Lebanon
2009 Article IV Consultation and Assessment of Performance Under the Program Supported by Emergency Post-Conflict Assistance: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Lebanon
Author: International Monetary Fund
Publication Date:
23 Apr 2009
eISBN:
9781451822755
Language:
English
Keywords:
ISCR; CR; dollarization; Banque du Liban; deposit dollarization; inflow; support deposit growth; U.S. dollar; real GDP; private sector; current account; financial crisis
Download PDF (409.4 KB)

The Lebanese financial system has so far weathered the global financial crisis. The 2009 Article IV Consultation highlights that deposit inflows decelerated briefly in the aftermath of the Lehman Brothers bankruptcy, but have resumed at a rapid pace since then. Executive Directors have welcomed the remarkable resilience of the Lebanese economy in the face of the global financial crisis. Directors have also supported the authorities’ monetary policy aimed at safeguarding the exchange rate peg and facilitating a further buildup of international reserves.

Abstract

The Lebanese financial system has so far weathered the global financial crisis. The 2009 Article IV Consultation highlights that deposit inflows decelerated briefly in the aftermath of the Lehman Brothers bankruptcy, but have resumed at a rapid pace since then. Executive Directors have welcomed the remarkable resilience of the Lebanese economy in the face of the global financial crisis. Directors have also supported the authorities’ monetary policy aimed at safeguarding the exchange rate peg and facilitating a further buildup of international reserves.

I. Introduction

1. Despite its large vulnerabilities, Lebanon has so far weathered the global financial crisis. Lebanon’s public debt-to-GDP ratio remains among the highest in the world. Its banking system, with assets of more than three times nominal GDP, is highly exposed to the sovereign, and dependent on deposit inflows from nonresidents. Moreover, the country lies at the crossroads of regional and international political tensions. Despite these challenges, Lebanon has managed to maintain financial stability since the global crisis erupted in September 2008. There have been no pressures on the peg so far, and the Banque du Liban (BdL) has continued to accumulate international reserves at a swift pace. Deposit inflows took a short breather after the Lehman failure, but have resumed at a rapid pace since then, and deposit dollarization has declined steadily. Eurobond and Credit Default Swap (CDS) spreads are now below the emerging market average, and the banking system has withstood the global financial crisis.

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Lebanon: International Reserves

(In billions of US dollars)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

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Lebanon: Eurobond and Credit Default Swap Spreads

(In basis points)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

2. The improved political and security situation has been crucial to this outcome. The Doha agreement in May 2008 put an end to the armed fighting between supporters of the majority and minority coalitions, and opened the way to the formation of a unity government to take the country to the June 2009 general elections.

3. Fund engagement in Lebanon through the EPCA policy has contributed to the economy’s resilience. The authorities’ macroeconomic policies have been supported by the international community—most notably at the Paris III donor conference in January 2007—and by the Fund, through a quarterly monitoring framework and two drawings under the Emergency Post-Conflict Assistance policy, in April 2007 and November 2008.

Performance Under EPCA and Implementation of Past Fund Advice

The end-December 2008 quantitative indicative targets have been met, but there are some slippages in structural policies. The primary balance excluding grants and net government borrowing from the BdL have comfortably met the respective targets, and gross international reserves of the BdL have exceeded the target by $1.8 billion (around 10 percent of reserves). Lower oil prices have reduced the pressure to adjust electricity tariffs (though electricity subsidies remain significant), resulting in the non-observance of the corresponding end-December monitorable action. In January 2009, the BdL established an investment committee and prepared formal guidelines for foreign reserve management (end-December monitorable action).

The authorities also reported progress toward achieving the end-March monitorable actions. In part due to the worse international financial conditions, telecom privatization has been postponed, and the associated monitorable action to launch the request for applications will not be met. The draft Global Income Tax bill will be submitted to the Council of Ministers by end-March and soon thereafter to Parliament, likely implying a minor delay in the corresponding monitorable action. The BdL has already adopted the policies for the selection, appointment, and rotation of external auditors (end-June monitorable action).

Economic policy since the Paris III conference has been broadly in line with the Fund’s policy advice. The Paris III medium-term economic and reform program was developed in close consultation with staff. While the planned fiscal consolidation and structural reforms have repeatedly been postponed due to the difficult security situation and the worsening of the political tensions between the government and the opposition, the Paris III program remains the anchor for medium-term policy objectives. Implementation of the program supported by the first drawing under EPCA was successful despite slippages in structural policies. The Fund has supported the authorities’ view that the peg remains instrumental in maintaining financial stability.

