## cr1719 ## Source details **Canonical URL:** [cr1719](https://www.imf.org/-/media/files/publications/cr/2017/cr1719.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr1719.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr1719.pdf.json) --- ### Refugee impact and context - Syrian crisis described as “now in its sixth year.” - Refugee scale: - around one third of local population; - UNHCR: more than 1.4 million Syrian refugees in Lebanon. - Political developments: - parliament elected a president on October 31; a new prime minister appointed shortly after. - Growth and inflation: - protracted low growth of 1–2 percent; - growth about 1 percent in 2015; similar projection for 2016; - inflation declined sharply in 2015, to an average of -3.7 percent. ### Fiscal position and public debt - Fiscal strain and dynamics: - Tax revenues as a share of GDP continue to decline. - Interest payments have moved upward in line with public debt. - Small primary surplus of 1.4 percent of GDP in 2015 was insufficient to offset slowing nominal output growth and higher interest payments. - Public debt increased by 5 percentage points in 2015, to 138 percent of GDP. - Priority: “Restoring fiscal sustainability. The growth of public debt (above 140 percent of GDP) needs to stop immediately.” - Direct and indirect refugee costs: - Direct budget costs estimated at around $400 million per year. - Indirect costs exceed $2½ billion in terms of erosion of public services. - Potential poverty impact: as many as 170,000 residents may be tipped below the poverty line (uncertainty noted). - London Conference financing need: - $11 billion over 2016–20 ($5 billion in grants, $6 billion in loans). ### Banking sector, deposit concentration, and BdL financial operation - Deposit concentration (end-2015): - 16,000 accounts (less than 1 percent) held 50 percent of total deposits. - 1,600 accounts (less than 0.1 percent) held 20 percent of total deposits. - By bucket sizes: - 84.6 percent of total deposits in accounts with balances greater than $100,000; - 50.2 percent in accounts with balances greater than $1 million; - 3.7 percent of deposits in accounts with balances greater than $100 million. - Deposit growth (end-2008 to end-2015): - “Smaller accounts” (< $1 million) grew by 55 percent. - “Large accounts” (> $1 million) grew by 185 percent. - Growth of > $1 million accounts about 12–14 percent per year in recent years; declined to about 5.8 percent in 2015. - BdL financial operation (figures and outcomes): - As of May 2016, BdL gross reserves declined y/y by 10.1 percent or $3.9 billion and stood at $35.1 billion. - BdL purchase of newly-issued Eurobonds from the Ministry of Finance: $2 billion. - BdL sale of Eurobonds and other FX securities to the banks: $13 billion (staff estimate). - BdL gross FX reserves increased to $40.6 billion by end-October. - Consolidated NFA position turned positive in September, to a cumulative $555 million. - Discount of T-bills and CDs at zero percent equivalent to a money-financed capital injection (staff estimate: equivalent to 10 percent of GDP). - Annualized deposit growth rate increased from 3.5 percent at end-May to 4.7 percent by early-November. - Banks’ FX liquidity held abroad declined from $18 billion in June 2011 to $10.4 billion by May 2016; by end-August it was below $8.5 billion. - Operation resulted in sizable excess LL liquidity (equivalent to a third of GDP). - BdL policy responses to excess LL liquidity and dollarization risks: - Issuing long-maturity term deposits (of 5 years or more) at rates slightly below prevailing LL rates, with subscription conditions in 5-year, 5-percent government bonds. - Asking banks to extend additional LL lending. - Risks and caveats from operation: - Weakened banks’ internal FX liquidity, increased reliance on BdL for FX liquidity. - Lower FX liquidity led to increased FX deposit rates, narrowing the spread between LL and FX deposit rates and reducing attractiveness of LL deposits. - Operation added to BdL’s foreign exchange liabilities and associated carry costs. ### Outlook, inflows, and risks - Baseline assumptions: - Impact of the Syrian conflict assumed to remain broadly unchanged over the forecast horizon. - Lebanon’s output gap will remain open toward the end of the projection period. - Inflation expected to return to trend (around 2 percent) by early 2017 as oil prices normalize. - Deposit inflows: - Taking into account the BdL’s financial operation, deposit inflows likely total about $8 billion in 2016, up from about $7 billion in 2015. - Staff estimate: an average deposit growth of about 6–7 percent is sufficient to maintain the economy’s foreign currency buffers. - Key vulnerabilities and risk assessments (selected from Risk Assessment Matrix): - Deceleration of financial inflows: Relative Likelihood — High; Expected Impact — High. - Intensification of the Syria crisis: Relative Likelihood — High; Expected Impact — High. - Materialization of dollarization risk: Relative Likelihood — Medium; Expected Impact — High. - Deterioration in fiscal performance: Relative Likelihood — Medium; Expected Impact — Medium. - Withdrawal of correspondent banking relationships: Relative Likelihood — Medium; Expected Impact — Medium. - Upside potential: - Election of a president and formation of a government could boost confidence, growth, inflows, financial stability, and debt dynamics. - Early resolution of Syria crisis could enable reconstruction and improved regional investor confidence. ### Fiscal adjustment: amounts, timing, and composition - Growth and debt trade-offs: - Proposed composition and size of upfront adjustment expected to reduce growth temporarily by 0.8 and 0.4 percentage points in 2017 and 2018 respectively. - Postponing adjustment by two years increases debt-to-GDP ratio by about 10 percentage points of GDP. - Amount needed: - A primary balance of 4 percent of GDP would stabilize debt, requiring an upfront adjustment of about 3 percent of GDP. - Debt would then slowly decline to 133 percent of GDP by 2030 under that adjustment. - Limits of alternative supports: - Donor assistance of $400 million to $1 billion per year (about 0.5 to 1.9 percent of GDP) over 2017–21 would have only small impact on debt trajectory. - Even a favorable rapid resolution of Syria would not be sufficient for debt sustainability. - Oil and gas revenues are uncertain and likely many years away. - Recommended fiscal measures (package to be adopted in its entirety): - increase corporate income tax rate from 15 to 17 percent; - introduce a capital gains tax on real estate; - increase rate on interest income tax from 5 to 7 percent; - increase VAT rate from 10 to at least 11 percent; - increase tobacco excises; - new stamp duties and fees; - restore VAT on diesel and increase gasoline excises to earlier levels; compensate via strengthened social safety net; - increase tax compliance (tax collection is only 50 percent of estimated capacity); - implement salary scale adjustment in public sector only if fully offset to preserve fiscal adjustment; - strengthen the National Poverty Targeting Program (NPTP) and approve additional government funding as a matter of priority. - VAT gap (2013): - overall VAT gap estimated at around 7.4 percent of GDP in 2013 (up from 6.1 percent in 2009); - compliance gap: 3.3 percent of GDP; - policy gap: 4.0 percent of GDP. - VAT policy simulation (assumptions: gradual elimination of 50 percent of compliance gap and partial elimination of policy gap over five years): - primary balance would increase from 1.1 percent to 5.2 percent of GDP; - overall balance would improve from -8.1 to -5.6 percent of GDP; - public debt would stabilize at about 150 percent of GDP in 2021. ### Public Debt Sustainability Analysis (Annex II) — baseline and stress tests - Current position and baseline: - Public debt already above 140 percent of GDP; gross financing needs close to 30 percent of GDP. - Under baseline: debt projected to reach 160 percent of GDP by 2021; gross financing needs projected to reach 33 percent of GDP by 2021. - Baseline assumptions include no improvement in Syria, real GDP growth of 2 percent in 2017 rising to 3 percent by 2019, inflation (GDP deflator) 1 percent in 2016 and 2017 rising to slightly below 2 percent by 2018–2021, and primary balance surplus about 1–1½ percent of GDP from 2016 onwards. - Projected debt-to-GDP and financing: - Public debt-to-GDP: from 138 percent in 2015 to 160 percent in 2021. - Gross financing needs projected to increase to 33 percent of GDP in 2021 and reach about 40 percent beyond 2021. - Stress-test outcomes (selected): - Growth shock: debt-to-GDP above 180 percent of GDP in 2021; financing needs 37 percent of GDP in 2021. - Interest rate shock: debt-to-GDP above 165 percent by end projection; financing needs 35 percent in 2021. - Combined macro-fiscal shock: debt-to-GDP would exceed 190 percent at end of projection horizon; financing needs 40 percent of GDP. - Contingent liability shock (standardized 10 percent of financial sector assets): debt-to-GDP would reach 200 percent at end of projection; financing needs 40 percent of GDP in 2021. - Key numeric projections and series (selected): - Nominal gross public debt series (2014–2021): 153.6 133.4 138.3 143.6 147.9 151.1 153.7 156.9 160.1 - Public gross financing needs series includes values ending with 33.1 (2021) and 3.15 (presentation artifact in source). - Real GDP growth (2014–2021): 5.3 2.0 1.0 1.0 2.0 2.5 3.0 3.0 3.0 - Inflation (GDP deflator, 2014–2021): 4.2 2.8 0.9 0.9 1.0 1.6 1.8 1.7 1.9 - Effective interest rate (2014–2021): 7.3 6.6 6.7 6.7 7.1 7.5 7.7 7.8 7.7 - Primary balance (baseline projections, 2016–2021): 1.1 1.5 1.4 1.4 1.2 1.0 ### External sector and reserve adequacy (Annex III) - Goods trade and current account: - Oil imports account for approximately 20 percent of Lebanon total imports. - In 2015, the import bill decreased by about $1.9bn or about 4 percent of GDP. - Estimated current account deficit for 2016: 17.5 percent of GDP. - External debt: - External debt at end-2015: 175 percent of GDP. - Baseline: external debt projected to peak at 180 percent of GDP in 2017 and decline slightly to 175 percent of GDP in 2021. - Scenario sensitivity (selected): - A real depreciation of 30 percent increases external debt to 253 percent of GDP. - Growth shock: external debt would increase to 190 percent of GDP by 2021. - Shock to the non-interest current account balance: external debt would increase to 198 percent of GDP by 2021. - Reserve adequacy: - Reserve coverage adequate according to the ARA metric; coverage in the range of 100–150 of the metric considered adequate; Lebanon has been within this range since 2009 with a small deviation by end-2015. - Selected projections and key statistics (2011–2021) (selected entries preserved exactly as presented): - External debt (percent of GDP): 2011: 169.2; 2012: 163.9; 2013: 167.1; 2014: 170.0; 2015: 174.7; 2016: 179.0; 2017: 180; 2018: 179.2; 2019: 177.5; 2020: 176.4; 2021: 174.8. - Gross external financing need (in percent of GDP): 2011: 148.5; 2012: 158.7; 2013: 158.7; 2014: 166.1; 2015: 166.5; 2016: 170.6; 2017: 171.6; 2018: 169.5; 2019: 168.0; 2020: 166.2; 2021: 163.5. ### Structural reforms, growth, and jobs - Diagnosis: - Structural reform necessary for job-rich, inclusive growth; employment growth elasticity low for Lebanese nationals. - ILO estimates national unemployment around 9 percent; rises to 12 percent including refugees. - Electricity sector: over 2006–14 government transferred an average of 4½ percent of GDP each year to EdL, representing over 40 percent of the current debt stock. - London Conference plan (Box 7, authorities’ plan): - $11 billion over 2016–20 ($5 billion grants, $6 billion loans). - Projected job creation: 300,000–350,000 jobs, with 60 percent accruing to Syrian refugees. - STEP (Subsidized Temporary Employment Programme) estimated to generate a further 100,000 jobs shared between residents and Syrian refugees. - Key policy recommendations to boost investment and jobs: - Electricity reforms: reduce electricity transfers to zero over time; raise tariffs toward cost recovery while protecting vulnerable consumers; link tariffs to expansion of capacity. - Foster knowledge economy: revisit incentive scale; finalize and implement capital market