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### Macroeconomic context and recent developments
- Lebanon maintained strong growth during the global recession; Real GDP rose 9 percent in 2009 and growth "now expected to reach at least 8 percent" in 2010.
- Political reconciliation (Doha 2008) and formation of a national unity government in late 2009 helped restore stability and spur capital inflows.
- Primary surplus increased to 3 percent of GDP in 2009.
- Government debt-to-GDP ratio declined to 148 percent by end-2009; sovereign gross debt: LL 77 trillion (US$51 billion) as of end-2009.
- Banque du Liban (BdL) accumulated international reserves to over $29 billion (international reserves excluding gold reached around $29.7 billion in mid-July 2010).
- Structural reform progress limited relative to Paris III / EPCA commitments: little headway on raising the VAT rate; reforming the electricity sector; privatizing the mobile phone carriers; reducing the wage bill as percent of GDP; eliminating extrabudgetary funds; and reforming the pension system.

### External position, capital flows, and reserves
- Current account remained stable in 2009; expected to widen in 2010 due to buoyant domestic demand and partial rebound of oil prices.
- Non-resident inflows surged in 2009; commercial bank deposits grew by more than 23 percent in 2009 and deposit dollarization declined (below 64 percent in 2009).
- Deposit inflows moderated in first half of 2010 but remained "healthy overall" at an annualized growth rate of about 11 percent; deposits picked up in first half of July, increasing by $1.3 billion (1.3 percent).
- BdL increased international reserves to over $29 billion while sterilizing much of the domestic money supply impact through issuance of Certificates of Deposit (CDs).
- Gross official reserves (excluding gold, year-end, in millions of U.S. dollars): 18,769; 27,405; 29,559; 31,848; 35,138; 40,832; 47,244; 52,996 (2008–15 series).

### Banking sector and financial stability
- Banking system remained sound: profitable, well-capitalized, highly liquid, with low and falling NPL ratios; banking sector problem loans (percent of total loans): 6.8; 4.7; 3.1; 2.3; 2.1 (2006–10).
- Capital adequacy ratio (Basel II / selected series): 12.5 / 12.1 / 12.4 (selected entries); average return on assets (post tax): 1.0 / 1.1 / 1.1 / 1.0; average return on equity (post tax): 12.1 / 13.8 / 14.4 / 14.5.
- Large banking system highly exposed to the sovereign: claims on the sovereign/total assets: 50.8 / 54.8 / 55.9 / 56.0 (selected series).
- Regionalization: more than 50 affiliates operate in about 20 countries; total assets of foreign affiliates roughly $25 billion (19 percent of domestic banking sector); loans to non-residents booked by parent banks reached 16 percent of private sector credit.
- Net foreign assets (Banque du Liban and commercial banks, in millions of U.S. dollars): Banque du Liban 36,927; 52,665; 57,346; 61,034; 66,383 (2010–14 sequence); Commercial banks 22,344; 28,763; 29,607; 34,955; 41,088.
- Staff recommendations: continue focus on preventing excessive risk taking; consider increasing effective reserve requirements and phasing out exemptions if credit growth accelerates; strengthen cross-border supervision, stress testing, and scenario analyses.

### Inflation, exchange rate, and monetary policy
- Inflation rose since fall 2009, partly driven by energy prices; CPI inflation dropped to 3.5 percent year-on-year in June 2010 (May: 4.9 percent).
- Exchange rate peg to the U.S. dollar remains the lynchpin of financial stability; real effective exchange rate broadly in line with fundamentals.
- CGER estimates of Real Exchange Rate Overvaluation (in percent): Macrobalance approach: 2.8, 7.4, 4.3, 8.8; External sustainability approach: 4.0, 9.1; Equilibrium real exchange rate approach: -10.4 to -0.2 (MinMax range).
- Policy interest rates reduced markedly (by more than 400 basis points since mid-2008 on 5-year T-bills/BdL CDs, of which 70bps in April and May 2010 alone); deposit rates declined more gradually.
- Staff and Directors: a pause in policy interest rate reductions may be warranted to allow pass-through and manage asymmetric risks; BdL encouraged to clearly communicate policy objectives.

### Fiscal position, 2010 budget, and medium-term outlook
- Draft 2010 budget (approved by cabinet mid-June, under discussion in parliament) features a 2.4 percent of GDP (200 percent nominal) increase in capital spending and revenue measures amounting to 0.8 percent of GDP; a proposed VAT hike was dropped.
- Full implementation of the draft budget would imply primary surplus falling from 3 percent of GDP in 2009 to 0.5 percent of GDP in 2010; authorities and staff expect actual primary surplus could reach about 1.5 percent of GDP because of delays and favorable revenue trends.
- Staff recommendation: target a primary surplus of at least 2 percent of GDP in 2010 by cautiously executing current spending and saving any revenue overperformance.
- Central government finances (headline figures, percent of GDP, selected 2008–15): Revenue (including grants): 23.8, 24.6, 24.1, 24.1, 24.2, 24.5, 24.5, 24.5; Expenditure: 33.4, 32.7, 32.8, 33.7, 32.3, 32.3, 32.7, 33.0; Budget balance (including grants): -9.6, -8.1, -8.7, -9.6, -8.1, -7.8, -8.2, -8.5; Primary balance (including grants): 1.4, 3.0, 1.5, 0.5, 1.5, 1.5, 1.5, 1.5; Total government debt (percent of GDP): 157, 148, 139, 137, 137, 137, 137, 138.
- Government debt level and structure (Box 5): Debt ratios: 148 percent of GDP; 139 percent of GNDI; 53 percent of commercial bank assets. Currency and maturity structure: Domestic currency debt 58 percent (average maturity 1.6 years); Foreign currency debt 42 percent (average maturity 4.6 years). Debt holders: Commercial banks 58 percent; BdL 15 percent; Other government institutions 8 percent.
- Debt sustainability (baseline and shocks, Box 5): Baseline with medium-term primary balance at 1.5 percent of GDP and real growth slowing to about 4 percent keeps debt-to-GDP roughly unchanged near 140 percent. Shock outcomes: permanent increase in real interest rate of 230 basis points → debt-to-GDP 158 percent by 2015; permanent decrease in real GDP growth of 1.7 percentage point → debt 161 percent of GDP; combination → 183 percent; permanent decrease in primary balance of 1.6 percent of GDP → 150 percent.
- Reform scenario: increase primary surplus to 5 percent of GDP by 2015 while maintaining higher public investment and social spending could reduce debt by 25–30 percentage points by 2015 (debt could decline to below 110 percent by 2015 under consolidated reforms).

