Lebanon
Use of Fund Resources: Request for Emergency Post-Conflict Assistance: Staff Report; and Press Release on the Executive Board Discussion
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International Monetary Fund
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Publication Date:
25 Nov 2008
eISBN:
9781451822748
Language:
English
Keywords:
ISCR; CR; government debt-to-GDP ratio; Emergency Post-Conflict Assistance; policy commitment; policy; amount; debt ratio; broad money; private sector; headline inflation; reform strategy; Global; debt-to-GDP ratio
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The Lebanese authorities have requested follow-up Emergency Post-Conflict Assistance with an access of 12.5 percent of quota to support their economic program. The 2006 war with Israel led to a political stalemate and repeated outbreaks of domestic fighting until the formation of a national unity government in July 2008. Macroeconomic conditions have improved, but fuel and food prices have boosted inflation. Financial market developments have been favorable, despite the global financial crisis, which has had little effect on Lebanon.

Abstract

The Lebanese authorities have requested follow-up Emergency Post-Conflict Assistance with an access of 12.5 percent of quota to support their economic program. The 2006 war with Israel led to a political stalemate and repeated outbreaks of domestic fighting until the formation of a national unity government in July 2008. Macroeconomic conditions have improved, but fuel and food prices have boosted inflation. Financial market developments have been favorable, despite the global financial crisis, which has had little effect on Lebanon.

I. Introduction

1. The 2006 war with Israel led to political stalemate and repeated outbreaks of domestic fighting until the formation of a national unity government in July 2008. Shortly after the war, the parliamentary minority withdrew from cabinet, and parliament did not convene for over a year. A string of security incidents culminated in an armed domestic conflict in May 2008. The Doha agreement, brokered by the Qatar government, provided for the election of a president, the reconvening of parliament, and the formation of a national unity government to lead the country to the May 2009 general elections. The security situation remains tense.

2. The authorities have requested a follow-up EPCA to continue benefiting from the macroeconomic and financial discipline provided by Fund involvement. Their request is based on an economic program for 2008 and 2009 that builds on the achievements in 2007 (Box 1), and seeks to further reduce the government debt-to-GDP ratio, build up the international reserve buffer, and start to implement key reforms under the Paris III framework.

3. Staff’s judgment is that Lebanon continues to meet the eligibility criteria for EPCA.

  • Balance of payments need. Continued balance-of-payments support is urgently needed in 2008-09 to maintain confidence in the face of a growing current account deficit, which is now projected at around 10-11 percent of GDP in 2008 and 2009 (partly because of delayed reconstruction spending), large foreign currency debt obligations, and the need to rollover foreign exchange deposits in the context of a volatile international financial environment. While improved, the level of international reserves needs to be further increased to support investor confidence in the still fragile post-conflict (and pre-election) political environment.

  • Institutional and administrative capacity. The protracted political paralysis and domestic conflicts in 2007-08 have prevented the full restoration of institutional and administrative capacity, weakened by the 2006 war—key ministries were vacant, and parliament did not convene for over a year. In this context, it will take time to deal with the substantial legislative backlog (including passage of the budgets for 2006-08), and for the new ministers to rebuild the administrative capacity needed to implement a comprehensive economic program that could warrant upper credit tranche support from the Fund.

Lebanon: The Authorities’ 2007 Program Supported by EPCA1

The program, with an access of 25 percent of quota (SDR 50.75 million), aimed at maintaining financial stability, containing the budget deficit, and initiating structural reforms that are critical to the success of the medium-term Paris III reform program. The authorities:

  • Succeeded in maintaining confidence in the domestic banking system and the exchange rate peg, which translated into an acceleration of deposit growth and an increase in international reserves.

  • Achieved a primary fiscal surplus (excluding grants) which contributed to a reduction in the debt-to-GDP ratio.

  • Advanced preparations for the privatization of two mobile phone operators to near completion. Given the political stalemate, the auction was postponed.

  • Prepared audit plans for the National Social Security Fund (NSSF) and the power utility Electricite du Liban (EdL).

However, they did not:

  • Introduce a floor on gasoline excises as envisaged in the program, because they considered that the implied increase in retail prices was not politically feasible at the time.

  • Manage to fully restore administrative and institutional capacity, largely because of continuing political and security issues.

1 See also April 2008 EPCA report (IMF Staff Country Report No. 08/150).

  • Capacity for policy planning and implementation and demonstrated commitment. Some progress in capacity rebuilding has been made, and the government’s commitment and capacity for policy planning remain adequate, as demonstrated by the successful implementation of the 2007 program and the good performance during the first half of 2008.

  • Fund support as part of a concerted international effort. EPCA would constitute an integral and catalytic part of the overall financial assistance package in the context of the Paris III reform program. Donor support has been delayed because many Paris III projects could not be initiated in the absence of a working parliament and continuing security problems. Several donors have indicated that their continued support would depend on Fund involvement.

II. Background

4. Macroeconomic conditions have improved since the Doha agreement, but international price developments have boosted inflation (Box 2). Real GDP growth is likely to reach at least 6 percent in 2008 and 5 percent in 2009, led by construction and tourism—but significant downside risks have emerged in light of the global financial meltdown. Pushed by rising international commodity prices and the past depreciation of the U.S. dollar, average consumer price inflation is likely to reach 12 percent in 2008, and decline to 8 percent in 2009—somewhat higher than inflation in trading partners on account of an increase in domestic wages (Box 3). The external current account deficit has widened, reflecting commodity price increases, a recovery in domestic demand, and continued reconstruction needs. A global recession would further widen the current account deficit mainly through lower remittances and tourism inflows.

5. Financial market developments have been favorable, despite the global financial crisis. Eurobond spreads declined after the Doha agreement, and, more recently, have increased less than in other emerging markets. Annual broad money growth has accelerated to 15 percent reflecting deposit inflows, and boosted gross international reserves (excluding gold) to $16.7 billion in August (also thanks to seasonal factors). Dollarization has declined in response to lower dollar interest rates and broadly unchanged returns in Lebanese pounds. There have been no noticeable direct effects of the recent global financial turbulence on Lebanon (Box 4).

Figure 1.
Figure 1.

Lebanon: EMBI Sovereign Spreads in Selected Countries

(Difference between sovereign spread and EMBI Global, in basis points)

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Source: JPMorgan.

Lebanon: Food and Fuel Price Inflation

As in most countries, rising international food prices have pushed up headline inflation. Food import prices in Lebanon have risen by around 31 percent year-on-year in July 2008, with net food imports accounting for 2.9 percent of annual GDP. As a result, the food and beverage component of the CPI increased by 21 percent year-on-year in July, contributing about 50 percent to headline inflation. Food and beverages have a weight of 35 percent in the CPI.

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Lebanon: Contribution to Headline Inflation, January 2006-August 2008

(year-on-year, in percent)

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: Lebanese authorities; and Fund staff calculations.

International fuel prices have only now started to affect headline inflation. The CPI component for transportation and communications increased by 16 percent year-on-year in July 2008, explaining another 17 percent of headline inflation.1 Transportation and communication have a weight of 14 percent in the CPI. With the recent decline in oil prices, inflationary pressures should subside.