regulation and development plan; improve internet connectivity and electricity. - Facilitate donor support: improve framework for channeling funds through government; expedite disbursement from transit accounts; elevate coordination framework post-London Conference. - Pending legislation: pass PPP framework law (awaiting parliamentary approval for three years); ratify EU agreement on simplified rules-of-origin for exports. ### Supervision, banking regulation, and AML/CFT - Key supervisory and regulatory issues: - Supervisor (BCC) well respected but supervisory approach needs to better support risk profiling and systemic relevance assessments. - Loan classification rules not aligned with international best practice. - Reported NPLs stable at 10.4 percent by end-June 2016 (official definition excludes accrued interest, off-balance sheet assets, and restructured loans). - Banks’ foreign-currency liquidity abroad weakened; 1 percent of deposits (or $1.6 billion) represents 4 percent of BdL’s gross reserves. - Recommendations: - BCC announced graduated increase of capital adequacy ratio to 15 percent (from 12 percent) by 2018. - Forward-looking capital planning tied to multi-factor stress testing. - Align risk weight on BdL foreign-currency exposure with Basel Accord. - Align regulatory treatment of restructured loans with international good practice. - Strengthen AML/CFT supervision and remain vigilant on risk of withdrawal of correspondent banking relationships. ### Data quality and statistical issues - Main deficiencies: - Data provision has serious shortcomings, especially in national accounts and external sector statistics. - National accounts only compiled and disseminated annually; data available through 2013 with significant delays publishing 2014 accounts. - Fiscal data reported with long and increasing lags; GFS coverage incomplete. - Balance of payments statistics subject to frequent and sizable revisions; errors and omissions increased substantially. - Key recommendations: - Improve timeliness of fiscal data; - Finalize and publish IIP data; - Strengthen collaboration between CAS, BdL, customs, and the ministry of finance. - Reporting to STA and indicators (selected): - CPI latest observation: 9/30/16, Date Received 10/21/16, Frequency M. - GDP/GNP latest observation: 12/31/13, Date Received 12/11/14, Frequency A. - International Reserve Assets latest observation: 9/30/16, Date Received 11/1/16, Frequency M. ### Authorities’ views and staff appraisal - Authorities broadly agree on need for fiscal consolidation, maintaining financial stability, and structural reforms; they emphasize international assistance and political constraints. - Authorities’ assessment of BdL operation: viewed as meeting several objectives (strengthening foreign currency assets, enhancing banks’ capital, increasing local currency liquidity, improving government debt profile, targeting positive inflation, improving rating/outlook). - Authorities noted staff’s assessment as “rather negative” and stressed market needs time to absorb operation. - Staff appraisal: - Lebanon at a critical juncture; need for immediate adjustment and reform predates Syrian crisis. - BdL operation is a stop-gap and cannot sustainably resolve funding needs. - Fiscal adjustment essential; neither donor funding, temporary growth, nor gas revenue alone can substitute for consolidation. - IMF stands ready to assist, including through the Middle East Technical Assistance Center. *Source: IMF staff report (cr1719).* ### 1. Dealing with the Impact of the Refugees _________________________________________________________ 6 ### 1. Dealing with the Impact of the Refugees ### Context and overview - The Syrian crisis is a dominant factor in Lebanon’s outlook, described as “now in its sixth year.” - Refugee scale: - Estimated at around one third of local population. - According to UNHCR, the number of Syrian refugees in Lebanon is now more than 1.4 million. - Political developments: parliament elected a president on October 31; a new prime minister was appointed shortly after, with consultations ongoing to form a cabinet. - Growth environment: Lebanon is in a protracted period of low growth of 1–2 percent. - Growth estimated at about 1 percent in 2015, with a similar projection for 2016. - Inflation declined sharply in 2015, to an average of -3.7 percent. ### Fiscal position and public debt - Fiscal strain: - Tax revenues as a share of GDP continue to decline. - Interest payments have moved upward in line with public debt. - A small primary surplus of 1.4 percent of GDP in 2015 was insufficient to offset slowing nominal output growth and higher interest payments. - Public debt increased by 5 percentage points in 2015, to 138 percent of GDP. - Priority policy area: “Restoring fiscal sustainability. The growth of public debt (above 140 percent of GDP) needs to stop immediately.” ### Impact of the refugee presence - Direct and indirect costs: - Authorities estimate direct budget costs at around $400 million per year. - Estimates of indirect costs exceed $2½ billion in terms of the erosion of public services. - Theoretical effects summarized: - Short-run: new migrants with labor-market access tend to lower incumbents’ wages and reduce employment for some incumbents, while increasing returns to capital. - Long-run: higher returns should prompt investment, raising capital stock and restoring wages to prior levels under standard theory. - Factors making Lebanon’s reality different from standard theory: - Investment climate constraints (poor infrastructure and low public investment) slow scaling up of capital. - Labor market features: almost half of the workforce estimated in the informal sector—high competition with refugees and limited social safety nets; early estimates suggest unskilled wages in some areas have fallen by as much as 50 percent, potentially tipping as many as 170,000 residents below the poverty line (although it is unclear how many are existing Syrian migrants). - Scale of the shock: the rapid, large inflow likely exceeds the scope of typical empirical studies. - Unpriced public goods and infrastructure may be overburdened given limited fiscal space and political constraints. ### International support and response - The London Conference on “Supporting Syria and the Region” (February 2016): authorities presented a plan calling for $11 billion over 2016–20 (composed of $5 billion in grants and $6 billion in loans). - Funding to date remains short of estimated needs. - The international community’s role is emphasized: “Lebanon requires and deserves significant support.” ### Policy priorities highlighted - Restore fiscal sustainability (stop growth of public debt above 140 percent of GDP). - Anchor financial stability: - Maintain the exchange rate peg as the nominal anchor. - Banque du Liban (BdL) should stand ready to increase interest rates if necessary. - Continue monitoring and mitigating banking sector risks. - Promote sustainable and inclusive growth by addressing infrastructure deficits (e.g., electricity provision) and investment climate constraints. ### Key numerical context and metrics (as presented) - Refugees: around one third of local population; UNHCR more than 1.4 million. - Growth: 1–2 percent protracted low growth; about 1 percent in 2015; similar projection for 2016. - Inflation: average of -3.7 percent in 2015. - Primary surplus: 1.4 percent of GDP in 2015. - Public debt: increased by 5 percentage points in 2015, to 138 percent of GDP; growth of public debt described as “above 140 percent of GDP” needing to stop. - Direct budget cost of refugees: around $400 million per year. - Indirect costs of refugees: exceed $2½ billion. - Potential poverty impact: as many as 170,000 residents may be tipped below the poverty line (uncertainty noted). - London Conference financing need: $11 billion over 2016–20 ($5 billion grants, $6 billion loans). *Source: IMF staff report excerpt, “Dealing with the Impact of the Refugees.”* ### 17. There has been limited progress on ### 17. There has been limited progress on ### Structural reform progress - Laws on anti-money laundering and combating the financing of terrorism (AML/CFT) were passed in November 2015. - Legislation on tax transparency and exchange of information was also passed. - Parliament has met rarely in recent years and key legislative initiatives remain pending: - Legislation on developing Lebanon’s offshore gas fields has yet to pass. - Electricity- and safety-net reforms remain similarly delayed. - The OECD Global Forum will deliberate by June 2017 on whether the new legislation complies with its recommendations. ### Deposit concentration and deposit growth (Box 3) — key findings - At end-2015, 16,000 accounts (less than 1 percent of all deposit accounts) held 50 percent of total deposits. - At end-2015, 1,600 accounts (less than 0.1 percent of all accounts) held 20 percent of total deposits. - By bucket sizes: - 84.6 percent of total deposits are in accounts with balances greater than $100,000, - 50.2 percent in accounts with balances greater than $1 million, - 3.7 percent of deposits in accounts with balances greater than $100 million. - Concentration is higher in foreign currency than LL accounts. - Deposit growth by size (end-2008 to end-2015): - “Smaller accounts” (< $1 million) grew by 55 percent. - “Large accounts” (> $1 million) grew by 185 percent. - Growth slowdown in 2015 largely attributable to large depositors: - In recent years, accounts with balances greater than $1 million had grown by about 12–14 percent per year. - In 2015, their growth rate declined to about 5.8 percent. - Given the size of large deposits, the share of nonresident deposits may be larger than commonly believed. ### The BdL’s financial operation (Box 4) — operation steps and effects - Context: - As of May 2016, BdL gross reserves had declined y/y by 10.1 percent or $3.9 billion and stood at $35.1 billion. - Operation components: - BdL’s purchase of newly-issued Eurobonds from the Ministry of Finance ($2 billion). Swap of LL government debt for new Eurobonds with the MoF. - BdL’s sale of Eurobonds and other FX securities to the banks ($13 billion according to staff estimates). - Banks’ sales of LL instruments to the BdL and strengthening of banks’ capital position via incentives. - Outcomes and figures: - BdL gross FX reserves increased to $40.6 billion by end-October. - The consolidated NFA position turned positive in September, to a cumulative $555 million. - The discount of T-bills and CDs at zero percent is akin to a money-financed capital injection (without any equity stake in return; according to staff estimates, equivalent to 10 percent of GDP). - Annualized deposit growth rate increased from 3.5 percent at end-May to 4.7 percent by early-November. - Before the operation, banks’ FX liquidity held abroad had declined from a peak of $18 billion in June 2011 to $10.4 billion by May 2016; by end-August, it was below $8.5 billion. - The operation resulted in sizable excess LL liquidity (equivalent to a third of GDP). - Policy measures taken by BdL to address excess LL liquidity and dollarization risks: - Issuing long-maturity term deposits (of 5 years or more) at rates slightly below prevailing LL rates, provided participating banks subscribe 14 percent of any placement with the BdL in 5-year, 5-percent government bonds. - Asking banks to extend additional LL lending. - Risks and caveats: - Banks’ internal FX liquidity position weakened, increasing reliance on BdL for FX liquidity. - Lower FX liquidity led to increased FX deposit rates, narrowing the spread between LL and FX deposit rates and reducing attractiveness of LL deposits. - Incentives offered to depositors focused on one-off upfront income, making prospects for keeping new inflows uncertain. - The operation added to BdL’s foreign exchange liabilities and associated carry costs. ### Outlook and risks - Baseline assumptions and projections: - Impact of the Syrian conflict assumed to remain broadly unchanged over the forecast horizon. - Lebanon’s output gap will remain open even toward the end of the projection period. - As oil prices normalize, inflation is expected to return to trend (around 2 percent) by early 2017. - Deposit inflows: - Taking into account the BdL’s financial operation, deposit inflows will likely