Lebanon: Staff Report for the 2015 Article IV Consultation
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
17 Jul 2015
eISBN:
9781513567563
Language:
English
Keywords:
ISCR; CR; currency peg; refugee crisis; crisis; U.S. dollar peg; nominal GDP; U.S. dollar; foreign currency; private sector; exchange rate; Oil prices; Electricity; Commercial banks; Global
Download PDF (1.5 MB)

The Syrian crisis and the associated inflow of refugees continue to dominate Lebanon’s short-term outlook, compounding long-standing policy weaknesses and vulnerabilities. Political paralysis has set in, with virtually no progress on the structural front. Growth has remained modest and insufficient to make a dent in rising poverty and unemployment. A welcome improvement in the primary fiscal position in 2014 was largely due to temporary factors, and will not be sustained absent adjustment efforts—implying that, without additional effort, Lebanon’s already-sizable public debt burden will only worsen. Financial conditions have nonetheless remained stable, as deposit inflows continue to fund the economy and sizeable buffers support the credibility of the exchange rate peg.

Abstract

The Syrian crisis and the associated inflow of refugees continue to dominate Lebanon’s short-term outlook, compounding long-standing policy weaknesses and vulnerabilities. Political paralysis has set in, with virtually no progress on the structural front. Growth has remained modest and insufficient to make a dent in rising poverty and unemployment. A welcome improvement in the primary fiscal position in 2014 was largely due to temporary factors, and will not be sustained absent adjustment efforts—implying that, without additional effort, Lebanon’s already-sizable public debt burden will only worsen. Financial conditions have nonetheless remained stable, as deposit inflows continue to fund the economy and sizeable buffers support the credibility of the exchange rate peg.

Context: Policy Inertia…

1. Lebanon has a reputation of living close to the edge. In the past, it has weathered significant shocks, sustained macroeconomic imbalances even wider than those currently experienced, with political dynamics often preventing a more strategic approach to addressing underlying vulnerabilities.

2. But this time may be different. The Syria crisis—now in its fifth year—represents one of the worst humanitarian crises since the Second World War, and is the key determinant of Lebanon’s short-term outlook and longer-term prospects (Box 1). The number of refugees has steadied, partly as a result of tighter border restrictions. But they nonetheless comprise over one-quarter of the population, straining local communities, adding to poverty and unemployment, and placing further pressure on Lebanon’s already-weak public finances and infrastructure. The authorities have stepped forward and should be commended for hosting the refugees, but they cannot shoulder this overwhelming burden alone. International support has helped, but remains insufficient given the sheer scale of Lebanon’s humanitarian and development needs.

3. The country is in the grip of a protracted political crisis. The presidency has been vacant since May 2014, and parliament lacks sufficient consensus to convene to discuss key legislation. Without a president, cabinet can still enact legislation, but only if agreed unanimously by all 24 ministers—which is very difficult given the current political fissures. Parliament’s term was recently extended (for a second time) to June 2017, adding to concerns as to its legitimacy. In this environment, a few targeted policy actions would send a strong signal about the country’s will and determination to move forward despite the many challenges ahead.

4. Growth has decelerated significantly. Following a crash from 8 percent in 2010 to less than 1 percent in 2011, growth has inched upward to around 2–3 percent, but remains well short of its potential. Inflation also declined sharply in 2014, owing to lower oil prices and a number of additional one-off developments, but is expected to return to a trend rate of about 3 percent in 2015. In this regard, lower CPI inflation has essentially offset the recent appreciation of the Lebanese pound (pegged to the U.S. dollar), leaving Lebanon’s real effective exchange rate broadly unchanged.

A01ufig1

GDP Indicators

(Percent growth, annual)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: National authorities, and IMF staff calculations.

5. Rising uncertainty is taking a toll on the economy, but incomes and consumption are receiving a temporary boost from lower oil prices. Lebanon’s traditional growth sectors—tourism, real estate, and construction—have all taken a significant blow, and a strong rebound is unlikely in the immediate future. Indeed, early indications for 2015 point to a marked softening of the construction sector, particularly for high-end residential projects. However, the pass-through of global oil prices to local fuel prices is relatively high in Lebanon, so the recent drop in global prices will boost local incomes (Box 2). Remittance inflows, a significant portion of which come from oil-exporting Gulf countries, have been stable in the face of volatile oil prices. Projections also suggest that activity in key oil exporting countries will remain steady, as financial buffers are expected to cushion any adverse impact on growth. Taking all these factors into account, staff estimate Lebanon’s GDP growth at about 2 percent in 2014 (slightly less than the previous year) and project a similarly modest rate for 2015.1 Looking further forward, staff have also scaled back their medium-term projections. Domestic demand will remain relatively subdued from 2016 onward and the economy’s medium-term recovery will be driven mostly by the normalization of broader global conditions. Thus, Lebanon’s return to potential growth (4 percent) is now unlikely before 2019.

A01ufig2

Lebanon: GDP Coincident Indicator Components, 2011–15

(Rolling 12-month average, annual growth, percent)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: National authorities; and IMF staff calculations.

6. Exceptional factors allowed for a welcome primary surplus in 2014, but without decisive action fiscal deterioration is set to resume in 2015. At an unexpected 2½ percent of GDP, the 2014 primary surplus largely resulted from unusually high telecom transfers (part of which, estimated at about 1 percent of GDP, will be transferred to municipalities in 2015), the non-implementation of a much-awaited salary increase for the public sector, and, to some extent, withheld and delayed payments.2 Without a repetition of these one-off factors, staff project that the primary balance will likely deteriorate to almost 1¼ percent of GDP in 2015, with public debt remaining at 132 percent of GDP, very high by international standards (Annex I).

The Prolonged Impact of the Syrian Refugee Crisis

The Syrian crisis is now entering its fifth year. According to the United Nations High Commission for Refugees (UNHCR), the number of Syrian refugees exceeded 1.4 million in January 2015. Combined with an estimated 0.4 million Palestinians already in Lebanon, refugees now exceed one third of Lebanon’s total resident population. And looking ahead, UNCHR expects the number of Syrian refugees will surpass 1.8 million by the end of the year.

Although all parties agree that such a number of refugees is unsustainable, there are few quantitative estimates of their economic impact.

  • The authorities’ have been clearly confronted with rising healthcare, education, electricity, and security costs, and the quality of public-service provision has suffered. But to date, the only comprehensive costing comes from a 2013 study led by the World Bank, which estimated the direct fiscal impact of the crisis over 2012–14 at $2.6 billion (5½ percent of GDP).1 It also suggested that restoring public-service provision to pre-crisis levels would require an additional $2.5 billion. These results remain the most reliable assessment of the crisis’ fiscal cost.

  • As for the broader macroeconomic impact of the crisis, a recent UNDP study2 estimated the multiplier associated with humanitarian aid at around 1.6. Thus, while the (net) impact of the crisis has clearly been negative, aid inflows in 2014 added 1.3 percent to overall GDP growth.

