Statement by Mr. Shaalan on Lebanon, June 26, 2014
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International Monetary Fund. Middle East and Central Asia Dept.
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KEY ISSUESContext: The economy is being severely tested by the Syria crisis. The refugee influx has reached one quarter of the population, fueling already high unemployment and poverty. The political impasse from the presidential elections—following months of negotiations over a new government—adds to the uncertainty. The economy is meanwhile suffering from a broad-based deterioration, with subdued growth and widening fiscal imbalances. Public debt is on the rise. Progress on structural reforms has been limited. On the positive side, deposit inflows have held up and foreign exchange reserves are sizeable; and security conditions have significantly improved, lifting tourism prospects.Key challenges: There is an urgent need for fiscal adjustment to achieve a sustainable debt reduction, and structural reforms to boost growth and address social inequities.Key policy recommendations:• Fiscal policy. The immediate priority is to stop the fiscal deterioration and return to primary surpluses, to avoid a possible loss of market confidence and put debt on a sustainable path. The consolidation strategy should minimize the impact of a planned salary increase for the public sector; include broad-based and non- distortionary revenue measures; and rebalance expenditure away from electricity transfers toward capital and social spending, to promote inclusive growth. Passing a budget for 2014 would help anchor confidence. Fiscal management should be strengthened and anchored in a medium-term perspective.• Monetary policy. The Banque du Liban (BdL) should continue to maintain high foreign exchange reserves as a buffer and signal of commitment to macro-financial stability. It should gradually withdraw from T-bill auctions, and adopt a strategy to improve its balance sheet over time.• Financial sector. Capital buffers should be strengthened, and the loan classification and restructuring rules and the AML/CFT regime further enhanced.• Structural reforms. Reforms in the electricity sector and the labor market are imperative to address current competitiveness pressures, lay the foundations for higher-productivity growth, and improve social conditions.• Refugee crisis. Lebanon cannot shoulder the costs of the massive inflow of Syrian refugees alone, and international budget support is needed. Strong government commitment to adjustment and reforms—along with a concerted policy framework to deal with the refugee crisis—would bolster credibility and help mobilize support.

Abstract

KEY ISSUESContext: The economy is being severely tested by the Syria crisis. The refugee influx has reached one quarter of the population, fueling already high unemployment and poverty. The political impasse from the presidential elections—following months of negotiations over a new government—adds to the uncertainty. The economy is meanwhile suffering from a broad-based deterioration, with subdued growth and widening fiscal imbalances. Public debt is on the rise. Progress on structural reforms has been limited. On the positive side, deposit inflows have held up and foreign exchange reserves are sizeable; and security conditions have significantly improved, lifting tourism prospects.Key challenges: There is an urgent need for fiscal adjustment to achieve a sustainable debt reduction, and structural reforms to boost growth and address social inequities.Key policy recommendations:• Fiscal policy. The immediate priority is to stop the fiscal deterioration and return to primary surpluses, to avoid a possible loss of market confidence and put debt on a sustainable path. The consolidation strategy should minimize the impact of a planned salary increase for the public sector; include broad-based and non- distortionary revenue measures; and rebalance expenditure away from electricity transfers toward capital and social spending, to promote inclusive growth. Passing a budget for 2014 would help anchor confidence. Fiscal management should be strengthened and anchored in a medium-term perspective.• Monetary policy. The Banque du Liban (BdL) should continue to maintain high foreign exchange reserves as a buffer and signal of commitment to macro-financial stability. It should gradually withdraw from T-bill auctions, and adopt a strategy to improve its balance sheet over time.• Financial sector. Capital buffers should be strengthened, and the loan classification and restructuring rules and the AML/CFT regime further enhanced.• Structural reforms. Reforms in the electricity sector and the labor market are imperative to address current competitiveness pressures, lay the foundations for higher-productivity growth, and improve social conditions.• Refugee crisis. Lebanon cannot shoulder the costs of the massive inflow of Syrian refugees alone, and international budget support is needed. Strong government commitment to adjustment and reforms—along with a concerted policy framework to deal with the refugee crisis—would bolster credibility and help mobilize support.

1. On behalf of the Lebanese authorities, I would like to thank staff for the valuable Article IV discussions and the resulting informative reports. The authorities also wish to express their appreciation for the continued provision of technical assistance.