### Infrastructure, PPPs, and public investment
- Capital spending averaged 2.5 percent of GDP during 2003–08 and fell to 1.5 percent of GDP in 2009; substantial infrastructure gaps in electricity, telecommunications, water, and roads.
- Electricity sector: EdL requires high budgetary transfers; staff cautioned that investment without cost recovery reforms would increase losses and subsidies.
- PPPs: potential for higher quality services at lower cost but main risk is unforeseen fiscal contingencies; five preconditions listed for successful PPPs including a strong institutional framework and Ministry of Finance gatekeeper role; recommended specialized PPP unit in the Ministry of Finance.
- Financing outlook: barring a major shock, remaining 2010 financing needs could be covered by the market; rollover of $1.2 billion in 10-year Eurobonds in March; no major foreign currency maturities until November–December ($1.4 billion). Authorities intend to lengthen maturity profile and lower foreign currency share of debt; continue funding in local currency some foreign currency debt service coordinated with BdL.

### Revenue mobilization, expenditure rationalization, and fiscal institutions
- Expenditure rationalization: shift poorly targeted budget transfers to EdL (4.2 percent of GDP in 2009) to productive uses; reform EdL administration and move tariff toward cost recovery.
- Revenue measures: menu of options to generate about 3 percent of GDP over five years, including income tax reform (covering capital gains for individuals), broadening VAT base by eliminating exemptions, raising excises on alcohols, and indexation of excises.
- Tax administration reforms: modernize tax administration; integrate VAT and income tax administrations; strengthen the large taxpayers unit; introduce electronic filing; discontinue amnesties on fines and penalty interest; introduce more uniform income tax law.
- Public financial management: cast future budgets in a multi-year framework; broaden budget coverage; introduce a Treasury Single Account; strengthen treasury and debt management capacity.

### BdL balance sheet and monetary-financial recommendations
- Sterilization of reserve purchases via high-yielding LL CDs has weighed on BdL’s net income; management of past crises and large sterilization operations weakened BdL’s net income position.
- Recommended measures: BdL should prepare a strategy to strengthen its income position; phase out exemptions from reserve requirements; privatize non-financial assets (e.g., planned partial sale of MEA and divestment of real estate portfolio) to improve BdL finances.
- Staff conclusion: BdL’s balance sheet needs strengthening; authorities should devise a medium-term plan.

### Statistical system and data gaps
- Serious shortcomings in data: national accounts (only annual data currently available until 2008), employment, general government and rest of nonfinancial public sector, and balance of payments; no national data on wages and real estate activity and prices.
- Planned actions: transfer national accounts compilation to Central Administration of Statistics (CAS) and launch comprehensive economic surveys in 2011; STA and METAC assistance scheduled.
- Table of Common Indicators: selected dates preserved (e.g., Exchange Rates latest observation 06/14/10; International Reserve Assets 04/2010; Broad Money 04/2010).

### Output gap and potential growth (Appendix 1)
- Methods: Hodrick-Prescott filter, Ravn/Uhlig filter, and growth accounting using tax-payer and health insurance proxies for employment.
- Five out of six estimates suggest the output gap turned positive in 2009.
- Range of output gap estimates for 2009: -3.2 to +7.6 percent of GDP.
- Reported numerical estimates (selected):
  - HP Filter — Output Gap 2009: 3.2 (percent of GDP); Potential Output Growth 2009: 4.2.
  - RU Filter — Output Gap 2009: 1.1; Potential Output Growth 2009: 4.1.
  - Growth Accounting (Tax Payer proxy) — HP Filter Output Gap 2009: -3.2; Potential Output Growth 2009: 4.3.
  - Growth Accounting (Health Insurance proxy) — HP Filter Output Gap 2009: 7.6; Potential Output Growth 2009: 7.7.
- Policy implication: evidence of a narrowing or closed output gap suggests additional fiscal or monetary stimulus could add to overheating risks; cautious macroeconomic policies warranted; need to develop national labor statistics.

### Staff appraisal: key findings and policy recommendations
- Strengths: strong growth during global crisis, controlled inflation, prudent macro policies (primary surplus rise, debt reduction, reserve accumulation).
- Remaining vulnerabilities: public debt-to-GDP ratio among highest globally; almost half of debt denominated in foreign currency; banking system reliance on short-term nonresident deposits; high loan dollarization; exposure to real estate price boom and contingent liabilities from PPPs; risks from regional tensions.
- Near-term guidance:
  - Manage buoyant economy cautiously to prevent overheating.
  - Aim for a primary surplus of at least 2 percent of GDP in 2010, achievable by prudent spending execution and saving revenue overperformance.
  - Allow higher public investment only with accompanying structural reforms to improve efficiency and cost recovery, notably in electricity.
- Monetary and exchange rate policy:
  - Pause in interest rate reductions may be warranted; coordinate policy between BdL and Ministry of Finance.
  - Maintain exchange rate peg given high foreign-currency debt and dollarization.
- Financial sector supervision: continue preventing excessive risk taking and heighten focus on banks’ regionalization.
- Medium-term strategy: reduce public debt-to-GDP substantially while allowing permanently higher investment and social spending through expenditure rationalization (notably reducing transfers to electricity) and a socially balanced tax package; strengthen tax administration and public financial management; establish framework to limit PPP contingent liabilities.
- Communication and statistics: proactively communicate policy intentions and debt reduction objective; strengthen statistical system to improve economic monitoring.

### Reform scenario vs Baseline (selected projection comparisons, 2010–15)
- Real GDP (market prices): Baseline 8.0 (2010), 5.0 (2011), 4.0 (2012–15); Reform scenario 8.0 (2010), 5.0 (2011), 5.0 (2012–15).
- Revenue (percent of GDP): Baseline 24.1 (2010), 24.2 (2011), 24.5 (2012–15); Reform scenario 24.1 (2010), 26.0 (2011), 26.6, 26.9, 26.8, 26.4 (2012–15).
- Primary balance (percent of GDP): Baseline 1.5 (2010), 0.5 (2011), 1.5 (2012–15); Reform scenario 2.0 (2010), 3.1 (2011), 3.6, 4.3, 5.0, 5.1 (2012–15).
- Total government debt (percent of GDP): Baseline 139 (2010), 137 (2011–14), 138 (2015); Reform scenario 139 (2010), 134 (2011), 130, 125, 118, 106 (2012–15).
- Budget balance (including grants): Baseline -8.7 (2010), -9.6 (2011), -8.1, -7.8, -8.2, -8.5 (2012–15); Reform scenario -8.2 (2010), -6.8 (2011), -5.1, -3.3, -2.1, -1.2 (2012–15).

### Telecom privatization and structural reform priorities
- Telecom sector inefficient in infrastructure investment and pricing; privatization of two public mobile phone providers could be envisaged later (authorities ruled out short-term privatizations).
- Privatization could unlock growth potential and contribute to lowering public debt.
- Annex III and joint Bank–Fund priorities: electricity sector reform; telecommunications sector reform; public financial management reform; social services and safety net reform; investment climate reform; financial sector stability assessment (FSSA); reform of the statistical system.
- Division of labor: World Bank to lead electricity and telecom technical work and investment support; Fund to lead taxation and fiscal analysis; joint assistance on PPP frameworks, fiscal risk assessment, and FSSA updates.