  • The social costs of the crisis have also been significant. Poverty in Lebanon has increased by 4 percentage points to 32 percent; the labor force has risen by an estimated 50 percent compared to 2011; and income inequality has widened, as Syrian refugees accept much lower wages than Lebanese workers.3

A comprehensive strategy is yet to be put in place. As a matter of policy, Lebanon has long maintained that it is not a country of asylum, a final destination for refugees, or a country of resettlement. But there is no consensus on the best way to curb the inflows or deal with existing refugees—memories about Palestinian refugee camps have prevented the consideration of organized settlements or any measure that might allude to a permanent presence. After a long delay, the authorities adopted a policy paper in October 2014 focusing on three broad principles: (i) reducing the number of individuals registered in Lebanon as displaced; (ii) addressing local security concerns; and (iii) sharing the burden of the crisis by expanding the humanitarian response to include local communities and infrastructure. It also encouraged relocation to safe areas in Syria, or for third countries to offer more resettlement opportunities. As part of this policy, the authorities have tightened border-control requirements; and registrations of new refugees are now down to around 10,000 per month, compared to around 30,000 per month prior to October 2014.

Humanitarian support has been substantial, though more is needed and on a sustained basis. Humanitarian assistance, directly targeting the refugees and the agencies working with them, exceeded $1 billion in 2013 and almost reached that level in 2014. While sizable, donor support has not covered increasing needs. Most visibly, the World Food Program (WFP)’s card voucher scheme aims to meet basic subsistence requirements ($30 per month) for around 883 thousand refugees in Lebanon—its coverage increased from 28 percent of eligible refugees in 2013 to about 40 percent in 2014. Due to a shortfall in funding, however, the WFP announced in December that it had suspended payments to all Syrian refugees. Payments were quickly restored following an emergency fundraising campaign, but chronic shortfalls persist and support is now often below targeted (subsistence) levels, at less than $20 per month per refugee. On current funding trends, the WFP will have to suspend the program in the summer, leaving many refugees without food assistance.

A01ufig4

Lebanon: Humanitarian Contributions

($ millions)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Source:UNDP.

The emphasis of donor support is shifting from humanitarian to development aid. In December 2014, the government and UNDP launched the Lebanon Crisis Response Plan (LCRP)—a 2-year stabilization and development plan that targets 1.5 million refugees while also including 1.9 million vulnerable Lebanese. Unlike the previous year’s plan, which focused primarily on humanitarian relief, approximately one-third of the LCRP will address Lebanese stabilization/development needs. So far, of the $2.14 billion required under the plan, only some $400 million has been made available. The Third International Humanitarian Pledging Conference for Syria (Kuwait III), held at end-March 2015, led to pledges of $3.8 billion to fund the Regional Refugee and Resilience Plan 2015–16 (which includes the LCRP). While these are significant amounts, actual disbursements may once again disappoint.

1 World Bank, 2013. “Economic and Social Impact Assessment of the Syrian Conflict”, WB Report No. 81098-LB.2 UNDP, 2015. “Impact of Humanitarian Aid on the Lebanese Economy, Fiscal Multiplier Report”.3 IMF, 2015. “The Impact of the Syrian Conflict on Lebanon,” Selected Issues Paper (IMF Country Report No. 14/238).

Can Nominal GDP Increase with Falling Prices and Stagnant Growth?

Despite weak growth and falling prices, Lebanon’s nominal GDP is rising. Staff have recently scaled back their real GDP growth estimates, amidst falling inflation (actually negative at end-2014). But nominal GDP projections have actually increased. So why is nominal GDP rising so rapidly? The answer stems from the relationship between two commonly used measures of inflation—the consumer price index (CPI) and the GDP deflator.

The CPI and deflator typically move together, but not always. Indeed, there may be occasions when they provide very different pictures of inflation. The discrepancy often stems from movements in a country’s terms of trade, i.e. the ratio of export prices to import prices. Essentially, the CPI basket includes imports, but not exports; whereas the GDP deflator includes exports, but not imports. So, if the prices of these two trade-related items move in different directions, the gap between the CPI and the deflator may be significant. To gauge the size of the gap, it is useful to note that:

GDP⁢  deflator=“Domestic⁢  prices”+α×e⁢xport⁢  prices−β×import⁢  prices

where α and β are the relative importance of exports and imports, respectively, as a proportion of GDP. If Lebanon’s terms of trade improve—either through rising export prices or falling import prices—then the deflator will tend to rise faster than the CPI. And as a result, nominal GDP will grow relatively quickly; reflecting the fact that Lebanon is effectively wealthier.

Looking forward, nominal GDP is projected to grow rapidly in 2015. WEO projections imply a significant improvement in Lebanon’s terms of trade in 2015, owing in large part to the recent drop in oil (import) prices, but reflecting also the strengthening U.S. dollar. These factors will boost nominal GDP growth, despite subdued consumer prices and modest real growth.

7. There has been virtually no progress on structural reforms. There have been long delays in electricity reforms and enhancing social safety nets. Policy inertia has also prevented the development of offshore gas fields—as the bidding process for exploration has been repeatedly delayed, with decrees on field delineation and an Exploration and Production Agreement still pending and the Petroleum Tax Law yet to be passed by parliament. On a positive note, the publication of a quarterly T-bill calendar and updated public debt strategy are welcome (Box 3).

A01ufig5

Reserve Adequacy

(USD billions)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: National authorities; and IMF staff calculations.

8. Despite Lebanon’s political impasse and sizable external requirements, foreign-exchange and financial markets have remained resilient. Following recent data revisions, the current account deficit is estimated at around 25 percent of GDP in 2014 (see Annex II). This is a clear source of vulnerability, particularly in light of the peg to the U.S. dollar. Nonetheless, foreign inflows continue to grow, and have allowed the Banque du Liban (BdL) to maintain an adequate level of gross reserves, which stood at around $38 billion as of end-March 2015 (107 percent of the Fund’s composite metric). In this regard, the exchange-rate peg remains a key anchor for confidence and stability, and continues to serve the economy well. Lebanese Eurobond spreads have generally moved in line with regional peers, and are broadly at pre-crisis levels (400 bps). Indeed, in February, a $2.2 billion Eurobond issue by the Treasury—the largest so far—was significantly oversubscribed. Nonetheless, S&P maintained the rating unchanged at B-level in March 2015, warning about potential downside risks.

A01ufig6

EMBI Spreads, 2014

(Basis points)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: National authorities; Bloomberg; and IMF staff calculations.