total about $8 billion in 2016, up from about $7 billion in 2015. - With the operation closed, under an unchanged-policy baseline (no adjustment and reform), inflows are projected to return to levels seen in the early half of the year—short of levels needed to fund the economy over the medium term. - Staff estimate: an average deposit growth of about 6–7 percent is sufficient to maintain the economy’s foreign currency buffers. - Upside potential: - Election of a president and the prospect of a government able to tackle long-pending reform agenda could materially boost confidence, growth, inflows, financial stability, and debt dynamics. - Early resolution of the Syria crisis could allow Lebanon to benefit from reconstruction, reestablishment of trade, and improved regional investor confidence. - Key vulnerabilities and risks (from Risk Assessment Matrix): - Deposit inflows could decelerate further due to tighter regional/global financial conditions or geopolitical tensions; concentration of deposits, short-term maturity structure, and share of nonresident depositors increase vulnerability. - Growth could weaken further, compounding adverse debt dynamics and impairing banks’ asset quality. - Fiscal imbalances could widen through increased spending pressure or continued inertia, raising public debt and possibly triggering financing pressures and lower investor confidence. - Withdrawal of correspondent banking relationships could hurt cross-border payments, trade finance, and remittances. - Risk likelihood and impact assessments (selected): - Deceleration of financial inflows: Relative Likelihood — High; Expected Impact — High. - Intensification of the Syria crisis: Relative Likelihood — High; Expected Impact — High. - Materialization of dollarization risk: Relative Likelihood — Medium; Expected Impact — High. - Deterioration in fiscal performance: Relative Likelihood — Medium; Expected Impact — Medium. - Withdrawal of correspondent banking relationships: Relative Likelihood — Medium; Expected Impact — Medium. ### Authorities’ views - Authorities broadly agreed with staff’s assessment of risks, highlighting: - Significance of regional political developments, particularly the Syrian conflict. - Importance of continued deposit inflows and intensified regional competition for funds. - Much of the recent slowdown in activity resulted from the prolonged political impasse; formation of a new government would likely result in a substantial turnaround in confidence, investment, and growth. ### Policy: action needed to anchor confidence - With limited policy change, domestic and external vulnerabilities have deepened: - Lower growth and a larger debt burden have increased the adjustment needed to stabilize debt dynamics. - Slow deposit inflows, if persistent, could weaken the external position. - Urgent corrective measures needed: - Short term: preserve confidence of foreign investors by articulating a credible policy mix that starts to address fiscal imbalances as a matter of urgency, while strengthening the resilience of Lebanon’s banking sector. - Longer term: promote job-rich, sustainable growth to ensure social stability and shared prosperity. - 2016 consultation focus — three key themes: - (i) Starting the process of fiscal adjustment immediately. - (ii) Standing ready to increase interest rates to support financial inflows, if needed, while safeguarding financial stability. - (iii) Laying the ground for higher-quality and more inclusive growth. ### No substitute for fiscal consolidation (Section A) — findings and projections - Historical context: - Over 2005–10, public debt dropped by 5 percentage points of GDP per year on average due to high growth and sustained primary surpluses. - Real growth decelerated in 2011; by 2015 the debt ratio started to increase again. - Drivers of adverse debt dynamics: - Drop in tax revenue of 4 percentage points of GDP in just four years, reflecting tax policy changes and deteriorating compliance. - Wages, interest payments and transfers to Electricité du Liban (EdL) accounted for close to 70 percent of total expenditure in 2015. - Capital spending narrowed to about 1 percent of GDP. - Social spending remains inadequate. - Baseline projection under current policies: - Low oil prices assumed to help secure sustained primary surpluses of about 1½ percent of GDP. - Nonetheless, higher interest rates and subdued nominal growth will push public debt to 160 percent of GDP by 2021—almost 20 percentage points higher than today (Annex II). - Interest bill projected to exceed 11 percent of GDP by 2021, or about 60 percent of total revenue. - Fiscal risks that may add pressure include sizable pension liabilities, demands to adjust public wages, a potential increase in oil prices, and possible softening in investor appetite for Lebanese debt. *International Monetary Fund — Lebanon: selected sections from the 2016 Article IV consultation (as provided).* ### 30. Fiscal adjustment is essential. And while adjustment at a time of low growth makes policy ### 30. Fiscal adjustment is essential. And while adjustment at a time of low growth makes policy ### Fiscal adjustment and growth trade-offs - Fiscal policy affects growth via many channels, mainly by tax and expenditure policies. - Empirical evidence on size and durability of fiscal impact on growth is limited and may depend on: - type of fiscal instrument used, - state of the business cycle, - degree of trade openness, - type of the exchange rate regime. - Evidence is extensive for advanced economies but much less is known about the impact of fiscal policies in MENAP countries. - Assuming the composition and size of the proposed upfront adjustment: - growth is expected to be temporarily reduced by 0.8 and 0.4 percentage points in 2017 and 2018. - based on Cerisola and others (2015), elimination of a transfer to EdL has only a temporary effect on growth, while the impact of the proposed tax measures is expected to last for two years. - While the impact of lower growth on debt dynamics is negligible, postponing the adjustment by two years increases debt-to-GDP ratio by about 10 percentage points of GDP. - Assuming more lasting and negative impact of the proposed tax measures on growth is unlikely to affect debt dynamics as negatively as postponed implementation. ### Amount and timing of adjustment needed - A primary balance of 4 percent of GDP would be sufficient to stabilize debt, requiring an upfront adjustment of about 3 percent of GDP—if sustained, such an adjustment would place debt on a downward path within 5–6 years. - Debt would then slowly decline to 133 percent of GDP by 2030. - Such a surplus needs to be viewed against high budget deficits and mounting funding needs and interest bills. - There is no substitute for upfront adjustment: neither donor assistance, resolution of the Syrian conflict, nor prospective oil and gas revenue would, in itself, sustainably resolve Lebanon’s debt dynamics. ### Limits of alternative sources of support - Donor assistance: - Assuming grants increase over 2017–21, each year by between $400 million and $1 billion (about 0.5 to 1.9 percent of GDP), the impact on Lebanon’s debt to GDP trajectory would be small. - Resolution of the Syrian conflict: - Even under a favorable scenario—with the Syrian conflict ending by end-2017, Lebanon’s output gap closing immediately, and economic output rising by the equivalent of 10 percent of Syrian GDP—the positive impact on growth will not be sufficient for debt sustainability. - Oil and gas resources: - Size and income from Lebanon’s off-shore resources are uncertain; exploration has not yet started and it could take several years before the government would start receiving revenue. ### Key recommendations on fiscal measures - Proposed adjustment package combines revenue and spending measures; the package needs to be adopted in its entirety to achieve the targeted primary adjustment. - Passing a credible budget—the first in more than a decade—is a critical priority; ongoing work to close accounts since 1993 needs to continue in parallel with passing a budget. - Long-standing revenue measures need to be implemented, including: - increase in the corporate income tax rate (from 15 to 17 percent); - introduction of a capital gains tax on real estate; - increase in the rate on interest income tax (from 5 to 7 percent, though timing may depend on deposit behavior); - increase in the VAT rate from 10 to at least 11 percent; - increase in tobacco excises; - new stamp duties and fees. - Increasing fuel taxation: - restore VAT on diesel (suspended in 2011); - increase gasoline excises (significantly lowered in 2012) to earlier levels; - compensate impact of such measures by strengthening the social safety net. - Increase tax compliance: - Tax collection is only 50 percent of estimated capacity. - Ongoing efforts (e.g., electronic tax declaration) need to be strengthened. - Capacity of tax administration increased by 120 staff in 2016, but needs are estimated to be five times higher. - Electricity tariffs: - Average electricity tariffs need to be increased to reduce and eventually eliminate transfers to Electricité du Liban (EdL). - Current proposals to link tariffs to new additional capacity, while protecting lower-end consumers, are welcome but only a first step. - Goal: eliminate the EdL subsidy altogether. - Salary scale adjustment for the public sector: - If passed, budgetary costs need to be fully offset to preserve the targeted fiscal adjustment (e.g., by broadening VAT base and increasing VAT rates); - at a minimum, salary increases should be phased in without retroactive payments; - ideally linked to measures to strengthen productivity and rationalize public sector employment growth. - National Poverty Targeting Program (NPTP) needs strengthening; a proposal for additional government funding is waiting for the ministry of finance’s approval, which should be granted as a matter of priority. ### VAT—revenue mobilization potential (Box 6) - Lebanon’s tax revenue performance is weak and has driven the drop in public revenues since 2010; remains below the regional average. - Lebanon’s tax effort (ratio of actual tax revenue to capacity) is 50 percent based on Fenochietto and Pessino (2013), indicating tax revenues might be doubled to around 30 percent of GDP at maximum effort. - VAT characteristics: - VAT is one of the least distortive taxes and generally has the highest share in total tax revenue. - Lebanon’s economy oriented towards private consumption and high share of imports implies significant potential gains from mobilizing VAT revenues. - VAT gap analysis (2013): - overall VAT gap was estimated at around 7.4 percent of GDP in 2013; up from 6.1 percent in 2009. - compliance gap: 3.3 percent of GDP (stable over time). - policy gap: 4.0 percent of GDP (rising; substantial part due to discretionary policy decisions—mainly VAT exemption of gasoil in March 2012). - Policy simulation: - assuming gradual elimination of 50 percent of the compliance gap and partial elimination of the policy gap over next five years: - primary balance would increase from 1.1 percent to 5.2 percent of GDP; - overall balance would improve from -8.1 to -5.6 percent of GDP; - public debt would stabilize at about 150 percent of GDP in 2021. - conclusion: even partial elimination of the VAT gap can lead to significant improvement in fiscal performance. - Central government revenue, 2010–2015 (percent of GDP): - Revenue: 2010 22.1, 2011 22.8, 2012 21.8, 2013 19.8, 2014 21.8, 2015 18.8 - Tax revenue: 2010 17.4, 2011 16.4, 2012 15.3, 2013 14.1, 2014 13.8, 2015 13.5 - Nontax revenue: 2010 3.6, 2011 5.2, 2012 5.4, 2013 4.6, 2014 5.8, 2015 4.3 ### Medium-term spending and oil & gas framework - Over time, as adjustment takes hold and growth recovers, public investment and social spending need to be increased. - An appropriate oil and gas framework is needed: - Legislation on an exploration and fiscal regime for the oil and gas sector needs to be passed. - A formal engagement with the Extractive Industries Transparency Initiative (EITI) would signal commitment to transparency and accountability. ### Authorities’ views on fiscal adjustment - Authorities are aware of importance of front-loaded fiscal adjustment and costs of delay; acknowledged debt-service costs pose a problem for