## _cr07382

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### Executive summary — background and recent developments
- Economy slowly recovering from the 2006 conflict; political stalemate and repeated security incidents weighing negatively on activity.
- Donor pledges and conflict financing:
  - Donors pledged $1.7 billion for relief and recovery (mostly at the Stockholm conference in August 2006).
  - 2006 disbursements roughly offset immediate fiscal costs of the conflict.
- Key 2006 outcomes:
  - Real GDP estimated flat in 2006.
  - Inflation accelerated in July–August 2006; receded by mid-2007.
  - Government debt rose to over $40 billion (178 percent of GDP) at end-2006.
- First quarter 2007:
  - GDP recovered to early-2006 level; gross international reserves fell by $300 million to $11 billion at end-March (excluding gold valuation changes).
  - Bank deposits grew at an average (annualized) rate of 9 percent between October 2006 and May 2007.
  - Deposit dollarization at 76 percent.
  - Lebanese Eurobond and CDS spreads about 200 basis points above pre-2006-conflict levels and volatile.

### Outlook and Paris III reform strategy
- Paris III five-year reform program aims to reduce debt overhang and financial vulnerabilities; central focus on fiscal adjustment and privatization.
- Staff Paris III scenario (full implementation beginning in 2008) projects:
  - Government debt reduced by almost 50 percentage points to below 130 percent of GDP by 2012 (authorities’ target).
  - Contributions to debt reduction (percentage points): Fiscal adjustment: 7; Privatization: 31; Projected Paris III donors assistance: 6; Transfer of unrealized gold valuation gains from BdL to the budget: 7.
  - Associated improvement in confidence assumed to raise growth to 4–5 percent a year and narrow interest rate spreads.
- Risks to strategy:
  - Political risk that reforms cannot be initiated or will be reversed.
  - Macroeconomic risks: shortfalls in growth or higher than projected real interest rates.
  - Uncertainties over reform yields and unquantified contingent liabilities.

### Debt Sustainability Analysis (Box 2) — scenarios and key figures
- DSA conclusion: under a number of shocks the debt-to-GDP ratio would revert to an unsustainable path.
- Scenarios analyzed (Panels 1–6):
  - Panel 1: Baseline — full implementation of Paris III.
  - Panel 2: Permanent increase in the real interest rate by 170 basis points (one-half standard deviation).
  - Panel 3: Growth shock — average GDP growth drops from 4 percent (baseline) to 3 percent (historical 2002–06 average).
  - Panel 4: Primary balance shock — halving of fiscal reform yield; average primary surplus just over 1 percent of GDP in 2007–12 versus over 4 percent in baseline; long-run primary surplus converges to 1 percent vs 3 percent in baseline.
  - Panel 5: No sustained reforms — no privatization and only partial fiscal adjustment; primary surplus reaches 3 percent by 2012; growth 3 percent p.a.; interest rate spreads widen by 220 basis points.
  - Panel 6: No privatization — converges to same long-run debt-ratio as baseline absent dynamic growth/interest impacts.
- Key scenario statistics (as presented):
  - Baseline debt ratio marker: 93.
  - Panel 4 (Primary Balance Shock) (In percent of GDP): Baseline:4.9; Shock:6.7; Historical:8.6.
  - Panel 3 (Growth Shock) (In percent per year): Baseline:4.0; Shock:3.2; Historical:2.8.
- Notes on assumptions:
  - Growth shock based on average 2002–06 values; interest rate shock is permanent one-half standard deviation shock.
  - From 2012, primary fiscal surplus reverts slowly to 3 percent of GDP (baseline).
  - In an adverse scenario, planned reform yields are only half through 2012 and primary surplus declines to 1 percent thereafter.

### Fiscal performance and 2007–08 fiscal policy
- 2007 objectives:
  - Contain the budget deficit and maintain financial stability while preparing for major 2008 fiscal adjustment and structural reforms.
- 2007 performance and financing:
  - Authorities expected to contain the primary fiscal deficit (excluding grants) to 3.7 percent of GDP in 2007.
  - Gasoline excise revenues fell near zero in May; projected shortfall of around ½ percent of GDP for the year if no corrective action.
  - Planned floor on excises of $0.20 per liter by September 2007 expected to yield ½ percent of GDP during remainder of 2007 if implemented.
  - Authorities expected disbursements of grants and loans could amount to $1.9 billion in 2007 (authorities’ view).
  - Government borrowing from BdL in Q1: LL 106 billion ($70 million) above the LL 903 billion ($602 million) flow envisaged for the first quarter.
- Fiscal and structural measures planned for 2008:
  - Increase VAT and tax on interest income as of 2008; preparations for Global Income Tax (GIT) in 2008 with draft law to parliament in 2007.
  - Revenue administration reforms: medium taxpayer office, new audit procedures, property valuation changes.
  - Expenditure reforms: finalize plans for EdL and NSSF; across-the-board cut in discretionary spending of five percent in 2008 targeted.
  - Establish a debt management office; roll back carry-over of committed spending beginning 2008.

### Energy sector (Box 5) — problems, reforms, fiscal impact
- EdL budget transfers net of debt service: $750 million (3.3 percent of GDP) in 2006.
- Sector problems: weak management and governance, inadequate infrastructure, high technical losses (15 percent) and non-technical losses (18 percent), reliance on oil vs less expensive gas.
- Average tariff: 9.4 cents/kWh achieves cost recovery at fuel price of $25/barrel.
- Reform measures under finalization with World Bank cooperation:
  - Corporatization of EdL, new board and advisors, audited accounts, installation of remote meters.
  - Promote private sector involvement; tendering for independent power producers envisaged early 2008.
  - Switch to natural gas in at least one power plant in Q2 2008; unbundle and partially privatize sector toward end of reform period with regulator set up in parallel.
- Staff scenario: net transfers to EdL (excluding debt service but including investment costs) decline to 1.3 percent of GDP by 2012 from 3.3 percent in 2006.

### Banking sector — vulnerabilities, policy, and consolidation
- Banking sector balance sheet: $77 billion (320 percent of GDP).
- Exposure to sovereign (government and central bank) around 50 percent of assets.
- Maturity mismatch from sourcing government paper from short-term deposits; high dollarization increases credit risk.
- Banking indicators (selected):
  - Banking sector assets (millions USD): 2006 79,948; 2007 79,140.
  - Capital adequacy ratio: 2006 24.7.
  - Net problem loans/net total loans: 2006 6.9; 2007 6.8.
  - FC deposits/total deposits (percent): 2006 75.7; 2007 75.5.
- BdL relief scheme for 2006 conflict: estimated total subsidy at most $180 million (disbursements could be lower due to eligibility).
- Consolidation:
  - BdL promotes mergers as preferred instrument to exit non-viable banks; staff recommends strengthening bank resolution mechanism to facilitate consolidation while minimizing moral hazard.
- Basel II:
  - Authorities expect commercial banks to strengthen risk management for Basel II introduction in 2008; increased risk weights on FX-denominated government and BdL debt instruments anticipated.

### Monetary policy, exchange rate peg, and BdL balance sheet
- Exchange rate peg viewed as key to financial stability given widespread dollarization and high foreign currency debt servicing obligations; staff and authorities agree exchange rate not misaligned (Box 3).
- Monetary instruments:
  - BdL occasionally used central bank CDs, special discount windows, swaps to manage liquidity.
  - Intention to introduce repos and reverse repos once financial situation improves; technical working group planned to enhance information sharing between Ministry of Finance and BdL for EPCA monitoring.
- BdL balance sheet:
  - Authorities view weakening of BdL’s balance sheet as not impairing monetary control; weakening largely from managing past crises and some quasi-fiscal activities.
  - Fiscal adjustment and improved confidence expected to reduce dollarization and strengthen BdL’s income and reserves.

### Statistical, institutional capacity, and data issues
- National accounts revision with INSEE; 2004 National Accounts released; quarterly GDP compilation underway.
- Significant deficiencies remain in balance of payments, prices, employment, wage and social indicators.
- Consumer price index preparations for national coverage well under way; CPI inflation decelerated to below 2 percent year-on-year in July (consistent with end-year projection of 2 percent or lower).
- Balance of payments weaknesses: unrecorded exports, underestimation of services and remittances, gaps in capital and financial accounts.
- Lebanon participates in GDDS; data dissemination and coverage require strengthening.

### Monitorable actions and program monitoring (March–December 2007 highlights)
- Fiscal measures and deadlines:
  - Submit draft 2007 budget law consistent with targeted primary balance — Target: End-June 2007. Status: Draft budget approved by cabinet on May 21.
  - Issue Cabinet decision setting gasoline excise floor of LL 300 per liter — Target: End-September 2007.
  - Appoint auditor for NSSF accounts and prepare audit plan for 2001–06 — Target: End-June 2007.
- Power sector:
  - Appoint auditor for EdL accounts and prepare audit plan for 2002–06; publish 2001 audit report — Target: End-June 2007.
- Privatization:
  - Submit to parliament draft law to authorize sale of mobile sector assets and licenses — Target: End-June 2007.
  - Issue invitation for expression of interest for MIC1 and MIC2 licenses/assets — Target: End-December 2007.

### Selected macroeconomic projections and key numeric indicators (selected exact values preserved)
- Real GDP (market price): 2006 Act. 0.0; 2007 Prel. 2.0; 2008 Proj. 3.5; 2009 Proj. 4.5; 2010 Proj. 5.0; 2011 Proj. 5.0; 2012 Proj. 5.0.
- Consumer prices (end-of-period): 2006 Act. 7.2; 2007 Prel. 2.0; 2008 Proj. 3.0.
- Current account including official transfers (percent of GDP): 2006 -6.2; 2007 -10.6; 2008 -9.4; 2012 -5.5.
- Total government debt (percent of GDP): 2006 178; 2007 173; 2008 143; 2012 127.
- Gross international reserves (excluding gold, end-year): 2006 11,353; 2007 11,121; 2008 12,347 (millions of U.S. dollars).
- Banking sector balance sheet: $77 billion (320 percent of GDP).
- Projected foreign currency debt service payments in 2008: over $4 billion, of which $3.6 billion for Eurobond debt service.
- Paris III pledges and disbursement status:
  - Total pledged at Paris III: US$7.6 billion.
  - Agreements signed: about US$3.4 billion.
  - Of US$1.6 billion in budgetary support pledged for 2007, only US$0.6–0.9 billion likely to be received in 2007.
  - US$175 million has been disbursed to date; a US$100 million World Bank Development Policy Loan is in process of disbursement.