Policies Since the 2014 Article IV Consultation

The 2014 consultation called for fiscal discipline, by restoring a primary surplus and reducing the public debt-to-GDP ratio. The authorities managed to achieve a primary surplus, but mostly through one-off measures including: sizeable transfers from the telecom company, non-implementation of a salary increase for the public sector, under-spending on capital projects, and flat social and other current spending. Excises on gasoline were minimally increased, but more could have been done in light of the recent large drop in oil prices. In line with staff advice, the BdL decreased rates on CDs across the full spectrum of longer maturities to encourage banks to invest in long-term T-bill issuances.

The 2014 consultation also stressed the importance of continued efforts to strengthen bank regulation and supervision, as well as the balanced development of capital markets. On the former, the authorities have continued their efforts and have recently requested an FSAP update. On the latter, the Capital Markets Authority (CMA) continued apace to issue regulations and took over a part of supervision from the BdL, which staff welcome.

There was minimal progress on structural reforms. The 2014 consultation highlighted the need for structural reforms toward more inclusive growth and economic resilience, especially in light of the prolonged presence of Syrian refugees and the resulting pressures on Lebanon’s fiscal accounts, infrastructure capacity, social fabric and labor markets. Staff underlined the need to implement electricity reform to improve service provision and reduce the EdL’s drain on the budget, embark on strengthening social safety nets, and re-activate the legislative process to pass pending legislation. On the positive side, staff welcomed the Ministry of Finance’s initiative to publish for the first time a quarterly T-bill issuance calendar regularizing long-term issuances, and an updated public debt strategy. Parliament’s agreement to pass a law allowing for new Eurobond issuances was also a positive step. The authorities also embarked on anti-corruption campaigns in the health sector and at customs. Reform progress in other areas is still very slow. The provision of statistical information has generally remained weak, with longer delays and an increasing lack of cooperation and coordination among various agencies (Box 6).

…Amid Mounting Risks

9. Lebanon’s unique macro-financial structure is a source of resilience, but also of key risks. With aggregate assets exceeding 350 percent of GDP, the Lebanese banking sector is one of the largest in the world and the largest in the MENA region as a share of GDP. Banks attract substantial deposits from both residents and nonresidents, including from Lebanon’s large overseas diaspora. And they play a crucial role in channeling these funds to both the private and public sectors, helping fund large budget and current account deficits. In itself, the banking system has a relatively conservative business model, is well-supervised, and enjoys a relatively stable funding base with significant buffers. While the nexus between the banks and the sovereign has been at the core of Lebanon’s resilience, it also means that broader macroeconomic stability depends in large part on the banks’ continued ability to attract foreign deposits.

A01ufig7

Lebanon’s Macro-Financial System

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Note: The width of the arrows is proportionalto the size of the exposures.

10. Based on traditional financial-soundness indicators, there is little evidence of a build-up of risks to financial stability.

  • Credit to the nonfinancial private sector has grown by about 9 percent per year over 2013–14, faster than nominal output. As a result, the private sector credit-to-GDP ratio increased from 86 to 91 percent over the same period, in part driven by three BdL stimulus packages totaling $3.4 billion. While this might otherwise be a cause for concern, standard metrics such as the “credit gap” (the deviation of credit-to-GDP from its long-run trend) suggest that, based on Lebanon’s past experience, risks to financial stability are not currently out of line.

    A01ufig8

    Credit to the Private Sector

    (y/y growth, percent)

    Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

    Sources: Banque du Liban ;and IMF staff calculations.

  • At the same time, the BdL has introduced new macroprudential measures to contain the build-up of risk, tightening provisioning rules for retail loans and imposing new restrictions on lending to households, in the form of lower loan-to-value ratios and debt-service-to-income ratios.

  • Private sector leverage appears contained. Leverage is not a pressing worry for Lebanese banks, as the system’s leverage ratio (at 6.5 percent) is well above Basel Ill’s minimum requirement of 3 percent. Similarly, household indebtedness is reasonable, at around 44 percent of household income. However, there is little available data on non-financial corporate leverage.

  • Risks could arise following a sharper downturn of the real estate market. A sizable fraction of bank loans to the private sector have been directed at the real estate sector, where activity is softening. But, in the absence of a price index, the number and value of property sales can serve as a proxy for the housing cycle. Both indicators grew by close to 3 percent in 2014. This is slightly more than the 2009–14 average for the number of transactions, but well below the past average for the value of sold properties (around 11 percent).

A01ufig9

Bank Loans by Sector, June 2014

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: Banque du Liban;and IMF staff calculations.

11. Nonetheless, the structure of Lebanon’s financial system, and the tight nexus between banks and the sovereign, make the economy dependent on the confidence of non-resident depositors. As noted above, deposit inflows are the key source of funding for the economy. These inflows have been resilient, including in the face of financial- and commodity-market volatility. Deposit growth has decelerated over recent years—but at 7–8 percent, it has remained sufficient to cover Lebanon’s (public and external) financing needs and to maintain the current international reserve buffer. However, risks from a further escalation of regional conflict (or other external events) are exceptionally high, and could lead to a negative and potentially protracted investor response.

A01ufig10

Non-Resident Deposits 1/

(y/y growth)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

1/ Includes depositsof non-resident banks.Sources: National authorities; IMF staff calculations.

12. Spillovers from the Syria crisis pose the most serious threat to the economy. Under the baseline, staff assume that the conflict in Syria will begin to ease toward the end of 2016; at which point confidence will come back and growth will gradually return to potential—a modest 4 percent. Thus, in contrast to the recent past, when high GDP growth helped contain Lebanon’s imbalances, subdued growth over the foreseeable future will likely remain too low to stabilize debt, create jobs, or address the country’s deepening social tensions. On the (so far unlikely) upside, however, if the crisis in Syria were to be resolved, Lebanon would be in a unique position to assist in its reconstruction, with significant and positive implications for local incomes and growth.

A01ufig11

Public Debt Repayment Profile

(USD billion)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: National authorities; and IMF staff calculations.

13. Downside risks associated with the Syrian crisis are exceptionally high. In addition, two key risks also loom large (see Risk Assessment Matrix):

  • Continued fiscal deterioration due to political stalemate and entrenched social tensions. In the face of social pressures and refugee needs, the authorities may postpone fiscal adjustment as politically too difficult. Any such course would further increase public debt, possibly leading to financing pressures and lower investor confidence. This could, in turn, quickly spread into the macro-financial sphere—triggering lower deposits, higher financing costs, deteriorating bank finances, mounting exchange-rate pressures, and falling reserves.

  • Stalled structural reforms. Continued erosion of already weak infrastructure, and further disappointments, especially on the electricity front—compounded by the pressures from the refugee presence—could further weaken growth and competitiveness. This would have a direct impact on Lebanon’s already-adverse debt dynamics and social stability (with a longer-term feedback loop on domestic security).

Authorities’ views

14. The authorities broadly agreed with staff’s assessment of risks. They viewed developments in the region, most notably the crisis in Syria, as the main risk to security and relatedly, macroeconomic stability. They continued to believe that, although the international community had helped, it had done too little to allow Lebanon to deal adequately with the tragedy of the refugees, and that much more was needed to stem a crisis that transcended national and regional borders.