### Executive Board and Article IV consultation timing
- It is proposed that the next Article IV consultation be held on the standard 12-month cycle.
- Public Information Notice: Executive Board welcomed strong performance but cautioned on large vulnerabilities and recommended continued fiscal consolidation, structural reforms, and vigilance in financial supervision.

*IMF staff report based on discussions held in Beirut during May 27–June 9, 2010; Statement by the Staff Representative on Lebanon, Executive Board Meeting, July 30, 2010.*

### 1.      Background      ................................................................................................

### 1. BACKGROUND

### Key developments and context
- Lebanon’s economy “bucked international trends” during the global recession, maintaining strong growth momentum despite large underlying vulnerabilities.
- Political reconciliation (Doha 2008) and formation of a national unity government in late 2009 helped restore relative political stability and spurred confidence and capital inflows.
- Macroeconomic policy outcomes:
  - Primary surplus increased to 3 percent of GDP in 2009.
  - Government debt-to-GDP ratio declined to 148 percent by end-2009.
  - Banque du Liban (BdL) accumulated international reserves.
- Structural reform progress was limited relative to Paris III / EPCA commitments (see Box 1). Areas with little headway included: raising the VAT rate; reforming the electricity sector; privatizing the mobile phone carriers; reducing the wage bill as percent of GDP; eliminating extrabudgetary funds; and reforming the pension system.

### Sources and mission
- Report based on discussions in Beirut during May 27–June 9, 2010. Staff team: Messrs. Bauer (head), Finger, Hesse, Mottu (Resident Representative), Sadikov (all MCD), and Lopez Murphy (FAD). Ms. Choueiri (OED) joined some discussions.
- Meetings included the Minister of Finance, the Governor of the BdL, cabinet members, parliamentarians, private sector and academic representatives.

### Macroeconomic resilience and vulnerabilities
- Positive factors:
  - Global low-interest rate environment and large capital inflows supported growth and reserve accumulation.
  - Buoyant revenues (including reintroduction of fuel excises) supported the fiscal position.
- Remaining vulnerabilities and new risks:
  - Government debt at 148 percent of GDP, almost half denominated in foreign currency.
  - Large banking system highly exposed to the sovereign and dependent on short-term deposit inflows from nonresidents.
  - Bank lending largely dollarized, creating exposure to unhedged borrowers.
  - Potential future vulnerabilities from rapidly rising real estate prices, planned PPPs, or regionalization of local banks.

---

### The current state of Lebanon’s economy (as presented)

### Growth, inflation, and prices
- Real GDP rose 9 percent in 2009.
- Growth momentum carried into 2010 with growth “now expected to reach at least 8 percent” (Appendix 1).
- Inflation rose since fall 2009, partly driven by energy prices.
- Real estate prices increased rapidly.
- Peg to the U.S. dollar: the weak euro should help keep inflation in check in coming months provided no further build-up of non-tradable price pressures.

### External position and reserves
- Current account:
  - Remained stable in 2009 as rebounding tourism and lower energy import prices offset rising domestic demand.
  - Expected to widen in 2010 due to buoyant domestic demand and a partial rebound of oil prices.
- Capital inflows and reserves:
  - Non-resident inflows surged in 2009; commercial bank deposits grew by more than 23 percent in 2009 and deposit dollarization declined.
  - BdL increased international reserves to over $29 billion while sterilizing much of the domestic money supply impact through issuance of CDs.
  - Deposit inflows moderated in the first half of 2010 after interest rate cuts but remained “healthy overall” at an annualized growth rate of about 11 percent.
  - Sovereign and CDS spreads increased somewhat in recent weeks, broadly in line with emerging market averages.

### Banking sector and credit
- Banking system remained sound: profitable, well-capitalized, highly liquid, low and falling NPL ratios.
- Limited exposure to Dubai and virtually no exposure to Southern Europe.
- Falling interest rates compressing margins; banks responding by regional expansion and accelerating domestic credit.
  - Private sector credit accelerated to 21 percent y-o-y growth in April.
- Banking sector indicators (selected):
  - Capital adequacy ratio (Basel II): 12.5 / 12.1 / 12.4 (years not separately identified in provided extract).
  - Net problem loans/net total loans: 4.7 / 3.1 / 2.3 / 2.1.
  - Claims on the sovereign/total assets: 50.8 / 54.8 / 55.9 / 56.0.
  - Average return on assets (post tax): 1.0 / 1.1 / 1.1 / 1.0.
  - Average return on equity (post tax): 12.1 / 13.8 / 14.4 / 14.5.

### Near-term risks
- Main near-term risks linked to political and regional security.
- A sudden negative confidence shock from political deadlock or regional tensions could reprice sovereign risk, hurt debt dynamics, and pressure international reserves.
- Lebanon’s limited exposure to external government debt markets and a loyal depositor base mitigate some but not all risk.

---

### Managing the buoyant economy in 2010

### Policy focus
- Shift from supporting the economy during a global recession to managing rapid expansion.
- Key objectives:
  - Fiscal policy: reconcile increased infrastructure investment needs with macro stability and debt reduction.
  - Monetary policy: slow deposit inflows to avoid excessive credit growth, reserve accumulation, and sterilization costs.
  - Prudential/supervisory policy: address vulnerabilities from high credit growth, rapidly rising real estate prices, and regionalization of banks.

### A. 2010 Budget — Balancing spending needs and stability goals
- Draft 2010 budget (approved by cabinet in mid-June; under discussion in parliament) features:
  - A 2.4 percent of GDP (200 percent nominal) increase in capital spending, including substantial investments in electricity generation (Box 2).
  - Revenue measures amounting to 0.8 percent of GDP, including a 2 percentage point increase in the interest income tax, an asset revaluation tax, and higher registration fees for high-end properties.
  - A proposed VAT hike was dropped for lack of political support.
- Fiscal arithmetic and projections:
  - Full implementation of the draft budget would imply a fall in the primary surplus from 3 percent of GDP in 2009 to 0.5 percent of GDP in 2010, but would still allow a further moderate decline in the government debt-to-GDP ratio given strong growth.
  - Authorities and staff believe the actual primary surplus could reach about 1.5 percent of GDP because of delays in approving the budget, lags in public investment execution, and favorable revenue trends.
- Staff advice and recommendations:
  - From a cyclical perspective, staff saw little need for a fiscal impulse and encouraged aiming for a higher primary surplus.
  - Staff suggested a primary surplus target of at least 2 percent of GDP for 2010, attainable by cautiously executing current spending and saving any revenue overperformance.
  - Planned investments to address infrastructure bottlenecks could be accommodated within this fiscal envelope, provided related structural reforms proceed in parallel to avoid reinforcing existing deficiencies.
  - Staff cautioned that in the electricity sector, substantial investment without simultaneous movement toward cost recovery could lead to additional losses and subsidies from the budget.