### Staff appraisal — priorities and policy recommendations (concise)
- Maintain strict expenditure discipline in 2007 to create a fiscal buffer; promptly raise gasoline prices or introduce excise floor to safeguard revenues.
- Full implementation in 2008 of major fiscal and structural reforms (privatization, EdL and NSSF reforms, GIT) critical to establish credibility and safeguard external stability.
- Limit new borrowing from BdL to short-term bridge financing; reduce BdL financing gradually to safeguard reserves and BdL balance sheet.
- Strengthen public financial management: implement action plan with Fund technical assistance (cash and budget management), establish debt management office, avoid across-the-board cuts where possible.
- Strengthen bank resolution framework to facilitate consolidation while minimizing moral hazard; enhance supervision for cross-border expansion and implement Basel Core Principles.
- Maintain exchange rate peg supported by fiscal adjustment, greater interest rate flexibility, and strengthened BdL balance sheet; introduce market-based short-term monetary instruments when conditions permit.
- Accelerate statistical improvements and high-level commitment to close data gaps in national accounts, prices, and balance of payments.

*Source: IMF staff report excerpts and related annexes (cr07382).*

### Executive Summary ......................................................................................................

### Executive Summary

### Background and recent developments
- The economy is slowly recovering from the 2006 conflict with Israel; a political stalemate continues to paralyze legislative activity and, combined with repeated security incidents, is weighing negatively on economic activity.
- Money demand has remained robust. In support of the government’s 2007 program, the Executive Board approved EPCA in April 2007.
- Conflict-related and immediate post-conflict financing:
  - Donors pledged $1.7 billion for relief and recovery (mostly at the Stockholm conference in August 2006).
  - Disbursements in 2006 roughly offset the immediate fiscal costs of the conflict.
- Key 2006 outcomes:
  - Real GDP is estimated to have been flat in 2006, with strong growth in the first half offset by disruptions created by the conflict.
  - Inflation accelerated in July–August 2006, largely reflecting supply shortages during the conflict and the ensuing blockade.
  - Financial pressures were managed effectively owing to the banking system’s strong liquidity position.
  - The overall fiscal deficit increased in 2006 because of rising interest expenditures and higher than expected transfers to Electricité du Liban (EdL).
  - Government debt rose to over $40 billion (178 percent of GDP) at end-2006.
- Text Table 1: Lebanon: Economic Impact of the July–August 2006 Conflict, 2006–09 (In billions of U.S. dollars)
  - Damage 2006 Act. 2.0
  - Of which: to housing 1.1
  - Budgetary impact 2006 Act. 0.7; 2007 Proj. 0.9; 2008 Proj. 0.4; Cumulative ...2.0
  - Estimated conflict-related revenue loss 2006 Act. 0.5
  - Conflict-related spending 2006 Act. 0.2; 2007 Proj. 0.9; 2008 Proj. 0.4; Cumulative ...1.5
  - Grant disbursements (including Stockholm conference) 2006 Act. 0.7; 2007 Proj. 0.6; 2008 Proj. 0.2; Cumulative ...1.4
  - Sources: Lebanese authorities; and Fund staff estimates. 1/ May not add up due to rounding. 2/ Excluding support pledged at the Paris III conference.
- First quarter 2007 developments:
  - Indicators suggest GDP had recovered, faster than expected, to the level of early 2006.
  - Inflation has receded as supply-shortage effects fade, notwithstanding the depreciation of the U.S. dollar to which the currency is pegged.
  - Strong year-on-year import growth widened the trade deficit in Q1 2007.
  - Gross international reserves fell by $300 million, to $11 billion at end-March (excluding gold valuation changes).
- Political and security situation:
  - Political tensions between government and opposition remain high and could lead to a constitutional crisis by the presidential election later in the year.
  - On June 10, the United Nations established a tribunal to investigate the assassination of former Prime Minister Hariri.
  - Security incidents include fighting in northern Lebanon and bomb explosions in and around Beirut.
- Financial markets and banking indicators:
  - Bank deposits grew at an average (annualized) rate of 9 percent between October 2006 and May 2007.
  - Lebanese Eurobond and Credit Default Swap spreads remain some 200 basis points above pre-2006-conflict levels and have been volatile.
  - Deposit dollarization is currently at 76 percent.
  - The stock market index has remained broadly constant since end-2006 on very low trading.

### Outlook and policy discussions
- The government’s five-year reform program (Paris III) aims to reduce Lebanon’s large debt overhang and financial vulnerabilities; the strategy faces risks from domestic and regional tensions, macroeconomic shocks, contingent fiscal liabilities, and difficulty mobilizing political support.
- The authorities’ fiscal strategy is complemented by structural reforms to promote private sector growth (privatization is central) and social sector reforms.
- Objectives for 2007:
  - Contain the budget deficit and maintain financial stability during a difficult transition year while preparing for sizeable fiscal adjustment and structural reforms in 2008.
  - Revenue, expenditure, and public financial management reforms have been identified; structural reforms in the power and social sectors are being finalized with the World Bank.
- Monetary and central bank implications:
  - Successful fiscal adjustment would provide an opportunity to strengthen the central bank’s balance sheet and reform the monetary policy framework by relying on short-term monetary instruments.
- Banking sector:
  - Banks face balance sheet risks from dollarization and exposure to the sovereign.
  - Banks are diversifying through regional expansion and increased retail lending.
  - The sector appears well prepared for the introduction of Basel II in 2008.
- Paris III scenario and debt dynamics:
  - Staff scenario incorporates full implementation of the Paris III reform program with fiscal adjustment and privatization beginning in 2008.
  - Government debt would be reduced by almost 50 percentage points to below 130 percent of GDP by 2012, in line with authorities’ targets.
  - Contributions to the debt reduction (percentage points):
    - Fiscal adjustment: 7 percentage points
    - Privatization: 31 percentage points
    - Projected Paris III donors assistance: 6 percentage points
    - Transfer of unrealized gold valuation gains from the Banque du Liban (BdL) to the budget: 7 percentage points
  - The associated improvement in confidence is assumed to result in a pick-up of growth to 4–5 percent a year and a narrowing of interest rate spreads.
  - The authorities considered the macroeconomic scenario realistic but believed they will obtain a higher fiscal yield from their reforms.
- Risks to the Paris III strategy:
  - Political risk that reforms cannot be initiated or would be reversed.
  - Macroeconomic risks: shortfalls in growth or higher than projected real interest rates.
  - Uncertainties over reform yields and unquantified contingent liabilities.
  - Debt sustainability concerns are illustrated in the debt sustainability analysis (Box 2).

### Staff appraisal and policy recommendations
- First-quarter performance:
  - Performance in the first quarter was consistent with the 2007 program objectives, but the uncertain economic and financial outlook requires monitoring.
- Fiscal stance and revenue protection:
  - Authorities rightly intend to create a fiscal buffer through tight expenditure control.
  - Early introduction of a floor on gasoline excises would help safeguard revenues.
- Importance of 2008 measures:
  - Full implementation of major reforms and adjustment measures planned for 2008 will be important to establish the credibility of the strategy and safeguard external stability over the medium term.
- Exchange rate and financial stability:
  - The exchange rate peg remains key to financial stability and needs to be supported by the authorities’ planned fiscal adjustment, greater interest rate flexibility, and a strengthening of the central bank’s balance sheet.

*Source: IMF staff Executive Summary (cr07382).*

### Box 2. Debt Sustainability Analysis

### Box 2. Debt Sustainability Analysis

### Overview
- The debt sustainability analysis (DSA) indicates that under a number of shocks the debt-to-GDP ratio would revert to an unsustainable path.
- The DSA presents the impact of six shocks on the baseline debt trajectory and the implications of using historical values for the interest rate, growth rate, and the primary balance.

### Scenarios analyzed (Panels 1–6)
- Panel 1: The baseline scenario—full implementation of the Paris III agenda.
- Panel 2: A permanent increase in the real interest rate by 170 basis points (i.e., one-half standard deviation from its past distribution) relative to the baseline.
- Panel 3: A drop in average GDP growth from 4 percent in the baseline to 3 percent, i.e., the average rate for 2002–06.
- Panel 4: A shortfall in the yield from fiscal reforms (halving of the yield of the fiscal reform package). This reduces the average primary surplus to just over 1 percent of GDP in 2007–12, compared with over 4 percent of GDP in the baseline, and implies that the primary surplus converges to 1 percent of GDP in the long-run, compared with 3 percent of GDP in the baseline.
- Panel 5: Absent sustained reforms, no privatization and only partial fiscal adjustment (the primary surplus reaches only 3 percent by 2012); growth remains sluggish at 3 percent per annum, while interest rate spreads widen by 220 basis points relative to the baseline.
- Panel 6: No privatization—since privatization essentially brings forward the income stream from the privatized companies, the scenarios with and without privatization converge to the same debt-ratio in the long-run. This scenario abstracts from the negative impact that abandoning privatization plans would have on growth and possibly interest rates relative to the Paris III scenario.

### Key scenario statistics (as presented)
- Baseline debt ratio marker in figures: 93 (public debt in percent of GDP shown as "Baseline 93").
- Panel 4 (Primary Balance Shock) figures (In percent of GDP):
  - Baseline:4.9
  - Shock:6.7
  - Historical:8.6
- Panel 3 (Growth Shock) figures (In percent per year):
  - Baseline:4.0
  - Shock:3.2
  - Historical:2.8
- Panel 2 (Real Interest Rate Shock) depiction: interest rate shock is a permanent one-half standard deviation shock.
- Notes on scenario assumptions:
  - 1/ Growth shock based on average 2002–06 values. Interest rate shock is permanent one-half standard deviation shock. Figures in the boxes represent average projections for the respective variables in the baseline scenario and shock scenario; historical refers to 10-year averages.
  - From 2012, the primary fiscal surplus reverts slowly to a long-term level of 3 percent of GDP.
  - 2/ Through 2012, the planned revenue and expenditures reforms generate half of their estimated yield in the scenario; after 2012, the primary surplus slowly declines to 1 percent of GDP.
  - 3/ Lack of consensus on reform prevents privatization and allows only partial fiscal adjustment.
  - 4/ No privatization in the projected period. Assumes no adverse dynamic impact of no privatization.