15. They were less concerned about spillovers from global financial market volatility and increased interest rates. They noted that, in the past, the pass-through from dollar to domestic interest rates had been gradual and incomplete, and that Lebanon would manage as long as a sufficiently large differential vis-à-vis dollar rates was maintained.

16. They shared staff’s assessment on the key role of continued deposit inflows. However, they underscored that, as the stock of deposits grows larger, less emphasis should be put on the growth rate per se rather than on the absolute size of the inflows, which continued to be sufficient to fund the economy. A slowdown in itself was not a pressing concern and was to be expected, given the domestic and regional outlook.

Lebanon: Risk Assessment Matrix1

article image

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Policy Discussions

17. Lebanon needs to take action. Over the short term, the key challenge will be to articulate a coherent policy mix, starting immediately with credible adjustment to restore fiscal sustainability. Over the longer term, social stability requires job-rich, sustainable growth that benefits all, which cannot happen without a more inclusive macroeconomic environment and structural reform. These two themes—ushering in a more balanced policy mix and laying the ground for higher and more inclusive growth—featured prominently in the 2015 Consultation.

A. A More Balanced Policy Mix

18. The need for fiscal adjustment is inescapable. Without it, and in the context of Lebanon’s slowing growth and rising global interest rates, public debt will increase. Similarly, without adjustment, government financing needs will continue to rise; the underlying codependence between banks and the sovereign will intensify; and Lebanon’s reliance on deposit inflows will grow larger, exposing the economy even more to sudden swings in depositors’ confidence. On all these counts, delayed adjustment will simply exacerbate Lebanon’s underlying vulnerabilities.

19. The case for fiscal adjustment is also grounded in fairness. Without it and with ever more debt, interest payments will soar to some 12 percent of GDP, or about 40 percent of total spending, crowding out essential social programs and infrastructure projects and largely benefitting public debt holders at the expense of the less-privileged. Thus lack of fiscal adjustment is also costly and inequitable.

A01ufig12

Lebanon: Government Spending, 2014

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

2 squares = 1 percent of GDPSources: National authorities; and IMF staff calculations.

20. Yet, on current policies fiscal sustainability will remain elusive. Under the baseline scenario, staff assume that the salary scale adjustment for the public sector will be implemented as part of a package including the following revenue measures:3 an increase in the corporate income tax rate (from 15 to 17 percent); the introduction of a capital gains tax on real estate; an increase in the tax rate on interest income (from 5 to 7 percent); and new stamp duties and fees. However, while the proposed package generates moderate primary surpluses, it would not be sufficient to tackle Lebanon’s deteriorating debt dynamics. As a result, debt is projected to reach 143 percent of GDP by 2020, with its trajectory subject to significant downside risks (Annex I).

21. So fiscal adjustment is essential to restore sustainability. Staff’s proposed strategy seeks to achieve a number of objectives: (i) deliver a sustained reduction in the public debt ratio, by targeting primary surpluses comfortably above the debt-stabilizing level of 2.3 percent of GDP (Annex I); (ii) promote more fair fiscal policies, by targeting a broad-based increase in taxation; and (iii) mitigate the procyclical impact of fiscal adjustment, by increasing productive spending (see adjustment scenario in text chart). More specifically:

A01ufig13

Fiscal Scenarios

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Source: IMF staff calculations.

  • There is scope to increase taxation in a fair manner across all economic sectors, including by broadening tax bases and strengthening compliance. According to staff analysis, Lebanon’s tax capacity remains largely under-utilized;4 and while ongoing efforts by the ministry of finance to tighten tax collections (including through better enforcement and oversight, especially of VAT refund claims) are welcome, more is needed. Staff endorsed the authorities’ planned measures (with the caveat that double taxation on incomes be avoided); 5 however, it cautioned against optimistic yield projections. It also called for a modest increase in the VAT rate by one percentage point, to 11 percent.

    A01ufig14

    Tax Effort

    (Ratio)

    Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

    Source: IMF staff calculations.

  • Low oil prices provide an opportunity to reform fuel taxation. As the pass-through from global oil prices to domestic retail prices is relatively large, staff argued that now is an opportune time to remove the VAT exemption on diesel introduced in 2012 and increase gasoline excises, significantly reduced in 2011. Such increases will also promote a more efficient use of fuel products and mitigate the costs of pollution and congestion (Box 4).

Why Increasing Fuel Taxation Makes Sense

Among regional peers, Lebanon has seen the largest pass-through from falling oil prices. Retail fuel prices declined by about 30 percent in 2014.

Yet taxes levied on these products remain unchanged at very low levels. Currently gasoline is subject to 10 percent VAT and low excises, at less than 20 U.S. cents per liter (excises were lowered significantly in 2011, with a subsequent minimal increase in January 2015). “Green” and “red” diesels, for transportation and heating, respectively, are totally tax free, as they were made VAT exempt in 2012 and have never been subject to excises. More generally, fuel taxes have often been adjusted in an effort to mitigate changes in retail fuel prices deemed politically unacceptable, acting as shock-absorbers to offset movements in international prices. But once taxes are lowered, it then becomes difficult to increase them when conditions change.

A01ufig15

Regional Retail Fuel Prices

(USD per liter)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Sources: IMF Staff Calculations

But lower fuel taxes may not be the best policy. First, revenue losses have been significant (the cost of the VAT exemption on diesel was originally estimated at some ½ percent of GDP, but consumption has increased since 2012 in line with the growing refugee presence, suggesting that losses are probably larger). Second, the gains associated by implicitly subsidizing road transport are not distributed fairly: by income, the poorest 20 percent of the population receives only 6 percent of the subsidy, while the richest 20 percent receives 55 percent.1 Finally, low fuel taxes are not efficient. Setting fuel prices (inclusive of taxes) at an artificially low level encourages over-consumption, and adds to negative externalities—namely global environmental damage, and local air pollution, congestion, accidents, and roadway wear and tear.

Higher fuel taxes could lead to improved public health, lower environmental costs, less congestion, and more efficient fuel use. In setting the optimal tax level, consideration should be given to the complete set of social externalities associated with fuel use. And while the chief goal is to align private and social costs, rather than raise revenue, corrective taxes would also serve as a much needed source of funding for the government, given Lebanon’s pressing fiscal consolidation needs.

There is ample scope to increase fuel taxation in Lebanon. An optimal-pricing tool prepared by the IMF’s Fiscal Affairs Department2 suggests that, at minimum, the level of excises on gasoline should be increased and the VAT on diesel should be re-instated. Though politically difficult, these measures could be framed as part of a broader set of steps to ensure that fiscal adjustment is as growth-friendly and equitable as possible—indeed, experience in other countries suggests that fuel-tax changes are most well received when part of a more general strategy that also addresses public-transport and infrastructure shortcomings. Compensating measures for the less well-off should also be considered.