---

*IMF staff report based on discussions held in Beirut during May 27–June 9, 2010.*

### Box 2. Lebanon’s Infrastructure Deficit

### Box 2. Lebanon’s Infrastructure Deficit

### Infrastructure gaps and public investment
- Capital spending averaged only 2.5 percent of GDP during 2003–08, and reached a low of 1.5 percent of GDP in 2009.
- Low investment levels have contributed to severe infrastructure gaps, mainly in electricity, telecommunications, water, and the road network, adversely affecting the medium-term growth potential.
- Many infrastructure sectors suffer from deficiencies in regulatory frameworks and poor governance and inefficiencies of public utilities.
- The electricity sector requires high budgetary transfers; Electricité du Liban (EdL) is inefficient in its structure and operations.
- Telecommunications lag behind regional peers in quality, range of services offered, and competitiveness of pricing, partly due to a lack of competition.

### Financing outlook and government debt management
- Barring a major shock, the government’s remaining financing needs for 2010 could be covered by the market, as banks remain very liquid despite the recent slowdown in deposit growth.
- Following the rollover of $1.2 billion in 10-year Eurobonds in March, the government does not face major foreign currency maturities until November–December ($1.4 billion).
- Authorities intend to gradually lengthen the maturity profile and lower the foreign currency share of government debt.
- A suggested instrument: continue to fund in local currency some of the government’s foreign currency debt service, coordinated with the BdL and implemented to safeguard an adequate level of international reserves.
- Staff highlighted desirability of gradually increasing the share of non-bank funding, and welcomed authorities’ intention to mobilize concessional loans pledged at past donor conferences.

### Reserve accumulation and monetary policy stance
- After two years of substantial accumulation, international reserves have reached adequate levels; reserves cover a comfortable share of broad money and short-term debt and have reached optimal levels according to an applied insurance model.
- Self-insurance required the BdL to sterilize reserves purchases mainly through issuance of high-yielding LL CDs, which weighs significantly on the BdL’s net income position.
- Policy interest rates have been allowed to drop markedly (by more than 400 bps since mid-2008 on 5-year T-bills/BdL CDs, of which 70bps in April and May of 2010 alone).
- Deposit rates have declined more gradually, reflecting imperfect monetary transmission with variable lags; deposit rates have recently started to fall more rapidly.
- A pause in policy interest rate reductions may be warranted to ensure a smooth adjustment process: risks judged asymmetric, with the risk of drying up inflows due to lags in market response considered costlier than temporarily accumulating more reserves than optimal.
- Staff encouraged the BdL to clearly communicate its monetary policy objectives to the public.

### Exchange rate peg and competitiveness
- The exchange rate peg provides a strong nominal anchor and remains the lynchpin of financial stability; maintenance of the peg is essential given the government’s high debt and debt service obligations in foreign currency and widespread loan dollarization.
- Authorities and staff agreed the real effective exchange rate remains broadly in line with fundamentals (see Box 3).
- Box 3 findings:
  - Goods and services export volumes are estimated to have grown by close to 15 percent on average over the past five years (2005-09), and by 6 percent on average over the last twenty years.
  - Tourism accounts for one third of services exports.
  - CGER methodologies produce mixed signals: macroeconomic balance and external sustainability approaches point to a somewhat overvalued exchange rate (between 3 and 9 percent), while the equilibrium real exchange rate approach suggests a modest undervaluation (by up to 10 percent).
  - For Lebanon: Real Exchange Rate Overvaluation Estimates Using CGER Approaches (selected figures preserved):
    - Macrobalance approach: Overvaluation (in percent) 2.8, 7.4, 4.3, 8.8 (corresponding to underlying/steady-state parametrizations)
    - External sustainability approach: Overvaluation (in percent) 4.0, 9.1 (NEAP 1 - IFS / NEAP 2 - BIS)
    - Equilibrium real exchange rate approach: Overvaluation (in percent) -10.4 to -0.2 (MinMax range)
  - All three methodologies should be given about equal weight in the overall assessment.

### Banking supervision, regionalization, and AML/CFT
- Authorities focus bank regulation and supervision on preventing excessive risk taking; example: limited loan-to-value ratio for most real estate loans to 60 percent.
- BdL and Banking Control Commission (BCC) should remain vigilant to risks from weakening credit standards, increasing leverage in specific sectors, and deteriorating asset quality.
- If credit growth accelerates further, authorities should consider increasing effective reserve requirements and phasing out existing exemptions created to stimulate lending in domestic currency; BdL and BCC could consider introducing countercyclical prudential regulation.
- Regional expansion of Lebanese banks:
  - More than 50 affiliates (branches, subsidiaries and representative offices) operate in about 20 countries.
  - Total assets of foreign affiliates amount roughly to $25 billion, or 19 percent of the domestic banking sector.
  - Loans to non-residents booked by parent banks have tripled since 2006, reaching 16 percent of private sector credit.
  - Top foreign affiliate asset exposures (in US$ billions): Syria 7.09; France 4.24; Egypt 3.73; Cyprus 2.2; Jordan 1.93; Switzerland 1.22; Belgium 0.91; Turkey 0.81; Sudan 0.62; United Kingdom 0.41.
- Current supervisory activities broadly in line with good practices; further enhancements include deeper cooperation and information sharing with host country supervisors, and greater focus on stress testing and scenario analyses.
- AML/CFT: authorities committed to conform to the Financial Action Task Force’s 40+9 Recommendations; Mutual Evaluation Report recognized significant progress (e.g., Financial Intelligence Unit) but noted need for further strengthening, particularly criminalization of money laundering and financing of terrorism, and reinforcement of the AML/CFT supervisory system.

