the issue of how to compensate for the loss of fuel excise revenue is still open, and the draft budget does not provide enough guidance on the timing and cost of energy sector reform, or the policies underlying assumed reductions in transfers. Details on fiscal policy plans for 2008 will need to be discussed with the next government.

1/

In the program definition, reserves (including gold and Lebanese Eurobonds) increased to $17.8 billion. For program purposes, however, the floor on international reserves is adjusted for changes in the Eurobond portfolio (See the Technical Memorandum of Understanding attached to the EPCA Letter of Intent, IMF Staff Country Report No. 07/177).

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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 384
Publisher:
International Monetary Fund
ISBN:
9781451943313
ISSN:
1934-7685
Pages:
12
DOI:
https://doi.org/10.5089/9781451943313.002
  • Figure 1.
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    Figure 1.

    Lebanon: Recent Developments, January 2005–November 2007

Figure 1.

Lebanon: Recent Developments, January 2005–November 2007