Statement at Donor Meeting

Stockholm, Sweden
August 31, 2006

1. On behalf of IMF management and staff, I would like to start by conveying to the Lebanese people our deep sympathy for the terrible toll the conflict has exacted on them and on the country. I would also like to thank the government of Sweden for hosting this conference and giving us an opportunity to provide our views on how we could help Lebanon in these testing times.

2. Given that only two weeks have elapsed since the ceasefire took effect, our understanding of the economic impact of the conflict is still evolving. What is clear, though, is that the relief and reconstruction effort that is needed to alleviate the suffering of the Lebanese people and rebuild the country is of a scale that Lebanon cannot shoulder on its own. As the international community mobilizes itself to assist the Lebanese government in this process, we at the IMF are ready to work closely with the Lebanese authorities and donors. In what follows, I will review the economic and financial impact of the conflict, and then discuss the macroeconomic policy challenges associated with the relief and recovery efforts.

3. Lebanon has suffered a substantial setback on the economic front, and it will take time and resources to recover from it. Real GDP, which was expected to grow by around 5 percent this year, will most likely contract in 2006. The cost in terms of economic activity and growth is likely to stretch well beyond 2006. Much productive capacity has been lost: we have heard of preliminary estimates of $3½ billion in infrastructure damage, to which one needs to add the impact of the massive displacement of the population, the exodus of many professionals, and possible private sector bankruptcies. It will also take time for Lebanon to resume its role as a premier regional center, providing tourism and financial services to the region, as well as high value added health, education and other business services.

4. On the financial front, Lebanon has once again demonstrated remarkable resilience. The economy's large external financing needs have been met in recent years by large inflows of deposits into the Lebanese banking system, and a large scale reversal of these flows could have precipitated a financial crisis. However, private capital outflows have been relatively modest in comparison with the scale of the economic disruption. The ample liquidity cushion maintained by the central bank and commercial banks going into the crisis played an important role in preserving depositor confidence, as did the authorities' skillful handling of financial pressures. A significant added boost to confidence was given by the generous financial support of Saudi Arabia and Kuwait which deposited with the central bank $1 billion and $0.5 billion respectively, on top of $800 million they pledged toward reconstruction.

5. However, what was already a difficult budgetary and debt situation has been made much more precarious by the conflict. Government debt stood at 175 percent of GDP at end-2005, one of the highest ratios in the world. The conflict has made matters much worse. First, the war and the blockade have caused revenues to dry up almost completely. Second, as we have been discussing today, the government is facing massive expenditure needs for relief, recovery, and reconstruction. The resulting widening of the fiscal deficit will come at a time when market borrowing may prove quite expensive, if it can be mobilized at all at this stage.

6. A strong commitment by the international community to assist Lebanon in this difficult hour will be critical. Lebanon has repeatedly shown to the world its insurmountable spirit in the face of adversity, and we are seeing that once again. In addition to the early recovery assistance that is being addressed at this conference, Lebanon will need considerable and highly concessional external support for reconstruction, which the donor community will have the opportunity to discuss in the coming months. Without such assistance, there is a real risk that the combination of a growing government financing need, higher world interest rates, and lower GDP growth will cause Lebanon's debt to spiral up. The Fund will work closely with the Lebanese authorities and the donor community on the macroeconomic dimension of this international effort, and to help ensure that macroeconomic vulnerabilities related to the debt overhang are properly addressed in the recovery and reconstruction process.