### Medium-term roadmap, fiscal scenarios, and reform priorities
- Top medium-term priority: lowering government debt-to-GDP ratio to reduce macro-financial vulnerabilities.
- Under staff’s baseline no-policy-change scenario:
  - Debt-to-GDP ratio would remain above 135 percent throughout the medium term and could become explosive if the economy suffers a negative shock and policies are not strengthened.
  - Baseline would imply a further temporary relaxation of the fiscal primary balance in 2011: the increase in public investment set in motion in the 2010 draft budget would be executed to a significant extent in 2011.
  - With unchanged policies, the primary surplus would decline in 2011 to about 0.5 percent of GDP, before returning to around 1.5 percent of GDP in 2012-15.
  - With this, the debt-GDP ratio would stabilize at around 137 percent of GDP over the medium-term.
- Reform scenario:
  - Envisages increasing the government’s primary surplus to 5 percent of GDP by 2015, while maintaining a permanently higher level of public investment and social spending.
  - Under these assumptions, the government debt-to-GDP ratio could decline by 25–30 percentage points by 2015.
- Fiscal consolidation and structural reforms to create fiscal space:
  - Expenditure rationalization:
    - Room to shift high and poorly targeted budget transfers to EdL (4.2 percent of GDP in 2009) to more productive uses.
    - Reform EdL’s administration to achieve efficiency gains and move tariff structure toward cost recovery.
    - Authorities noted a strategy on electricity reform developed with World Bank support and approved by cabinet.
    - Budget subsidies to EdL were 1 percent of GDP lower during the first quarter of 2010 than in the first quarter of 2009, reflecting lower fuel costs and some improvements in bill collection.
  - Revenue measures:
    - Menu of options to generate additional revenues of about 3 percent of GDP over five years.
    - Options include reforming the income tax (including to cover capital gains for individuals); broadening the VAT base by eliminating exemptions; raising excises on alcohols; protecting the real value of excise taxes through indexation.
    - Both the VAT and the corporate income tax rates are comparatively low and offer potential for a gradual increase.
    - Authorities intend to submit a new income tax law to parliament later this year that goes in the recommended direction and will consider further tax reforms for the 2011 budget, recognizing the need for consensus-building.

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

### 27.      Telecom privatization could enhance the economy’s growth potential while

### 27.      Telecom privatization could enhance the economy’s growth potential while

### Telecom sector and privatization
- The telecom sector is inefficient in infrastructure investment and pricing.
- Privatization of the two public mobile phone providers could be envisaged at a later stage (authorities ruled out privatizations in the very short term).
- Privatization could be one route towards unlocking the sector’s large growth potential and could contribute to lowering the public debt.

### Government debt level and structure (Box 5)
- Sovereign gross debt: LL 77 trillion (US$51 billion) as of end-2009.
- Debt ratios:
  - 148 percent of GDP.
  - 139 percent of GNDI.
  - 53 percent of commercial bank assets.
- Currency and maturity structure:
  - Domestic currency debt: 58 percent of total government debt; average maturity of 1.6 years.
  - Foreign currency debt: 42 percent of total government debt; average maturity of 4.6 years.
- Debt holders:
  - Commercial banks: 58 percent.
  - BdL: 15 percent.
  - Other government institutions: 8 percent.

### Debt sustainability: baseline and shocks (Box 5)
- Baseline (“no policy-change”) assumptions:
  - Medium-term primary balance (including grants) kept constant at 1.5 percent of GDP.
  - Real growth slows to a potential growth rate of around 4 percent.
  - Lebanese interest rates increase over time in line with projected world interest rates.
  - Debt-to-GDP ratio outcome: would remain roughly unchanged from its 2010 level of nearly 140 percent of GDP.
- Shock scenarios (relative to baseline):
  - A permanent increase in the real interest rate of 230 basis points (one-half standard deviation from its past distribution) would increase the debt-to-GDP ratio to 158 percent by 2015.
  - A permanent decrease in real GDP growth of 1.7 percentage point (one-half standard deviation from its past distribution) would raise the debt to 161 percent of GDP.
  - A combination of the above two shocks would increase the debt to 183 percent of GDP.
  - A permanent decrease in primary balance of 1.6 percent of GDP (one-half standard deviation from its past distribution) relative to the 2000–09 average would lift the debt to 150 percent of GDP.

### Reform scenario (Box 5)
- Under fiscal consolidation, higher investment in social and physical infrastructure, structural reforms to strengthen economic institutions, and measures such as telecom privatization:
  - Debt could decline to below 110 percent by 2015.

### Public-Private Partnerships (PPPs) (Box 6 and paragraph 28)
- PPPs defined: mechanisms for the provision and operation of infrastructure assets and services; alternative to traditional public procurement or privatization.
- Main advantage: potential for higher quality services at lower costs.
- Main risk: unforeseen fiscal contingencies and contingent liabilities.
- Preconditions for successful PPPs (country experience suggests five):
  - A sound institutional framework covering all major aspects of the PPP process and conducive to private participation.
  - Government and public administration with sufficient technical expertise to handle a PPP program, including capacity to evaluate and select projects.
  - Allocation of PPP contracts based on competitive bidding and reliance on incentive-based regulation.
  - Adequate risk transfer to the private sector.
  - Proper accounting and reporting of the fiscal implications of PPPs.
- Recommended institutional arrangements:
  - Ministry of Finance to have a strong “gatekeeper” role to assess and manage fiscal risks.
  - Set up a specialized PPP unit in the Ministry of Finance to screen and evaluate potential projects, with authority to approve or reject feasibility studies, tender documents, preferred bidders, and PPP contracts.
- Policy caution: PPPs should only be pursued if they provide efficiency gains and limit fiscal risks and contingent liabilities; particularly important given the country’s high debt-to-GDP ratio.
- Authorities are strengthening an earlier draft framework law for PPPs, which could be re-submitted to parliament during the summer.

### Fiscal institutions, tax administration, and public financial management
- Tax administration reforms and measures:
  - Modernize tax administration to improve compliance and avoid perceptions of uneven taxpayer impact.
  - Integrate VAT and income tax administrations.
  - Strengthen the large taxpayers unit.
  - Introduce electronic filing of tax returns.
  - Discontinue amnesties on fines and penalty interest for tax arrears.
  - Introduce the planned more uniform income tax law to simplify procedures.
- Public financial management reforms:
  - Cast future budgets in a multi-year framework (provision in the draft 2010 budget welcomed).
  - Reenergize efforts to broaden budget coverage.
  - Introduce a Treasury Single Account.
  - Strengthen treasury capacity.
  - Enhance debt management capacity at the Ministry of Finance, including preparing a decree to operationalize the debt management unit.

### BdL balance sheet and related measures
- Recent developments:
  - Management of past crises and large sterilization operations in the last two years have substantially weakened the BdL’s net income position.
  - Lower interest rates and a much slower pace of reserve accumulation are helping to ease the drain of sterilization operations on the BdL’s finances.
- Recommended measures:
  - BdL should prepare a strategy for strengthening its income position.
  - Phasing out exemptions from reserve requirements would be beneficial.
  - Privatization of non-financial assets, including planned partial sale of the national air carrier MEA and ongoing divestment of the real estate portfolio, would help improve the BdL’s financial balance.
- Staff conclusion: The BdL’s balance sheet is in need for strengthening; authorities should devise a medium-term plan to bolster the BdL’s balance sheet.

### Statistical system improvements
- Remaining gaps to address:
  - Improve national accounts and balance of payments statistics.
  - Expand coverage of fiscal statistics to encompass various extrabudgetary entities.
  - Develop regular and timely wage, employment, and real estate statistics to enhance economic monitoring and policy development.
- A high-level commitment from the government is needed to push the statistical reform agenda forward.