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Lebanon: Food Price Inflation, January 2007-August 2008

(year-on-year, in percent)

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: Lebanese authorities; and Fund staff calculations.

The government has taken some steps to protect low-income groups from rising food prices. In May, the government reduced customs duties on selected food items. Moreover, starting in September (the new school year), the government increased cash transfers for public school students.

1 The impact of rising international petroleum prices on headline inflation was mitigated until November 2007 by the government lowering excises on gasoline products, until these reached zero.

Lebanon: The September 2008 Wage Increase

In September 2008, the government raised the private sector minimum wage and civil service wages and pensions, retroactively effective as of May 2008. However, high nominal GDP growth will keep wages broadly constant in percent of GDP.

  • The private sector minimum wage increased by 67 percent to $333 per month, after being frozen at $200 since 1996. This will shift up the whole wage structure, and the authorities estimate that this implies an increase in the average wage of around 15 percent.

  • Public sector wages and pensions rose by a flat $110-130 per month. The authorities estimate that this would imply an increase in the average public sector wage of around 17 percent (the last increase took place in 1998). More than half of the retroactive component will be paid out in 2008, and the remainder in the first two months of 2009. The annual cost of the wage increase is estimated at 1.4 percent of GDP. Still, the public sector wage bill is projected to remain constant in percent of GDP owing to the ongoing hiring freeze and strong nominal GDP growth. In all, the public sector wage bill in Lebanon is still comparable to that in similar countries.

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Public Sector Wages and Pensions in Lebanon and Regional Neighbors, 2007

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: National authorities and IMF staff calculations.

The wage increase will put some upward pressure on domestic prices in 2008-09. The authorities estimate that the wage increase will temporarily raise inflation by around three percentage points, as producers will pass on cost increases to some degree. Demand effects should be minor given that real wages are projected to stay broadly constant in 2008-09. The impact will be felt mostly in 2009, pushing domestic inflation somewhat above that in trading partners, and thus leading to a modest loss of competitiveness. However, this comes after a period of sustained depreciation of the real effective exchange rate.

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Lebanon: Exchange Rate Developments, January 1995-July 2008

(Index, January 1995 = 100) 1

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: National authorities and IMF staff calculations.1/ Increase indicates appreciation.
Figure 2.
Figure 2.

Lebanon: Recent Developments, January 2005-August 2008

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: Lebanese authorities; J.P. Morgan; Bloomberg; and Fund staff calculations.1/ Coincident indicator is a composite 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 and other official creditors.

Lebanon: Impact of the Recent Financial Turbulence

Lebanese banks have only few direct links to foreign counterparties affected by the recent global financial market turmoil, and, under BdL directives, had no exposure to structured products.

  • On the liability side, the banks’ funding model relies mostly on deposits, which account for 82 percent of banks’ liabilities and come mostly from residents, the Lebanese Diaspora, and regional investors. Banks have no significant exposure to the international wholesale funding markets.

  • On the asset side, about 51 percent of banks’ assets are invested in government and BdL instruments (treasury bills, Eurobonds, certificates of deposits); lending to the private sector accounts for 23 percent of assets, and liquid foreign assets for about 13 percent of assets. Over the last few years, banks have pursued a regional expansion strategy to diversify away from the sovereign.

The non-bank financial sector is not of systemic importance, though individual institutions may have some exposure to the U.S. market.

Lebanon could eventually be affected indirectly through a regional slowdown and a fall in stock market valuations as a result of the global financial crisis (and/or falling oil prices):

  • GDP growth could be adversely affected by sluggish tourism and subdued FDI.

  • The external current account could widen if remittances and tourism receipts were to slow.

  • A sharp slowdown in deposit inflows, combined with a rising current account deficit, could put pressure on reserves and interest rates, with adverse impact on the government’s financing strategy.

6. Donor support is expected to continue in 2008-09. Only $930 million of the pledges for government support made at the Paris III conference were received through June 2008, because of political and security conditions and longer than expected negotiations.1 During the remainder of 2008 and in 2009, disbursements of Paris III pledges could reach $910 million, helped by the resumption of Paris III reforms and the authorization of new project loans by the reconvened parliament.

Lebanon: Foreign Assistance to the Government

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

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Sources: Lebanese authorities, and Fund staff estimates.

III. Policy Discussions

7. Discussions took place against the backdrop of a worsening global economic and financial outlook. So far there have been no spillovers to Lebanon from the global financial crisis. However, the authorities are well aware of Lebanon’s vulnerabilities and exposure to both domestic and regional political and economic shocks. In particular, there is a significant risk that the evolving crises could affect the growth and interest rate projections for 2009. The authorities remain committed to their Paris III debt reduction objectives, and discussions focused on three main challenges for 2008-09:

  • Making further progress toward fiscal adjustment and debt reduction;

  • Maintaining financial stability and reducing external vulnerabilities; and

  • Re-invigorating the authorities’ medium-term reform program.

A. Fiscal Program and Financing

8. The authorities’ fiscal and structural program for 2008-09 includes key measures from their medium-term fiscal reform agenda, in particular the privatization of the two existing mobile phone licenses and actions to reduce the fiscal drain from the energy sector. The effort on the primary balance and the favorable interest rate-growth differential should help lower the government debt-to-GDP ratio by 9 percentage points in 2009 while privatization should contribute at least another 16 percentage points. As a result, the government debt ratio would decline to 136 percent of GDP by end-2009.

9. For 2008, the authorities aim at maintaining a modest primary surplus. Fiscal performance has been strong so far in 2008, but the impact of increasing transfers to EdL on account of high oil prices weigh on the outlook for the year.2 Still, the authorities target a primary surplus (excluding grants) of 0.2 percent of GDP in 2008, broadly the same as in 2007, corresponding to an overall deficit of just above 10 percent of GDP.

10. The authorities plan for further consolidation in 2009. On the revenue side, they will (a) raise the withholding tax on interest income from 5 to 7 percent; (b) remove provisions in the VAT law that allow refunds on exempted activities; (c) impose rental charges on illegal seashore constructions; and (d) allow firms to revalue their assets, and raise the capital gains tax on this one-off revaluation from 1.5 percent to 2 percent.3 On the expenditure side, the authorities intend to (a) reduce transfers to EdL by revising the electricity tariff structure;4 and (b) rationalize other existing subsidies, while, in parallel, introducing a targeted social transfer system. At the same time, the envisaged privatization would entail a substantial loss of non-tax revenues (1.2 percent of GDP). Despite this, the authorities aim for a primary surplus (excluding grants) of 0.6 percent of GDP with their 2009 budget, which corresponds to an overall deficit in percent of GDP broadly unchanged from 2008.

Lebanon: Measures Underlying the Authorities’ 2009 Adjustment Scenario

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Sources: Lebanese authorities; and IMF staff projections. Figures may not add up due to rounding.

+ equals loss of revenue or higher spending.

Includes changes in capital and foreign financed spending, and settlement of past NSSF dues.