sustainability and crowd out needed spending. - Draft 2016 budget presented measures; additional measures expected once a new government is formed. - Authorities noted post-electoral spending pressures might intensify, especially if additional hiring in the public sector continues. - Salary scale adjustment remains sensitive; authorities aware of need to combine salary increases with public sector employment reforms and to eliminate wage distortions across sectors. - Authorities view: improvements in tax compliance and collections should precede increases in tax rates. - Agreed EdL transfers should be reduced and eventually eliminated, while noting lack of progress on changing tariff structure. - Authorities reiterated international community needs to provide additional assistance, especially direct budget support, noting Lebanon’s hosting of a large refugee presence and the need for longer-term commitments. ### Preserving confidence in Lebanon’s financial system—Using interest rates to secure buffers - BdL (Banque du Liban) has been acting as policy maker of last resort, preserving stability and supporting the exchange rate peg. - BdL’s recent financial operation has helped offset a decline in reserves but cannot offer a sustainable solution to Lebanon’s funding needs. - Absent improvement in depositor sentiment, BdL will need to attract fresh inflows, which may require higher interest rates. - To date, BdL has not raised rates owing to concerns about public debt dynamics and growth; a policy change would be unavoidable if deposit growth does not improve. - Timing and extent of any potential change in interest rates will depend on Lebanon’s fiscal stance: - Fiscal adjustment would reduce government financing requirements, especially in foreign exchange. - BdL has been providing foreign exchange to the government through an overdraft facility—allowing the government to draw foreign exchange resources beyond the ceiling set by law on its (non BdL) foreign currency borrowing. - Government maintains positive net balances with the BdL in domestic currency (equivalent to $4.3 billion at end-September 2016). - Fiscal adjustment would pave the way for more market-determined interest rates. BdL has sometimes financed the government by offering long-term instruments to banks and channeling proceeds to cover shortfalls in the T-bill and Eurobonds markets; T-Bill yields have remained largely unchanged since 2012. - BdL has adopted quasi-fiscal initiatives to channel subsidized credit, particularly to the real estate sector ($4.4 billion over 2013–16). ### Key recommendations on monetary policy and BdL actions - Monetary policy needs to remain geared to supporting the exchange rate peg. - If deposit growth were to soften, BdL should use interest rates as a direct policy tool to secure foreign exchange inflows rather than repeat recent operations. - BdL needs to communicate the size and scope of its recent operation to reduce market uncertainty. - Interest rate increases would affect debt service for private and public sectors and banks’ cost of funding, but such costs should be cast against implications of the recent BdL operation. - Given the size of reserve buffers (which remain adequate), authorities have some freedom to choose pace and timing of any interest rate move. - Steps to absorb excess liquidity need to be accompanied by efforts to encourage banks to improve their net foreign asset position: - BdL should continue to sterilize excess Lebanese pound liquidity created by the financial operation while ensuring new lending does not undermine asset quality. - As financing needs are reduced, banks should be encouraged to rebuild foreign exchange liquidity buffers abroad—taking into account rollover and dollarization risks. - As fiscal adjustment takes hold, BdL would need to withdraw from T-Bill and Eurobond auctions and encourage banks to participate directly; gradually reduce attractiveness of placements with BdL to pave way for more flexible and market-based yields on government instruments. - As conditions normalize, BdL needs to withdraw from quasi-fiscal schemes, allow old subsidized credit schemes to expire, and refrain from adding new ones. - Need to strengthen BdL’s balance sheet as its income has been impacted by repeated policy interventions. *Source: IMF staff report (cr1719).* ### 42. In the authorities’ view, the financial operation has met several objectives and has ### cr1719 - 42. In the authorities’ view, the financial operation has met several objectives and has ### Financial operation: authorities’ objectives and views - BdL emphasized seven objectives: strengthening BdL’s foreign currency assets; enhancing the capital base of banks; increasing liquidity in local currency; improving the government debt profile by reducing the cost of borrowing; improving the balance of payments; targeting positive inflation rate; and improving the country’s rating and outlook. - Authorities pointed to steps being taken to sterilize the excess (local-currency) liquidity created by the operation and underscored that the operation had boosted confidence. - Authorities viewed staff’s assessment of the operation as “rather negative,” noting that the market needed time to absorb the operation’s implications. - Authorities considered interest rate tools excessively costly to the economy and viewed the financial operation as the best option given constraints and pressures at the time it was undertaken. ### Preserving confidence in the banking system — risks and recent indicators - Lebanon’s resilience depends on the continued health of its macro-financial structure; FSAP findings indicate the economic environment and growing government funding needs are affecting banks. - Despite regulatory capital requirements exceeding Third Basel Accord minimums, banks’ capital buffers are modest given significant exposure to local-currency sovereign debt and foreign-currency BdL instruments. Key risk areas (as identified in the text): - Sovereign exposure: - Risk weights are not in line with international standards. - In the event of a sovereign downgrade to a rating below “B-” and a corresponding increase in risk-weights for all FX-denominated instruments to 150 percent—as per Basel’s standardized approach—the impact would be a reduction of regulatory capital by an estimated 6 percentage points. - Footnote: Currently, banks are allowed to apply a risk-weight of 50 percent for FX-denominated BdL exposure (instead of 100 percent, as applied to FX government debt and as per Basel standards in case of sovereign ratings of B or B- equivalent). - Interest rate risk: - Banks are primarily funded via short-term deposits and hold a large portion of investments in long-term sovereign instruments, indicating interest rate risk. - Asset quality: - Reported nonperforming loans (NPLs) have remained relatively stable over past five years, at 10.4 percent by end-June 2016. - Banks are significantly exposed to Lebanon’s softening real estate sector via housing loans, loans to developers, and corporates collateralized by real estate. - Footnote: The official definition excludes accrued interest, off-balance sheet assets, and restructured loans. - Foreign currency liquidity needs: - A large share of banks’ foreign currency assets (e.g., long-term deposits with the BdL) cannot be immediately pledged in the interbank market to raise liquidity, implying that large liquidity shocks might quickly involve the BdL as lender of last resort. - Net foreign assets of banks have declined (chart referenced: Banks' Net Foreign Asset/(Liability) Position (In USD billions), Source: BdL). - At present, 1 percent of deposits (or $1.6 billion) represents 4 percent of BdL’s gross reserves, highlighting the systemic importance of sufficient liquidity buffers. ### Supervision and Basel Core Principles (BCP) assessment - The supervisor (BCC) is well respected and has raised supervisory standards, but continued progress is needed. - The supervisory approach does not yet support a clear view on the risk profile and systemic relevance of individual banks. - The ongoing BCC supervisory review of capital needs must better reflect banks’ risk profiles. - Loan classification rules are currently not aligned with international best practice. ### Key recommendations on banking sector resilience and supervision - BCC announced a graduated increase of the capital adequacy ratio to 15 percent (from 12 percent) by 2018. - Forward-looking capital planning: - Banks need forward-looking capital planning reflecting their risk profile and linked to multi-factor stress testing. - Supervisory review of capital planning is welcome. - The risk weight on BdL foreign-currency exposure needs to be aligned with the Basel Accord to allow a reduction in sovereign exposure over the medium term and incentivize diversification of liquidity holdings as banks strengthen their net foreign asset position. - Strengthen banking regulation and supervision: - Align regulatory treatment of restructured loans with international good practice. - Stay vigilant on asset quality, including monitoring loan-loss migrations at the bank level. - Put in place a systematic reporting system on the funding structure and liquidity risk profile. - Strengthen the AML/CFT framework: - Despite progress since 2009 (including legislative steps in November 2015), gaps remain. - Authorities need to better align AML/CFT supervision with current ML/TF risks and continue close focus on the risk of withdrawal of correspondent banking relationships. ### Authorities’ clarifications and disagreements - On capital adequacy: - BdL places banks’ foreign currency deposits with foreign central banks and prime banks whose credit assessment is BBB and above; hence, the 50 percent risk weight for banks’ exposure to BdL placements in foreign currency should be considered in that context. - BCC regularly conducts scenario analyses, including on a downgrade below B-; such analyses indicate that a downgrade to CCC+ would not cause all banks to breach minimum required capital ratios. - The new regime of a graduated increase in the capital adequacy ratio to 15 percent from 12 percent will protect against the mentioned risks. - On problem assets, provisioning, and AML/CFT assessment: - Authorities disagreed with the BCP assessment of problem assets and provisioning and with the assessment of the AML/CFT framework. - They state the regulatory framework prescribes criteria for supervisory loan classification and follow-up, with special care for loans classified as Class 3 or worse. - BCC reviews a large sample of credit portfolios, covering at least 50 percent of total banks’ loan portfolios, through its missions. - Authorities asserted full compliance with AML/CFT rules according to FATF and MENA FATF. ### Lebanon’s long-term solution: investment, jobs, and growth — diagnosis - Structural reform is necessary for enduring and inclusive growth; traditional drivers have not provided high-quality, job-rich growth. - Employment growth elasticity is one of the lowest in the region (at least for Lebanese nationals); job creation has not kept up with the economy’s growing labor force, now expanded by the refugee influx. - ILO estimates: national unemployment rate is estimated at around 9 percent, but rises to 12 percent including refugees. - Current account deficit and competitiveness: - The sharp increase in the deficit reflects, in part, disruption from the Syria crisis and elevated regional uncertainty. - Abstracting from Syria, the external balance is weaker than fundamentals suggest, pointing to underlying problems with productivity and competitiveness (see Annex III). - EBA methodology suggests Lebanon’s real exchange rate may be overvalued by anywhere between 0–23 percent (results should be treated with caution). - Electricity sector: - Electricity reform is a long-standing priority and a major budget drain. - Over 2006–14 the government transferred an average of 4½ percent of GDP each year to EdL, representing over 40 percent of the current debt stock. - Progress on reform has been hindered by political disagreements within the government. - Human capital and knowledge economy: - Lebanon has a steady stream of well-educated labor market entrants but struggles to match them with suitable job opportunities, resulting in