### Staff appraisal: key findings and policy recommendations
- Recent performance and strengths:
  - Lebanon’s economy performed remarkably well during the global crisis: growth fueled by regained political stability and continued capital inflows; inflation remained under control.
  - Authorities pursued prudent macroeconomic policies; primary surplus increased in 2009, contributing to a further reduction in the debt-to-GDP ratio; BdL bolstered international reserves.
- Remaining vulnerabilities:
  - Public debt-to-GDP ratio remains among the highest in the world.
  - Government financing and financial sector stability are reliant on continued inflows of short-term non-resident deposits.
  - Confidence depends crucially on continued political stability and absence of regional tensions.
  - Additional vulnerabilities could emerge from rapidly rising real estate prices, potential fiscal contingencies from planned PPPs, or ongoing internationalization of local banks.
- Near-term policy guidance:
  - Manage the buoyant economy cautiously to prevent overheating.
  - Staff believes a higher-than-budgeted primary surplus of at least 2 percent of GDP in 2010 is both appropriate and achievable, leaving room for a substantial increase in capital expenditures.
  - Higher public investment is important to address infrastructure gaps but must be accompanied by reforms to improve efficiency and cost recovery of public utilities, particularly the electricity sector.
- Monetary and exchange rate policy:
  - Monetary policy has rightly focused on moderating deposit inflows as international reserves have reached adequate levels.
  - A pause in policy interest rate reductions may now be warranted given slowed deposit growth and imperfect monetary transmission.
  - Policy plans need to be well-coordinated as interest rate policy is effectively conducted jointly by the BdL and Ministry of Finance.
  - The exchange rate peg remains the adequate exchange rate regime given high foreign-currency debt and balance-sheet mismatches; efforts should continue to reduce vulnerabilities over time.
- Financial sector supervision:
  - Bank regulation and supervision should continue to focus on preventing excessive risk taking, with heightened focus on banks’ regionalization.
- Medium-term strategy:
  - Target a substantial reduction in the public debt-to-GDP ratio while allowing space for permanently higher investment and social spending.
  - Achieve goals by rationalizing current expenditures (in particular reducing budget transfers to the electricity sector) and implementing a socially balanced tax package.
  - Support the medium-term fiscal strategy with institutional reforms: strengthen tax administration, reenergize public financial management reforms, and put in place a strong framework to minimize contingent liabilities from PPPs.
  - Reforming the telecom sector, through privatization or otherwise, would help unlock the sector’s large growth potential.
- Communication and statistical reform:
  - Clear, timely and proactive communication of policy intentions is important to anchor expectations and build ownership for reforms; communication of the government’s debt reduction objective is particularly relevant.
  - The statistical system needs further improvement; data insufficiencies hamper economic analysis and policy development.

*Source: _cr10306 - 27.      Telecom privatization could enhance the economy’s growth potential while*

### 45.       It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

### _cr10306 - 45.       It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

### Consultation timing
- It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

### Key macroeconomic indicators (selected, 2008–15)
- Real GDP (market prices): 9.3, 9.0, 8.0, 5.0, 4.0, 4.0, 4.0, 4.0
- GDP deflator: 9.3, 5.8, 5.0, 3.5, 2.2, 2.2, 2.2, 2.2
- Consumer prices (end-of-period): 6.4, 3.4, 4.7, 2.8, 2.2, 2.2, 2.2, 2.2
- Investment (Gross capital formation): 30.0, 30.2, 31.0, 31.0, 29.8, 29.2, 28.6, 28.5
- Gross national savings: 20.7, 20.7, 20.0, 19.8, 19.4, 19.2, 18.7, 18.6
- Current account (including official transfers, percent of GDP): -9.3, -9.5, -11.1, -11.2, -10.4, -9.9, -9.9, -9.9
- Gross reserves (excluding gold, in billions of U.S. dollars): 18.8, 27.4, 29.6, 31.8, 35.1, 40.8, 47.2, 53.0
- Nominal GDP (in billions of U.S. dollars): 29.9, 34.5, 39.1, 42.5, 45.2, 48.1, 51.1, 54.3

### Central government finances (cash basis) — headline figures (2008–15; percent of GDP unless otherwise indicated)
- Revenue (including grants): 23.8, 24.6, 24.1, 24.1, 24.2, 24.5, 24.5, 24.5
  - Grants: 0.9, 0.4, 0.4, 0.2, 0.3, 0.3, 0.2, 0.2
- Expenditure: 33.4, 32.7, 32.8, 33.7, 32.3, 32.3, 32.7, 33.0
- Budget balance (including grants): -9.6, -8.1, -8.7, -9.6, -8.1, -7.8, -8.2, -8.5
- Primary balance (including grants): 1.4, 3.0, 1.5, 0.5, 1.5, 1.5, 1.5, 1.5
- Total government debt (in percent of GDP): 157, 148, 139, 137, 137, 137, 137, 138
- Nominal GDP (annual and in billions of LL): 45,124; 52,051; 59,018; 64,128; 68,180; 72,482; 77,021; 81,825

### Central government budget aggregates (in billions of Lebanese pounds, selected years and items)
- Revenue and grants (2010–15, annual projections): 23,824; 14,224; 15,454; 16,496; 17,718; 18,857; 20,028 (table presents series across years and Q1)
- Total expenditures (2010–15): 15,101; 17,092; 19,335; 21,595; 22,052; 23,414; 25,191; 26,979
- Interest payments (2010–15): 4,979; 5,799; 6,023; 6,485; 6,582; 6,747; 7,490; 8,162
- Overall balance (checks issued) (2010–15): -4,360; -4,290; -5,111; -6,141; -5,556; -5,696; -6,334; -6,951
- Total government debt (levels, 2010–15): 70,888; 77,019; 77,588; 82,013; 88,147; 93,696; 99,385; 105,718; 112,667