11. The authorities intend to meet their financing needs from the market. The government has already met most of its 2008 foreign currency needs by issuing Eurobonds, and will continue to fund its domestic currency needs from the market. Foreign currency financing needs for 2009 are likely to reach $6 billion (of which around $1.3 billion are on behalf of EdL). The authorities plan to meet these foreign currency requirements from the Eurobond market, expected donor financing, and the government’s foreign currency revenues. The impact of the global financial crisis on Eurobond issuances should be limited as Eurobonds are mainly placed with domestic commercial banks. The expected privatization receipts would be used to retire government debt. The government intends to refrain from central bank financing in 2009, after succeeding to reduce the stock of government net-borrowing from the BdL so far in 2008.

B. Monetary Policy, Exchange Rate Policy, and Financial Markets

12. The authorities view the exchange rate peg as an effective nominal anchor that has supported financial stability. They cautiously project deposit growth to slow somewhat in 2009 and deposit dollarization to stabilize, but intend to further strengthen reserves (Box 5). The authorities stand ready to adjust interest rates as needed to meet their balance of payments objectives.

13. The authorities view domestic financial market developments favorably. Bank profitability is rising, and balance sheets are expanding. They noted that their regulatory framework has prevented Lebanese banks from having an exposure to structured products that have been at the core of the global financial market turmoil, even though banks remain vulnerable to a fall in deposit inflows that could result from a slowdown in the Gulf. The BdL continues to support the banks’ regional expansion strategies and their emphasis on growing private sector credit. At the same time, the BdL has recently tightened mortgage lending regulations in the face of rapidly rising real estate prices in 2008 to prevent a real estate bubble. The Banking Control Commission (BCC) has also stepped up supervision to limit the risks stemming from the global crisis. The authorities are reconsidering the main features of the deposit insurance fund and the principles for the supervision of the non-banking financial sector.

C. Structural Reforms

14. The authorities believe that the current political environment offers a good opportunity to push forward their privatization agenda. They view privatization as important to enhance competition and raise Lebanon’s growth potential over the medium term. In the telecom sector, the authorities aim to re-launch the sale of the two existing mobile phone licenses by holding an auction in April 2009.5 The timetable for this is ambitious, but the authorities believe that there is sufficient domestic consensus to move ahead before the elections, and that there will be strong interest for the two licenses. In addition, the authorities are preparing to corporatize the fixed line operator Telecom du Liban, and to auction broadband licenses. Outside the telecom sector, the authorities are assessing whether conditions are right for the sale of the BdL’s non-financial assets, including shares in the national airline and a holding company that owns Casino du Liban.

Lebanon: Measures of Reserve Adequacy

Based on two common approaches, estimates for reserve adequacy in Lebanon range from $18 billion to $27 billion using 2008 data. This compares to gross international reserves excluding gold of $16.7 billion as of August 2008, suggesting that Lebanon should continue to gradually strengthen its reserve position. In addition, commercial banks hold $12 billion in liquid foreign assets that serve as a buffer against capital outflows.

Building on rules of thumb such as the Greenspan-Guidotti rule, Wijnholds and Kapteyn (2001), and Lipschitz, Messmacher, and Mourmouras (2006) have proposed composite minimum reserve adequacy thresholds. Based on the first approach, thresholds are calculated as full coverage of short-term external debt plus 20 percent of broad money.1 For Lebanon, this yields a minimum reserve level of $20 billion. Based on the second approach, thresholds are calculated as full coverage of foreign debt service, plus 10 percent of broad money, plus 20 percent of annual imports.1 This yields a minimum reserve level of $18 billion.

Lebanon: Main Calibration Parameters

(In percent, otherwise indicated)

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Source: Fund staff.

Size of the sudden stop, is measured as short-term foreign currency debt, plus the deposit coverage ratio times total deposits (in percent of GDP). Probability of a crisis is set at the probability of a sudden stop for a typical emerging market, as estimated by Jeanne and Ranciere (2006).

Cumulative output loss is set in line with estimates on output losses during twin crisis episodes (Hutchison and Noy, 2006).

Term premium is set as in Jeanne and Ranciere (2006) close to the average differential between the yield on 10-year U.S. Treasury bonds and the federal fund rate over the last 10 years.

Risk aversion is set in line with the standard in the real business cycle literature.

Jeanne and Ranciere (2006) derive optimal reserves based on a calibrated model where reserves are costly (foregone interest), but also yield benefits in case of a sudden stop (crisis mitigation).2 Using standard parameterization adapted to Lebanon, the model suggests an optimal level of reserves of $22 billion. However, this point estimate is sensitive to the model’s key parameters which are difficult to measure. With more conservative values for the model’s parameters, an optimal level of reserves of $27 billion results.

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Lebanon: Sensitivity of Optimal Level of Reserves

(in billions of U.S. dollars)

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: National authorities and IMF staff calculations.1/ Model-based optimal level of reserves for different deposit coverage ratio values, leaving all other parameters at their baseline value.
1 Short-term debt is on a remaining maturity basis and does not include deposits, which are covered by the broad money term. 2 The model does not include the benefit of crisis prevention, so that the optimal reserve level could be viewed as a lower bound.

15. The authorities are taking initial steps toward reforming the energy sector. Besides revising the electricity tariff structure to reduce budgetary transfers to the power utility (5.2 percent of GDP in 2008), the planned switching to less expensive gas at one power plant would yield additional savings. Moreover, the government is finalizing an energy sector reform plan in collaboration with the World Bank that seeks to enhance generation capacity and service quality while restoring EdL’s financial health.

16. The government is also reinvigorating its structural fiscal reform agenda, which stalled during the political stalemate. The government will finalize the global income tax law with a view to submitting it to parliament by March 2009, adopt a new tax procedure, and pilot a new risk-based tax audit manual. On the public finance management side, a public debt directorate has been formed, and a treasury single account will be introduced. With World Bank assistance, the authorities are also developing a reform program for the National Social Security Fund that will seek to restore its financial health, including through an actuarial study of the pension plan.

17. The central bank is further strengthening its governance structure. The BdL is developing a roadmap toward full implementation of the International Financial Reporting Standards. The BdL will also adopt a formal policy for the selection, appointment, and rotation of its external auditors, in line with good practices. In addition, it will adopt formal guidelines for foreign reserve management and establish an investment committee.

18. The authorities intend to seek further technical assistance from the Fund in the areas of consumer price statistics, national accounts, balance of payments, revenue administration, and public finance management.

D. Medium-Term Outlook and Debt Sustainability Analysis

19. The government’s debt-to-GDP ratio has declined faster than targeted at the time of Paris III. Buoyant revenues and expenditure control have yielded a quicker improvement in the primary balance than initially envisaged, even though some of the fiscal adjustment measures planned for 2008 in the Paris III program were delayed. In addition, debt reduction has benefited from favorable real interest rate developments.

20. Successful implementation of the authorities’ 2008-09 program and continued decisive fiscal adjustment would ensure further progress toward sustainability. From 2010, phased implementation of the Paris III fiscal consolidation measures, together with further privatization and pledged donor support, would reduce the debt-to-GDP ratio by 21 percentage points to 115 percent of GDP in 2013. The associated improvement in confidence is expected to sustain growth at 4-5 percent a year (similar to the historical average over the last 15 years) and a narrowing of interest rate spreads.

Lebanon: Measures Underlying Staff’s Adjustment Scenario: 2010-13

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Sources: IMF staff projections. Figures may not add up due to rounding.

Refers to the technical risk (e.g., simulations based on inadequate data, etc.) in achieving the expected yield.