Economically Efficient Fuel Prices in Lebanon, January 2015

article image
Sources: IMF Staff calculations
1 UNDP, 2015, “Fossil Fuel Subsidies in Lebanon: Fiscal, Equity, Economic and Environmental Impacts.”2 The tool is available at http://www.imf.org/external/np/fad/environ/. See also Parry I., D. Heine, E. Lis, and S. Li, 2014, Getting Energy Prices Right: From Principle to Practice, International Monetary Fund.
A01ufig16

Lebanon: Fiscal Scenarios, 2016–18

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Source: IMF staff estimates.

  • Telecom transfers should be managed transparently. Staff noted that their ad-hoc nature hampered proper cash management and called for a system of regular transfers.

  • The state-owned Electricité du Liban (EdL) should urgently be placed on a sound financial footing to reduce the need for government transfers. Staff noted that low oil prices have created some fiscal space, but that they cannot be relied upon to contain future transfers. Ideally, transfers should be eliminated. Staff therefore renewed calls for a comprehensive reform of the electricity sector (see next section). Ultimately, as service provision is improved, tariffs (unchanged since 1993) should be increased toward cost recovery levels while protecting lower-income consumers.

  • The salary scale adjustment should be implemented only if funded by credible revenue measures, phased in gradually and without retroactive payments. Staff underscored that it should be accompanied by steps toward comprehensive public-sector reform, such as lengthening working hours from 32 to 35 a week and capping overtime and benefits, to ensure that public servants are adequately remunerated based on their productivity.6 However, staff also noted that the salary debate had drawn attention away from the more pressing need for fiscal adjustment, and that fully funding the salary increases—the primary focus of ongoing political discussions—would do nothing to reduce the budget deficit, but would instead add pressures to already unsustainable public pension schemes (see below).

  • There is also a great need to increase capital and social spending. Capital outlays have been cut to the bone, well below (modest) regional averages—and at a time when the refugee presence is adding further strains to already weak infrastructure. At the same time, social safety nets remain insufficient, especially as poverty and unemployment have widened. In this context, staff presented analysis on rebalancing the spending mix to mitigate the procyclical impact of fiscal adjustment. Starting from the adjustment scenario presented above (scenario a), capital expenditure could be further increased by 1 percent of GDP (funded in a budget neutral way by additional VAT revenue, scenario b),7 resulting in a more growth-friendly fiscal package.

    A01ufig17

    Same Adjustment, Different GDP Outcomes

    (In percent of GDP)

    Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

    Source: IMF staff calculations.

  • Finally, delaying payments is a clearly suboptimal way to compress spending and should be avoided. Although data are not available, staff noted that the frequently reported increase in delayed payments is not a lasting strategy to reduce the budget deficit. It could also result in future government obligations and further weaken economic activity.

22. Passing a credible budget—the first in a decade—remains a critical priority. Staff reiterated that it would provide a tangible and credible sign of reform commitment.

23. Sustained fiscal adjustment will also reduce Lebanon’s reliance on foreign deposit inflows—and thus reduce rollover risks. Banks hold over half of Lebanon’s T-bills and Eurobonds, funded primarily by deposits, with a sizable portion coming from non-resident inflows.8 And banks have a strong incentive to continue financing the government as long as they have enough liquidity. Staff noted that current buffers are sufficient to sustain a temporary decline in deposit growth, though a sustained decline in deposit inflows could jeopardize banks’ ability to finance the government.9

24. Fiscal adjustment would reduce the financial—and institutional—burden on the BdL. The key priority of the BdL has, appropriately, been to build up Lebanon’s foreign exchange (FX) reserve buffers, given the central role of the peg as a nominal anchor. To this effect, the BdL has been channeling FX resources from the banking system into international reserves. Over the past couple of years, however, some of these funds have also been used to meet the FX needs of the government. At the same time, the BdL has also played a growing role in the allocation of credit to the private sector, by introducing subsidized schemes—accounting for about 20 percent of total outstanding loans and close to 75 percent of housing loans in 2014. Staff called for a gradual withdrawal from such quasi-fiscal schemes, allowing old subsidized credit schemes to expire. All these operations have taken a toll on the BdL’s income position. Looking forward, there is a need to gradually strengthen the BdL’s balance sheet.10

25. Finally, fiscal adjustment would allow for more market-determined interest rates. Staff noted that the BdL, at times, has helped finance the government by offering well-remunerated term deposits to banks in local currency, and channeling the proceeds to cover shortfalls in the T-bill market. As a result, the BdL has been effectively managing short- and medium-term T-Bill yields (unchanged since 2012) by using rates on its own CDs as a key signal. While financial conditions do not appear excessively loose or tight (Box 5), staff underscored that unchanging interest rates tend to dampen market signals, potentially distorting resource allocation and hindering market development. It therefore recommended that, as fiscal adjustment takes hold, the BdL should scale back its role as intermediary between banks and the sovereign, paving the way for more market-based benchmark T-bill yields.

Authorities’ views

26. The authorities agreed that reducing the debt ratio is the main priority. They noted however that the political environment is extremely difficult, as shown by the protracted debate on the 2015 budget. While there was general consensus around the need to tackle well-known issues—such as reforms of electricity and civil service—concrete steps were unlikely. At the same time, they acknowledged that even small steps could have high impact as a signal of political action. Views remained split on the salary adjustment package, with some underscoring the need to bring hiring under control and adopting differentiated salary scale increases for different categories of public sector. At the same time, some noted that higher salaries were needed to secure a more decent living for public servants, and to mitigate corruption; while others were of the view that such increases cannot be afforded now.

27. The authorities also welcomed the emphasis on growth and fairness. They appreciated that, in contrast with past advice, staff was no longer recommending a VAT rate increase up to 15 percent, which they had viewed as regressive and politically unacceptable. They welcomed the Fund’s ongoing technical assistance on boosting tax capacity through broadening tax bases and strengthening compliance, which would help spread the burden of adjustment.

28. There was broad agreement on the need to rebalance the policy mix to lighten the burden placed on the BdL. The authorities generally recognized that the BdL has been doing much to preserve the credibility of the peg while providing support to the government and the economy. They noted that recent steps to lower CD rates to align them fully with T-bill rates had been well-received, and could pave the way over time to a less active role in the management of government debt. But they disagreed with the claim that the BdL was actively intermediating the flow of funds between the banks and the government. Instead, they stressed that the issue of longer-term CDs was, in part, motivated by the BdL’s capital-market development goals—long-term BdL CDs were viewed as a key first step in extending the yield curve, and would ultimately help promote the issuance of longer-term T-bills by the Treasury. In this connection, they also explained that T-bills are more desirable than CDs to banks because they are more liquid—in fact when the government followed the central bank with the issuance of longer maturity bonds, banks showed appetite for these instruments. More broadly, they remained confident that the balance sheet of the BdL would be strengthened over time, though conditions were not yet favorable for pursuing alternative policy actions in the short term.