### Authorities’ views, program pillars, and institutional measures
- Political economy and public support:
  - Broad domestic support needed to achieve and sustain targeted fiscal adjustment; tranched donor support conditional on reform implementation viewed as an effective incentive.
  - Growth and social pillars of Paris III intended to build public support by compensating for difficulties of fiscal adjustment.
- Growth pillar:
  - Centered on privatization, improvements in the business climate, and opening of markets.
  - Privatization of the telecom sector described as the lynchpin of the growth strategy; additional public sector enterprises slated for privatization.
  - Establishing a competitiveness council (private sector and government representatives) to identify legal and administrative impediments to growth.
  - Steps to streamline business licensing and lower cost of doing business.
  - Accession to the World Trade Organization—envisaged for 2008; authorities expected to have all relevant legislative changes ready for parliament by the end of 2007.
- Social pillar:
  - Main elements: improve service delivery in health and education and strengthen social safety nets.
  - Measures include redirecting existing social spending, improving public services, and creating public social safety nets (including a cash transfer system).
- Reform yield uncertainty and upside potential:
  - Authorities less concerned about uncertainties over yield of reforms; cited ongoing revision of the reform plan for EdL expected to lower reform costs while yielding same budget transfer reduction.
  - Expected tax administration reforms to increase tax buoyancy relative to staff’s revenue projections.
  - Acknowledged risk of added spending pressures from the security situation.
- Pensions and health system reforms:
  - Reforms being developed to address imbalances and contingent liabilities in pension and health systems.
  - No immediate pressures seen in the public pension system; ongoing assessments and planned reforms.
  - Private pension reform in parliament: transformation from an end-of-service allowance to a fully funded pension system; transition costs may be borne by the state, extent dependent on audits of NSSF accounts and finalized contribution and replacement rates.
  - Plan to introduce professional asset management to raise private pension system returns.
  - Health fund losses of the NSSF noted; discussions with the World Bank on options to address structural problems in contribution rates and coverage.
- Institutional reforms to sustain adjustment:
  - Steps to develop a medium-term budget framework and move toward program budgeting.
  - Considering adoption of a fiscal responsibility law to provide a self-reinforcing mechanism of fiscal adjustment and debt reduction.

### Monetary and exchange rate policy positions
- Monetary policy framework:
  - Authorities consider framework enabled effective dealing with financial pressures; interest rate stability in T-bill rates played a key role in maintaining confidence.
  - BdL occasionally relied on alternative instruments (central bank CDs, special discount windows, swaps) to manage liquidity and safeguard international reserves.
  - BdL’s mandate viewed as maintaining financial stability, including providing temporary financing to the government in shortfalls; prolonged shortfalls would require raising T-bill rates.
- Market-based instruments:
  - Intention to introduce new short-term instruments (repos and reverse repos) once financial situation improves; prerequisites include resolution of political/security situation and an improved fiscal environment.
  - Plan to establish a technical working group to enhance information sharing between the ministry of finance and the BdL in the context of EPCA monitoring.
- Exchange rate peg:
  - Authorities regard the exchange rate peg as key to financial stability given widespread dollarization and high government foreign currency debt servicing obligations.
  - Agreed with staff analysis (Box 3) that the exchange rate is not misaligned; fiscal adjustment expected to help improve the current account.
- BdL balance sheet and dollarization:
  - Authorities confident that weakening of BdL’s balance sheet has not impaired monetary control; weakening largely from managing past crises and some quasi-fiscal activities.
  - Expected fiscal adjustment and improved confidence to reduce dollarization, facilitate build-up of net international reserves, and strengthen BdL’s income position.

### Box 3 — Real Exchange Rate assessment (summary)
- Traditional indicators do not suggest an external competitiveness problem for Lebanon.
- REER and exchange-rate movements:
  - The real effective exchange rate (REER) has depreciated 20 percent relative to its 2000–02 average, largely reflecting the weakening of the U.S. dollar.
  - The bilateral real exchange rate vis-à-vis the U.S. dollar has remained broadly stable over the past decade.
- Exports performance:
  - Merchandise exports grew at an average rate of 5 percent a year in volume terms in 2004–05 (staff estimate based on Lebanese customs data).
  - Exports maintained positive momentum in 2006 (2 percent) and into 2007 despite conflict-related disruptions.
  - Market shares vis-à-vis all trading partners were stable in 2005–06.
  - Exports of services (primarily tourism) suffered in 2005–07 but retain strong growth potential.
- CGER methodologies applied do not suggest the REER is misaligned:
  - Equilibrium REER approach: REER could be modestly undervalued relative to estimated equilibrium but within margins of error.
  - External sustainability approach: Depending on NEAP choice, REER is either slightly undervalued or slightly overvalued, within typical margin of error.
  - Macroeconomic balance approach: A current account norm of –5 to –6 percent of GDP is derived. With full implementation of Paris III, projected current account deficit for 2012 would narrow to –5½ percent of GDP. If fiscal adjustment is not achieved, the projected current account deficit under current policies would exceed the norm, potentially leading to external instability. Historical scenarios of the DSA show an unsustainable debt path if the program is not implemented and key macro variables remain at their decade-average levels.

### Banking sector vulnerabilities and relief measures
- BdL relief scheme for 2006 conflict:
  - BdL would provide loans to banks at below-market interest rates; banks would re-invest in fresh T-bills and use the interest differential to provide a 60 percent subsidy toward reconstruction of productive facilities destroyed during the conflict.
  - Authorities estimated the total subsidy under the scheme would be at most $180 million, although disbursements could be significantly lower owing to strict eligibility requirements.
- Banking sector characteristics and vulnerabilities:
  - Banking sector balance sheet: $77 billion (320 percent of GDP).
  - Exposure to the sovereign (government and central bank) around 50 percent of assets.
  - Substantial maturity mismatch from sourcing government paper from short-term deposits.
  - High degree of dollarization exposes banks to substantial credit risk.
  - Banking sector profitability increased in 2006 and early 2007, partly reflecting regulatory measures to ease provisioning rules after the conflict.
- Diversification and supervision:
  - Larger banks expanding rapidly in regional markets via subsidiaries and branches; 20 percent of assets of larger banks now in foreign operations with objective of generating half of profits abroad within three years.
  - Banking control commission raised limits on exposure to non-resident borrowers and is seeking memoranda of understanding on consolidated supervision with supervisory authorities in expansion countries.
- Basel II and risk management:
  - Authorities expect commercial banks to strengthen risk management in response to Basel II introduction in 2008.
  - Increased risk weight on foreign currency–denominated government and BdL debt instruments would force banks to internalize part of systemic risks.
  - Authorities decided not to reopen the repo window for Lebanese lira T-bills (closed during the conflict) to encourage better maturity management.

*Source: International Monetary Fund staff report excerpt (Box 2 and related text).*

### 23.      The authorities saw scope for consolidation of the banking sector over the

### The authorities saw scope for consolidation of the banking sector over the medium term

### Banking sector consolidation: findings and risks
- Smaller banks whose main source of income is lending to the government may lose ground to larger banks better positioned to adapt to Basel II and diversify asset structure.
- Promotion of mergers, including through financial incentives provided by the BdL, has been the main instrument to facilitate the exit of non-viable banks in the past.
- The BdL considers mergers the most suitable instrument in the Lebanese context because of concerns that outright bank failures would destabilize the system.
- Moral hazard risks associated with this instrument include depositor, shareholder, and management behavior.
- Staff recommendation: strengthen the bank resolution mechanism to facilitate consolidation when needed, while minimizing moral hazard and increasing banks’ management accountability and shareholder responsibility.
- As banks expand regionally and into new cross-border activities, deeper regulatory and supervisory reforms are needed, including implementation of the applicable Basel Core Principles.

### Macroeconomic outlook and risks for 2007 (policies for 2007 and 2008)
- Real GDP growth is projected at about 2 percent in 2007.
- Under the fixed exchange rate regime, CPI inflation should return to around 2 percent by year-end.
- Money growth is put at 5 percent for the year as a whole (capital and deposit inflows subject to high uncertainty).
- Current account deficit is expected to increase to 11 percent of GDP in 2007, largely financed by official inflows and foreign direct investment.
- Political tensions and outbreaks of violence are key obstacles to reform implementation and economic recovery and are expected to weigh negatively on economic activity.

### Fiscal performance, revenues, and financing
- Authorities expected to contain the primary fiscal deficit (excluding grants) to 3.7 percent of GDP in 2007 as programmed.
- First-quarter performance was within program targets, though the ceiling on government borrowing from the BdL was exceeded by a small margin.
- Gasoline excise revenues were reduced to near zero in May due to the widening gap between domestic and international oil prices; on current trends, gasoline excise revenues would fall short of program targets by around ½ percent of GDP for the year.
- Authorities planned to introduce a floor on excises of $0.20 per liter by September 2007, expected to yield ½ percent of GDP during the remainder of 2007 if implemented.
- Other revenues have been more buoyant than expected.
- Authorities confident they could meet financing needs through donor support and market access: disbursements of grants and loans could amount to $1.9 billion in 2007.
- Recent T-bill auctions and a Eurobond issue in May indicated commercial banks were returning to the market; authorities saw no immediate need to raise T-bill rates.
- Insufficient demand for government paper by commercial banks led to greater reliance on BdL financing in Q1: government borrowing from the BdL was LL 106 billion ($70 million) above the LL 903 billion ($602 million) flow envisaged for the first quarter.
- Authorities aimed to reduce net borrowing from the BdL and achieve the programmed build-up of international reserves over the rest of 2007.
- Negotiations with domestic banks on a possible Paris III contribution had not progressed; banks were reluctant to make commitments before reform implementation.

### Fiscal and structural measures planned for 2008
- Draft 2007 budget provides for increasing the value-added tax rate and the tax on interest income as of 2008.
- Preparations for introduction of a global income tax (GIT) in 2008 were advancing, with a view to submitting the draft law to parliament in 2007.
- Revenue administration reforms expected to yield gains: introduction of a medium taxpayer office, new audit procedures, and changes to the property valuation system.
- Expenditure-side reforms: finalizing reform plans for EdL and NSSF, and developing a reform plan for the health sector in cooperation with the World Bank.
- Authorities aiming for an across-the-board cut in discretionary spending of five percent in 2008 and a reduction of expenditure duplication across ministries.
- Planned establishment of a debt management office to reduce debt service costs and improve asset management (details to be worked out).
- Authorities plan to roll back carry-over of committed spending starting in the 2008 budget; revoke line ministries’ ability to carryover uncommitted expenditures beyond one month into the new budget year in the 2007 budget.
- 2008 budget circular introduces medium-term planning and top-down spending envelopes; pilot medium-term budgeting in four ministries and agencies.

### Energy sector (Box 5): problems, reform measures, and fiscal impact
- Electricity production comes at a high budgetary cost with poor service delivery.
- Budget transfers to EdL net of debt service amounted to $750 million (3.3 percent of GDP) in 2006.
- Sector problems: weak management, poor governance, inadequate infrastructure, reliance on oil instead of less expensive gas.
- Technical losses estimated at 15 percent of production; non-technical losses (essentially illegal connections) account for another 18 percent.
- Average tariff of 9.4 cents/kWh achieves cost recovery at a fuel price of $25/barrel.
- Reform measures under finalization with World Bank cooperation:
  - Corporatization of EdL, appointment of a new board and qualified advisors, auditing of accounts, installation of remote meters.
  - Promote private sector involvement and increase capacity through independent power producers; tendering envisaged for early 2008.
  - Switch to natural gas in at least one power plant in the second quarter of 2008; that plant might be privatized alongside entry of independent power producers.
  - National Control Center planned for 2008 to realize distribution efficiency gains.
  - Plan to unbundle and partially privatize the sector toward the end of the reform period, with a regulator set up in parallel.
- Tariff issues: tariff structure far from achieving cost recovery given high production costs and losses; tariff increases may be required but should follow service quality improvements to avoid higher non-payment and illegal connections.
- Lebanon’s tariff is already significantly higher than regional tariffs, disadvantaging Lebanese producers; inefficiencies in tariff structure (e.g., peak tariff for industry encourages self generation).
- Staff scenario: net transfers to EdL (excluding debt service, but including investment costs) would decline to 1.3 percent of GDP by 2012, from 3.3 percent of GDP in 2006.