Refers mainly to political risk.

+ equals loss of revenue or higher spending.

Includes increases in capital spending; and settlement of past NSSF dues.

21. The authorities are aware of the risks to their strategy. Given Lebanon’s large debt overhang—the debt-to-GDP ratio is projected at 136 percent at end-2009—and fiscal and external imbalances, the country will remain vulnerable to liquidity shocks for years, even with full implementation of the reforms. Delays in privatization and the implementation of fiscal adjustment imply that these vulnerabilities would be reduced more slowly than envisaged. Moreover, Lebanon is vulnerable to macroeconomic shocks, such as shortfalls in growth or higher than projected real interest rates, that could materialize also as a consequence of the ongoing global financial crisis. Lastly, there are some uncertainties over the yield of reforms, as well as contingent liabilities (mainly from NSSF) that are being quantified. The effects of these risks are illustrated by the debt sustainability analysis (Box 6 and Figure 3).

Figure 3.
Figure 3.

Lebanon: Public Debt Sustainability, 2003-13

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2008, 363; 10.5089/9781451822748.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Growth and interest rate shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline scenario and shock scenario; historical refers to 10-year averages.2/ The planned revenue and expenditures reforms generate half of the estimated yield of the baseline scenario. This leads to a primary surplus of 3 percent of GDP by 2013.3/ None of the revenue (i.e, increase in the tax on interest income), or expenditure measure (i.e., revision of the electricity tariff schedule) planned for 2009 are implemented.4/ No privatization in the projected period. Assumes no adverse dynamic impact of no privatization.

E. Access, Program Monitoring, and Capacity to Repay the Fund

22. The authorities have indicated that they would seek access to Fund resources of 12.5 percent of quota (SDR 25.375 million, $37.6 million). Staff considers that this level of access is justified. While access would be small relative to Lebanon’s financing needs, Fund involvement would facilitate continued donor support. Exceptional financing for 2008-09 is projected at close to $1.5 billion (Table 6). As in the past, staff intends to update the Executive Board regularly on progress under EPCA in the form of short factual reports.

23. Lebanon is expected to meet its financial obligations to the Fund in a timely manner. The authorities note that, to date, Lebanon has maintained a perfect record of meeting external debt payments, even during its civil war and recent episodes of financial pressures. Fund credit would be low relative to quota and in absolute terms, and debt service to the Fund would remain below 0.2 percent of exports of goods and non-factor services. An update of the 2007 safeguard assessment of the Banque du Liban has been initiated.

Lebanon: Shock Scenarios for Debt Sustainability Analysis

The debt sustainability analysis (DSA) shows that the decline in the debt-to-GDP ratio is broadly stable under most shocks. The DSA shows the impact of five shocks:

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24. The provision of Fund financing to Lebanon under the existing circumstances poses risks to the Fund, owing to Lebanon’s very high debt ratio. Staff and management have consulted with the authorities and, through the relevant Executive Directors, with the bulk of Lebanon’s official bilateral donors and creditors to address the risks that are posed by the provision of Fund financing. Based on these consultations, Management has understood that these members confirm the Fund’s preferred creditor status in respect of drawing by Lebanon under the EPCA and, similarly, that they acknowledge the importance of timely repayment to the Fund of the amounts provided under the EPCA.

25. The main risks to program implementation stem from a deterioration in the political and security situation, and a possible impact of the global financial crisis. The government is committed to its economic program and determined to move ahead with reforms. However, a renewed political stalemate in the run-up to the 2009 elections or pre-election pressures could delay or derail the implementation of specific measures. A spill-over of the global financial market crisis to the region could jeopardize the authorities’ financing strategy, set back the schedule for privatization, and exacerbate existing vulnerabilities.

IV. Staff Appraisal

26. Achievements: Lebanon’s macroeconomic conditions have improved, despite the political strife and security problems. Growth remains strong, the government debt-to-GDP ratio is on a downward trend, deposit inflows have accelerated, and the BdL’s foreign reserve position is now much stronger. The improved political climate that has followed the formation of the national unity government provides the opportunity to: (a) solidify these achievements by addressing the country’s major vulnerabilities, and (b) start much needed reforms to lift Lebanon’s growth potential.

27. Challenges: The top priority remains further lowering the public debt-to-GDP ratio toward sustainable levels to shore up market confidence and maintain strong deposit inflows, which are needed to satisfy the government’s large financing requirements. This is also key to reducing external vulnerabilities and safeguarding BdL’s foreign exchange position by ensuring full market financing of the government’s foreign currency needs. To sustain the recent growth acceleration experienced recently over the medium term, financial stability is necessary, but not sufficient. Structural reforms need to tackle the obstacles that have held back economy-wide productivity, in particular in the energy and telecom sectors. The authorities’ program starts to address these challenges, despite the close electoral deadline and the need to build broad consensus on policy actions.

28. Fiscal policy: The authorities’ fiscal targets are appropriately ambitious. The targeted improvement in the primary surplus (excluding grants) would help bring down the debt-to-GDP ratio, even if the privatization of the telecom companies were not to materialize in 2009. The envisaged fiscal effort is substantial, given that telecom privatization would imply a large loss of non-tax revenues. To achieve these targets, the authorities need to timely implement the planned revenue measures and maintain strict control on outlays, not least in the run-up to the May elections. In particular, it will be essential to ensure that lower transfers to EdL materialize as envisaged through a combination of sufficiently higher electricity tariffs and savings in power generation. In light of the recent increases in food prices, a well-targeted and cost-effective safety net—under preparation by the authorities—is also needed. Such a safety net would be more efficient than generalized wage increases, which are costly, compress the pay scale, hurt external competitiveness, and do not necessarily benefit the most vulnerable people. The decision to submit the draft GIT law to parliament signals the government’s commitment to tax reform, which should help make the tax system more efficient and equitable, and mobilize much needed tax resources. The authorities should profit from the decline in oil prices from their 2008 peak and gradually restore gasoline excises to 2004 levels.

29. The peg and monetary policy: The exchange rate has constituted the effective anchor for Lebanon’s financial stability in the face of persisting large vulnerabilities and repeated shocks. Monetary policy will need to continue to safeguard the peg, with fiscal consolidation addressing the external imbalance. Although the surge in inflation reflectedtrends in international prices, there is a risk that wage increases could ignite inflationary pressures that may require shoring up confidence in the peg through higher interest rates, in addition to fiscal tightening. The BdL targets an accumulation of gross international reservesthat is appropriate, but close monitoring of its net-foreign-asset position is needed. The government’s intention to avoid central bank financing should help the BdL to achieve its international reserve target.

30. The impact of the global financial turmoil: Prudent oversight by the central bank and the supervisory authority has so far shielded the banking system from a direct impact by limiting exposure to structured products. Nevertheless, the global crisis could eventually affect Lebanon’s economic outlook, in particular via a weakening of conditions in the Gulf. Deposit inflows, remittances, and direct investment from the region may slow down and erode banks’ profitability. The BCC and the BdL should stand ready to step up supervision to minimize risks to the banking system, which has been the linchpin of financial stability. In this context, the recent regulation that limits bank financing of real estate speculation is welcome. Moreover, since banks have tried to reduce their excessive exposure to sovereignrisk by rapidly increasing lending to the private sector, there is a need for continued close monitoring of the quality of the loan portfolio.