brain drain. - BdL launched a new financing program (under BdL Circular 331) to boost startup investment in the knowledge economy. - Knowledge economy growth is promising, but infrastructure bottlenecks—frequent electricity outages and slow internet speeds—remain major hindrances. - Capital markets: - The Capital Markets Authority (CMA) is now operational and a new trading platform is beginning market initiatives. - Successful development requires strengthening regulatory and institutional frameworks and shifting CMA oversight towards monitoring, risk-based supervision of intermediaries, and market surveillance. - Refugee presence implications: - The refugee presence has increased infrastructure gaps and intensified the need for investment and job-rich growth. - Lebanon’s policy is that Syrian refugees are not expected to stay permanently; however, many refugees are likely to remain over the medium term, calling for a shift away from protracted short-term humanitarian aid toward investment and employment support. - Regulatory requirements (residency fee and documentary requirements) have restricted refugees’ access to the labor market; authorities committed at the 2016 London conference to review these regulations and most recently replaced the pledge not to work with a pledge to abide by Lebanese Law, which allows legal employment in a number of specified sectors. ### Box 7 — The 2016 London Conference (summary of authorities’ plan) - The authorities’ plan called for substantial international assistance: $11 billion over 2016–20, including both grants ($5 billion) and loans ($6 billion). - The plan focuses on stimulating growth and employment through targeted investment initiatives addressing high-priority infrastructure needs and maintenance of key public services (education, municipal services, etc.). - Authorities project the interventions could create 300,000–350,000 jobs, of which 60 percent would accrue to Syrian refugees. - The Subsidized Temporary Employment Programme (STEP) is intended to encourage job creation in labor-intensive sectors and is estimated to generate a further 100,000 jobs, shared between local residents and Syrian refugees. - The plan acknowledges policy tensions regarding integration of refugees into the labor market and notes legal limits under Decree 197 (December 2014) restricting Syrians to agricultural, construction, and domestic service sectors; administrative requirements for legal residency can be prohibitive for vulnerable Syrian households. ### Key policy recommendations to boost investment, jobs, and growth - Electricity reforms: - Reduce electricity transfers to zero over time; use low oil prices as an opportunity to begin bringing tariffs up to cost-recovery levels while protecting vulnerable consumers. - Adopt proposals to link the tariff structure to the expansion of capacity to allow increased production (and lower production costs) without increasing budget transfers. - Foster the knowledge economy: - Revisit the scale of incentives to avoid excessive funding chasing too few ideas. - Finalize and implement capital market regulation and prepare and adopt a capital market development plan. - Build the supporting ecosystem for the knowledge economy, beginning with reliable internet connectivity and electricity. - Facilitate donor support: - Improve the framework for channeling funds through the government. - Expedite disbursement of donor money from budgetary transit accounts (current procedures are slow). - Elevate the coordination framework launched after the London Conference to a high-level forum to discuss strategic issues. - Pending legislation: - Pass the framework law for Public Private Partnerships (awaiting parliamentary approval for three years) to help mobilize private sector resources for infrastructure investment, while attending to possible fiscal risks. - Ratify an agreement with the European Union regarding simplified rules-of-origin for Lebanese exports. ### Authorities’ views on reform agenda - Authorities broadly agreed with staff’s diagnosis and priorities but emphasized that slow reform progress reflected protracted political impasse. - The election of a president and formation of a new government could allow the reform agenda to proceed swiftly. - Authorities agreed particularly on the pressing need for electricity reform and noted that a tariff structure allowing expansion of generating capacity would be key to lowering overall production costs. *Source: cr1719 - 42. In the authorities’ view, the financial operation has met several objectives and has* ### 57. The authorities also underscored that Lebanon’s reform agenda was closely linked to ### cr1719 - 57. The authorities also underscored that Lebanon’s reform agenda was closely linked to ### Refugee presence, infrastructure, and donor funding - Lebanon’s reform agenda is closely linked to the refugee presence; additional donor funding is critical. - Lebanon’s infrastructure deficit has widened sharply owing to the added demands of the refugee community. - Most donor support to date has been short-term humanitarian assistance, and even this has been short of actual needs. - Longer-term funding—either in the form of budget support to reduce the government’s cost of borrowing, or concessional finance for infrastructure spending—has not yet materialized. - Authorities urged the international community to step up their support "as a matter of urgency." - Specific funding risk noted: the authorities are currently at risk of losing a £90 million grant for the education sector, as timely delivery from the transit account to the education sector cannot be guaranteed. ### Data issues and key recommendation - Data quality remains weak, with a general deterioration in data provision. - Fiscal data are reported with long and increasing lags. - National accounts compilation suffers from serious shortcomings. - Balance of payments statistics are subject to frequent and sizable revisions. - The Central Administration of Statistics (CAS) and the External Sector Section of the BdL are aware of problems and are working to improve data quality, but progress has been slow and uneven. Key recommendation: - The authorities need to address data gaps. At a minimum: - The timeliness of fiscal data need to be improved; - IIP data need to be finalized and published; - Collaboration between CAS and other institutions needs to be strengthened. ### Staff appraisal — situation and vulnerabilities - Lebanon is at a critical juncture following a recent presidential election and the appointment of a new prime minister with a mandate to form a new government. - Lack of adjustment and reform historically reflected internal and regional political fissures, not lack of capacity. - The Syria shock has been profound and long-lasting: costs of regional conflicts significant; growth stalled; infrastructure and services strained by refugee inflows. - Despite pressures, Lebanon has endured; response reflects generosity and resilience. - Need for adjustment and reform pre-dates the Syrian crisis: long-standing infrastructure gaps (chief among them, the electricity sector), and spending rigidities (salaries, debt service, transfers to EdL). - Past high growth rates masked these factors; with growth dissipated they now weigh heavily on fiscal performance. - Staff estimates and projections are less benign compared to the prior Article IV consultation, especially on public debt dynamics. - A new development: slowdown in financial inflows at a time of sizeable funding needs and tighter liquidity conditions among Lebanon’s traditional funding sources (regional oil exporters). - As a result, Lebanon’s foreign exchange reserves dropped for the first time in eleven years in 2015, and the decline continued into mid-2016, prompting the BdL to take action. ### BdL’s recent financial operation and implications - The BdL’s recent financial operation has been a stop-gap measure and cannot sustainably resolve Lebanon’s funding needs. - The BdL has supported financial stability and the exchange rate peg (the appropriate nominal anchor) using unconventional measures. - Effects of the operation: - Bolstered BdL’s gross international reserves and banks’ capital; - Resulted in a large injection of local currency liquidity; - Erosion of banks’ foreign currency buffers, which now need to be addressed; - Affected the BdL’s balance sheet. - Recommendation: BdL should communicate the size and scope of its unconventional measures in a timely manner. ### Policy agenda and fiscal recommendations - Fiscal adjustment is essential—large enough to halt adverse debt dynamics. - Composition of adjustment should: - Broaden the tax burden (starting from fuel taxation); - Rebalance the spending mix toward more efficient programs and better social safety nets. - Neither large donor funding, temporarily higher growth, nor prospective gas revenue can permanently substitute for fiscal adjustment. - Passing a credible budget remains a critical priority and would signal a strong commitment to discipline. - Fiscal adjustment would reduce the government’s reliance on bank funding and the need for ongoing financial inflows—relieving pressure on the BdL and allowing more flexible interest rate policy. ### Financial sector recommendations - Financial stability has been a pillar of sustained confidence; the banking system is renowned for resilience. - Current challenges: more difficult macroeconomic environment, growing exposure to the sovereign, lower foreign currency liquidity buffers abroad, significant interest-rate risk, and greater international scrutiny. - The Banking Control Commission is proactively vigilant. - Complementary measures needed: - Introduce forward-looking capital planning; - Strengthen regulation and supervision, including aligning loan classification rules and sovereign risk weights with international good practice; - Support liquidity risk management; - Strengthen AML/CFT frameworks further. ### Growth, reforms, and job creation - Higher, more sustainable, and more inclusive growth is needed; current growth rates are insufficient to address employment or social needs. - Lebanon has resources: an innovative and resilient business sector and high-quality human talent. - Unlocking potential requires reinvigorating structural reform agenda to address infrastructure bottlenecks and improve competitiveness. - Job-rich investment is urgently needed now, particularly given the large-scale refugee presence. - Authorities’ ambitious proposal at the London Conference to boost employment and growth deserves attention and international support. ### Role of the international community - International community needs to play a stronger role. - Lebanon has received significant assistance, but largely for humanitarian purposes and below estimated needs. - Funding volatility undermines the effectiveness of spending programs. - Larger and more stable support to help Lebanon address the costs of the Syrian crisis is both needed and warranted. ### Additional staff recommendations and administrative note - Data gaps need to be addressed; stronger cooperation among agencies and high-level support for the Central Administration of Statistics would help. - The IMF stands ready to assist, including through the Middle East Technical Assistance Center. - Staff propose that the next Article IV consultation take place on the standard 12-month cycle. *Source: IMF staff report text (excerpt provided).