4. Policy discussions focused on the authorities’ objectives:

  • In the near term, safeguarding the recent progress, in particular with regard to international reserve accumulation and fiscal consolidation, and preparing the economy to withstand the impact of a deepening global economic and financial crisis;

  • In the medium term, relaunching the Paris III agenda, and in particular sustained debt reduction and structural reform.

II. Navigating the Crisis

5. The authorities’ policies in 2008 put Lebanon in a position to weather the first round impact of the crisis:

  • Monetary and exchange rate policy aimed at building up international reserves. To this end, the BdL allowed a growing deposit interest rate differential in favor of the local currency in order to maintain confidence in the Lebanese financial system, attract deposit inflows, and promote a de-dollarization of deposits.

  • Fiscal policy capitalized on the 2008 growth dividend to achieve further reduction in public debt. Revenues increased, following the unprogrammed reintroduction of the gasoline excises, made politically more acceptable by lower oil prices.1 The primary fiscal balance (excluding grants) reached 0.5 percent of GDP in 2008, helping the public debt decrease from 168 to 162 percent of GDP in the course of the year.

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Lebanon: Commercial Bank Deposits

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

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Lebanon: Deposit Dollarization and Interest Rate Spread

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

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Lebanon: Government Debt and Fiscal Deficit

(In Percent of GDP)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

6. Given the improved political and macroeconomic situation, Lebanon achieved record growth in 2008. With a pick-up in activity in the second half of the year driven by construction and tourism, real GDP achieved a growth of more than 8 percent for the year. In line with international prices, inflation declined to 4 percent in January 2009. Despite a strong export performance (26 percent growth in 2008), high oil prices and strong domestic demand pushed the current account deficit to over 11 percent in 2008.

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Contribution to Headline CPI Inflation

(y-o-y, in percent)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

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Lebanon: GDP Growth and Coincident Activity Indicator, 2005–08

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

7. However, the worsening international macroeconomic outlook will affect Lebanon in 2009. The authorities expect lower global liquidity and the world economic downturn, particularly in the Gulf, to affect remittances, tourism, foreign direct and portfolio investment, as well as deposit inflows. Thus, growth is likely to slow to 3 percent this year from over 8 percent in 2008, and deposit growth is expected to decline to 10 percent from 15 percent in 2008. Inflation will remain low, in line with international price trends. Lower oil prices will reduce the current account deficit, even though the capital account will likely weaken due to lower investment flows.

The Lebanese Banking Sector in the Face of the Global Crisis

Banks have so far been little affected by the global financial crisis.

  • While commercial bank assets amount to 324 percent to GDP, one of the highest ratios among emerging markets, banks source around 90 percent of their non-equity funding from deposits, which has served them well as global wholesale funding dried up. The relationship-based banking system and the large Lebanese diaspora support a solid deposit base that has proven resilient in the past even when faced with large domestic shocks. Banks also maintain large liquidity buffers, with a 50 percent ratio of liquid assets to short-term liabilities (including deposits).

  • Banks have also been largely insulated from financial losses on their assets. High exposure to the sovereign and new growth opportunities in the region have ensured bank profitability and reduced the need to search for yield in the high-risk market segments at the heart of the global crisis. Moreover, prudent bank regulation strongly discouraged exposure to structured products and limited the banks’ exposure to real estate speculation. While Lebanese banks maintain large liquid foreign assets, they did not suffer significant losses (equivalent to less than 1 percent of core capital) following the failure of Lehman and the troubles of regional banks in Kuwait and the UAE.

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Non-deposit funding

(percent of liabilities)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

Sources : Lebanese authorities, IFS, and Fund staff1/ China, P .R.:Hong Kong

Banks suffer, however, from long-standing structural vulnerabilities. Commercial bank assets are concentrated on the sovereign, which accounts for 55 percent of assets. Moreover, banks carry a substantial maturity mismatch from funding their lending operations largely from short-term deposits, and a significant indirect currency exposure from foreign exchange lending to unhedged clients. Looking forward, the fall in the stock market (which at end-February had lost 26 percent year-on-year), the end of the housing boom, and the projected economic slowdown more generally could lead to an increase in non-performing loans (from 3.1 percent at end-2008), including from regional operations. However, stress tests carried out by the Banking Control Commission (BCC) have shown that banks could easily absorb a hypothetical increase in non-performing loans by 50 percent, to levels experienced after the 2006 war with Israel.