31. Energy sector reform: The revision of the tariff structure is only an initial step of a broader medium-term reform strategy that aims at increasing electricity supply, improving the quality of service, and reducing the high fiscal cost of power generation. In collaboration with the World Bank, the authorities are finalizing a comprehensive reform plan that envisages private sector participation. The potential benefits that such a plan could bring in terms of productivity gains and eventually higher economic growth cannot be overstated.

32. Telecom privatization: The government’s intention to speed up the sale of the telecom companies is welcome. However, completing the sale by June 2009 requires immediate action to ensure broad political support across all parties. The authorities’ projections and the staffs DSA conservatively assume that this sale does not affect the fiscal position over the medium term. However, a liberalized telecom sector has the potential to generate significant additional fiscal resources in the future.

33. Donor support: The success of the authorities’ reform strategy requires sustained donor support. Unfortunately, in 2007-08, disbursements fell short of the pledges made under Paris III, also because of the protracted stalemate and security incidents. Donor should take advantage of the improved situation to step up implementation of several reconstruction projects and deliver on their pledges. Staff stands ready to provide the needed technical assistance to help restore institutional and administrative capacity, particularly in the fiscal area.

34. Risks: An unraveling of the domestic political situation and a deterioration of the highly volatile regional security conditions constitute the main risks for program implementation. Lebanon remains highly vulnerable to shifts in market confidence, and could also be affected by the evolving global financial crisis. The BdL has prudently sought to increase international reserves to build a buffer against these risks. Support from donors and the Fund is an essential component for the success of this strategy.

35. The staff considers that the criteria for Fund support under EPCA have been met, and, therefore, recommends that the Board approve the authorities’ request.

Table 1.

Lebanon: Selected Economic Indicators, 2003-13

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Sources: Lebanese authorities; and Fund staff estimates.

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

Table 2.

Lebanon: Central Government Overall Deficit and Financing: 2003-09

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Sources: Lebanese authorities; and Fund staff estimates and calculations.

Domestic excises, which are collected at customs, are classified as taxes on international trade.

Excludes principal and interest payments paid on behalf of EdL.

From 2005 onward includes additional transfers to the social security funds (NSSF) to clear the stock of arrears.

Includes $275 million for telecom settlements (2006 and 2007).

Includes transfers to municipalities.

Debt cancellation and Banque du Liban revaluation of gold and foreign exchange and privatization proceeds.

Table 3.

Lebanon: Central Government Overall Deficit and Financing: 2003-09

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Sources: Lebanese authorities; and Fund staff estimates and calculations.

Domestic excises, which are collected at customs, are classified as taxes on international trade.

Excludes principal and interest payments paid on behalf of EdL.

From 2005 onward includes additional transfers to the social security funds (NSSF) to clear the stock of arrears.

Includes $275 million for telecom settlements (2006 and 2007).

Includes transfers to municipalities.

Debt cancellation and Banque du Liban revaluation of gold and foreign exchange and privatization proceeds.

Table 4.

Lebanon: Government Debt, 2003-09 1/

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Sources: Lebanese authorities; and Fund staff estimates and calculations.

Includes all debt contracted by the treasury on behalf of the central government and public agencies other than the Banque du Liban; accrued interest; and Banque du Liban lending to Electricite du Liban. Excludes possible government arrears to the private sector.

Defined as gross debt less government deposits.

Denominated in domestic currency; mainly to the National Social Security Fund, and the National Deposit Insurance Fund.

Table 5.

Lebanon: Monetary Survey, 2003-09 1/

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Sources: Banque du Liban; and Fund staff estimates and projections.

The monetary projections assume that the mobile telecom companies are privatized in Q2 2009, with financing partly from domestic banks and partly from FDI.

Broad money (M5) is defined as M3 (currency + resident deposits) + non-resident deposits.

Defined by currency (not by residency), as official foreign currency assets, including gold and SDR, less foreign currency liabilities.

Liabilities include the exceptional deposits by GCC governments, but exclude liabilities to the government of Lebanon and other official creditors.

Defined as all official foreign currency assets, less gold and encumbered foreign assets.

Table 6.

Lebanon: Balance of Payments, 2003-13

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Sources: Lebanese authorities; BIS; and IMF staff estimates and projections.

Classification of some large-scale flows into current account or capital and financial account transactions for 2007 remains uncertain.

Excluding official budgetary transfers.

Excluding budgetary loan disbursements.

Change in the foreign liabilities of the BdL, excluding IMF purchases.

Differs from banks’ reported data, to include estimated deposit flows by Lebanese nationals living abroad but classified as residents.

Net of non-deposit foreign liabilities.

Excludes Eurobonds and encumbered reserves.

Includes all banking deposits held by non-residents, including estimated deposits of Lebanese nationals living abroad but classified as residents.

Table 7.

Lebanon: Banking Sector Financial Soundness Indicators, 2003-08

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Sources: Banque du Liban, Banking Control Commission and staff estimates.

FC and LL stand for “foreign currency” and “Lebanese pound,” respectively.

For 2007, the low headline growth reflects a change in reporting of non-performing loans.

Underlying private sector credit growth has trended above 10 percent in 2007.

Table 8.

Lebanon: Public Sector Debt Sustainability Framework, 2003-13

(In percent of GDP, unless otherwise indicated)

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Sources: Lebanese authorities; and Fund staff projections.

Central government gross debt.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - n (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

This path assumes that, from 2008 onwards, real GDP growth is set at its 10-year average level while the primary fiscal balance and real interest rates are the same as in the baseline scenario.

This path assumes that, from 2008 onwards, real interest rate and real GDP growth are set at their 10-year average level while the primary fiscal balance is the same as in the baseline scenario.

Table 9.

Lebanon: Indicators of Financial and External Vulnerability, 2003-08

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

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Sources: Lebanese authorities; Bank for International Settlements; and Fund staff estimates and projections.

Includes estimates for public debt and banking deposits held by non-residents, and non-resident claims on the nonfinancial sector.

On a remaining maturity basis (scheduled amortization over the next year).

Short-term foreign currency debt of the public sector and the banking sector plus external debt of the nonbank sector.

Excludes gold and encumbered assets.

Table 10.

Lebanon: External Financing Requirements and Sources, 2003-09

(In millions of U.S. dollars)

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Sources: Lebanese authorities; BIS; and IMF staff estimates and projections.

Excluding official transfers.

Excluding IMF.

Table 11.

Lebanon: Indicators of Capacity to Repay the Fund, 2003-13

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Sources: Lebanese authorities; and IMF staff estimates and calculations.

Appendix. Lebanon—Letter of Intent

November 3, 2008

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

700 19th Street, N.W.

Washington, D.C. 20431

Dear Mr. Strauss-Kahn:

The agreement reached at Doha in May 2008 paved the way for the election of a new president and the formation of a new national unity government, which was sworn in on July 11, 2008. The government’s principal task is now to prepare for the legislative elections of May 2009. In parallel, the country’s main political forces have resumed their national dialogue under the auspices of President Suleiman, with a view to finding a solution to the contentious political issues that have fueled internal strife and dissent.