* ### Annex I. Status of the Article IV 2015 Recommendations ### Annex I. Status of the Article IV 2015 Recommendations ### Recommendations (2015 consultation) - Fiscal discipline: restore a primary surplus to place debt on a more sustainable path through: - increased fuel taxation - increasing the VAT from 10 to 11 percent - increasing the tax rate on interest income from 5 to 7 percent - introducing a capital gains tax on real estate transactions - introducing new stamp duties and fees - regularizing telecom transfers - pass a budget - Financial stability: strengthen bank supervision and increase capital buffers; improve loan classification and restructuring rules; enhance the AML/CFT framework. - Capital market development: privatize the Beirut Stock Exchange. - Structural reform for inclusive growth and resilience: - reform the electricity sector, including gradual tariff increases toward cost recovery levels - reform the pension system - encourage employment opportunities for high-skill workers - pass long-delayed legislation (e.g., on Public Private Partnerships, or on the use of gas resources) to signal potential investors - improve the provision and quality of statistical information ### Progress against recommendations - Fiscal: - authorities managed a small primary surplus in 2015, which is likely to be repeated in 2016 - telecom transfers over 2015–16 were substantially more regular than in 2014 - the minister of finance presented the 2017 budget to cabinet within constitutional deadlines, but no action has been taken so far by cabinet or parliament - Monetary/AML: - parliament passed legislation related to the AML/CFT framework - Structural/legislation: - parliament convened two emergency sessions to pass a series of long delayed legislation, including measures to comply with international tax transparency norms, and to help unlock funding from the World Bank - Statistics: - delays in the dissemination of statistical information have increased *Source: Annex I. Status of the Article IV 2015 Recommendations (IMF).* ### Annex II. Public Debt Sustainability Analysis ### Overview and key risk metrics - Public debt already above 140 percent of GDP and gross financing needs close to 30 percent of GDP - Under the baseline scenario: - debt projected to reach 160 percent of GDP by 2021 - gross financing needs projected to reach 33 percent of GDP by 2021 - Debt dynamics are sensitive to macro-economic shocks, especially to growth and contingent liability shocks - Mitigating factors: level of foreign exchange reserves and a captive investor base ### Baseline scenario assumptions - No improvement in the conflict in Syria within the projection horizon - Real GDP growth: - 2 percent in 2017 - increase gradually to 3 percent in 2019 and for the rest of the projection horizon - Inflation (GDP deflator): - 1 percent in 2016 and 2017 - between 2018 and 2021 marginally increase and settle slightly below 2 percent - Primary balance: - projected to stay in a surplus of about 1–1½ percent of GDP from 2016 onwards - projections assume no corrective measure will be introduced on the revenue and expenditure side - Projections do not assume improvement in Syria or additional corrective fiscal measures ### Plausibility and forecast track record - Baseline assumptions broadly plausible - Lebanon’s forecast track record is not systematically biased; median forecast errors for growth, inflation and primary balance during 2010–15 are broadly in line with other countries ### Projected debt dynamics and drivers - Public debt-to-GDP ratio forecast: from 138 percent in 2015 to 160 percent in 2021 - Gross financing needs trajectory: - projected to increase by only 3 percentage points of GDP to 33 percent of GDP in 2021 - would reach about 40 percent of GDP beyond 2021 - Key drivers: large fiscal deficits and debt maturity profile (average maturity around 5 years for domestic debt and 7 years for foreign debt) - Positive interest rate-growth differential is the main deteriorating factor ### Stress-test scenarios and outcomes - Growth shock: - assume decline in growth by one standard deviation in 2017 and 2018 - debt-to-GDP ratio forecast to reach above 180 percent of GDP in 2021 - financing needs projected to reach 37 percent of GDP in 2021 - Interest rate shock: - debt-to-GDP ratio reaches above 165 percent at end of projection horizon - financing needs projected to reach 35 percent of GDP in 2021 - Combined macro-fiscal shock (growth, interest rate, and primary balance simultaneously): - debt-to-GDP ratio would exceed 190 percent at the end of the projection horizon - financing needs would reach 40 percent of GDP and continue growing - Contingent liability shock: - standardized shock of 10 percent of financial sector assets used - debt-to-GDP ratio would reach 200 percent at the end of the projection horizon - financing needs would reach 40 percent of GDP in 2021 - scenario does not assume any feedback on GDP growth and interest rates due to the contingent liability shock ### Uncertainty and fan charts - Symmetric fan chart width estimated at around 60 percent of GDP, illustrating significant uncertainty for equal-probability upside and downside shocks - Asymmetric fan chart: upside shock to growth constrained to zero (reflecting downside skew due to Syria crisis), resulting in a more upward-sloping debt path ### Debt profile vulnerabilities and assessments (2015 indicators) - External financing needs: well above the upper risk-assessment benchmark - Public debt in foreign currency: above the lower risk-assessment benchmark - Bond spreads: above the lower risk assessment benchmark, but relatively stable in past stress episodes - Public debt held by nonresidents: estimated to be only slightly above the lower risk assessment benchmark - Level of, and change in, short-term debt: below the lower risk assessment benchmarks ### Mitigating factors - Investor base: - debt largely held by domestic financial institutions tightly regulated in net open positions and investment strategies - captive investor base driven by low demand for private sector credit and limited regional investment opportunities - domestic banks sold part of their Eurobond holdings to foreign clients during a recent financial operation - domestic financial institutions fund positions from deposits largely held by nonresidents, though these have started to decelerate - significant share of domestic debt held by the BdL - Debt financing profile: - large external financing needs amounting to almost 170 percent of GDP reflect payments related to debt and large nonresident short-term deposits - debt denominated in foreign currency accounts for about 40 percent of total public debt but is held mostly by domestic financial institutions - Buffers: - high level of gross international reserves remains an anchor for investors’ confidence - ample LL liquidity suggests excess demand for government papers denominated in LL ### Key numeric projections and historical series (selected) - Nominal gross public debt: 153.6 133.4 138.3 143.6 147.9 151.1 153.7 156.9 160.1 (series heading 2014–2021) - Public gross financing needs: 46.8 24.2 26.2 29.2 36.7 27.7 21.0 21.8 33.1 3.15 (series as presented) - Real GDP growth (in percent): 5.3 2.0 1.0 1.0 2.0 2.5 3.0 3.0 3.0 (series 2014–2021) - Inflation (GDP deflator, in percent): 4.2 2.8 0.9 0.9 1.0 1.6 1.8 1.7 1.9 (series 2014–2021) - Effective interest rate (in percent): 7.3 6.6 6.7 6.7 7.1 7.5 7.7 7.8 7.7 (series 2014–2021) - Change in gross public sector debt (cumulative projection): -4.2 0.0 4.9 5.4 4.2 3.2 2.7 3.2 3.2 21.8 - Primary balance (projections): 1.1 1.5 1.4 1.4 1.2 1.0 (series 2016–2021 baseline) - Baseline scenario projection highlights: - Real GDP growth (baseline): 1.0 2.0 2.5 3.0 3.0 3.0 (2016–2021) - Inflation (baseline): 0.9 1.0 1.6 1.8 1.7 1.9 (2016–2021) - Primary Balance (baseline): 1.1 1.5 1.4 1.4 1.2 1.0 (2016–2021) - Effective interest rate (baseline): 6.7 7.1 7.5 7.7 7.8 7.7 (2016–2021) *Source: Annex II. Public Debt Sustainability Analysis (IMF).* ### DSA Alternative Scenarios and Stress-Test Assumptions ### Alternative scenarios (selected underlying assumptions) - Historical scenario: - Real GDP growth: 1.0 4.8 4.8 4.8 4.8 4.8 - Inflation: 0.9 1.0 1.6 1.8 1.7 1.9 - Primary Balance: 1.1 1.8 1.8 1.8 1.8 1.8 - Effective interest rate: 6.7 7.1 6.8 6.5 6.3 6.0 - Constant Primary Balance scenario: - Primary Balance: 1.1 1.1 1.1 1.1 1.1 1.1 - Other assumptions aligned with baseline ### Stress-test specific assumptions (selected) - Primary Balance Shock scenario: - Real GDP growth: 1.0 2.0 2.5 3.0 3.0 3.0 - Inflation: 0.9 1.0 1.6 1.8 1.7 1.9 - Primary balance: 1.1 0.8 0.8 1.4 1.2 1.0 - Effective interest rate: 6.7 7.1 7.5 7.8 7.8 7.8 - Real GDP Growth Shock scenario: - Real GDP growth: 1.0 -1.9 -1.4 3.0 3.0 3.0 - Inflation: 0.9 0.0 0.7 1.8 1.7 1.9 - Primary balance: 1.1 0.6 -0.4 1.4 1.2 1.0 - Effective interest rate: 6.7 7.1 7.5 7.8 7.9 7.8 - Real Interest Rate Shock scenario: - Effective interest rate: 6.7 7.1 8.0 8.5 8.8 9.0 - Real Exchange Rate Shock scenario: - Effective interest rate: 6.7 7.3 7.4 7.7 7.8 7.7 - Combined Shock scenario: - Primary balance: 1.1 0.6 -0.4 1.4 1.2 1.0 - Effective interest rate: 6.7 7.3 7.9 8.5 8.8 9.0 - Contingent Liability Shock scenario: - Primary balance: 1.1 -12.4 1.4 1.4 1.2 1.0 - Effective interest rate: 6.7 7.4 8.5 8.6 8.6 8.5 *Source: Annex II. Public Debt Sustainability Analysis (IMF).* ### Annex III. External Sector Assessment ### Exchange rate and effective rates - Nominal effective exchange rate (NEER) appreciated while real effective exchange rate (REER) depreciated marginally and returned to its end-2014 level - NEER appreciation largely reflects appreciation of the U.S. dollar vis-à-vis the euro - CPI inflation differential declined as the drop in oil price passed through to domestic prices, leading to more muted behavior of the REER ### Current account and data quality - Current account deficit has decreased but remains large - Lebanon has sustained large current account deficits by international standards for almost a decade - Deficit widened notably after the Syrian crisis (by an average of 10 percent of GDP) - Errors and omissions also increased substantially during the same period (by an average of 9 percent of GDP), pointing to large unrecorded inflows (overstated outflows) - Data revisions have been frequent and large in magnitude (example: 2012 current account deficit revised from 11.7 percent to 24.6 percent within a year) - Revisions from 2014 onwards are likely though magnitude and sign remain uncertain; preliminary data led to sharp revision of some series such as errors and omissions but not yet confirmed - Estimated current account deficit for 2016: 17.5 percent of GDP *Source: Annex III. External Sector Assessment (IMF).* ### 3. The improvement in the goods trade balance reflects the substantial decline in oil ### 3. The improvement in the goods trade balance reflects the substantial decline in oil ### Goods trade balance and current account - Oil imports account for approximately 20 percent of Lebanon total imports. - In 2015, the import bill decreased by about $1.9bn or about 4 percent of GDP. - As a result, the current account balance deficit also narrowed. - The current account deficit is expected to continue to narrow in the medium term, as external demand increases at a faster pace than the gradual increase in oil prices. - The forecast assumes Lebanon would be able to: - finance its large external deficit, - have a gradual adjustment, - avoid a drastic current account reversal through import compression. ### EBA-lite methodology assessment - The EBA-lite methodology shows mixed results. - According to the current account (CA) approach: - the exchange rate is overvalued by 23 percent, - reflecting a CA norm of 13.2 percent of GDP. - According to the REER approach: - the REER is at equilibrium. - Given large uncertainty about the actual size of the CA deficit, actual misalignment could be lower than indicated by the CA approach. - The EBA-lite methodology suggests some overvaluation of the exchange rate. - The methodology’s ability to capture deviations from equilibrium could be compromised in an environment facing a temporary but protracted shock such as the Syrian crisis. ### Reserve adequacy (ARA metric) - Reserve coverage is adequate according to the ARA metric. - The ARA metric is constructed to capture reserve coverage against potential sources of drain on reserves. - Based on historical and cross-country experience, a coverage in the range of 100–150 of the metric is considered adequate. - In Lebanon, reserve coverage has been within this range since 2009—with a small deviation by end-2015. - Most of short-term debt, weighted at 30 percent, is in the form of short-term deposits of non-residents. ### External Debt Sustainability Analysis — key levels and projections - Lebanon’s external debt remained elevated at 175 percent of GDP as of end-2015. - Under the baseline: - external debt is projected to pick at 180 percent of GDP in 2017, - and decline slightly to 175 percent of GDP in 2021. - The high debt level reflects: - the sizable current account deficit, - the large stock