Remittances in Lebanon

Remittances to Lebanon are among the highest in the world. Reflecting both a rising global trend in remittances and the size of the Lebanese diaspora, gross remittances inflows have grown to an estimated 20 percent of GDP in 2008, placing the country among the largest recipients of remittances as a share of GDP in the world. With remittances outflows estimated at 8 percent of GDP, net remittances inflows amounted to 12 percent of GDP.

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Top Ten Recipients of Gross Remittances, 2007

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

The continuing global economic downturn is likely to lead to a marked decline in remittances. Some 54 percent of remittances to Lebanon originate in the Gulf Cooperation Council (GCC) and another 16 percent in Australia, the US, and Canada. The projected decline in GDP growth in these countries in 2009 is estimated to bring about a fall in gross and net remittances inflows of up to 12 percent (2.4 percent of GDP) and 25 percent (3 percent of GDP) respectively in 2009.

Lebanon and the GCC

There are strong economic links between Lebanon and the GCC:

  • Remittances from Lebanese living in the GCC amount to around half of total gross remittances to Lebanon. Anecdotal evidence and data on past migration flows suggest that up to 400,000 Lebanese are living in the Gulf, in large part well-educated professionals.

  • The GCC countries are Lebanese exports’ largest market, with a share of 24 percent in 2007.

  • Tourists from the GCC are a significant fraction of total tourists to Lebanon. In 2008, they bought 48 percent of total hotel nights (excluding Lebanese nationals). GCC nationals also spend proportionately more than tourists from other countries.

  • Direct investment flows from the GCC have accounted for around 60 percent of total FDI to Lebanon over the period 2002–07, more than half of which has been in real estate. Lebanon receives around one-third of all GCC investments to MENA countries. In addition, Gulf investors are thought to hold a large number of the high-value deposits at Lebanese banks.

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Share of GCC Imports and Exports

(In percent)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

III. Authorities’ Policies for 20092

8. The authorities see three key risks for the Lebanese economy and financial system, which present considerable challenges to Lebanon, particularly if they materialize at the same time:

  • First, the global recession and slowdown in the Gulf—even if cushioned by fiscal expansion—will affect capital flows and economic activity in Lebanon. While a soft landing in Lebanon remains the most likely outcome, there is a significant downside risk to domestic activity.

  • Second, government financing may become more difficult than anticipated if the fiscal stance is loosened, interest rates on government debt rise, or deposit inflows slow down.

  • Third, Lebanon remains exposed to political and security shocks, particularly in the run up to the elections.

The authorities aim at minimizing the possible impact of these risks by further increasing the international reserve buffer, reducing fiscal vulnerabilities, containing financing needs, and strengthening the banking sector this year.

Deposit Growth

Deposit growth remains the highest vulnerability to maintaining financial stability in Lebanon. The country’s large fiscal deficits have been financed to a substantial degree by domestic banks, which source their lending capacity largely from deposit growth. A severe slowdown in deposit growth could hence impede government market financing.

Deposit growth has recently picked up markedly. Since the end of the civil war in 1990, annual deposit growth never fell below 4 percent even in the face of marked domestic shocks such as the near-debt crisis in 2002, the political turmoil after the assassination of former Prime Minister Rafik Hariri in 2005, and the 2006 war with Israel and ensuing domestic political deadlock (shaded areas in the figure below). During these crises, there were short-lived outflows that were quickly recovered. Since mid-2008, deposit growth has picked up considerably and, after a brief slowdown in the aftermath of the Lehman failure, reached 15.6 percent in December 2008.

A large share of deposit inflows comes from abroad, including the Gulf region. As a regional financial center, the Lebanese banking system sources a substantial share of its deposits from abroad. While reliable statistics are not available, anecdotal evidence points to the growing importance of the GCC, a popular destination for emigrants and migrant workers during the recent oil boom (see Box 4). Industrial countries, such as the United States, Canada, and Australia, also host a substantial share of the Lebanese diaspora and are an important source of Lebanese non-resident deposits (see Box 3).

Nonetheless, domestic factors appear to have a stronger bearing on deposit growth than trends in the Gulf. Since the mid 1990s, deposit growth has moved broadly in line with the interest differential between local currency and U.S. dollar-denominated deposits (left panel), except during episodes of domestic shocks. However, deposit growth appears also to be increasingly correlated to the economic cycle in the GCC (right panel).