### Reform scenario vs Baseline (selected comparisons, 2010–15)
- Real GDP (market prices)
  - Baseline scenario: 8.0 (2010), 5.0 (2011), 4.0 (2012–15)
  - Reform scenario: 8.0 (2010), 5.0 (2011), 5.0 (2012–15)
- Revenue (including grants, percent of GDP)
  - Baseline scenario: 24.1 (2010), 24.2 (2011), 24.5 (2012–15)
  - Reform scenario: 24.1 (2010), 26.0 (2011), 26.6, 26.9, 26.8, 26.4 (2012–15 sequence)
- Expenditure (percent of GDP)
  - Baseline scenario: 32.8 (2010), 33.7 (2011), 32.3, 32.3, 32.7, 33.0 (2012–15)
  - Reform scenario: 32.3 (2010), 32.8 (2011), 31.7, 30.2, 28.9, 27.6 (2012–15)
- Budget balance (including grants)
  - Baseline scenario: -8.7 (2010), -9.6 (2011), -8.1, -7.8, -8.2, -8.5 (2012–15)
  - Reform scenario: -8.2 (2010), -6.8 (2011), -5.1, -3.3, -2.1, -1.2 (2012–15)
- Primary balance (including grants)
  - Baseline scenario: 1.5 (2010), 0.5 (2011), 1.5, 1.5, 1.5, 1.5 (2012–15)
  - Reform scenario: 2.0 (2010), 3.1 (2011), 3.6, 4.3, 5.0, 5.1 (2012–15)
- Total government debt (percent of GDP)
  - Baseline scenario: 139 (2010), 137 (2011–14), 138 (2015)
  - Reform scenario: 139 (2010), 134 (2011), 130, 125, 118, 106 (2012–15)
- Two-year treasury bill yield (percent)
  - Baseline scenario: 8.6, 7.6, 5.8, 6.3, 6.9, 7.4, 7.7, 7.8 (2008–15 series)
  - Reform scenario: 5.8, 5.7, 5.7, 5.7, 5.5, 5.6 (projected series)

### Balance of payments and external sector (selected)
- Current account (excl. official transfers, in millions of U.S. dollars): -2,902; -3,350; -4,435; -4,779; -4,729; -4,790; -5,083; -5,394 (2008–15)
- Exports f.o.b. (in millions of U.S. dollars): 5,251; 4,716; 5,282; 5,705; 6,161; 6,654; 7,186; 7,761
- Imports f.o.b. (in millions of U.S. dollars): -16,261; -15,895; -17,802; -19,084; -20,611; -22,362; -24,263; -26,326
- Direct investment (net, in millions of U.S. dollars): 2,620; 3,678; 3,916; 4,139; 4,268; 4,414; 4,571; 4,706
- Gross official reserves (excl. gold, year-end, in millions of U.S. dollars): 18,769; 27,405; 29,559; 31,848; 35,138; 40,832; 47,244; 52,996
- External debt (year-end; in percent of GDP): 172; 171; 160; 162; 169; 178; 188; 198

### Monetary and banking sector (selected indicators)
- Broad money (M5, in billions of Lebanese pounds): 120,862; 148,845; 166,707; 186,712; 209,117 (2008–12 series)
- Broad money (annual percent change): 15.5; 23.2; 12.0; 12.0; 12.0 (2008–12)
- Claims on private sector (year-on-year percent change): 18.5; 15.1; 18.0; 9.7; 9.0 (2008–12)
- Banking sector problem loans (percent of total loans): 6.8; 4.7; 3.1; 2.3; 2.1 (2006–10)
- Capital adequacy ratio: 25.0; 12.5; 12.1; 12.4; n.a. (2006–10)
- Net foreign assets (Banque du Liban and commercial banks, in millions of U.S. dollars): Banque du Liban 36,927; 52,665; 57,346; 61,034; 66,383 (2010–14 sequence in Table 5); Commercial banks 22,344; 28,763; 29,607; 34,955; 41,088
- Gross official reserves (including gold, in millions of U.S. dollars): 26,801; 37,467; 40,394; 42,682; 45,973 (2008–12 series)

### Public sector debt sustainability (Table 11 highlights)
- Baseline public sector gross debt (percent of GDP): 179.9 (2006), 167.7 (2007), 157.1 (2008), 148.0 (2009), 139.0 (2010), 137.5 (2011), 137.5 (2012), 137.2 (2013), 137.3 (2014), 137.7 (2015)
- Debt-stabilizing primary balance (percent of GDP): 2.1 (reported)
- Identified debt-creating flows (percent of GDP): 6.7 (2006), -13.9 (2007), -17.7 (2008), -12.7 (2009), -8.8 (2010), -1.5 (2011), 0.0 (2012), -0.3 (2013), 0.1 (2014), 0.4 (2015)
- Automatic debt dynamics contribution (percent of GDP): 8.4 (2006), -6.3 (2007), -16.3 (2008), -9.8 (2009), -7.3 (2010), -1.0 (2011), 1.5 (2012), 1.1 (2013), 1.6 (2014), 1.9 (2015)
- Key macro assumptions (selected):
  - Real GDP growth (percent): 0.6 (2006), 7.5 (2007), 9.3 (2008), 9.0 (2009), 8.0 (2010), 5.0 (2011), 4.0 (2012–15)
  - Average nominal interest rate on public debt (percent): 7.6 (2006), 7.8 (2007), 7.9 (2008), 8.2 (2009), 7.8 (2010), 7.9 (2011), 7.5 (2012), 7.2 (2013), 7.5 (2014), 7.7 (2015)
  - Inflation rate (GDP deflator, percent): 2.0 (2006), 3.9 (2007), 9.3 (2008), 5.8 (2009), 5.0 (2010), 3.5 (2011), 2.2 (2012–15)

### Scenario and shock analysis (figure summary)
- The Public Debt Sustainability Framework presents baseline and shock scenarios including:
  - Growth shock, real interest rate shock, combined real interest rate and growth shock, and fiscal shock.
  - Baseline public debt in percent of GDP indicated as 138 (figure labels).
  - Reform scenario and alternative paths yield notably lower debt ratios (figure panels show outcomes across 2005–15).

*Sources: Lebanese authorities; and Fund staff estimates and projections.*

### APPENDIX 1. THE OUTPUT GAP

### APPENDIX 1. THE OUTPUT GAP

### Context and question
- Lebanon experienced three years of rapid economic growth since 2007 after a series of profound shocks in the early and mid-2000s, raising questions whether recent strength is catching-up or reflects a rise in potential growth allowing sustained medium-term growth with limited overheating risk.

### Methods used to estimate potential output and the output gap
- Univariate filtering using the Hodrick-Prescott filter, with two standard calibrations for the smoothing factor λ.
- An alternative filter specification based on Ravn/Uhlig (2002).
- Growth accounting approach using:
  - Income tax payer data as a proxy for employment.
  - Employment-linked public health insurance contributions as an alternative proxy for employment (used because national labor statistics are absent).