of non-resident deposits (largely with short-term maturity). - The slight decline in external debt is explained by: - the reduction in the current account deficit, - a reduction in the growth rate of non-resident deposits, - an increase in GDP growth forecasts. ### External debt sensitivity and scenario outcomes - A real depreciation of 30 percent represents the most severe scenario tested and would increase external debt to 253 percent of GDP. - Other scenario outcomes by 2021: - under a permanent shock to the interest rate: debt would increase to 180 percent of GDP, - under a growth shock: debt would increase to 190 percent of GDP, - under a shock to the non-interest current account balance: debt would increase to 198 percent of GDP. - The sensitivity of debt dynamics to the 30 percent depreciation highlights the importance of the exchange rate peg to maintain macroeconomic and financial stability in Lebanon. - The bound tests are based on ½ standard deviation shocks calculated on 10-year historical data. ### Table 1 — Selected projections and key statistics (2011–2021) - External debt (percent of GDP): 2011: 169.2; 2012: 163.9; 2013: 167.1; 2014: 170.0; 2015: 174.7; 2016: 179.0; 2017: 180; 2018: 179.2; 2019: 177.5; 2020: 176.4; 2021: 174.8. - Change in external debt: 2011: 6.1; 2012: -5.3; 2013: 3.3; 2014: 2.8; 2015: 4.8; 2016: 4.3; 2017: 1.1; 2018: -0.9; 2019: -1.7; 2020: -1.1; 2021: -1.7. - Identified external debt-creating flows (sum of lines 4, 8, 9): 2011: 5.0; 2012: 7.1; 2013: 11.1; 2014: 14.4; 2015: 13.2; 2016: 13.7; 2017: 11.9; 2018: 11.0; 2019: 10.2; 2020: 9.6; 2021: 8.9. - Current account deficit, excluding interest payments (percent of GDP): 2011: 10.2; 2012: 19.3; 2013: 21.4; 2014: 19.6; 2015: 12.3; 2016: 12.1; 2017: 11.5; 2018: 10.3; 2019: 8.9; 2020: 7.9; 2021: 7.2. - Deficit in balance of goods and services (percent of GDP): 2011: 18.7; 2012: 25.3; 2013: 26.4; 2014: 27.0; 2015: 21.5; 2016: 22.5; 2017: 23.7; 2018: 23.0; 2019: 22.0; 2020: 21.3; 2021: 20.5. - Exports (percent of GDP): 2011: 59.7; 2012: 46.8; 2013: 43.9; 2014: 38.6; 2015: 38.8; 2016: 39.0; 2017: 40.2; 2018: 40.6; 2019: 41.4; 2020: 42.1; 2021: 42.5. - Imports (percent of GDP): 2011: 78.5; 2012: 72.1; 2013: 70.3; 2014: 65.5; 2015: 60.3; 2016: 61.5; 2017: 63.9; 2018: 63.6; 2019: 63.4; 2020: 63.3; 2021: 63.0. - Net non-debt creating capital inflows (negative, percent of GDP): 2011: -1.8; 2012: -1.3; 2013: -2.7; 2014: -3.2; 2015: -2.0; 2016: -2.1; 2017: -2.1; 2018: -1.7; 2019: -1.4; 2020: -1.3; 2021: -1.2. - Automatic debt dynamics (percent of GDP): 2011: -3.4; 2012: -10.9; 2013: -7.6; 2014: -2.0; 2015: 2.9; 2016: 3.7; 2017: 2.4; 2018: 2.5; 2019: 2.7; 2020: 2.9; 2021: 2.9. - Contribution from nominal interest rate (percent): 2011: 5.0; 2012: 4.6; 2013: 4.5; 2014: 5.7; 2015: 5.9; 2016: 5.4; 2017: 5.9; 2018: 6.8; 2019: 7.8; 2020: 8.0; 2021: 8.0. - Contribution from real GDP growth (percent): 2011: -1.4; 2012: -4.3; 2013: -3.8; 2014: -3.2; 2015: -1.7; 2016: -1.7; 2017: -3.5; 2018: -4.3; 2019: -5.1; 2020: -5.1; 2021: -5.0. - Contribution from price and exchange rate changes (percent): 2011: -7.0; 2012: -11.1; 2013: -8.2; 2014: -4.6; 2015: -1.3; [table continues in source]. - Residual, including change in gross foreign assets (2-3) (percent of GDP): 2011: 1.2; 2012: -12.4; 2013: -7.8; 2014: -11.6; 2015: -8.4; 2016: -9.4; 2017: -10.8; 2018: -11.9; 2019: -11.9; 2020: -10.6; 2021: -10.5. - External debt-to-exports ratio (in percent): 2011: 283.3; 2012: 350.4; 2013: 380.8; 2014: 440.4; 2015: 449.9; 2016: 459.0; 2017: 448.5; 2018: 441.0; 2019: 428.9; 2020: 419.3; 2021: 411.1. - Gross external financing need (in billions of US dollars): 2011: 59.5; 2012: 70.0; 2013: 75.5; 2014: 82.9; 2015: 84.6; 2016: 88.4; 2017: 91.6; 2018: 94.3; 2019: 98.0; 2020: 101.5; 2021: 104.8. - Gross external financing need (in percent of GDP): 2011: 148.5; 2012: 158.7; 2013: 158.7; 2014: 166.1; 2015: 166.5; 2016: 170.6; 2017: 171.6; 2018: 169.5; 2019: 168.0; 2020: 166.2; 2021: 163.5. ### Key macroeconomic assumptions underlying baseline (selected) - Real GDP growth (in percent): 2011: 0.9; 2012: 2.8; 2013: 2.5; 2014: 2.0; 2015: 1.0; 2016: 4.8; 2017: 3.9; 2018: 1.0; 2019: 2.0; 2020: 2.5; 2021: 3.0. - GDP deflator in US dollars (change in percent): 2011: 4.5; 2012: 7.0; 2013: 5.3; 2014: 2.8; 2015: 0.8; 2016: 4.2; 2017: 3.4; 2018: 1.0; 2019: 1.0; 2020: 1.7; 2021: 1.8. - Nominal external interest rate (in percent): 2011: 3.2; 2012: 3.0; 2013: 3.0; 2014: 3.6; 2015: 3.5; 2016: 4.0; 2017: 1.1; 2018: 3.2; 2019: 3.4; 2020: 3.9; 2021: 4.6. - Growth of exports (US dollar terms, in percent): 2011: 17.7; 2012: -13.8; 2013: 1.3; 2014: -7.8; 2015: 2.4; 2016: 7.0; 2017: 17.8; 2018: 2.4; 2019: 6.0; 2020: 5.5; 2021: 6.8. - Growth of imports (US dollar terms, in percent): 2011: 7.6; 2012: 1.1; 2013: 5.2; 2014: -2.2; 2015: -6.4; 2016: 8.1; 2017: 12.9; 2018: 4.0; 2019: 7.0; 2020: 3.8; 2021: 4.5. - Current account balance, excluding interest payments (percent of GDP): 2011: -10.2; 2012: -19.3; 2013: -21.4; 2014: -19.6; 2015: -12.3; 2016: -10.0; 2017: -9.3; 2018: -12.1; 2019: -11.5; 2020: -10.3; 2021: -8.9. - Net non-debt creating capital inflows (percent of GDP): 2011: 1.8; 2012: 1.3; 2013: 2.7; 2014: 3.2; 2015: 2.0; 2016: 3.4; 2017: 1.5; 2018: 2.1; 2019: 2.1; 2020: 1.7; 2021: 1.4. ### World Bank–IMF collaboration and macrocritical reform recommendations - Shared assessment: Lebanon is in the midst of a protracted period of low growth; fiscal consolidation is essential to put the debt on a sustained downward path and reduce reliance on external funding. - Immediate measures to anchor confidence include: - restoring fiscal sustainability, - anchoring financial stability, - promoting sustainable and inclusive growth, - swiftly passing pending fiscal laws. - Identified macrocritical structural reform areas: - Implementation of long-standing revenue measures, including: - increase in the corporate income tax rate (from 15 to 17 percent); - introduction of a capital gains tax on real estate; - increase in the rate on interest income tax (from 5 to 7 percent, though timing may depend on deposit behavior); - increase in the VAT rate from 10 to at least 11 percent, while broadening its base and strengthening compliance; - increase in tobacco excises; - new stamp duties and fees. - Increase of fuel taxation: - at a minimum, restore the VAT on diesel; - increase gasoline excises to earlier levels and shift to ad valorem rates. - Recalibrating electricity tariffs: - proposals linking higher tariffs to the addition of new capacity are welcome as a first step; - improved service from EdL should help reduce the average household energy bill and provide scope for further tariff increases with the ultimate goal of eliminating the EdL subsidy; - protect lower-end consumers. - Strengthening of the National Poverty Targeting Program: - program is funded in part by grants from the World Bank and UNDP; - a proposal for additional funding is waiting for ministry of finance approval and should be approved as a matter of priority. - Tapping into the knowledge economy as a promising source of growth: - create a conducive institutional and business climate and strengthen infrastructure; - focus more on seed financing stage; - finalize and implement capital market regulation and prepare and adopt a capital market development plan. *Source: IMF staff report excerpts (Lebanon Country Report).* ### 3. The teams agreed to the following division of labor: ### 3. The teams agreed to the following division of labor ### Division of labor: major reform areas - Fiscal reform (Fund) - Providing capacity building on fiscal regimes and revenue administration for the oil and gas sector. - Providing analytical advice and TA on: - capacity building for the macro-fiscal department, in collaboration with the World Bank; - improving the transparency and accountability of public accounts; - modeling compliance in income tax; - promoting the use of indirect audit techniques. - Electricity sector reform (Bank) - Little progress in implementing electricity sector plans over the past 5 years owing to ongoing political disagreements. - The Bank has suspended its engagement in this area, pending a renewed consensus to move forward. - The Bank’s current Country Partnership Framework (2017-20) has no has no significant financing plans in the electricity sector. - National Poverty Targeting Program (Bank) - The Bank will continue to strengthen the National Poverty Targeting Program. - The Bank and donors scaled-up the successful e-card food voucher program after the Syrian crisis. - A pilot graduation program will be introduced for selected beneficiaries to improve their employability. - Knowledge economy (Fund and Bank) - The Fund met various stakeholders in the knowledge economy ecosystem and prepared analytical work with cross country comparisons. - The Bank is moving forward with its TA on the development of the capital market. - Reform of the statistical system (Fund) - The Fund will continue to provide TA on the consumer price index, producer price index and national accounts. ### Coordination and information requests - The teams request to be kept informed of progress on the other institution’s agenda. - Timing: when milestones are reached (and at least semi-annually). - The table in the source lists the teams’ separate and joint work programs in 2016–17. ### Bank Work Program: selected lending and TA (as presented) - IBRD Lending Program—projects and expected delivery dates: - Education Development Project II ($40 m) — Ongoing — Effectiveness 12/31/2017 - Greater Beirut Water Supply ($200 m) — Ongoing — Expected Delivery 06/30/2019 - Supporting Innovation in SMEs ($30 m) — Ongoing — Expected Delivery 06/30/2018 - RACE Support Project ($100 m IDA + $4 m Grant) — Pending — Expected Delivery 02/28/2023 - Grants/Trust Funds: - Second Emergency Social Protection Imp. Support 2 ($6.6m – Special Funding) — Ongoing — Expected Delivery 12/31/2016 - Emergency National Poverty Targeting Project ($8.2 m / Lebanon Trust Fund/LTF + $10 m /Lebanon Syrian Crisis Trust Fund/LSCTF) — Ongoing — Expected Delivery 12/31/2017 - Emergency Education System Stabilization ($32 m – LSCTF) — Ongoing — Expected Delivery 11/30/2018 - Emergency Primary Healthcare Restoration ($15 m – LSCTF) — Ongoing — Expected Delivery 12/30/2018 - Technical Assistance / Economic & Sector Work (selected items and expected delivery dates): - Lebanon Capital Markets Regulation & Development — Ongoing — 03/31/2017 - MSME TA - Lebanon MSME TA Facility — Ongoing — 03/31/2017 - Hydropower development in Lebanon — Ongoing — 05/31/2017 - Financial Sector Assessment Program (FSAP) Update — Ongoing — 11/30/2016 - Financial Sector Assessment Program (FSAP) follow up — Ongoing — 06/30/2017 - PPP Diagnostic and SEZ Advisory Technical Assistance — Ongoing — 08/25/2017 - Subsidized Temporary Employment Program — Ongoing — 06/17/2019 ### Fund Work Program: selected items (2016–2017) - Article IV Consultation Staff Report 2016 — 2016 - Technical Assistance on: - Public Accounting - Public Financial Management Reform - Budget System Law - Statistics (National Accounts, CPI, IIP) - Further enhance the supervisory framework and implement Risk Based Supervision - Build the capacity of the BCCL supervisors to efficiently supervise and assess banking risks - Oil and Gas Taxation and Revenue Administration - VAT Gap Analysis - Timing/status: - Items marked Ongoing with expected completion year entries: 2017 for most TA items; some items listed as Completed in 2016. - FSAP Update — Completed ### Joint Work Program - FSAP — Completed ### Key statistics and program dates (selected as presented) - Country Partnership Framework period: 2017-20 - Bank project effectiveness/delivery dates listed: 12/31/2017; 06/30/2019; 06/30/2018; 02/28/2023; 12/31/2016; 12/31/2017; 11/30/2018; 12/30/2018. - Technical assistance target dates: 03/31/2017; 05/31/2017; 11/30/2016; 06/30/2017; 08/25/2017; 06/17/2019. --- ### STATISTICAL ISSUES (Appendix as of November 2016) ### I. Assessment of data adequacy for surveillance — principal findings - General - Data provision has serious shortcomings that significantly hamper surveillance, particularly in national accounts and external sector statistics. - Lack of timely, comprehensive and reliable national accounts data and social and labor market