### Statistical and institutional capacity
- Authorities revising national accounts with support from INSEE; 2004 National Accounts have just been released and compilation of quarterly GDP data is underway.
- Significant deficiencies remain in statistical provision for balance of payments, prices, employment, wage and social indicators.
- Lebanon is due to be assessed by the Middle East North Africa Financial Action Task Force in January 2008.

### Staff appraisal: key recommendations and priorities
- The authorities’ reform strategy lays out a promising path toward reducing Lebanon’s large debt overhang and financial vulnerabilities; medium-term fiscal adjustment objectives are appropriately ambitious.
- Move from planning to implementation is critical and would be facilitated by improvements in the political and security situation.
- Maintain strict expenditure discipline in 2007 to create a buffer; promptly raise gasoline prices in line with recent increases in international oil prices to safeguard gasoline excise revenues.
- Limit new borrowing from the BdL to short-term bridge financing to safeguard international reserves; increase interest rate flexibility.
- Ensure legislative and administrative work for GIT introduction in 2008 is completed before end-2007.
- Prioritize completion and swift implementation of structural reforms in the energy and social sectors; careful sequencing of infrastructural and governance initiatives in the energy sector is essential.
- Comprehensive public financial management reforms are necessary: follow up on the action plan developed with Fund technical assistance to improve cash and budget management functions; avoid across-the-board expenditure cuts where possible.
- Fiscal adjustment will facilitate reform of the monetary policy framework; once stable market conditions prevail, the BdL should guide interest rates through transparent short-term instruments and consider reopening the repo window and relying on the repo rate to influence banks’ behavior.
- Strengthen the BdL’s balance sheet: avoid financing operations that adversely impact the BdL’s income and balance sheet (e.g., transfer of unrealized gold valuation gains to the budget, subsidized lending to banks); consider privatization of assets held by the BdL to strengthen its financial position and contribute to the government’s growth agenda.
- Macroeconomic policies need to support the exchange rate peg; address fiscal imbalances (debt overhang and large external current account deficits) via the Paris III fiscal adjustment program.

*Source: IMF staff report excerpts provided in the supplied content unit.*

### 38.      The authorities’ program appropriately emphasizes private sector growth and

### 38.      The authorities’ program appropriately emphasizes private sector growth and

### Private sector growth, privatization, and business climate
- The authorities’ program "appropriately emphasizes private sector growth and improved delivery of social services."
- "Privatization of the telecom sector is a crucial element of the growth strategy" and should be accompanied by "endowing the regulatory authority with the powers and capacity to ensure proper competition in the sector."
- Staff "welcomes the authorities’ intention to widen the privatization agenda to other sectors, as well as ongoing efforts to improve the business climate."
- Recommendation: "The growth agenda should be complemented by actions to dismantle oligopolistic practices and eliminate barriers to entry and exit."

### Paris III pledges and donor disbursement
- "Timely and flexible disbursement of Paris III pledges is another important element for the success of the authorities’ strategy."
- Progress: "Progress has been made in locking in the terms and conditions for the release of funds from some key donors."
- Ongoing issue: "Negotiations are still underway with others."
- Staff position: "Staff fully supports the authorities’ request that donors make timely disbursements and convert their pledges from project to budget support, or at least align their project disbursements to the government’s own spending priorities."

### Risks to the reform strategy and mitigation
- Key risks identified:
  - "Shocks to the macroeconomic environment"
  - "Shortfalls in the privatization program"
  - "Contingent fiscal liabilities (from actuarial imbalances in the public and private pension systems, open-ended transfers to the health fund, and unforeseen costs from power sector reform)"
- Potential consequences: these risks can "throw the economy off course relative to the targeted debt reduction path, and to require corrective actions."
- Implementation risks: "Particularly in view of domestic and regional tensions and the need to maintain consensus around the reform program."
- Mitigating measures:
  - "The authorities’ emphasis on a multipillar approach of fiscal adjustment, growth promotion, and improved social services should help mitigate these risks."
  - "A wider public debate about the economic and financial challenges facing Lebanon would be important to sustain public and political support for reform and adjustment during and beyond the Paris III horizon."

### Data gaps and statistical capacity
- Finding: "Data gaps hamper the analysis of real and external sector developments."
- Recommendation: "High level commitment is needed to address these shortcomings through a comprehensive strategy to strengthen the statistical system."

*Source: IMF staff report excerpt (section 38–41).*

### 42.      It is proposed that the next Article IV consultation will be held on the standard

### _cr07382 - 42.      It is proposed that the next Article IV consultation will be held on the standard

### Article IV consultation timing and reporting
- Next Article IV consultation proposed to be held on the standard 12-month cycle.
- Quarterly reports on performance under the program supported by EPCA will be issued for the information of Executive Directors, as requested by Directors at the time of the EPCA approval.

### Output and prices (selected indicators, annual percentage change or end-of-period)
- Real GDP (market price): 2003 Act. 4.1; 2004 Act. 7.4; 2005 Act. 1.0; 2006 Act. 0.0; 2007 Prel. 2.0; 2008 Proj. 3.5; 2009 Proj. 4.5; 2010 Proj. 5.0; 2011 Proj. 5.0; 2012 Proj. 5.0
- Consumer prices (end-of-period): 2003 Act. 2.2; 2004 Act. 2.0; 2005 Act. 0.5; 2006 Act. 7.2; 2007 Prel. 2.0; 2008 Proj. 3.0; 2009 Proj. 2.0; 2010 Proj. 3.5; 2011 Proj. 2.0; 2012 Proj. 2.0
- Consumer prices (period average): 2003 Act. 1.3; 2004 Act. 1.7; 2005 Act. -0.7; 2006 Act. 5.6; 2007 Prel. 3.5; 2008 Proj. 2.5; 2009 Proj. 2.5; 2010 Proj. 2.8; 2011 Proj. 2.8; 2012 Proj. 2.0

### Investment, saving, and external current account (percent of GDP unless noted)
- Gross capital formation: 2003 19.3; 2004 22.0; 2005 17.0; 2006 11.4; 2007 17.6; 2008 17.1; 2009 18.7; 2010 20.1; 2011 21.3; 2012 21.4
- Gross national savings: 2003 6.1; 2004 6.5; 2005 3.4; 2006 5.2; 2007 7.0; 2008 7.7; 2009 9.2; 2010 12.1; 2011 15.5; 2012 15.9
- Current account excluding official transfers (in percent of GDP): 2003 -13.9; 2004 -16.0; 2005 -14.2; 2006 -7.4; 2007 -13.0; 2008 -12.0; 2009 -10.5; 2010 -8.5; 2011 -6.3; 2012 -5.9
- Current account including official transfers (in percent of GDP): 2003 -13.2; 2004 -15.5; 2005 -13.6; 2006 -6.2; 2007 -10.6; 2008 -9.4; 2009 -9.4; 2010 -8.0; 2011 -5.8; 2012 -5.5

### Public finances (central government, flows and fiscal ratios)
- Revenue (including grants, percent of GDP): 2003 22.1; 2004 23.1; 2005 22.8; 2006 24.8; 2007 26.5; 2008 25.9; 2009 22.0; 2010 23.2; 2011 23.4; 2012 23.3
- Expenditure (percent of GDP): 2003 35.4; 2004 31.8; 2005 31.2; 2006 35.9; 2007 38.7; 2008 35.1; 2009 30.1; 2010 28.2; 2011 27.1; 2012 26.3
- Budget balance (including grants, percent of GDP): 2003 -13.3; 2004 -8.6; 2005 -8.4; 2006 -11.1; 2007 -12.2; 2008 -9.1; 2009 -8.1; 2010 -5.0; 2011 -3.8; 2012 -3.0
- Primary balance (including grants, percent of GDP): 2003 3.3; 2004 3.5; 2005 2.1; 2006 1.7; 2007 0.1; 2008 2.6; 2009 1.8; 2010 4.4; 2011 5.2; 2012 5.6
- Total government debt (in percent of GDP): 2003 169; 2004 167; 2005 179; 2006 178; 2007 173; 2008 143; 2009 142; 2010 138; 2011 133; 2012 127

### Central government primary balance and composition (in billions of Lebanese pounds)
- Primary balance (2003–08, selected): 2003 975; 2004 1,129; 2005 680; 2006 578; 2007 -575; 2008 -98; 2009 -1; 2010 27; 2007 (Q1) 979
- Revenue and grants (2003–08): 2003 6,597; 2004 7,485; 2005 7,405; 2006 8,486; 2007 1,763; 2008 2,155; 2009 9,534; 2010 9,591; 2011 9,895
- Primary expenditure (2003–08): 2003 5,622; 2004 6,356; 2005 6,725; 2006 7,908; 2007 2,338; 2008 2,253; 2009 9,535; 2010 9,564; 2011 8,916

### Fiscal accounts (levels and percent of GDP, 2003–08 highlights)
- Interest bill (in billions LL): 2003 4,942; 2004 3,921; 2005 3,410; 2006 4,381; 2007 (Q1) 1,071; 2007 Year 4,408 (IMF Country Report 07/17 figures)
- Overall balance (checks-issued basis, in billions LL): 2003 -3,968; 2004 -2,793; 2005 -2,730; 2006 -3,803; 2007 (IMF Country) -4,409 (Proj. -4,398; 2008 -3,492)
- Net financing (in billions LL): 2003 4,093; 2004 3,139; 2005 2,816; 2006 3,655; 2007 projections 4,409; 2008 4,398; 2009 3,492
- Memorandum nominal GDP (annual, in billions LL): 2003 29,851; 2004 32,357; 2005 32,446; 2006 34,253; 2007 IMF Country 35,805; 2008 36,173; 2009 35,805; 2010 36,173; 2011 38,188; 2012 40,072