A. Maintaining a Strong Reserve Buffer in Times of Uncertainty

9. The BdL aims at further accumulating reserves to preserve confidence. To this end, the BdL intends to support deposit growth by keeping the interest rate differential between domestic currency and foreign currency rates at the current level.3 The authorities acknowledge that the policy of reserve accumulation is ultimately costly for the government, the private sector, and the BdL balance sheet. Following the elections, they would consider a further reduction in domestic currency interest rates only if deposit growth holds up at a comfortable pace.

10. The BdL continues to be of the view that maintaining the peg will serve as the lynchpin for Lebanon’s financial stability. This is essential given the currency mismatches deriving from both widespread deposit dollarization and the government’s high debt and debt service obligations in foreign currency. In the authorities’ view, the lack of pressures on the peg throughout 2008 and the beginning of 2009 constitutes further evidence of the appropriateness of the exchange rate regime. Looking ahead, the authorities do not believe that the projected slowdown in exports, tourism, remittances, and capital flows will endanger the targeted build-up of international reserves within the context of the peg in 2009, given a much reduced oil import bill and still large nonresident deposit inflows. They agree with the staff’s assessment that the real effective exchange rate is not out of line with fundamentals, although the recent strength of the U.S. dollar has led to the appreciation of the Lebanese pound in real effective terms (9 percent since last August).

Lebanon: Real Exchange Rate Overvaluation Estimates Using CGER Approaches

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Using CGER parameters and a current account elasticity of 0.4 (see IMF Country Report No. 07/382 for a description of the application of the exercise to Lebanon).

Using parameters calculated for MCD oil-importing countries and a Lebanon-specific current account elasticity of 0.15.

For each parametrization, compares the norms with a) underlying 2008 current account stripped of temporary factors and b) steady state (2014) current account.

Derived from the net external asset position-stabilizing current account.

Range of estimates obtained using different model specifications.

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Lebanon: Exchange Rate Developments

(Index, January 1995 = 100) 1/

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

1/ Increase indicates appreciation.

B. Containing the Government’s Financing Needs and Reducing Debt

11. The authorities believe that, with the slowing down of economic activity, the process of fiscal consolidation cannot continue this year as planned. In principle, the authorities agree that domestic and external risks warrant an aggressive stance toward reducing the public debt. However, they believe that, right now, fiscal consolidation imperatives should be weighed against the potential social needs arising from the effects of the global recession and the political pressures generated by the forthcoming elections.

12. The authorities see the 2009 draft budget as a reasonable compromise between these objectives. The budget envisages the primary balance (before grants) to fall to zero from 0.5 percent of GDP in 2008. The overall fiscal deficit would increase to 12.3 percent of GDP, 2.3 percentage points higher than 2008. The gross debt-to-GDP ratio would remain at 162 percent. Fiscal space has opened up this year with the reintroduction of gasoline excises and the reduced need for budgetary transfers to Electricité du Liban (EdL) arising from lower fuel costs. With delayed privatization of the mobile phone companies, the expected loss in non-tax revenue in the second half of the year will not take place. In addition, the budget includes the revenue measures envisaged under EPCA: increase in interest income tax,4 removal of VAT refunds from exempted activities, imposition of rental charges on seashore valuations, and capital gains tax on an exceptional revaluation of assets, (these measures would yield 0.6 percent of GDP). These additional resources would finance increased spending in wages and salaries (+2.1 percent of GDP over 2008), a part of which related to enhancing security, and higher capital expenditures (+1.2 percent of GDP).5

13. The government is preparing an anti-crisis action package. The authorities bank on the planned wage increases and one-off payments to public sector employees to boost real incomes and prop up consumption at a time when external demand might be flagging. But, to further counter the effect of the crisis, the authorities also prepared a draft anti-crisis plan that includes an acceleration and reprioritization of infrastructure spending by the Council for Development and Reconstruction, an expansion of interest subsidies for LL-denominated bank lending to the corporate sector, various measures to improve the business climate, and incentive programs to support job creation. The plan has not yet been fully costed, but the authorities believe that it is unlikely to have a significant impact on the overall fiscal stance.