B. Aiming Higher: Stronger and More Inclusive Growth

29. Higher growth, better growth. Current low growth rates are insufficient to address social inequities and create jobs; and even in the past, higher growth has often only benefitted a few. In discussing Lebanon’s longer-term prospects, staff stressed three key areas: strengthening the financial system; structural reform, especially in electricity; and more and better data.

Financial stability

30. Sustained, broad-based growth requires a sound financial system. The banking system is one of the economy’s most critical pillars, and has contributed to growth and prosperity. Access of households and firms to banking services is high compared to the region or with other countries of similar income level.

A Financial Conditions Index for Lebanon

A Financial Condition Index (FCI) combines several financial variables that influence GDP growth. It provides a summary measure of domestic financial conditions and can be used to assess macro-financial linkages. In particular, it points to the financial factors that are supporting or slowing real activity at any point in time.

Financial conditions appear to have tightened over the past year in Lebanon. Staff computed an FCI, showing that key drivers have been lower deposit growth and an appreciating real exchange rate, offset in part by low global interest rates.

The computation involves three steps.1

  • First, a vector-autoregressive model including financial variables and real GDP growth was estimated using quarterly data. The financial variables in the model include the 6-month LIBOR rate, deposit growth, the spread between lending and deposit rates (both in USD and local currency), and the real effective exchange rate (REER). The sample period covers 1995–2014.

  • Second, impulse responses are computed to assess the cumulative impact of a one-unit shock to the financial variables on GDP growth after 6 quarters. Structural shocks are identified through a Cholesky decomposition.2

  • Third, the estimated responses are used as weights for each variable in the FCI. All financial variables are expressed as deviations from their sample means.

LIBOR, deposit growth, and the REER are key drivers, with a more limited role for bank interest rate spreads.

Financial conditions eased significantly after 2008, supporting growth. The loosening reflected higher deposit inflows, lower global interest rates, a real depreciation and falling bank spreads.

But since 2014, financial conditions have tightened, in step with slowing economic activity. Deposit growth in particular has decelerated, and is below its 20-year average. Looking forward, rising global interest rates are expected to further tighten local conditions.

A01ufig18

Financial Conditions Index

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Source: IMF staff estimates.
1 See IMF’s Asia and Pacific Department Spring 2009 Regional Economic Outlook (Box 1.4), and Swiston (2008),“A U.S. Financial Conditions Index: Putting Credit Where Credit is Due,” IMF Working Paper 08/161.2 The ordering assumes that domestic financial variables do not have a contemporaneous effect on GDP growth and that GDP growth and domestic financial variables do not contemporaneously affect the LIBOR rate.

Indicators of Financial Inclusion

article image
Sources: National authorities; and World Bank FinStats Database.

31. But the current environment is particularly challenging. Banks’ capital buffers are modest, considering their significant exposure to zero-weighted local-currency sovereign debt. And despite the implicit subsidy associated with the BdL’s credit support schemes, net interest margins have been contracting (though from large levels) and profit growth is down. Although as noted above there is little evidence that credit growth in Lebanon is excessive, the unfavorable outlook, combined with limited private-sector lending opportunities and already-large exposures to the government, would affect banks’ medium-term profitability.

A01ufig19

Bank Risk Indicators

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Note: Away from center signifies higher risks.Sources: BCC; and IMF staff calculations.

32. Continued efforts to strengthen banking regulation and supervision are crucial. Nonperforming loans (NPLs) have increased slightly, from a low base, while provisioning has decreased and the use of overdraft facilities is widespread. Staff noted that the low level of NPLs, in particular, is potentially at odds with Lebanon’s slowing economy, and will likely increase in the short-to-medium term. In this regard, loan-classification rules do not provide an explicit test of whether the renegotiation or rescheduling of a loan could be concealing debt service problems. And there is no written rule regarding the classification of high-balance overdrafts that are permanently rolled over. Staff reiterated that the risk weights applicable to foreign currency claims on the BdL and holdings of Eurobonds should be set in accordance with the Basel capital adequacy framework. It welcomed the Banking Control Commission’s efforts to strengthen its supervision of banking groups with cross-border operations, and encouraged pursuing the establishment of supervisory colleges for Lebanese banking groups with significant operations abroad.

33. Macroprudential policies can be helpful to limit systemic risk. Staff welcomed the creation of a Financial Stability Unit within the BdL to monitor financial risks. New macroprudential measures were introduced in 2014—though it is too early to assess their effectiveness.

34. Risks related to Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) issues remain. The existing legislation is not in line with revised international standards, as a new AML/CFT Law has been pending in parliament since 2010. Staff therefore called for its adoption and for the allocation of sufficient resources for its effective implementation. The BdL has also recently strengthened monitoring requirements at the level of each banking branch. Efforts should also focus on the regulation of cross-border cash transactions and the risk-based supervision of banks, and money remitters in particular, along with developing a better understanding of the origin of non-resident deposits and their beneficial owners.

35. The authorities’ request for an FSAP update is most welcome. The update is scheduled for 2016, and should also tackle the development of capital markets to help promote a more diversified flow of resources to the economy.

36. Reform of capital markets should continue. Building on ongoing progress (Box 3), staff recommended a rapid move to transforming the Beirut Stock Exchange into a joint-stock company—already foreseen in the law that established the Capital Markets Authority—to pave the way for its privatization.

Authorities’ views

37. The authorities agreed that a sound banking system is critical to Lebanon’s future growth and prosperity. In this regard, both the banks and their supervisors were keenly aware of the economic and reputational risks associated with Lebanon’s challenging environment, and all agreed on the need for a continued culture of prudence and caution. They underscored the BdL’s efforts to address Basel requirements ahead of the implementation deadlines and to require additional capital buffers on top of the Basel III minimum and conservation buffers. They noted that the decline in the ratio of specific provisions to NPLs over the past year was due to a composition effect—NPLs include “substandard” loans, which had increased in importance, but do not require specific provisions. The Banking Control Commission is progressively moving toward the adoption of International Financial Reporting Standards (IFRS) 9 norms that would require provisioning based on expected losses. But in the interim, it was stressed that total provisioning, including both specific and general provisions, had increased as a share of total NPLs. The authorities agreed that NPLs would likely grow in the immediate future, but considered that banks had sufficient buffers to comfortably absorb any increase.

38. The authorities expressed confidence in the effectiveness of Lebanon’s AML/CFT regime. They noted that, although the current framework is not formally compliant with international standards, there are three draft laws pending parliamentary approval. In the interim, the BdL requires that Lebanese banks abide by the regulations in place in the countries of their correspondent banks whenever these are stricter. They mentioned the reluctance and even refusal of Lebanese banks to deal with small money remitters as evidence of bank awareness of AML/CFT issues and stricter controls. Hence there is no concern about derisking by international correspondent banks vis-à-vis their Lebanese counterparts.