The 2007 program supported by Emergency Post-Conflict Assistance (EPCA) was concluded successfully and was instrumental in strengthening internal financial discipline and mobilizing external financial support, although less than envisaged under Paris III. Since the 2006 conflict, Lebanon has made progress toward fiscal consolidation and has shored up its external position despite difficult circumstances. The primary fiscal balance (excluding grants) shifted into surplus in 2007, lowering the government debt-to-GDP ratio beyond what we envisaged under EPCA. Fiscal developments in the first seven months of 2008 have been favorable. In response to the heightened political uncertainty and the international financial turmoil, the policies of the Banque du Liban (BdL) ensured a steady increase in international reserves, which grew by $5.2 billion to $16.7 billion during the first eight months of 2008. The effective shielding of the domestic financial sector from exposure to international financial risks, also helped by prudent regulation, contributed to strengthening confidence in the exchange rate peg and the financial system, as reflected by the marked acceleration of deposit growth and dedollarization of deposits. As a consequence, the government was able to finance its domestic and foreign exchange currency needs largely from the market.

While macroeconomic developments have been favorable, Lebanon has not yet fully recovered from the 2006 conflict and the following stalemate. The absence of a functioning parliament and vacancies in key ministries created a substantial legislative backlog and the reconstruction and reform efforts did not progress as envisaged, also because of security issues. Finally, Lebanon will need considerable external support in 2008-09 to reinforce our balance of payments position—which has been adversely affected by the conflict and by the rise in food and energy prices–and to finance the reconstruction effort.

The government’s policy statement to parliament includes an explicit commitment to the Paris III reform objectives and restates the government’s intention of working closely with the IMF toward the implementation of these objectives. In this text, we hereby request continued IMF support in the form of a second drawing under the Fund’s EPCA policy, in an amount equivalent to SDR 25.375 million, or 12.5 percent of quota. In support of this request, and as described in the attached tables, the government and the BdL have selected key fiscal and financial indicators and structural measures that they intend to monitor closely and report on during the period December 2008-June 2009.

Our 2008-09 program aims at addressing Lebanon’s main vulnerabilities, chief among them the very high level of public indebtedness and the large external financing needs. We expect tourism and strong domestic demand to boost GDP growth to at least 6 percent in 2008 and 5 percent in 2009. The surge in consumer prices in 2008 reflects the increase of international commodity prices and the dollar weakness, and, as the impact of these factors wanes, we expect inflation to decline in 2009. Against this background, macroeconomic policies in 2008-09 will be geared toward safeguarding our achievements of 2007 and strengthening our international reserve buffer. The government will also introduce key measures from its medium-term reform agenda, including the privatization of the telecom sector and the reform of the energy sector.

In addition to fiscal consolidation efforts, the government has also taken steps to alleviate the impact of higher food prices on the poor. The government has introduced cash transfers for public school students starting this school year, and reduced customs duties on 28 selected food items in May 2008. More broadly, the government is also working with the World Bank to strengthen its social safety net. In addition, the government approved, with retroactive effect as of May 2008, an increase of public sector wages, public pensions, and the private sector monthly minimum wage, with the aim to preserve the purchasing power of the population. Public sector wages and pensions had remained stagnant since 1998, and the minimum wage had not been increased since 1996. The increase in the minimum wage was negotiated with the social partners and, while substantial, we expect that the private sector will be able to absorb it without undue pressures, partly because many private firms have already increased salaries over the past few years. With prices in Lebanon largely being determined by international developments, we also expect that the second round inflation effect from wage increases will be moderate.

We intend to achieve a further reduction in the government debt-to-GDP ratio. In 2008, the government aims at maintaining a primary surplus of the central government (excluding grants), despite mounting EdL transfers and the budgetary cost of the new social measures. In 2009, the government plans to continue fiscal consolidation through the following measures: (i) increase in the withholding tax on interest income from 5 to 7 percent; (ii) application of rental charges related to seashore real estate; (iii) elimination of the VAT law provision which allows for a refund on some exempted activities; (iv) increase of capital gains tax on revaluation of assets by companies from 1.5 to 2 percent; (v) rationalization of subsidies; and (vi) reduction of transfers to EdL, mainly by adopting a new tariff structure. In addition, the government will consider reforming the determination of regulated profit margins for fuel importers, which would allow to increase the gasoline excise without affecting retail prices.

On current trends, continued strong deposit inflows in the rest of 2008 and in 2009 should allow the government to meet its financing needs from the market and avoid relying on BdL borrowing to the extent possible. While the government expects to continue meeting its financing needs in local currency at current interest rates, it stands ready to adjust rates on Treasury bills in line with market conditions. We expect that parliament will soon raise the ceiling on contracting foreign currency debt, enabling the government to meet all of its remaining foreign currency financing needs ($6 billion during 2009) in the market. In the second half of 2009, the government will use the proceeds from the expected sale of the telecom companies to reduce, as envisaged under the law, foreign exchange and domestic currency debt held by the private sector and the BdL, which will help increase international reserves.

The exchange rate peg to the U.S. dollar has been key to maintaining financial stability and remains appropriate. In this context, our objective is to further strengthen our gross international reserves position. So far, Lebanon has remained relatively insulated from the ongoing global financial crisis, as banks are severely restricted from entering positions in derivative products. Nevertheless, we have closely followed developments in international financial markets and their possible impact on Lebanon, including via the Gulf countries, to which Lebanon has been increasingly linked. To limit risks, the Banking Control Commission is stepping up controls on allocation and quality of banks’ assets with foreign banks. We will also stand ready to adjust interest rates if needed.

Reforms to strengthen fiscal management are ongoing. On the revenue side, the government will finalize the remaining steps for the introduction of the global income tax by (i) adopting the revision of the tax procedure code; (ii) submitting the GIT law to parliament by end-March 2009; and (iii) eventually merging taxpayer services, auditing and collection for VAT and income tax administration. At present, the government is also reviewing procedures related to domestic VAT refund claims, which have recently increased by more than expected. Similarly, the government is improving the administration of the built-property tax and stamp duties, which we envisage to continue yielding additional revenue gains. On the public financial management side, the government expects parliament to approve the 2009 budget, by end-year, and the Treasury Single Account, which we want to make operational by end-June 2009. In addition, parliament has just approved the law establishing the public debt directorate.

EdL’s losses remain a large drain on budget resources. Transfers in 2008 are estimated at $1.5 billion or 5.2 percent of GDP. The government will contain losses by revising electricity tariffs with a yield of about $240 million. Further savings will be obtained in 2009 as production is switched from oil to less expensive natural gas at the Beddawi power plant starting in January 2009, lowering fuel costs by $100 million. In parallel, the government plans to enhance the service quality in the power sector (e.g., through the installation of remote meters).

To strengthen Lebanon’s growth potential, the government intends to resume the privatization of the telecom mobile companies, which was interrupted by the May conflict. It also intends to gather broad parliamentary support for the modalities of the telecom sale and issue the request for applications in March 2009 with the objective to complete the sale by June 2009.