14. Budget implementation will be prudent. The implementation of the draft budget would still allow the authorities to meet the EPCA fiscal targets for March and June 2009. In case of revenue shortfall or expenditure overruns, the authorities are ready to consider additional measures to maintain the debt-to-GDP ratio constant. Should the budget fail to be approved, a significant portion of spending would be based on the 2005 budget (the last to be passed by parliament) and thus more easily contained, possibly bringing savings of up to 0.6 percent of GDP compared to the draft budget.

Social Safety Nets in Lebanon

Poverty in Lebanon is high. According to the UNDP, 28 percent and 8 percent of the population in 2004-05 could be considered respectively poor and very poor. Poverty is concentrated outside Beirut, in the North and in the South of the country. The Gini coefficient, at 0.37, was close to the MENA average; the bottom 20 percent of the population accounted for 7 percent of consumption, while the top 20 percent accounted for 43 percent of consumption.

Social spending in Lebanon is high, but its share specifically allocated to poor households (i.e., safety nets) is small. While spending in education, health, pensions and social assistance accounted approximately for 30 percent of primary expenditures in 2007, social assistance was less than 20 percent of this amount. Significant budgetary resources are used for electricity subsidies (transfers to EDL), which absorbed 23 percent of primary spending in 2008 but mainly benefit the top income bracket customers, who consume more electricity per capita.

The effectiveness of safety nets is undermined by the lack of coordination between the various providers. Most of the benefits financed through the Ministry of Social Affairs (MoSA) are provided by a range of welfare institutions and non-governmental organizations contracted by the MoSA, resulting in extensive overlaps and administrative waste.

The government developed in 2007 a Social Action Plan (SAP) to reduce poverty, improve social indicators, and achieve the Millennium Development Goals. The SAP contains a medium-term strategy to introduce safety net programs such as: i) cash transfers to the very poor households; ii) school feeding, books, stationery, and transportation facilities to students living in poor locations; and iii) free hospitalization for all households under the poverty line.

The MoSA, in conjunction with the World Bank, is now working on a National Targeting Program (NTP). One of the main goals of the NTP is to develop a credible and reliable database, enabling an objective assessment of households’ welfare so as to more effectively target safety net programs. A pilot is now being conducted in three low-income districts, with the objective of extending it gradually to the national level.

15. Despite the likely slowdown in deposit growth, the authorities expect to meet the 2009 financing needs from the market. A peak in debt service swells the government’s gross financing needs in 2009 to LL 21.9 trillion, of which the foreign currency share is LL 8.5 trillion (US$5.6 billion). Nevertheless, the authorities believe that domestic commercial banks will be able to finance these needs through treasury bills and Eurobonds (of which banks are the main holders), even if there is little rollover by international investors. The authorities were encouraged by the successful completion in March 2009 of an Eurobond exchange which rolled over $1.9 billion in maturities coming due later in the year (implying a rollover rate of 83 percent) and provided new cash for around $440 million, with yields ranging from 7.5–9 percent for the new instruments depending on maturity. The exchange should be sufficient to bridge the financing needs until after the June elections, when the authorities plan to issue new Eurobonds to roll over maturing instruments and raise new borrowing, provided that the latter is authorized by parliament through the budget law or separate legislation. Throughout the year, external financing will also be forthcoming from donors, mostly in the context of the Paris III commitments. In order to protect the foreign exchange buffer, the government will avoid to the extent possible relying on central bank financing.

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Lebanon: Government FX Debt Service

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.A001

Lebanon: Gross Financing Needs and Sources, 2008–09

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16. The authorities are considering contingency plans in case financing difficulties materialize. A discussion of stress tests developed by staff highlighted that the authorities’ financing plans are highly dependent on deposit growth, and underlined the importance of preparing contingency plans. Should deposit growth slow to critical levels, the authorities will consider a policy response that would include: (i) higher interest rates; (ii) a temporarily lower accumulation of international reserves; (iii) further fiscal adjustment, such as compression of discretionary spending, additional increases in excises and/or bringing forward the VAT hike now slated for 2010; and (iv) efforts to mobilize additional donor support.

C. Strengthening the Banking Sector

17. The authorities are stepping up their vigilance over the banking sector. The authorities believe that the banking system is in a good position to address a stronger-than-expected fall in deposit growth, or a significant worsening in loan quality—in Lebanon or in the regional operations—under the stress of the slowdown in the real economy. Nevertheless, the BCC has strengthened reporting requirements on domestic and foreign operations, carried out stress tests for the banking system and intensified on-site inspections specifically aimed at assessing the impact of the global financial turbulence. To further increase the already high capitalization of banks, the BdL has recently recommended limiting dividend payments to 25 percent of 2008 profits. Finally, the BdL, in coordination with the government and the BCC, has prepared draft legislation for the creation of the regulatory authority for financial markets, which are currently supervised jointly by the BdL and the BCC.