indicators undermine accountability and economic analysis. - Fiscal reporting is lagging and irregular treasury inflows and outflows undermine data compilation. - National accounts - National accounts data are weak. Only annual data are compiled and disseminated at this time. - Data are available through 2013, with significant delays in the publication of 2014 national accounts. - Plans to start publishing quarterly data exist; priority should be to improve annual estimates before developing quarterly ones. - Responsibility for producing national accounts statistics was transferred to the Central Administration of Statistics (CAS) in 2012 for the publication of 2011 accounts. - Data sources are limited, mainly administrative data. - Access to comprehensive business financial records maintained by the Ministry of Finance would greatly improve annual national accounts estimates and support quarterly data release. - Improvement expected with ongoing efforts at the ministry to promote electronic tax declarations and e-service portals. - Price statistics - A new Consumer Price Index (CPI) was released in March 2014 by the CAS with Fund assistance. - Improvements: dissemination of more detailed national level index data; publication of regional indexes; monthly collection of rent prices; improved index calculation methods. - The CPI covers all areas in Lebanon and is disseminated within three weeks after the end of the reference month. - The January 2016 CPI was adversely impacted after the prime minister’s office refused to approve the contractual data collectors; CAS relied only on permanent data collection staff, raising costs. - Immediate need: develop regular and timely statistics on producer prices. - Medium- to long-term needs: data on labor markets, wages and real estate prices. - Government finance statistics (GFS) - Significant delays continue in release of fiscal data. - Coverage of government finance statistics is not comprehensive. - Published monthly central government budgetary accounts exclude certain transfers, financing data, foreign-financed capital expenditure, and arrears; they include dues that should be transferred to third parties (Telecom revenue due to municipalities). - Some (treasury) spending is only identified ex post and presented in an economic classification with a lag; these items are provided to the Lebanon team for surveillance. - Government finance statistics are on a modified cash basis for revenue (transfers from the Telecom) and budgetary expenditure data (issuance of payment orders). - GFS data for budgetary central government based on 2001 GFS Manual are published in the GFS Yearbook; these data cover only transactions and no balance sheet data are reported. - In 2016, data was reported based on GFS 2014. - Monetary and financial statistics - Sectorization of institutional units and classification of financial instruments in data reported to STA fall short of what is needed for Standardized Report Forms. - Reflecting in part domestic legislation restrictions, the Banque du Liban (BdL) does not publish externally-audited financial statements, and its reporting practices are not fully compliant with International Financial Reporting Standards (IFRS). - Lack of a reliable classification of deposits by residency (also due to bank secrecy) complicates balance of payments analysis. - Financial sector surveillance - Lebanon is a regular reporter of Financial Soundness Indicators (FSIs). - All core and eight encouraged FSIs are reported quarterly, except two indicators on capital adequacy that are reported semi-annually. - Compilation of FSIs for other sectors (other financial corporations, non-financial corporations, households, real estate markets) is needed to expand the list of FSIs for macro prudential analysis. - Balance of payments - Efforts to improve BoP statistics include better compliance in surveys, but significant challenges remain. - Data issues in the current account (unrecorded exports and imports, uncertainty in private sector services, workers’ remittances, and investment income), the capital account (grants), and the financial account (FDI, equity investment in the nonbank private sector, and corporate borrowing abroad). - Data are subject to frequent and very large revisions that hamper accurate assessment of Lebanon’s external sector position. - An FDI survey is currently in progress. - An IIP statement was compiled with technical assistance though not yet ready for publication. - Forms and reporting requirements for banks and non-banks were amended in January 2010 and May 2013 to include more comprehensive BoP breakdowns. - Lack of effective inter-agency cooperation and data sharing among BdL, CAS, customs and the ministry of finance impede progress; an increase in lack of cooperation and coordination on data sharing is noted. ### II. Data standards and quality - Lebanon joined the General Data Dissemination System in January 2003. - Metadata and plans for improvement need to be updated. - No Report on the Observance of Standards and Codes (ROSC) for data dissemination is available for Lebanon. ### III. Reporting to STA - Lebanon currently reports annual data based on GFSM 2001 to be published in the Government Finance Statistics Yearbook (GFSY), but the data suffer from weaknesses, mainly limited coverage. - CAS does not currently report any data to STA. - Lebanon reports monetary statistics on a regular monthly basis, covering the Central Bank and commercial banks only. - The monetary data are reported with a timeliness of approximately three months. - In September 2011, the BdL started regular submission of core Financial Soundness Indicators data and metadata; data for 2015 were posted on the IMF website. ### Table of Common Indicators Required for Surveillance (selected entries) - Exchange Rates — Date of Latest Observation 11/3/16 — Date Received 11/3/16 — Frequency D — Frequency of Reporting D — Frequency of Publication D - International Reserve Assets and Reserve Liabilities of the Monetary Authorities — Date of Latest Observation 9/30/16 — Date Received 11/1/16 — Frequency M — Frequency of Reporting M — Frequency of Publication M - Reserve/Base Money — Date of Latest Observation 9/30/16 — Date Received 11/1/16 — Frequency M — Frequency of Reporting M — Frequency of Publication M - Broad Money — Date of Latest Observation 9/30/16 — Date Received 11/1/16 — Frequency W/M — Frequency of Reporting W/M — Frequency of Publication M - Central Bank Balance Sheet — Date of Latest Observation 9/30/16 — Date Received 11/1/16 — Frequency M — Frequency of Reporting M — Frequency of Publication M - Consolidated Balance Sheet of the Banking System — Date of Latest Observation 9/30/16 — Date Received 11/1/16 — Frequency M — Frequency of Reporting M — Frequency of Publication M - Interest Rates — Date of Latest Observation 10/28/16 — Date Received 10/31/16 — Frequency W/M — Frequency of Reporting W/M — Frequency of Publication W/M - Consumer Price Index — Date of Latest Observation 9/30/16 — Date Received 10/21/16 — Frequency M — Frequency of Reporting M — Frequency of Publication M - Revenue, Expenditure, Balance and Composition of Financing – Central Government — Date of Latest Observation 6/30/16 — Date Received 31/10/16 — Frequency M — Frequency of Reporting M — Frequency of Publication M - Stocks of Central Government and Central Government-Guaranteed Debt — Date of Latest Observation 9/30/2016 — Date Received 11/2/2016 — Frequency M — Frequency of Reporting M — Frequency of Publication M - External Current Account Balance — Date of Latest Observation 3/31/16 — Date Received 10/6/2016 — Frequency Q — Frequency of Reporting Q — Frequency of Publication Q - GDP/GNP — Date of Latest Observation 12/31/13 — Date Received 12/11/14 — Frequency A — Frequency of Reporting A — Frequency of Publication A - Gross External Debt — Date of Latest Observation 9/30/2016 — Date Received 11/2/2016 — Frequency M — Frequency of Reporting M — Frequency of Publication M - International Investment Position — N/A entries for Date of Latest Observation, Date Received, Frequency of Data, Frequency of Reporting, Frequency of Publication --- ### Statement by Hazem Beblawi and Sami Geadah (December 12, 2016) ### Context and macroeconomic performance - Lebanon faces major challenges from the Syrian crisis: - Massive influx of refugees now estimated at about one third of the population. - Disrupted trade routes, exacerbated domestic political frictions, and absence of a president for 2½ years. - These developments undermined consumer and business confidence and led to significant declines in trade, tourism, and construction. - Despite challenges, the economy performed remarkably well; macroeconomic stability maintained through responsible economic and financial policies and by preventing deterioration in security conditions. - World Bank estimate: the Syrian crisis lowered Lebanon’s annual GDP growth by an average of 2.9 percentage points. - Growth remained positive and is estimated in the range of 1-2 percent in 2016. The World Bank’s latest estimate for growth is 1.5-2 percent in 2016. - Additional indicators available since the staff report: - Inflation was 1.1 percent in the year ending in October 2016. - Deposit inflows increased by 6 percent in the year ending in September 2016, and remain more than sufficient to fund the economy. - Real estate prices have been resilient. - The stock market rose sharply following the presidential election; S&P revised Lebanon’s outlook from negative to stable in September 2016. - Authorities agree on the need for fiscal consolidation, the importance of maintaining financial stability, and the necessity of structural reforms. ### Fiscal and monetary policy observations - Public debt to GDP ratio: - After lowering the ratio by over 50 percentage points from a peak of 185 percent in 2006, the ratio started to increase again. - Main contributor to turnaround: slowdown in growth associated with the Syrian crisis. - World Bank estimate of crisis fiscal impact: 1¾ of GDP per annum over 2012-2014 (this estimate may have increased since then). - Authorities stress the need for additional international assistance, including direct budget support. - Political improvements (election of a president, forthcoming formation of a government) expected to facilitate adoption of fiscal reforms. - Ministry of Finance practices: - Lack of parliamentary approval of the budget has not undermined fiscal discipline. - Ministry issues spending limits to line ministries that cannot be exceeded; budgets must be approved by the Cabinet. - Additional spending initiatives must be matched by new revenue measures; this process helped the government achieve fiscal primary surpluses. - Central bank role: - With fiscal maneuver constrained, the central bank has played an important role maintaining macroeconomic and financial stability and supporting growth. - In late 2016 it used nonconventional policies in a financial operation that bolstered foreign exchange reserves, strengthened bank capital, lowered the government’s borrowing cost, and provided liquidity for domestic lending. ### Financial system and FSAP response - Lebanon has maintained financial stability through multiple extreme events and had only one financial crisis in modern history (1966). - Authorities requested an FSAP during a very challenging period; FSAP findings confirmed resilience of the financial system and effective supervision. - Authorities welcomed staff recommendations to further strengthen the system but were surprised by the suggestion to remove bank secrecy: - Staff recognized bank secrecy has not impeded supervision nor prevented lifting secrecy on AML/CFT grounds. - The central bank and the Special Investigative Commission have been agile in dealing with suspicious accounts, complied with TF related targeted financial sanctions, and required banks to close accounts with suspicious activities. - Lebanon was assessed as fully compliant with AML/CFT rules in the latest assessment by the Financial Action Task Force (FATF) and MENA FATF. - Authorities emphasize the importance of integrity and confidence in the banking system. *Source: cr1719 - 3. The teams agreed to the following division of labor (PDF chapter/section).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1719.pdf_