### Government debt structure (2003–12, selected levels in millions of U.S. dollars and percent of GDP)
- Net debt (2003–12, selected): 2003 32,838; 2004 34,719; 2005 36,700; 2006 39,452; 2007 40,544; 2008 40,389; 2009 40,799; 2010 40,757; 2011 35,284; 2012 37,458
- Gross debt by currency (2003–12): 2003 33,381; 2004 35,875; 2005 38,465; 2006 40,464; 2007 41,358; 2008 41,232; 2009 41,612; 2010 41,600; 2011 36,160; 2012 38,368
- Domestic currency debt and foreign currency debt (2003–12, selected): 2003 Domestic 17,806; Foreign 15,575. Percent of GDP (2003): Domestic 90; Foreign 79.
- Eurobonds (including Paris II) (2003–12, selected): 2003 13,007; 2004 15,709; 2005 16,413; 2006 17,540; 2007 18,172; 2008 17,633; 2009 17,571; 2010 17,367; 2011 15,090; 2012 13,843

### Monetary sector and monetary survey (2003–08, selected)
- Credit to the private sector (annual percentage change): 2003 0.3; 2004 5.2; 2005 1.9; 2006 6.0; 2007 5.0; 2008 6.3; 2009 24.0 (projection in table header)
- Base money (yearly change or level series as reported): 2003 12.3; 2004 10.3; 2005 4.7; 2006 8.2; 2007 5.9; 2008 5.1
- Broad money (M5) levels and changes: 2003 LL 76,357; 2004 LL 85,733; 2005 LL 88,720; 2006 LL 94,378; 2007 Act. LL 93,906; 2007 Report 07/177 LL 94,754; 2008 Proj. LL 97,710
- Broad money (M5, annual percent change): 2003 15.5; 2004 12.3; 2005 3.5; 2006 6.4; 2007 Act. -0.5; 2007 Report 07/177 0.4; 2008 Proj. 3.5; 2009 Proj. 5.0

### Banque du Liban balance sheet and reserves (2003–08, selected in millions of U.S. dollars)
- Net foreign assets (2003–08): 2003 33,509; 2004 36,803; 2005 37,832; 2006 43,594; 2007 41,460; 2008 43,224; 2009 43,181; 2010 46,578; 2011 52,753
- Gross international reserves (including gold) (memorandum): 2003 14,105; 2004 13,581; 2005 14,347; 2006 17,160; 2007 16,605; 2008 17,166
- Gross international reserves (excluding gold, end-year): 2003 10,271; 2004 9,575; 2005 9,611; 2006 11,353; 2007 11,121; 2008 12,347

### Balance of payments and external financing (2003–12 projections, selected in millions of U.S. dollars)
- Current account (annual, in millions USD): 2003 -2,615; 2004 -3,332; 2005 -2,926; 2006 -1,406; 2007 Prel. -2,596; 2008 Proj. -2,546; 2009 Proj. -2,391; 2010 Proj. -2,546; 2011 Proj. -2,314; 2012 Proj. -1,798; 2012 Proj. -1,829 (two similar entries shown)
- Goods exports f.o.b. (in millions USD): 2003 1,733; 2004 2,050; 2005 2,278; 2006 2,792; 2007 3,151; 2008 3,206
- Goods imports f.o.b. (in millions USD): 2003 -6,528; 2004 -8,502; 2005 -8,397; 2006 -8,547; 2007 -10,046; 2008 -10,026
- External debt (year end, percent of GDP): 2003 174.8; 2004 187.5; 2005 189.9; 2006 197.9; 2007 182.6; 2008 195.4; 2009 185.8; 2010 175.8; 2011 168.4; 2012 160.9
- Gross financing requirements (2003–08, in millions USD): 2003 -27,847; 2004 -27,209; 2005 -32,330; 2006 -31,945; 2007 Proj. -32,201; 2008 Proj. -33,851
- Available financing (2003–08, in millions USD): 2003 25,752; 2004 27,209; 2005 32,330; 2006 31,283; 2007 Proj. 29,657; 2008 Proj. 32,749
- Financing gap / Exceptional financing (2003–08): Financing gap 2003 -2,095; 2004 0; 2005 0; 2006 -662; 2007 -2,544; 2008 -1,103. Exceptional financing 2003 2,095; 2004 0; 2005 0; 2006 662; 2007 2,544; 2008 1,103

### Debt sustainability framework (public sector debt dynamics, percent of GDP unless otherwise indicated)
- Baseline public sector debt (central government gross debt, percent of GDP): 2003 168.6; 2004 167.1; 2005 178.7; 2006 178.1; 2007 173.4; 2008 142.7; 2009 142.1; 2010 137.8; 2011 132.5; 2012 126.8; 2017 114.1; 2022 102.4; 2026 92.6
- Change in public sector debt (percent of GDP): 2003 4.4; 2004 -1.4; 2005 11.6; 2006 -0.6; 2007 -4.7; 2008 -30.6; 2009 -0.6; 2010 -4.3; 2011 -5.3; 2012 -5.7
- Identified debt-creating flows (percent of GDP): 2003 5.2; 2004 -6.0; 2005 8.0; 2006 1.7; 2007 -3.9; 2008 -30.8; 2009 -0.8; 2010 -4.4; 2011 -5.4; 2012 -5.8
- Debt-stabilizing primary balance (percent of GDP): 0.5
- Key macro/fiscal assumptions underlying baseline:
  - Real GDP growth (percent): 2003 4.1; 2004 7.4; 2005 1.0; 2006 0.0; 2007 2.0; 2008 3.5; 2009 4.5; 2010 5.0; 2011 5.0; 2012 5.0; 2017 4.0; 2022 4.0; 2026 4.0
  - Average nominal interest rate on public debt (percent): 2003 10.7; 2004 7.8; 2005 6.3; 2006 7.6; 2007 7.3; 2008 7.1; 2009 7.4; 2010 7.1; 2011 7.0; 2012 6.9; 2017 6.8; 2022 6.7; 2026 6.7
  - Inflation rate (GDP deflator, percent): 2003 1.6; 2004 0.9; 2005 -0.7; 2006 5.6; 2007 3.5; 2008 2.0; 2009 2.0; 2010 2.0; 2011 2.0; 2012 2.0; 2017 2.0; 2022 2.0; 2026 2.0
  - Primary deficit (percent of GDP): 2003 -3.3; 2004 -3.5; 2005 -2.1; 2006 -1.7; 2007 -0.1; 2008 -2.6; 2009 -1.8; 2010 -4.4; 2011 -5.2; 2012 -5.6; 2017 -3.0; 2022 -3.0; 2026 -3.0

### Monitorable fiscal and structural actions (March–December 2007)
- Fiscal measures and deadlines:
  - Submit to parliament a draft 2007 budget law consistent with the targeted primary balance of the central government, including detailed HRC operations and CDR foreign-financed expenditures; budget law should not allow carryovers nor treasury advances of more than one month after fiscal year. Target: End-June 2007. Status: Draft budget approved by cabinet on May 21.
  - Issue a Cabinet decision setting a specific floor on gasoline excise of LL 300 per liter of gasoline. Target: End-September 2007.
  - Appoint auditor for NSSF accounts; auditor to prepare an audit plan for NSSF for 2001–06. Target: End-June 2007.
- Power sector:
  - Appoint auditor for EdL accounts; auditor to prepare an audit plan for EdL for 2002–06; publish 2001 audit report. Target: End-June 2007.
- Privatization:
  - Submit to parliament draft law to authorize sale of mobile sector assets and licenses. Target: End-June 2007. Note: Privatization might proceed without new law.
  - Issue invitation for expression of interest for acquiring licenses and assets of MIC1 and MIC2. Target: End-December 2007.

### Banking sector soundness and indicators (2003–07 selected)
- Banking sector assets (in millions USD): 2003 61,589; 2004 70,595; 2005 73,565; 2006 79,948; 2007 79,140
- Capital adequacy ratio: 2003 22.3; 2004 21.2; 2005 22.9; 2006 24.7; 2007 n/a (as of June 2006).
- Net problem loans/net total loans: 2003 12.8; 2004 10.6; 2005 9.1; 2006 6.9; 2007 6.8
- Provisions against problem loans/problem loans: 2003 46.3; 2004 46.1; 2005 49.0; 2006 53.9; 2007 54.2
- Net liquid assets/total assets: 2003 49.1; 2004 43.2; 2005 45.2; 2006 42.9; 2007 42.9
- FC deposits/total deposits (percent): 2003 66.2; 2004 70.1; 2005 73.2; 2006 75.7; 2007 75.5

### National Social Security Fund (NSSF) operations (2000–06, percent of GDP)
- Total NSSF revenue: 2000 4.7; 2001 4.1; 2002 3.8; 2003 3.7; 2004 3.5; 2005 3.9; 2006 3.8
- Total NSSF expenditure: 2000 2.6; 2001 3.3; 2002 3.5; 2003 3.0; 2004 2.7; 2005 2.6; 2006 2.7
- NSSF balance: 2000 2.0; 2001 0.8; 2002 0.4; 2003 0.7; 2004 0.8; 2005 1.3; 2006 1.1
- NSSF total assets (end-of-period, percent of GDP): 2000 10.0; 2001 10.7; 2002 10.4; 2003 10.8; 2004 11.0; 2005 11.2; 2006 n.a.

### Interest rates and market rates (selected end-of-period, in percent)
- Treasury bills, 3 months (government yield): 2003 5.5; 2004 5.2; 2005 5.2; 2006 5.2; 2007 5.2
- Treasury bills, 2 years: 2003 8.0; 2004 7.9; 2005 8.5; 2006 8.7; 2007 8.7
- Eurobond, 5 years: 2003 7.0; 2004 7.0; 2005 7.5; 2006 7.5; 2007 8.8
- BdL certificates of deposit in LL, 60 days: 2003 4.9; 2004 4.9; 2005 4.9; 2006 4.9; 2007 4.9

### Indicators of financial and external vulnerability (2003–07, selected)
- Broad money M5 (annual percentage change): 2003 15.5; 2004 12.3; 2005 3.5; 2006 6.4; 2007 4.7
- Private-sector credit (annual percentage change): 2003 0.3; 2004 5.2; 2005 1.9; 2006 6.0; 2007 6.3
- Overall fiscal balance (in percent of GDP): 2003 -13.3; 2004 -8.6; 2005 -8.4; 2006 -11.1; 2007 -13.4 (annualized presentation)
- Interest payments on debt (percent of GDP): 2003 16.6; 2004 12.1; 2005 10.5; 2006 12.8; 2007 12.3
- Gross public debt (in percent of GDP): 2003 168.6; 2004 167.1; 2005 178.8; 2006 177.8; 2007 177.5

### Program monitoring, targets, and memorandum items
- Quantitative indicative targets under EPCA (March–December 2007) include gross reserves of Banque du Liban, net debt of the government, primary balance before grants, government net borrowing from BdL, and other items (Table 17 provides stocks and flows at program exchange rates in millions of U.S. dollars and billions of Lebanese pounds).
- Memorandum items and program definitions are provided for reserves, external debt measures, and classification notes (e.g., M5 definition, short-term debt on remaining maturity basis).