18. In the authorities’ view, the current banking resolution framework provides for a flexible response capability. The authorities recently enacted a revised bank merger law, which enables the BdL to deal preemptively with troubled banks. The law, in line with past practice, is designed to prevent to the extent possible bank failures, relying on mergers and takeovers by sounder banks rather than outright bankruptcy. The authorities also developed plans to reform the deposit insurance fund, the coverage of which, at just over $3000 per depositor, is clearly inadequate. However, given the advantage of maintaining regulatory stability at this time, they intend to proceed with this reform after international financial conditions improve.

IV. Medium-Term Plans to Tackle Vulnerabilities

19. There is broad agreement across the political spectrum that reducing the high public debt-to-GDP ratio and launching structural reforms are the key medium-term priorities. The outcome of the June 2009 elections is uncertain. However, the authorities’ view of the Paris III agenda as the anchor for medium-term plans is likely to be shared by any future government. On that basis, medium-term fiscal tightening would mainly rely on the already planned gradual increase in the VAT rate from 10 to 15 percent, the introduction of the Global Income Tax, and cuts in non-essential expenditures. Further savings would come from tackling the large losses at EdL—a key priority—since, despite the fall in international oil prices, current electricity tariffs still imply a significant untargeted subsidy, underscoring the need for a tariff revision. The authorities also see as a priority the launch of the privatization of the mobile phone providers as soon as market conditions allow, thus boosting private sector activity and reducing the debt.

20. Timely and flexible disbursement of Paris III pledges is another important element of the authorities’ strategy. While progress has been made in the disbursement of these pledges, disbursements have fallen short of expectations partly because of political and security conditions and longer than expected negotiations. Furthermore, given the relatively insufficient share of budget support in the total, disbursements have not been fully aligned with the goal of debt reduction.

Lebanon: Paris III Aid

(In millions of U.S. dollars)

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Sources: Lebanese authorities, and Fund staff estimates.

Pledges for support to Lebanon through the government, the private sector, United Nations organizations and civil society organizations.

Not Paris III-related: support related to reconstruction after the 2006 war with Israel, reconstruction of surrounding areas of the Nahr El-Bared refugee camp, and various project grants and loans.

21. Several structural fiscal reforms are under preparation. Parliament approved the tax procedure code at end 2008, even though several associated regulations are still pending. A cash management unit was legally created by end 2008 and is implementing a pilot on monthly payment forecasts with three line ministries. The draft Global Income Tax bill should be submitted to the Council of Ministers and Parliament in the coming months. The authorities are in the early stages of restructuring the tax administration. Finally, the Treasury Single Account legislation is under examination in parliament.

Lebanon: Projected Yield from the Authorities’ Fiscal Measures: 2010–14

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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.

Positive values indicate loss of revenue or higher spending.

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

Lebanon: Shock Scenarios for Debt Sustainability Analysis

Even with an ambitious debt reduction strategy, Lebanon will remain vulnerable to shocks for many years. With full implementation of the strategy, primary surpluses (excluding grants) could reach over 5 percent of GDP over the medium term, and with this, government debt could decline to around 136 percent of GDP by 2014. However, this scenario is ambitious, and substantial risks to the downside remain: higher interest rates, lower economic growth, or delays in policy implementation could imply a renewed increase in the debt-to-GDP ratio.

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Figure 1.
Figure 1.

Lebanon: Public Debt Sustainability, 2004–14

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2009, 131; 10.5089/9781451822755.002.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 less than half of the estimated yield of the baseline scenario. This leads to a primary surplus of 3 percent of GDP by 2014.3/ Nil primary balance in 2009 and in the medium term, no privatization, and medium term growth assumed one percentage point lower than in the baseline.4/ No privatization in the projected period. Assumes no adverse dynamic impact of no privatization.

22. The authorities recognize the need to strengthen the BdL’s balance sheet over the medium term. The planned fiscal consolidation, together with de-dollarization, will allow a lowering of interest rates and help strengthen the BdL’s balance sheet. Privatization of the assets held by the central bank once market conditions permit will also help its financial balance, while contributing to the government’s growth agenda.