39. The authorities also underscored the importance of continuing the reform of capital markets. They highlighted the significance of market consultations on the capital markets regulations, with assistance from the World Bank, to marshal support and ownership of the reforms. As to the transformation of the Beirut Stock Exchange into a joint-stock company, they regretted that progress had been slow.

Structural reform

40. There cannot be enduring and inclusive growth without structural reform. The traditional drivers of growth in Lebanon are also those most vulnerable to region-wide uncertainty and security concerns. These sectors, in addition, have failed to provide the high-quality, job-rich growth needed to secure social stability. Indeed, Lebanon’s employment-growth elasticity (0.2) is one of the lowest in the region, and job creation has not kept up with the economy’s rapidly expanding labor force—now increased by the refugee influx.11 The reform agenda is well known, but little has been done.

41. Lebanon’s current account deficit suggests an underlying competitiveness problem, even factoring in the Syria crisis. The sharp increase in the deficit is attributable, in part, to the disruption of traditional trade relationships and elevated regional uncertainty—though the deficit is expected to improve (slowly) over the medium term. Nonetheless, even abstracting from the impact of Syria, the external balance is weaker than suggested by fundamentals, pointing to an underlying problem with productivity and competitiveness (see Annex II). If Lebanon is to transition to a stronger, more sustainable growth model, action is needed to boost productivity, fight corruption, and address the cost of doing business.

42. Electricity reform is an urgent priority. Lebanon’s inefficient electricity supply is a major impediment to growth: losses from EdL weigh heavily on public finances, and poor service delivery has prompted the extensive use of costly private generators. Implementation of longstanding plans to strengthen generation capacity, switch to less-expensive natural gas, and improve transmission and distribution would go a long way toward reducing business and consumption costs. It would also ensure more equitable access to essential services. In parallel, the authorities should start to bring electricity tariffs more in line with cost recovery to reduce the burden on public finances—though in a way that protects more vulnerable consumers.

A01ufig20

Lebanon: Competitiveness Rank, 2011–14

(Rank out of 144)

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Source: World Economic Forum.
A01ufig21

Losses Due to Electricity Outages

Citation: IMF Staff Country Reports 2015, 190; 10.5089/9781513567563.002.A001

Source: World Bank Enterprise Survey, 2013.

43. Similarly, the passage of pending legislation would be a welcome signal for potential investors. The framework law for Public Private Partnerships (PPPs)—awaiting parliamentary approval for three years—could help mobilize private-sector resources for infrastructure investment, though with due attention to possible fiscal risks. Similarly, long-delayed decrees on gas resources would not only signal to investors that the government is capable of moving beyond its current paralysis, it might also trigger the start of renewed FDI inflows.

44. Reforms are also needed to arrest the chronic de-skilling of Lebanon’s labor force, and promote high-productivity growth. While the immediate need is to create formal-sector employment opportunities for lower-skilled workers (for example, through special programs and targeted public work schemes), over time Lebanon needs to move toward higher-quality sectors to absorb its flow of new, highly-skilled job seekers. Indeed, preliminary results from a recent ILO survey suggest that prospects for university graduates in Lebanon—in terms of an education premium for entry-level salaries or the ease of transition to a regular job—is worse than the MENA average.12

45. Finally, better public services will not only improve competitiveness but also increase equity. In addition to Lebanon’s large current account deficit, other indicators suggest that the economy is losing external competitiveness. Part of the explanation is the fact that public-service delivery and social safety nets are far from satisfactory: hindering the economy’s ability to respond to new opportunities and to provide an environment in which dynamic and innovative firms can thrive. Indeed, Lebanon has an enviable supply of high-quality human capital, but halting the economy’s ongoing brain drain will require better core services and a social protection system that is both reliable and fair.

46. A case in point is the pension system, which is not only fiscally unsustainable but also suffers from striking equity shortcomings. Short-term improvements should include the implementation of selected parametric changes and only limited indexation to salaries—especially in view of the planned salary scale adjustment. Over the longer term, a unified pension scheme for public and private sector employees would go a long way to address the system’s sustainability and equity concerns.

Authorities’ views

47. The authorities agreed broadly with staff’s diagnosis and suggested priorities, but noted that the lack of reform was a symptom of Lebanon’s underlying political deadlock. The reform agenda is well known. Indeed, many specific measures—such as a proposed adjustment to electricity tariffs, the expansion of electricity generation capacity, the introduction of LNG facilities, the oil and gas laws, or an agreed PPP framework—had been prepared and agreed at a technical level, but were awaiting agreement by the council of ministers. Regrettably, further progress was unlikely without a resolution of the current political crisis. Nonetheless, the authorities noted that the ongoing dialogue between the various factions, and the recent concerted efforts to pass a budget underscored a general commitment by all parties to find a solution, and insisted that once found, action on the reform agenda could follow very quickly.

48. The authorities welcomed the renewed emphasis on pension reform. They underscored the need to address the generosity of the pension scheme, highlighted the system’s inadequacy and expressed concern that the planned salary scale adjustment will result in additional pressures on pension liabilities.

Data Issues

49. Timely and reliable data are crucial for greater accountability. Although data collection and dissemination have improved in some areas, national and external accounts, fiscal, social, and labor-market statistics remain weak, undermining economic decision making, transparency, and policy effectiveness. Staff expressed concern about accumulating delays in the provision of data to the public, and noted increasing lack of cooperation and coordination among various agencies (Box 6). Steps to restore and strengthen collaboration—along with adequate funding and high-level support for the Central Administration of Statistics—would help improve statistics.

Data Issues in Lebanon—Capacity Constraints

Even before the civil war, Lebanon had struggled to build a sound statistical system. Very few statistical surveys were undertaken.1 The only national population census comes from the French mandate in 1936 (never updated for political reasons) and the most comprehensive and first official study of Lebanon’s social and developmental situation was conducted in 1960 by the Institut International de Recherche et de Formation, Education Cultures Développement (IRFED) mission, published in 1961.2 The civil war destroyed many databases and led to the loss of much-needed human capital. In 1979, the authorities established the Central Administration of Statistics (CAS), with a mandate to collect, process, produce and disseminate official social and economic statistics at the national level.

Given its limited size and resources, CAS cannot finance and conduct its own surveys and has to rely heavily on other government bodies to receive source data.3 However, CAS has recently experienced increasing difficulties in accessing data from other agencies. For example, its plan to start computing a Producer Price Index has been hampered by the lack of access to basic data on individual enterprises. VAT records could be used as an alternative, but even here there have been increasing delays.