*Sources: Lebanese authorities; Banque du Liban; Ministry of Finance; Banking Control Commission; and Fund staff estimates and projections as presented in the Staff Report for the 2007 Article IV Consultation — Informational Annex (September 17, 2007).*

### Annex I. Lebanon: Fund Relations

### Annex I. Lebanon: Fund Relations

### I. Membership
- Status: Joined 04/14/47; Article VIII (07/01/93).

### II. General Resources Account
- Quota: 203.00 SDR Million (100.00 percent of Quota).
- Fund holdings of currency: 234.92 SDR Million (115.72 percent of Quota).
- Reserve position in Fund: 18.83 SDR Million (9.28 percent of Quota).

### III. SDR Department
- Net cumulative allocation: 4.39 SDR Million (100.00 percent of Allocation).
- Holdings: 23.14 SDR Million (526.81 percent of Allocation).

### IV. Outstanding Purchases and Loans
- Post-Conflict Emergency Assistance: 50.75 SDR Million (25.00 percent of Quota).

### V. Latest Financial Arrangements
- None.

### VI. Projected Payments to Fund
(SDR million; based on existing use of resources and present holdings of SDRs)
- 2007
  - Principal: 0.00
  - Charges/Interest: 0.69
  - Total: 0.69
- 2008
  - Principal: 0.00
  - Charges/Interest: 2.71
  - Total: 2.71
- 2009
  - Principal: 0.00
  - Charges/Interest: 2.70
  - Total: 2.70
- 2010
  - Principal: 12.69
  - Charges/Interest: 2.58
  - Total: 15.27
- 2011
  - Principal: 25.38
  - Charges/Interest: 1.44
  - Total: 26.82

### VII. Implementation of HIPC Initiative
- Not applicable.

### VIII. Implementation of Multilateral Debt Relief Initiative (MDRI)
- Not applicable.

### IX. Safeguards Assessment
- The Banque du Liban is subject to safeguards assessment with respect to EPCA approved on April 9, 2007.
- Documentation request: necessary documentation requested from the authorities on March 30, 2007.
- Status of information: Information received so far has been partial; staff is following up to obtain a complete set of documentation necessary for the assessment.

### Nonfinancial Relations

### X. Exchange Arrangement
- The Lebanese pound is a de facto peg.
- Since October 1999, the Banque du Liban has intervened to keep the pound around a mid-point parity of LL 1,507.5 per $1, with a bid-ask spread of LL+/-6.5.

### XI. Article IV Consultation
- The 2006 Article IV consultation was concluded by the Executive Board on May 3, 2006 (IMF Staff Country Report No. 06/201).

### XII. Financial Sector Assessment Program
- Lebanon participated in the FSAP in 1999; the related report was presented to the Executive Board at the time of the Article IV consultation.
- A Financial System Stability Assessment (FSSA) update was conducted in 2001; the related report was similarly presented to the Executive Board at the time of the Article IV consultation.

### XIII. Technical Assistance
- Fiscal area (FAD)
  - Advice provided on introducing the VAT, reforming customs tariffs and income taxes, strengthening tax and customs administration, improving public expenditure management, and consolidating fiscal accounts.
  - A fiscal ROSC report was published in May 2005.
  - Impact: Technical assistance was well received; notably on the VAT, its impact has been positive and substantial.
  - Remaining needs: considerable needs remain in tax policy, tax administration, budget preparation, fiscal management, and public accounting and reporting.
  - 2005 missions: focused on (i) consolidation of fiscal accounts, and (ii) public liquidity management.
  - October 2006: a multi-sector mission provided advice on fiscal reform priorities after the conflict with Israel.
- Financial area (now Monetary and Capital Markets Department)
  - Technical assistance on payments system and vulnerability indicators.
  - Activities: assessment of compliance with Core Principles for Systemically Important Payments Systems; advice on systems to improve efficiency and liquidity management in public sector payments and receipts; assistance in elaborating a framework for collecting and analyzing macro-prudential indicators.
  - Progress: Progress in implementing IMF recommendations has been limited.
  - 2006 mission: assessment of banking sector soundness, including a stress-test exercise, to develop a strategy for banking sector consolidation.
- Statistical area (STA)
  - Assistance on development of price and balance of payments statistics; little progress achieved.
  - Data gaps: no official PPI or CPI; balance of payments data remain incomplete; Lebanon does not report balance of payments data to the Statistics Department.
  - Early 2002: multisector statistics/GDDS mission assessed needs and prepared action plans.
  - February–March 2007: three missions provided assistance for the compilation of the CPI.
  - Remaining gaps: substantial, particularly in national accounts, price statistics, and balance of payments; stronger political commitment is needed for further technical assistance to be effective.

### XIV. Missions (Technical assistance missions during the last five years)
- March 25–April 5, 2002 — STA — Multisector statistics/GDDS
- April 15–26, 2002 — BTS — Database at Banque du Liban
- August 6–20, 2002 — FAD — VAT and customs administration
- Sept. 9–23, 2002 — FAD — Income tax reform
- Jan. 27–31, 2003 — MAE — Payment systems
- July 29–23, 2003 — FAD — Revenue administration
- July 26–August 10, 2003 — FAD — Public expenditure management
- Aug. 27–Sept. 8, 2003 — FAD — Tax policy
- September 24–29, 2003 — LEG — Income Tax Law
- March 18–29, 2004 — MFD — Payments and Settlement Systems and Developing Early Warning Systems
- September 6–17, 2004 — FAD — Fiscal transparency ROSC
- October 2004 — IMF — Creation of METAC
- December 8–22, 2004 — FAD — Tax policy
- January 11–15, 2005 — MFD — Payments and Settlement Systems and Developing Early Warning Systems
- February 1–11, 2005 — MFD — Liquidity Forecasting, Monetary Operations and the Interbank Money Market
- May 22–June 6, 2005 — FAD — Consolidation of Fiscal Accounts
- June 24–July 2, 2005 — LEG — Income Tax Law
- August 25–31, 2005 — MFD — Follow-up on Early Warning Systems
- April 12–20, 2006 — MFD — An Assessment of Banking System
- April 24–May 5, 2006 — STA/METAC — Government Finance Statistics
- October 9–16, 2006 — FAD — Post-Conflict Reform Challenges and priorities
- February 19–23, 2007 — STA — Consumer Price Statistics
- March 12–30, 2007 — STA — Consumer Price Statistics
- April 16–27, 2007 — STA — Consumer Price Statistics
- March 2007 — FAD — Improving Cash Management

### XIV. Resident Representatives
- None.

*Annex I. Lebanon: Fund Relations (As of August 31, 2007).*

### Annex III. Lebanon: Statistical Issues

### Annex III. Lebanon: Statistical Issues

### Coverage and data gaps
- Gaps in coverage of macroeconomic statistics hamper effective surveillance; some gaps widened owing to the effects of the 2006 conflict.
- Need for further work on compilation of the international reserves template to facilitate monitoring of gross and net international reserves and for accurately compiling counterpart data in the central bank balance sheet.
- Most components of:
  - monetary and financial statistics,
  - public debt statistics,
  - data on the central government budgetary accounts
  are available on a regular basis.
- Other macroeconomic statistics are largely estimated on the basis of partial information:
  - national accounts,
  - prices,
  - employment,
  - general government and the rest of the nonfinancial public sector,
  - balance of payments.
- Lebanon participates in the GDDS.

### Real sector and national accounts
- Availability of real sector data remains very limited, although progress has been made in compiling national accounts.
- The ministry of economy and trade is receiving technical assistance from INSEE for development of national accounts statistics, including quarterly GDP.
- First set of national accounts estimates for 1997 (the base year) published in 2003; estimates for 1998–2004 are now available.
- Prior to this initiative, official national accounts statistics had not been produced since the mid-1970s; preliminary estimates for major components of GDP at current prices for 1994 and 1995 were published in October 1997.
- A household income survey was published in 1997.
- With EU assistance, progress toward:
  - a new census on buildings, dwellings and establishments;
  - developing and undertaking economic surveys;
  - conducting a national household budget survey.

### Consumer prices
- Consumer price indices prepared by the Central Administration for Statistics (CAS) and private organizations use a limited basket for the greater Beirut metropolitan area.
- CAS index:
  - quarterly index,
  - price collection from Beirut and its suburbs,
  - index weights based on the 1997 Household Budget Survey and in need of an update.
- Preparations for a new index with national coverage are well under way.
- CPI inflation decelerated to below 2 percent year-on-year in July, consistent with an end-year inflation projection of 2 percent or lower.

### Fiscal and public sector statistics
- Published monthly data on central government budgetary accounts are not comprehensive:
  - published figures do not include certain transfers and financing data,
  - omit foreign-financed capital expenditure,
  - do not cover arrears,
  - no data on widespread quasi-fiscal activities by public corporations.
- Certain treasury spending is identified only ex-post and its economic classification occurs with a lag; these items are provided to IMF staff in surveillance context.
- No monthly data are available on central government social security funds.
- No sub-annual fiscal data are currently reported for publication in International Financial Statistics (IFS).
- Cash-based annual government finance statistics limited to the budgetary central government are published in the Government Finance Statistics Yearbook (GFSY); latest data received are for 2004, published in the 2006 GFSY.

### Monetary and financial statistics
- Lebanon has not received technical assistance in monetary and financial statistics in many years.
- A 2002 GDDS/multisector mission produced an action plan for improvement.
- Monetary and financial statistics are timely but institutional coverage limited to central bank and other depository corporations.
- Questions emerged about central bank’s statistical treatment of repos:
  - some Eurobond repo transactions undertaken by the central bank in mid-2005 were not recorded in its balance sheet until end-2006.
- Lebanon participated in the Coordinated Compilation Exercise for Financial Soundness Indicators (FSIs) and produced a comprehensive set for year-end 2005.

### Balance of payments (BOP)
- BOP statistics are weak with deficiencies in:
  - current account: unrecorded exports, underestimation of private sector services and workers’ remittances;
  - capital account: grants;
  - financial account: equity investment in the nonbank private sector, corporate borrowing abroad.
- Recommendations from November 2005 technical assistance mission:
  - Central Bank of Lebanon and CAS should give high priority to extending coverage of their inter-agency agreement on share of work for BOP data collection and compilation;
  - develop new data sources, particularly for direct investment;
  - adopt the definition for official reserve assets as set out in international guidelines;
  - improve periodicity of dissemination of detailed BOP data to a quarterly frequency.
- BOP source data improved after implementation in 2003 of the International Transactions Reporting Systems (ITRS).
- In July 2005, Lebanon provided STA quarterly data for 2002–04 and methodological notes; data covering 2002–2005 are published in the IFS and BOPSY.
- Significant revisions noted in financial account data; investment income-portfolio investment debit flows for 2003 remained very large, even larger than financial account flows for the same instrument.
- Official reserve assets are currently compiled on a gross basis consistent with international guidelines.