V. Other Issues

23. The mission discussed technical assistance (TA) needs and the new charging policy. The mission stressed that the Fund stands ready to provide assistance particularly in the areas of public financial management, tax administration, banking regulation/supervision, Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT), central bank reforms, and statistical issues (below). The authorities expressed interest in a possible FSAP update in the course of 2009.

24. The authorities are reinforcing their AML/CFT framework. In order to implement the Special Recommendations of the Financial Action Task Force (FATF), the authorities are improving the existing AML legislation, which would now also cover CFT. The amendments increase the powers of Lebanon’s Special Investigative Commission, an independent financial intelligence unit with judicial status charged with implementing AML, and stiffen the penalties for AML breaches. Lebanon is currently undergoing an AML/CFT assessment by MENAFATF (a FATF-style regional body).

25. The authorities are improving their statistical systems, but significant data problems remain. With support from INSEE, they are improving the quality of GDP data and the timeliness of their dissemination, recently publishing national accounts to 2007. In 2008, they have also launched an improved CPI index with the help of TA from the Fund. However, statistical provision in other areas (balance of payments, employment, wage and social indicators) remains seriously deficient. The authorities agree that improvement in statistical systems are essential to support economic analysis and policy making, and the next government is expected to increase investment in statistical resources.

VI. Staff Appraisal

26. Achievements: The resilience of the Lebanese economy in the midst of the ongoing global crisis demonstrates the benefits of macroeconomic policy discipline under the EPCA and strict oversight on the financial sector. International reserves have hit a record high. The banking sector has not come under stress. Lebanese Eurobonds have outperformed the emerging market average. So far, there are not clear signs of slowdown in economic activity. Thus, Lebanon has been insulated from the global deleveraging process that has hit those financial systems flushed with high-risk structured products or with a risky funding structure.

27. The EPCA: The quarterly monitoring framework set up in the context of the two drawings under EPCA has proved to be an effective tool to support the authorities’ efforts to preserve macroeconomic and financial stability despite the difficult domestic political conditions and the increasingly challenging external environment. The authorities deserve merit for having met all quantitative targets with substantial margins. However, while slippages in the structural reform agenda reflect the domestic and international environment, a swift implementation of the reform agenda after the elections is necessary to make inroads toward reducing Lebanon’s vulnerabilities.

28. Challenges and risks: These successes do not leave scope for complacency. The deepening global recession and the dysfunctional international credit markets make it even more urgent for Lebanon to address its still high vulnerabilities. Short-term policies will need to be geared toward reducing the possible impact from the downward risks to the outlook by safeguarding the recent progress toward debt sustainability and a stronger external position. The possible confluence of domestic political uncertainty, regional instability, and the faltering global economic conditions constitute the main risk. Therefore, both monetary and fiscal policies need to be prudent, and financial supervision vigilant. Proactive contingency planning should also top the policy agenda.

29. Monetary and exchange rate policies: Monetary policy needs to continue to safeguard the peg, a prerequisite for financial stability given the large currency mismatches of the government, corporate, and household sectors, and the government’s high debt and debt service obligations in foreign currency. Staff estimates suggest that the real exchange rate remains broadly in line with fundamentals. Given the various risks, staff agrees with the authorities that there is not much scope for lowering interest rates in the near term. This cautious approach should last at least until the elections to attract deposit inflows, foster de-dollarization, and buttress the international-reserve buffer to insure against a confidence backlash.

30. Fiscal stance: Lebanon’s high debt level does not leave scope for countercyclical action. The moderate loosening in the fiscal stance in the 2009 draft budget will bring to a halt the recent decline in the debt-to-GDP ratio, substantially widen the government overall deficit, and could complicate government financing in case downside risks to the scenario materialize. Thus, staff believe that a primary surplus of close to 2 percent of GDP would be desirable, to preserve the trend toward debt reduction and maintain an unchanged overall financing requirements in 2009. While the current political circumstances, the likely slowdown in economic growth, and the soaring wage bill could make it difficult to attain this target, staff believe that strict expenditure restraint in the run up to the elections and the implementation of the Paris III fiscal policy package thereafter should aim at achieving a significantly higher primary balance than envisaged by the draft budget. Staff, therefore, recommends that any revenue over-performance be saved and any shortfall in capital spending be preserved.