The government intends to restore actuarial balance of the National Social Security Funds (NSSF) to limit demands on the budget. Losses in the medical and family allowance branches constitute a large and open-ended drain on public finances. Initial steps to address these problems have been taken through auditing and the full computerization of the database of users. The government is discussing plans to reform access to medical care with the World Bank, and is considering the need to revise contribution rates and the income ceiling for calculating insurance premia. With the help of the World Bank, it is also carrying out an actuarial study of the NSSF liabilities.

The BdL is taking steps to strengthen its operating procedures. In particular, the BdL is working toward full adoption of the International Financial Reporting Standards, and will adopt an implementation roadmap by end-2008. In addition, the BdL will establish a formal investment committee, draft formal guidelines for foreign reserve management, and adopt formal policies for the selection, appointment, and rotation of its external auditors. It will also sharpen its focus on core activities by starting the privatization of shares in the BdL’s non-financial assets, notably Middle Eastern Airlines and the investment company Intra.

In the context of the program, we remain committed to an open trade and exchange system, and are taking steps to become a full member of the World Trade Organization. We will avoid imposing restrictions on payments and transfers for international transactions, introducing or intensifying trade restrictions for balance of payments purposes, or resorting to multiple currency practices.

A satisfactory implementation of our 2008 program under EPCA, a further strengthening of capacity, including through technical assistance from the Fund, and an improvement in economic and social conditions should allow the government to move to a more ambitious part of its reform program in the second half of 2009. At that stage, we intend to explore the possibility of further Fund support for our program through a Stand-By Arrangement.

The Government of Lebanon and the BdL will provide the IMF with any available information it may request on the implementation of the program, consistent with the understandings reflected in the attached Technical Memorandum of Understanding, and will consult with Fund staff regarding any revision to the policies described above.

Sincerely yours,

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Attachments to LOI

I. Quantitative Indicative Targets, December 2008-June 2009

II. Monitorable Actions, December 2008-June 2009

III. Technical Memorandum of Understanding

Attachment I. Lebanon: Quantitative Indicative Targets Under the Program Supported by Emergency Post-Conflict Assistance, December 2008-June 2009

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

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Source: Lebanese authorities.

At program (end-December 2007) 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.

3/ Defined by currency (not by residency), as official foreign currency assets, including gold and SDR, less foreign currency liabilities. Liabilities include the exceptional deposits by foreign governments at the BdL, but exclude liabilities to the government of Lebanon and other official creditors.

Attachment II. Lebanon: Monitorable Actions, December 2008-June 2009

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Attachment III. Lebanon: Technical Memorandum of Understanding

I. Introduction

1. This memorandum sets out the commitments of the Lebanese authorities for the period to June 30, 2009 relating to the Emergency Post-Conflict Assistance (EPCA) requested in the Letter of Intent. Section II defines the indicative quantitative targets and relative adjustors reported in Attachment I, and Section III establishes the content and frequency of the data to be provided to IMF staff for monitoring the program.

II. Quantitative Indicative Targets
A. Definitions and Concepts

2. Test dates. Quantitative indicative targets are set quarterly starting December 31, 2008 through June 30, 2009, and are to be met at the end of each quarter unless otherwise specified.

3. Government. For the purposes of the program, “government” includes the central government, the Council for Development and Reconstruction (CDR), and the grant-financed operations of the Higher Relief Commission (HRC). It excludes all other agencies not specifically listed, including, but not limited to, the following: Electricite du Liban (EDL), municipalities, the Regie, and NSSF. The government balance is defined on a modified cash basis to include foreign-financed expenditure of the CDR, all operations of the HRC, any treasury advance, and arrears (as defined below). Unless otherwise specified, fiscal data are compiled according to the Government Finance Statistics (GFS) manual 1986.

4. Project grants are defined as those grants to the government (as defined above) linked to specific project financing, and do not include grants received for general budgetary support. Budgetary grants are grants received for general budgetary support, including grants in support of specific budget lines and grants to be applied to debt reduction. These concepts include—but are not limited to—conflict-related and Paris III grants.

5. Arrears. Domestic arrears are defined as government expenditures that have not been paid within 90 days of a payment order being issued. External arrears are defined as overdue payments (principal or interest) on external debt contracted or guaranteed by the government or the Banque du Liban (BdL).

6. Valuation changes. All data are expressed in Lebanese pounds (LL), unless otherwise indicated. To exclude foreign exchange valuation effects: (i) gold will be valued at the December 31, 2007 price of US$ 828.4 per fine troy ounce; (ii) the U.S. dollar value of foreign assets and liabilities will be converted into LL at the exchange rate of US$1 = LL 1507.5; and (iii) all foreign assets and liabilities denominated in currencies other than the U.S. dollar will be converted into U.S. dollars and/or LL at their respective exchange rates prevailing as of December 31, 2007, as published in the IFS.

B. Indicative Targets

7. Target 1. For the purpose of the program, the Gross Reserves (GR) of the BdL (floor, U.S. dollars) are defined as BdL’s callable foreign exchange deposits abroad, foreign exchange holdings (including SDR), gold, Eurobonds issued by the Republic of Lebanon (henceforth “Eurobonds”), and holdings of investment grade liquid foreign currency-denominated securities. Encumbered assets will be excluded from GR. The floor for GR will be adjusted (i) downward (upward) for the full amount of any shortfall (excess) in disbursements of official grants and loans to the government relative to those projected in the program; and (ii) downward (upward) for the full amount of sale (purchase) by the BdL of Eurobonds relative to the baseline projection of BdL holdings.

8. Target 2. The primary balance of the government, before grants (floor) is defined as the overall fiscal balance on a modified cash basis plus interest payments minus grants received. Securitization proceeds will not be counted as above-the-line revenue. For the purpose of the program, any transfer from the BdL not related to realized profits (including from gold revaluation) will be considered to be capital (below the line) transfers and therefore excluded from the primary balance.

9. Monitoring of the primary balance before grants, for the purpose of the program, will be carried out from the financing side. The overall balance on a modified cash basis is calculated as the negative of the sum of the following: (i) the change in net BdL claims on the central government; (ii) the change in net claims on the central government by the rest of the banking system; (iii) the change in net claims on the central government by public sector institutions; (iv) the change in net claims on the central government by other creditors; (v) the net change in government arrears; (vi) proceeds from exceptional financing (items such as privatization revenues, gold or foreign exchange revaluation proceeds, and securitization proceeds); minus (vii) the net change in the CDR and HRC accounts at the BdL. Budgetary and project grants to the government (as defined above) will also be measured through BdL. All changes will be calculated as the difference between end-period stocks, net of any valuation changes resulting from currency movements and changes in accrued interest reflected in the gross debt stock that are reported separately by instrument. For the purpose of the program, interest payments will be measured on a cash basis.

10. The floor on the primary balance before grants will be adjusted (i) downward (upward) for higher (lower) than projected project grant disbursements and (ii) downward for the net amount of the revenues lost due to privatization pro-rated on the basis of the revenue projections specified in Attachment I.

11. Target 3. Net government borrowing from the BdL (ceiling) is defined as the difference between the BdL claims on the government, in domestic and foreign currency, including all holdings of government securities; and the deposits in domestic and foreign currency of the government at the BdL. For the purpose of the program, any transfers from the BdL other than realized profits (e.g., from securitization of future profits) will be treated as net government borrowing from the BdL. The ceiling for net government borrowing from the BdL will be adjusted: (i) downward for the full amount of any excess in transfers from the BdL’s gold revaluation relative to those projected under the program; and (ii) downward (upward) for higher (lower) than projected budgetary grant disbursements.