### Common indicators and data dissemination (as of June 18, 2007)
- Table entries (selected exact observations and dates preserved):
  - Exchange Rates — Date of latest observation: 05/2007; Date received: 6/04/2007; Frequency of Data/Reporting/Publication: D / D / D.
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities — Date of latest observation: 02/2007; Date received: 03/2007; Frequency: M / M / M.
  - Reserve/Base Money — Date of latest observation: 03/2007; Date received: 5/15/2007; Frequency: M / M / M.
  - Broad Money — Date of latest observation: 03/2007; Date received: 5/15/2007; Frequency: M / M / M.
  - Central Bank Balance Sheet — Date of latest observation: 03/2007; Date received: 5/15/2007; Frequency: M / M / M.
  - Consolidated Balance Sheet of the Banking System — Date of latest observation: 03/2007; Date received: 5/15/2007; Frequency: M / M / M.
  - Interest Rates — Date of latest observation: 03/2007; Date received: 5/15/2007; Frequency: M / M / M.
  - Consumer Price Index — Date of latest observation: 07/2005; Date received: 09/2005; Frequency: M / At the time of mission or on request / M.
  - Revenue, Expenditure, Balance and Composition of Financing – Central Government — Date of latest observation: 07/2005; Date received: 09/2005; Frequency: M / M / M.
  - Stocks of Central Government and Central Government-Guaranteed Debt — Date of latest observation: 08/2005; Date received: 09/2005; Frequency: M / M / M.
  - External Current Account Balance — Date of latest observation: Q4/2005; Date received: 07/2006; Frequency: Q / A / unpublished.
  - Exports and Imports of Goods and Services — Date of latest observation: 08/2006; Date received: 11/2006; Frequency: M / Q / M.
  - GDP/GNP — Date of latest observation: 2004 (est); Date received: 05/2005; Frequency: A / At the time of mission / A.
  - Gross External Debt — Date of latest observation: 06/2005; Date received: 09/2005; Frequency: M / M / M.

### IMF staff statement — recent developments, projections, and policy implications (Statement date: October 3, 2007)
- Political and security context:
  - Parliamentary majority and opposition in discussion over compromise presidential candidate.
  - Current president’s term ends on November 24, 2007; presidential election (by parliament) postponed to October 23.
  - Security situation tense after assassination of a member of the parliamentary majority on September 19.
  - Main military operations at Nahr al-Bared Palestinian refugee camp were successfully completed; authorities estimate cost of rebuilding the camp and surrounding communities at $300–400 million and will seek additional donor assistance.
- Growth, inflation, and external sector:
  - Latest indicators consistent with projection of 2 percent real GDP growth for 2007.
  - Economic recovery in first half of 2007 relatively modest and unlikely to pick up momentum in second half.
  - CPI inflation decelerated to below 2 percent year-on-year in July; end-year inflation projection of 2 percent or lower.
- Financial markets and monetary aggregates:
  - Eurobond market quiet; Eurobond spreads stood at 492 basis points on September 27, or 120 basis points higher than in mid-July.
  - Deposit inflows continued; broad money growth of 7 percent since the beginning of the year.
  - Deposit dollarization broadly unchanged at 76 percent.
  - Commercial banks provided no new net financing to the government in July and August; government turned to central bank financing in absence of fresh donor support.
  - Gross international reserves increased by $300 million in July–August to $11.9 billion.
  - Gross government debt stood at $40.2 billion at end-August.
- Fiscal policy and reform measures:
  - Government revenue and expenditure performance through July in line with annual program objectives, but authorities have not yet increased gasoline excises to the level agreed for end-September (monitorable action).
  - At current international prices, the excise rate has declined to near zero; reaching the target rate of $0.20 a liter would require a 30 percent increase in gasoline retail prices and would yield about 0.5 percent of GDP over three months.
  - Authorities expect to meet the primary deficit target for 2007 even without this measure due to overperformance on other revenue items and lower expenditures partly from delays in capital spending.
  - Authorities have requested IMF Fiscal Affairs Department technical assistance to prepare for removal of various subsidies and liberalization of gasoline prices and to advise on final stages of General Income Tax (GIT) preparation; preparations for a staff mission awaiting receipt of household expenditure survey information.
  - GIT still under review before submission to Cabinet; law would have to be approved by parliament this year to come into effect in 2008 as planned; deadline remains challenging due to significant preparatory administrative work.
- Donor support and budgetary financing:
  - Disbursements of Paris III budget support likely to fall significantly short of program assumptions.
  - Since June, authorities received a U.S. budgetary grant of $75 million; a $100 million World Bank Development Policy Loan is in process of being disbursed; expecting disbursement of $300 million in budgetary loans from the United Arab Emirates.
  - Out of total outright budgetary support (loans and grants) of around $1.6 billion projected for 2007, only $0.6–0.9 billion is likely to be disbursed this year, mainly due to technical and administrative reasons.
  - Paris III was premised on significant portion of project loans being converted into indirect budget support; negotiations on this are still under way.
- Safeguards and surveillance:
  - A safeguards assessment of the Banque du Liban is in progress with respect to Lebanon’s Emergency Post-Conflict Assistance; a mission visited Lebanon September 10–17 and a draft report is being prepared for authorities’ comments.
- Staff appraisal implications:
  - Deposit inflows stronger than expected, enabling greater reliance on domestic market financing but likely requiring upward adjustment in domestic interest rates.
  - Upward revision in oil prices relative to assumptions will adversely affect the financial position of the loss-making power utility (EdL); budgetary impact likely felt starting in 2008 due to lags in government financial support to EdL.
  - 2007 budget target remains achievable; early action to increase gasoline excise would enhance chances of meeting the target and is key to medium-term fiscal objectives under Paris III.
  - Resolution of political impasse expected to lower Eurobond spreads, but Lebanon’s financing costs likely increased due to global reassessment of risk; adverse impact on debt sustainability reinforces need for prompt implementation of adjustment and reform measures planned.

*Source: Annex III. Lebanon: Statistical Issues; Statement by the IMF Staff Representative, October 3, 2007.*

### 2008. Realizing the expected privatization receipts and securing donor disbursements

### 2008. Realizing the expected privatization receipts and securing donor disbursements

### Context and near-term financing needs
- Projected foreign currency debt service payments of over $4 billion in 2008, of which $3.6 billion for Eurobond debt service.
- Donor disbursements and privatization receipts are identified as critical to meeting these obligations.

### Economic and fiscal background (2006–2007)
- 2006 conflict with Israel: Real GDP estimated to have been flat; strong H1 growth offset by conflict disruptions.
- Inflation increased in 2006 mainly due to supply shortages and blockade; CPI declined through mid-2007 from its 2006 peak.
- Donor pledges immediately after the conflict: US$1.7 billion for relief and recovery (including Stockholm conference, August 2006); 2006 disbursements roughly offset immediate fiscal costs of the conflict.
- Overall fiscal deficit increased in 2006 because of rising interest expenditures and higher than expected transfers to Electricité du Liban.
- Government debt rose to over US$40 billion (178 percent of GDP) at end-2006.
- Political stalemate and episodes of violence persist into 2007; real GDP expected to rebound slowly in 2007 (about 2 percent per authorities).
- Gross international reserves: declined by US$300 million to US$11 billion in Q1 2007, then recovered to US$11.6 billion at end-June 2007; authorities report reserves recovered to about $12 billion at end-August 2007.
- Eurobond spreads: 495 basis points as of end-August 2007; spreads increased by around 80 basis points between mid-July and mid-August 2007.
- Deposit dollarization: around 76 percent (significantly higher than prior to the 2006 conflict).
- Trade flows resumed after the 2006 interruption; trade deficit in H1 2007 deteriorated slightly relative to H1 2006.

### Executive Board assessment — key findings
- Commended good policy performance under the Fund’s Emergency Post-Conflict Assistance (EPCA).
- Economy recovering despite high oil price and political uncertainty; inflationary pressures eased; gross international reserves increased further.
- Major challenges emphasized:
  - Large debt overhang.
  - Financial and macroeconomic vulnerabilities.
  - High energy costs.
- Authorities’ 2007–12 reform program viewed as ambitious and credible but difficult to implement given political and security situation.
- Donor support regarded as an important pillar of the reform strategy; Directors called for timely disbursement.

### Fiscal policy, reform priorities, and recommendations
- Directors welcomed:
  - Containment of the primary fiscal deficit in H1 2007.
  - Fiscal adjustment and privatization plans for 2008.
  - Steps to initiate reforms in social security and power sectors.
- Planned 2008 tax and administrative measures noted:
  - Planned increases in the value-added tax and the tax on interest income in 2008.
  - Preparations for the introduction of a global income tax in 2008.
  - Administrative reforms underway.
- Energy sector: further progress needed to realize expected medium-term expenditure savings.
- Privatization: planned privatization of the telecom sector viewed as crucial to reform success.
- Public financial management (PFM):
  - Need to strengthen cash and budget management functions; follow up on the authorities’ action plan.
  - Advice against across-the-board expenditure cuts; focus on curtailing low-priority current spending rather than capital spending.
  - Emphasis on strengthening social safety nets.
  - Establishment of a debt management office welcomed.
- Monetary and financial sector recommendations:
  - Gradual reduction of central bank financing of the government to safeguard the central bank’s balance sheet; rely increasingly on market finance.
  - Support for introduction of transparent short-term monetary instruments and greater interest rate flexibility in Treasury bill auctions.
  - Central bank advised to refrain from quasi-fiscal activities.
  - Support for a joint working group in the Ministry of Finance and the central bank to better coordinate market interventions.
  - Exchange rate peg to the U.S. dollar considered helpful for financial stability; gross international reserves plus banking liquidity appear sufficient for temporary pressures.
  - Continued sound macroeconomic policies and full implementation of fiscal adjustment plans deemed essential to support the peg.
  - Banking sector vulnerabilities: high sovereign exposure, maturity mismatches, high dollarization; reduction in government debt crucial to reduce vulnerabilities.
  - Need to strengthen risk management, diversify loan portfolios, and enhance cross-border supervision.
  - Commercial banks’ readiness to adopt Basel II requirements in 2008 welcomed.