31. Fiscal rigidities: The spending increase for wages and salaries is likely to absorb the fiscal space created by the drop in international oil prices and the welcome reintroduction of the gasoline excise in 2009. While the increase reflects in part the realization of contingent liabilities and unsustainable wage compression in the past, it adds a substantial budgetary rigidity and raises fiscal risk. Much of this increase will be permanent, whereas part of the fiscal space gained through reduced transfers to EdL depends on highly volatile oil prices. A targeted redirecting of expenditures would help meet the authorities’ social objectives much more efficiently than generalized wage increases. Careful phasing of expenditures is also needed to meet the fiscal targets under EPCA.

32. Contingency planning for government financing: The seizure in international capital markets and wider fiscal deficit will increase the burden on domestic banks to provide government financing, at a time of a slowdown in deposit growth. Staff agrees that under prudent assumptions banks should be able to provide sufficient financing, even in the absence of funding from international investors. Nevertheless, contingency planning remains essential to face the risk that election-related political uncertainty and a prolonged global recession could translate into a more substantial drop in deposit inflows. Staff and the authorities agree that the appropriate response would include a combination of fiscal adjustment, a lower pace of reserve accumulation, higher interest rates, and possibly additional use of Fund resources.

33. Banking sector: The specific funding and asset structure of banks, backed by effective banking supervision and regulation, have shielded the Lebanese banking system from exposure to global liquidity shortages, structured products, and real estate. Looking forward, continued vigilance is needed, since banks may still be affected by the global financial crisis, and the slowdown in growth in Lebanon and in the region could raise non-performing loans, although provisioning and capitalization remain sizeable. The authorities’ heightened focus on the bank resolution framework, including through the implementation of the merger law, is welcome, as it would help address potential negative effects of the global financial crisis on Lebanese banks.

34. The Paris III agenda: The proximity of the general elections and the global financial crisis has delayed implementation of key structural reforms that supported the debt reduction objectives of the Paris III agenda. There are three top priorities. First, the energy sector absorbs an unacceptably high amount of budgetary resources, and dampens Lebanon’s growth and productivity potential because of its inefficiencies. Despite the drop in international prices, current tariffs imply a significant untargeted subsidy that needs to be eliminated. Second, proceeding with the planned privatization of the mobile phone providers as soon as market conditions allow could go a long way toward promoting private sector growth and reducing debt-related vulnerabilities. Third, a gradual increase in the VAT rate to 15 percent would be needed to bring primary surpluses to levels that would approach debt sustainability over the medium term. Implementing these measures may prove to be difficult, but remains necessary to move towards sustainability. However, even under full implementation of the Paris III agenda, vulnerabilities would decline only gradually and significant risks would persist for many years.

35. Donor disbursements: Timely and flexible disbursement of the Paris III pledges is a key component of the debt reduction strategy. Unfortunately, disbursements have fallen short of expectations. Progress on the Paris III agenda, on which much of the pledges were conditioned, should help accelerate disbursements. Staff supports the authorities’ request that donors provide as much budgetary support as possible.

36. BdL balance sheet: The decline in international interest rates has highlighted the cost of maintaining high domestic interest rates to attract inflows and increase reserves. Action is needed to strengthen the BdL balance sheet. Staff believes the BdL should consider shifting from issuing higher-yielding securities toward using its large T-bill portfolio as the main tool for sterilizing excess liquidity. This would lower sterilization costs for the BdL and support fiscal discipline by making the cost of government financing more transparent. Over time a stronger fiscal position and reduced dollarization will also help strengthen the BdL balance sheet.

37. Data issues: The authorities have improved significantly GDP and CPI statistics. However, data insufficiencies still hamper the analysis of real and external sector developments. High-level commitment by the next government and by the BdL is needed to address these shortcomings through a comprehensive strategy to strengthen statistics.

38. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Table 1.

Lebanon: Selected Economic Indicators, 2006–14

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Sources: Lebanese authorities; and Fund staff estimates.

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

Short-term debt on a remaining maturity basis.

Table 2.

Lebanon: Central Government Overall Deficit and Financing: 2006–14

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

Includes domestic excises, which are collected at customs and 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 in 2007 and projected privatization proceeds in 2010-11.

Table 3.

Lebanon: Central Government Overall Deficit and Financing: 2006–14

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

Includes domestic excises, which are collected at customs and 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 in 2007 and projected privatization proceeds in 2010-11.

Table 4.

Lebanon: Government Debt, 2006–14 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.