Recent Developments and Outlook

2. The Lebanese economy faces difficult challenges associated with the conflict in Syria, which exacerbate already difficult domestic conditions. Since the onset of the Syrian crisis in early 2011, Lebanon has maintained an open border policy and has permitted refugees to freely settle across the country. Registered Syrian refugees account for about 25 percent of Lebanon’s pre-crisis population; including unregistered refugees raises this ratio to about 35 percent of the population. This has negatively impacted security and put serious pressures on virtually all aspects of the economy. As a result, growth is expected to be subdued in 2014 and the fiscal deficit and public debt are expected to increase. On the positive side, security conditions have recently improved since the formation of the government, deposit capital inflows remain resilient and foreign exchange reserves are high. Reflecting these developments, Standard & Poor’s upgraded Lebanon’s outlook from negative to stable last March.

3. The authorities remain committed to policies that ensure macroeconomic stability while addressing infrastructure bottlenecks and improving social conditions. However, Lebanon does not have the fiscal space to address the impact of the Syrian refugee crisis on the economy and local communities. Dealing with the refugee crisis requires strong international support.

Fiscal Policy and Reforms

4. In order to signal their commitment to fiscal discipline, the authorities are committed to putting in place a budget for 2014 aimed at balancing essential spending needs with stability goals.

5. The fiscal impact of the Syrian crisis is extensive. The negative impact on investor and consumer confidence and the disruption in the trade routes for exports and imports of goods, tourism, and financial services are placing downward pressure on government revenues. Combined with rising demand for public services due to the large refugee influx, this is further damaging Lebanon’s public finances. While the direct budgetary costs are not yet known with precision, the World Bank1 envisaged an immediate negative fiscal impact of $2.6 billion in 2012–14 (about 6 percent of 2013 GDP) through lower revenue and higher expenditure. It estimated the stabilization needs to be an additional $2.5 billion.

6. Large uncertainties surround the salary scale adjustment, which is still under parliamentary consideration. The authorities are confident, however, that the revenue measures they envisaged, if passed by parliament in a timely manner, would be sufficient to offset the cost of the salary scale adjustment. These measures include (i) an increase in the interest income tax rate from 5 to 7 percent; (ii) an increase in the corporate income tax rate from 15 to 17 percent; (iii) a new capital gain tax on real estate transactions; (iv) increases in tobacco excises; and (v) increases in various stamps and fees.

7. The authorities take note of staff’s work on a fiscal adjustment strategy that would reverse the debt dynamics. They consider that broadening the tax base and addressing tax loopholes are preferable to a large increase in VAT, which proved politically difficult to adopt in the past given its regressive nature.

8. The authorities do not share staff’s assessment that commitment to fiscal discipline will help mobilize budget support to deal with the refugee crisis. Fiscal discipline is necessary in itself in order to avoid a possible loss of market confidence and put debt on a sustainable path, although the current uncertainty overshadows policy decisions and may delay fiscal adjustment. In order to deal with the present refugee crisis and its repercussions on the Lebanese communities, the authorities reiterate their call for support from the international community.

Monetary and Exchange Rate Policies

9. Monetary policy helped maintain confidence in the Lebanese financial system, with the exchange rate peg providing a firm anchor for financial stability. The authorities share staff’s view on the importance of maintaining a high level of reserves. They are keen on reducing the Treasury’s reliance on central bank financing and agree with staff that this will have to be accompanied by a strong fiscal consolidation effort. The central bank remains open to further gradual reductions in the deposit remuneration rates and to increases in the Treasury-bill rates if and when conditions permit.

Banking Sector

10. The banking sector remains resilient despite the challenging environment, which has limited credit opportunities to the private sector and the banks’ expansion in neighboring countries. The authorities consider that staff’s assessment does not sufficiently acknowledge ongoing progress in the regulatory and supervisory framework. The central bank required banks to hold by end-2015 a supplementary capital buffer of 1.5 percent on top of the Basel III minimum, in addition to a 2.5 percent conservation buffer. Moreover, supervision was further enhanced with the establishment of colleges to strengthen the cross-border supervision of the largest banks. In addition, efforts to assess capital adequacy with respect to banks’ cross-border exposures through stress tests are ongoing. Lebanon’s AML/CFT regime is in practice fully compliant with international standards, and Lebanon’s financial intelligence unit, the Special Investigation Commission, actively cooperates with its foreign counterparts.

1

World Bank, Poverty Reduction and Economic Management Department, Middle East and North Africa Region, “Lebanon, Economic and Social Impact Assessment”, September 2013.

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