### Selected economic indicators (highlights from table)
- Change in real GDP: 2003: 4.1; 2004: 7.4; 2005: 1.0; 2006: 0.0; 2007 (Act.): 2.0; 2008 (Proj.): 3.5.
- Change in consumer prices (period average): 2003: 1.3; 2004: 1.7; 2005: -0.7; 2006: 5.6; 2007 (Act.): 3.5; 2008 (Proj.): 2.5.
- Exports, f.o.b. (in billions of U.S. dollars): 2003: 1.7; 2004: 2.1; 2005: 2.3; 2006: 2.8; 2007 (Act.): 3.2; 2008 (Proj.): 3.6.
- Imports, f.o.b. (in billions of U.S. dollars): 2003: -6.5; 2004: -8.5; 2005: -8.4; 2006: -8.5; 2007 (Act.): -10.0; 2008 (Proj.): -10.8.
- Current account balance (in billions of U.S. dollars): 2003: -2.6; 2004: -3.3; 2005: -2.9; 2006: -1.4; 2007 (Act.): -2.5; 2008 (Proj.): -2.4.
- Current account balance (in percent of GDP): 2003: -13.2; 2004: -15.5; 2005: -13.6; 2006: -6.2; 2007 (Act.): -10.6; 2008 (Proj.): -9.4.
- Capital and financial account balance (in percent of GDP): 2003: 5.7; 2004: 4.3; 2005: 2.0; 2006: 2.0; 2007 (Act.): 0.7; 2008 (Proj.): 3.2.
- Overall balance (in billions of U.S. dollars): 2003: 3.0; 2004: -0.7; 2005: 0.0; 2006: 1.7; 2007 (Act.): -1.8; 2008 (Proj.): 0.8.
- Gross official reserves, exc. Gold (in billions of U.S. dollars): 2003: 10.3; 2004: 9.6; 2005: 9.6; 2006: 11.4; 2007 (Act.): 11.1; 2008 (Proj.): 12.3.
- Budget balance (Overall balance, after grants, on a checks-issued basis, in percent of GDP): 2003: -13.3; 2004: -8.6; 2005: -8.4; 2006: -11.1; 2007 (Act.): -12.2; 2008 (Proj.): -9.1.
- Gross government debt (in percent of GDP): 2003: 169; 2004: 167; 2005: 179; 2006: 178; 2007 (Act.): 173; 2008 (Proj.): 143.
- Of which: in foreign currency (in percent): 2003: 78.7; 2004: 85.6; 2005: 88.9; 2006: 89.9; 2007 (Act.): 90.2; 2008 (Proj.): 79.0.
- Change in broad money (in percent, end-of-period): 2003: 15.5; 2004: 12.3; 2005: 3.5; 2006: 6.4; 2007 (Act.): 5.0; 2008 (Proj.): 5.0.
- Two-year Lebanese pound treasury bill rate (Primary market rate, in percent, end-of-period): 2003: 8.0; 2004: 7.9; 2005: 8.5; 2006: 8.7; 2007 (Act.): 8.7; 2008 (Proj.): 8.5.
- Change in real effective exchange rate (in percent): 2003: -10.7; 2004: -6.8; 2005: -4.1; 2006: 2.2.

### Authorities’ statement and donor disbursement status (Paris III)
- Authorities remain committed to the medium-term reform program presented at Paris III (January 2007).
- Paris III pledges and disbursement status:
  - Total pledged at Paris III: US$7.6 billion.
  - Agreements signed: about US$3.4 billion.
  - Of US$1.6 billion in budgetary support pledged for 2007, only US$0.6–0.9 billion is likely to be received in 2007.
  - US$175 million has been disbursed to date.
  - A US$100 million World Bank Development Policy Loan is in the process of being disbursed.
- Authorities seek donor flexibility to convert project loan pledges into budgetary support to reduce the debt burden; stress timely disbursement in line with macroeconomic objectives.
- Performance under EPCA: strong—All end-March 2007 quantitative targets observed except the ceiling on government borrowing from the Banque du Liban (BdL), which was exceeded by a small margin; all Q2 2007 quantitative targets observed with large margins.
- Authorities caution that failure of donors to accelerate disbursements in Q4 2007 would make it extremely difficult to identify additional fiscal measures to offset the shortfall and would weigh on government indebtedness.

*IMF Executive Board / Article IV consultation with Lebanon, Public Information Notice No. 07/137, November 26, 2007*

### 7.      Sound fiscal management to date in 2007 succeeded not only in avoiding a

### 7.      Sound fiscal management to date in 2007 succeeded not only in avoiding a

### Fiscal performance in 2007
- Sound fiscal management in 2007 avoided a deterioration in the fiscal position and improved the primary balance while addressing large social and reconstruction needs.
- First and second quarter performance was within the EPCA targets.
- Stronger than projected revenue collection and containment of expenditures below EPCA targets helped contain the primary deficit and the accumulation of net debt.
- The cabinet approved the draft budget for 2007, which includes the foreign financed component of the Council of Development and Reconstruction and activities of the Higher Relief Council.
- The primary budget deficit, excluding grants, is expected to be contained at 3.7 percent of GDP at end-2007, as programmed, supported by higher than projected revenues.
- Preliminary estimates indicate that the end-September 2007 revenue performance already exceeds the end-of-year target under the EPCA.

### Revenue measures, gasoline excise, and subsidies
- The authorities remain committed to introducing a floor on gasoline excises of $0.20 per liter.
- Given continued political instability, implementation of this measure may have to be postponed until after the presidential elections.
- Uncapping domestic gasoline prices in a context of high international oil prices would translate in a substantial hike in gasoline retail prices and could exacerbate existing tensions in the present political and economic environment.
- Delaying implementation of the gasoline excise floor will not jeopardize the primary balance target for 2007, as envisaged under the EPCA; potential loss from delay has been largely compensated by increases in other sources of revenue, including VAT, customs, income tax, and telecom transfer.
- The authorities have requested technical assistance from the Fund to prepare for the removal of various subsidies and the liberalization of gasoline prices.

### Preparations for the 2008 fiscal adjustment
- Draft 2007 budget provides for increasing the value-added tax rate and the tax on interest income as of 2008.
- The draft Global Income Tax law is near completion and should be ready for submission to parliament by year end.
- The review of the Tax Procedure Code has been finalized by the parliamentary committees and is awaiting ratification by Parliament.
- Ongoing revenue administration reforms expected to yield revenue gains include:
  - introduction of a medium taxpayer office,
  - new audit procedures,
  - update of the real estate tax database.
- Expenditure-side objectives: the medium-term program aims at gradually eliminating transfers to the public sector by reforming the energy and social sectors.
- Reform plans for Electricité du Liban (EdL) and the National Social Security Fund (NSSF) are being finalized in close cooperation with the World Bank.
- Administrative measures include better cooperation and information sharing across ministries, planned establishment of a debt management office, and measures to strengthen treasury and debt management capabilities.
- Progress achieved in implementing the public financial management reform plan developed with Fund assistance; a pilot project for program budgeting at the Ministry of Public Health was introduced in the draft 2008 budget.

### Monetary policy framework and banking sector
- The exchange rate peg continues to serve the economy by providing a firm anchor to financial stability, crucial given balance sheet risks related to widespread dollarization and the government’s high foreign currency debt servicing obligations.
- Debt overhang and large external current account deficits are the counterpart of fiscal imbalances and temporary post-conflict factors; these would be addressed by implementing the Paris III fiscal adjustment program.
- Authorities view the current exchange level as appropriate and agree with staff’s assessment outlined in Box 3.
- Interest rate stability contributed to addressing financial pressures but led to higher dollarization and FX market pressures; the BdL occasionally used dollar-denominated certificate of deposits, special discount windows, and swaps to manage liquidity and safeguard international reserves.
- Authorities agree that prolonged shortfalls in market demand for government paper would have to be met by raising treasury bills rates.
- Authorities view flexible interest rates as essential to counter further increases in dollarization and to assure an appropriate spread between returns on foreign currency and Lebanese pounds in the domestic market to encourage bank subscription to government paper.
- Authorities consider an upward adjustment in domestic interest rates at this stage may not attract sufficient market financing given existing uncertainties and could have an adverse signaling effect; once more stable conditions prevail, the central bank should better maintain price stability using short-term monetary instruments.
- Going forward, fiscal adjustment and improved confidence would help reduce dollarization, facilitate a further buildup of net international reserves, and strengthen the BdL’s income position.
- The banking sector remains profitable, well-capitalized, and well-supervised, but vulnerabilities are high due to:
  - high exposure to the sovereign,
  - substantial maturity mismatch on their books,
  - high degree of dollarization exposing them to credit risk.
- Regulatory and supervisory adaptations include the 2006 circular raising limits on exposure of Lebanese banks to non-resident borrowers and development of memoranda of understanding on consolidated supervision where Lebanese banks expand.
- Commercial banks are expected to further strengthen risk management with the introduction of Basel II standards in 2008.

### Other structural reforms: social, energy, and telecommunications
- Reforming social and energy sectors is pivotal to the medium-term structural reform agenda to address imbalances and possible contingent liabilities in pension and health systems.
- A draft pension law to transform private pension systems from an end-of-service allowance to a fully funded system has been submitted to parliament.
- Authorities, supported by the World Bank, are examining options to address losses of the health fund of the NSSF.
- The government is finalizing a comprehensive energy sector reform plan with the World Bank to restructure EdL and pave the way for partial privatization.
- Main reform measures envisaged for 2008 regarding EdL include:
  - completion of an audit of EdL accounts for 2002–2006,
  - completion of EdL’s asset registration and valuation,
  - corporatization of the company,
  - launch of a pilot project for remote meter installation and distribution management by private operators,
  - launching the privatization of the Beddawi power plant,
  - soliciting private sector investment in new capacity.
- Key progress already achieved in reforming EdL includes:
  - appointment of an auditor for the 2002-2006 fiscal years and publication of the audited 2001 financial statements,
  - appointment of international consultants at the Ministry of Energy and Water, EdL and the Higher Council for Privatization to assist in implementing restructuring,
  - appointment of a transaction advisor for the sale of Beddawi power plant and investment in new capacity by the private sector,
  - signature of an agreement with Egypt for the import of Natural Gas to the Beddawi power plant in the North,
  - appointment of a consultant to prepare a generation and transmission Master Plan for the energy sector.
- Privatization of the telecommunications sector is expected to start as early as October 2007:
  - A legal opinion by the ministry of justice concluded that the law for the sale of the fixed assets of the two state-owned mobile phone operators was no longer necessary.
  - Government expects invitations for expressions of interest for the two companies to be issued by the end of 2007.
  - Authorities are committed to privatizing the mobile sector companies through a transparent public offering.
  - Privatization of the fixed line, as well as a third mobile license, are planned to be launched in 2008.

### Conditions for successful implementation of the 2008+ reform agenda
- Three critical conditions for successful implementation:
  - a satisfactory outcome of the current ongoing presidential elections,
  - the international community’s delivery of aid committed under Paris III,
  - a reasonable environment of peace and security in Lebanon and the region as a whole.

*Source: _cr07382 - 7.      Sound fiscal management to date in 2007 succeeded not only in avoiding a*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07382.pdf_