12. Target 4. New gross domestic arrears of the government (continuous ceiling) are defined as the change in gross domestic arrears arising after September 30, 2008. “Gross” arrears indicates that the taxes and contributions owed to the government are not netted out of the arrears.

13. Target 5. New external arrears of the government and the BdL (continuous ceiling) are defined as the change in external arrears after September 30, 2008.

III. Reporting Requirements

14. To permit the monitoring of developments under the program, and as part of and in addition to the regularly reported data, the government will provide to the office of the Resident Representative of the IMF in Beirut the information specified below:

  • Gross Reserves and components (monthly).

  • BdL’s net foreign exchange position, defined, on the basis of currency, as official foreign currency assets, including gold and SDRs, less foreign exchange liabilities. These are defined to include the exceptional deposits by foreign government at the BdL and IMF purchases, but exclude liabilities to the government of Lebanon and other official creditors.

  • Weekly BdL gross foreign exchange market purchases and sales.

  • Monetary aggregates, including currency in circulation, M3 and non-resident deposits (weekly).

  • BdL balance sheet, including a break down of all assets and liabilities by instrument, by currency and remaining time to maturity (monthly).

  • Data on outstanding BdL instruments by type (coupon or discount), currency, amounts, remaining maturity, and yield (monthly). Data on auctions or sale of CDs by the BdL, including amount, maturity, yield, and any premium paid (monthly).

  • BdL income statement on an accrual basis (quarterly).

  • Commercial banks’ balance sheet (monthly).

  • On a checks-issued basis, summary budget operations, revenues, expenditures (including net advances), net domestic financing, balances in the government accounts with the BdL and commercial banks (including privatization accounts), the receipt and use of privatization proceeds (monthly), monthly cash data on foreign-financed capital expenditures, and relief and reconstruction expenditures.

  • Government debt and financing: Government debt statistics as per the usual reporting format provided by the BdL, including BdL lending to EdL. Government interest expenditure on a cash basis by debt instrument and currency. Grants received by government (including CDR and HRC), of which project-related grants. Privatization proceeds. Valuation changes to the outstanding stock of debt due to currency fluctuations. Changes in the outstanding stock of accrued interest that is reflected in the debt stock. The new stock of domestic and external arrears. Any put or call options, collateral guarantees, warrants or similar derivative arrangements entered into by the government or the BdL. On-lending operations of the government. Securitization of future payment flows to the government or resulting in future payment flows to or from the government. Amortization payments by debt instrument.

  • Outstanding debt contracted by EdL and guaranteed by the government, including letters of credit entered into, with breakdown of principal and interest (monthly).

  • The annual accounts of the NSSF, including the disaggregated accounts of each of the three NSSF funds and any contractual arrears (as defined above) from the central government on NSSF contributions.

  • Foreign assistance received (separating grants from loans and budget support from project financing), and full terms of the newly-contracted but not disbursed loans (monthly).

  • Balance of payments (current, capital, and financial accounts) (monthly);

  • List of short-, medium-, and long-term public or publicly guaranteed external loans contracted during each quarter; identifying, for each loan: the creditor, the borrower, the amount and currency, the maturity and grace period, and interest rate arrangements (quarterly);

  • Revision of electricity tariff structure and resulting savings for EdL.

15. Weekly data and data on the central bank CD auctions should be sent to the Resident Representative’s office in Beirut with a lag of no more than one week. Monthly and quarterly data should be sent within a period of no more than four weeks, except for balance of payments data, which should be sent within a period of no more than eleven weeks. Any revisions to previously reported data should be communicated to the Resident Representative’s office in the context of the regular updates.

16. The authorities will prepare and send to the Resident Representative’s office reports, with appropriate documentation, indicating progress achieved, explaining any deviations relative to the initial targets, and specifying expected revised completion dates of the monitorable actions specified in Section III.

17. Details on major economic and social measures taken by the government that are expected to have an impact on program sequencing (such as new legislation on decrees) will be sent in a timely manner to the Resident Representative’s office.
1

Moreover, $325 million in in-kind support was received or under preparation by end-June 2008, and private sector support totaling $1.27 billion was signed. Other support is being channeled through UN agencies and civil society organizations. In addition to the Paris III pledges, in 2007 Malaysia agreed to a debt exchange that lengthened maturities and lowered interest costs.

2

The increase in oil prices affects the budgetary transfers to EdL with a six-month lag because EdL’s oil imports are financed through letters of credit.

3

The last time enterprises were allowed to realize revaluation gains was in 1993.

4

The current electricity tariff structure would achieve cost recovery at an oil price of around $25/bl.

5

Earlier this year, the auction had to be postponed because of political and security developments.

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Cover IMF Staff Country Reports
Lebanon: Use of Fund Resources: Request for Emergency Post-Conflict Assistance: Staff Report; and Press Release on the Executive Board Discussion
Author:
International Monetary Fund
Volume/Issue:
Volume 2008: Issue 363
Publisher:
International Monetary Fund
ISBN:
9781451822748
ISSN:
1934-7685
Pages:
61
DOI:
https://doi.org/10.5089/9781451822748.002
  • Figure 1.
    View in gallery
    Figure 1.

    Lebanon: EMBI Sovereign Spreads in Selected Countries

    (Difference between sovereign spread and EMBI Global, in basis points)

  • View in gallery

    Lebanon: Contribution to Headline Inflation, January 2006-August 2008

    (year-on-year, in percent)

  • View in gallery

    Lebanon: Food Price Inflation, January 2007-August 2008

    (year-on-year, in percent)

  • View in gallery

    Public Sector Wages and Pensions in Lebanon and Regional Neighbors, 2007

    (In percent of GDP)

  • View in gallery

    Lebanon: Exchange Rate Developments, January 1995-July 2008

    (Index, January 1995 = 100) 1

  • Figure 2.
    View in gallery
    Figure 2.

    Lebanon: Recent Developments, January 2005-August 2008

  • View in gallery

    Lebanon: Sensitivity of Optimal Level of Reserves

    (in billions of U.S. dollars)

  • Figure 3.
    View in gallery
    Figure 3.

    Lebanon: Public Debt Sustainability, 2003-13

    (Public debt in percent of GDP)

Figure 1.

Lebanon: EMBI Sovereign Spreads in Selected Countries

(Difference between sovereign spread and EMBI Global, in basis points)

Lebanon: Contribution to Headline Inflation, January 2006-August 2008

(year-on-year, in percent)

Lebanon: Food Price Inflation, January 2007-August 2008

(year-on-year, in percent)

Public Sector Wages and Pensions in Lebanon and Regional Neighbors, 2007

(In percent of GDP)

Lebanon: Exchange Rate Developments, January 1995-July 2008

(Index, January 1995 = 100) 1
Figure 2.

Lebanon: Recent Developments, January 2005-August 2008

Lebanon: Sensitivity of Optimal Level of Reserves

(in billions of U.S. dollars)
Figure 3.

Lebanon: Public Debt Sustainability, 2003-13

(Public debt in percent of GDP)