Despite its mandate, CAS is not the only agency producing social and economic statistics. During the civil war, a private firm started producing a Consumer Price Index (CPI) for Beirut and its suburbs—still widely used particularly after the 2013 disruption in the production of official CPI data. In addition, responsibility for national accounts production and dissemination was only transferred to CAS in 2012, starting with the accounts for 2010.4 For the period 1997–2009, these statistics were produced by a special team appointed by the prime minister’s office, with technical assistance from the French National Institute of Statistics and Economic Studies.

Inadequate data sharing and dissemination are prime examples of the sometimes poor state of public-goods provision in Lebanon. Reliable, timely and accurate data as a key input for sound decision-making and accountability are lacking.

1http://www.kobayat.org/data/documents/arab_awlamat/awlamat25_26/ghaleb_bou_mousleh4.htm2http://www.undp.org.lb/programme/pro-poor/poverty/povertyinlebanon/molc/setting/A/1975.htm.3 CAS has a very small number of tenured staff and its budget—allocated from that of the council of ministers—was only $2.7 million is 2012.4 The last economic accounts published by CAS were for the years 1994–95.

Staff Appraisal

article image

The eye sees, but the arm is short (cannot reach), Arabic proverb

50. As the proverb goes, Lebanon can see but its arms are incapable of reaching. The problems and challenges it faces are well-known, though little is being done to address them. And since resilience in the face of adversity has always won the day, the main challenge now is a growing sense of complacency in the political system. In fact, political inertia is moving the country steadily backward—the legitimacy of Lebanese institutions is eroding, and the ability of the political class to work toward common solutions is waning. Perhaps more worryingly, even at the technical level political divisions are triumphing over traditional norms that have, in the past, tended to encourage cooperation. Data provision is a case in point, with increasing delays and difficulties in getting information across institutions, or even between departments in the same agency.

51. Lebanon’s traditional lifelines should not be taken for granted. Established growth sectors have been hit hard, while poverty and unemployment are increasing, and fiscal sustainability is in jeopardy. And although the bank-sovereign nexus has been a source of resilience, the economy relies on continued deposit inflows and so remains vulnerable to adverse shifts in confidence. The country has faced difficulties before, but this time they have come together in a particularly detrimental combination, with a potentially lasting impact. The oil price decline has provided breathing space, but only temporarily.

52. Lebanon’s economic problems are compounded by formidable security challenges. The country hosts over 1 million refugees from Syria, and faces growing security risks from an increasingly tense regional environment. International support has helped, but more is needed urgently, especially for the hosting communities. Still, despite all odds, Lebanon has managed so far—especially in the area of security, a key precondition for stability. Increasingly though, macroeconomic stability and shared prosperity will be critical in anchoring longer-term security, and in defusing looming social tensions.

53. Faced with exceptional circumstances, policies should aim at restoring fiscal sustainability and securing inclusive growth. While these goals will require a concerted medium-term strategy—a remote prospect at present, given the political impasse—efforts should be focused in the interim on a few concrete steps. These would not only serve as symbols of a nation that is now able to move forward, but would also in themselves help engineer a soft-landing to a better future. Two priority areas stand out.

54. The first priority is passing a budget for 2015—the first in a decade—to signal that the fiscal situation is under control. Attention has been focused on a controversial salary scale adjustment for the public sector, which has been promised but which the country can ill-afford right now. If passed, it should be conditional on measures to mitigate its impact (a strong revenue package; no retroactive payments and with installments; and measures to increase public sector productivity). However, there is an urgent need to pass revenue measures regardless, including increased fuel taxation, broader tax bases and strengthened compliance. This will help secure a sustainable primary balance, and create fiscal space for more capital projects and social spending. Finally, credible fiscal adjustment will allow monetary policy to refocus squarely on supporting the peg—which remains the key nominal anchor—and less on propping up the economy and ensuring an adequate flow of funding for the government.

55. The second priority is the electricity sector. Households and businesses have long suffered from inadequate electricity provision, having (almost universally) to resort to very expensive private generation, while the government has been bleeding funds to support EdL. Cabinet should urgently implement electricity improvements—a game-changer—for productivity, competitiveness, growth, and equity.

56. The authorities’ close oversight of the financial system is welcome but should be reinforced. Strengthened supervision will support bank stability. But, given Lebanon’s challenging environment, there is also a need to increase capital buffers, improve loan classification and restructuring rules, and further enhance the AML/CFT framework. The forthcoming FSAP will add recommendations in this area. In addition, privatization of the Beirut Stock Exchange will help deepen financial markets, by encouraging start-ups to launch IPOs and opening the door for trading commodities.

57. Structural reforms remain essential to enhance Lebanon’s growth potential. There is an urgent need to jump-start the legislative agenda—including on the new Petroleum Tax Law, the Exploration and Production Agreement for the oil and gas sector, and the Public Private Partnership framework law to attract private investment. Labor reforms that help create formal-sector employment opportunities for lower-skilled workers are also needed, especially given the added pressure from Syrian refugees. And more broadly, better public service provision and stronger safety nets, starting with the pension system, would improve competitiveness and increase equity.

58. Finally, strengthened cooperation towards, and proper funding for, data compilation and dissemination are crucial for greater accountability. Although data collection and dissemination have improved in some areas, national and external accounts, fiscal, social, and labor-market statistics remain weak. Statistics cannot improve without better inter-agency cooperation and high-level support for the Central Administration of Statistics.

59. Staff propose that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.

Lebanon: Selected Economic Indicators, 2012–20

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

Through 2008: based on the CPI index by Consultation and Research Institute; from 2009: based on the CPI index by Central Administration of Statistics.

According to a labor force survey conducted by the World Bank in April 2011. The latest official unemployment rate is 9.7 percent in 2007.

Defined as currency in circulation plus resident and nonresident deposits.

Includes nonresident deposits.

Excluding gold and encumbered assets.

Short-term debt on a remaining maturity basis, including short-term nonresident deposits.

Table 2.

Lebanon: Central Government Overall Deficit and Financing, 2012–20

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

Includes domestic excises, which are collected at customs and are classified as taxes on international trade.

Includes wages, salaries, related benefits, and pensions.

Excludes principal and interest payments paid on behalf of Électricité du Liban (EdL).

Includes transfers to the National Social Security Fund, hospitals, municipalities, Higher Relief Committee, Displaced Fund, Council of the South, bread subsidy, and the interest subsidy.

Table 3.

Lebanon: Central Government Overall Deficit and Financing, 2012–20

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

Includes domestic excises, which are collected at customs and are classified as taxes on international trade.

Includes wages, salaries, related benefits, and pensions.

Excludes principal and interest payments paid on behalf of Électricité du Liban.

Includes transfers to the National Social Security Fund, hospitals, municipalities, Higher Relief Committee, Displaced Fund, Council of the South, bread subsidy, and the interest subsidy.

Table 4.

Lebanon Government Debt, 2012–20 1/

article image
Sources: Lebanese authorities; and IMF 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 Électricité 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, 2012–20

article image
Sources: Banque du Liban; and IMF staff estimates and projections.

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

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

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