### Main findings on the output gap
- Five out of six estimates suggest that the output gap turned positive in 2009, indicating that slack has been eliminated from the economy.
- The range of estimates for the output gap in 2009 is between -3.2 and +7.6 percent of GDP, which is too large to draw conclusions about its precise magnitude.
- Numerical estimates (as reported in source table):
  - HP (Hodrick/Prescott) Filter — Output Gap 2009: 3.2 (percent of GDP); 2002-06 average: 4.8; Potential Output Growth (percent) 2009: 4.2
  - RU (Ravn/Uhlig) Filter — Output Gap 2009: 1.1 (percent of GDP); 2002-06 average: 7.1; Potential Output Growth (percent) 2009: 4.1
  - Growth Accounting (Tax Payer proxy) — HP Filter Output Gap 2009: -3.2 (percent of GDP); 2002-06 average: 4.4; Potential Output Growth (percent) 2009: 4.3
  - Growth Accounting (Tax Payer proxy) — RU Filter Output Gap 2009: 1.6 (percent of GDP); 2002-06 average: 2.9; Potential Output Growth (percent) 2009: 4.4
  - Growth Accounting (Health Insurance proxy) — HP Filter Output Gap 2009: 7.6 (percent of GDP); 2002-06 average: -0.8; Potential Output Growth (percent) 2009: 7.7
  - Growth Accounting (Health Insurance proxy) — RU Filter Output Gap 2009: 4.4 (percent of GDP); 2002-06 average: 2.3; Potential Output Growth (percent) 2009: 6.6
- Note on filter footnotes:
  - 1/ Filter specification based on Hodrick/Prescott (1997).
  - 2/ Filter specification based on Ravn/Uhlig (2002).

### Main findings on potential output growth
- Estimates for 2009 potential output growth range from -0.8 percent to 7.1 percent.
- Half of the estimates point to an increase from past potential output growth, and the other half suggest a decline.
- Estimates are sensitive to specification choices and underlying assumptions, particularly because proxies for employment were used in the absence of employment statistics.

### Implications and policy recommendation
- The evidence of a narrowing or closed output gap suggests that additional fiscal or monetary stimulus could add to overheating risks.
- Given the uncertainty and wide range of estimates, cautious macroeconomic policies are warranted going forward.
- The sensitivity of results to employment proxies underscores the desirability of developing national labor statistics.

*Source: APPENDIX 1. THE OUTPUT GAP (IMF staff report).*

### Annex III). A stronger commitment to fill these gaps is needed for further

### _cr10306 - Annex III). A stronger commitment to fill these gaps is needed for further

### World Bank–IMF collaboration and shared assessment
- Meeting date: June 4, 2010.
- Shared macroeconomic challenges identified:
  - Reduce the very high government debt-to-GDP ratio.
  - Maintain stability of the financial sector.
- Agreed prerequisites:
  - Achieve and maintain fiscal consolidation and strong growth over a number of years.
  - Maintain close vigilance in financial sector supervision.

### Macrocritical structural reform areas (seven)
- Electricity sector reform
  - Objectives: reduce budgetary transfers to the electricity provider by (i) reducing the cost of production, including through reducing reliance on expensive fuel oil, (ii) increasing revenue collection, (iii) enhancing electricity supply by making necessary investments and, (iv) gradually adjusting tariff towards cost recovery levels, possibly in conjunction with transfers to poor households.
  - Complementary action: comprehensive reform of the regulatory and institutional framework.
  - Rationale: very large budgetary transfers undermine fiscal sustainability; insufficient electricity supply weighs on growth.
- Telecommunications sector reform
  - Objectives: reduce costs and enhance quality and scope of telecom services by making necessary investments and implementing regulatory framework for increased private sector involvement.
  - Rationale: (i) the sector generates large revenues for the government; (ii) reforms can lift growth potential; (iii) proceeds from licensing and/or privatization could be used to repay part of the government’s large debt.
- Public financial management reform
  - Key elements: (i) establishing a macrofiscal unit in the Ministry of Finance; completing the coverage of the Treasury Single Account; strengthening expenditure programming, budget preparation, aid and debt management, and coordination with the Central Bank (feasible in the short to medium term); and (iv) strengthening accounting, payment, and auditing functions, including by introducing a Government Financial Management Information System (feasible in the longer term).
  - Note on PPPs: authorities’ plans to enter into public-private partnerships could help address infrastructure bottlenecks but require a sound institutional framework to control fiscal risks and maximize benefits.
  - Rationale: will help create fiscal space for fiscal consolidation and higher public investment and targeted social spending.
- Social services and safety net reform
  - Priority reforms: (i) health: rationalizing and expanding health insurance coverage; (ii) education: improving quality of public education including strengthening higher education and vocational training; (iii) pension systems: strengthening financial sustainability and administration of the National Social Security Fund, and creating a new pension system for private sector workers; and (iv) social safety nets: improving targeting to the most needy.
  - Rationale: enhance workforce productivity, strengthen growth prospects, reduce inequalities, and generate political support for fiscal consolidation.
- Investment climate reform
  - Problem drivers: extraordinarily high costs of doing business due mainly to weaknesses in governance, finance, power supply, regulatory systems, and weak contract enforcement.
  - Rationale: a more conducive investment climate is needed to maintain strong growth.
- Financial sector stability assessment
  - Recommendation: conduct a Financial System Stability Assessment (FSSA).
  - Rationale: large financial sector and high prevalence of dollarization make financial stability key for macroeconomic stability.
- Reform of the statistical system
  - Problem: fragmentation and limited ability to provide timely and reliable data; no national data on wages and real estate activity and prices; patchy data on poverty and income distribution.
  - Recommendation: strengthen statistical authorities; implement a statistical master plan and legal reforms; improve national accounts, monetary, price and balance of payments statistics.

### Division of labor: Bank, Fund, and joint responsibilities
- Electricity sector reform
  - Bank: elaborate reform options, draw on “Electricity Strategic Plan” prepared by the Ministry of Energy, provide technical and financial support under new Country Partnership Strategy; focus on priority measures.
- Telecommunications sector reform
  - Bank: support structuring the sector to introduce competition, improve capacity and quality, reduce consumer cost; provide advice and mobilize Institutional Development Fund Grant for Telecommunications Regulatory Authority capacity building; IFC Advisory and Investment may be leveraged if private sector participates.
  - Fund: lead work on taxation and broader budget implications.
- Public financial management reform
  - Bank: providing TA on budget preparation and execution, debt management, and aid coordination through the Emergency Fiscal Management project (EFMIS); macro-fiscal projection and capacity building as part of EFMIS.
  - Fund: TA via METAC to complete Treasury Single Account coverage and cash management; enhance consistency of budget classification and chart of accounts with GFSM 2001; review TA request on payments decentralization.
  - Joint: assist with establishing PPP framework if requested; Fund to build capacity for assessing/containing fiscal risks, Bank to lead on competitive bidding procedures and incentive-based regulation.
- Social services and safety net reform
  - Bank: continue analytical work, provide prioritized policy recommendations, preparing poverty-targeting project, launched a cash transfer pilot.
- Investment climate reform
  - Bank: completed update of survey-based Investment Climate Assessment in March 2010; draft report to government in second half of 2010; national workshop sponsored by the Prime Minister before end-2010 to share results and agree action plan.
- Financial sector stability assessment
  - Bank and Fund: encourage authorities to consider an FSSA update to provide prioritized recommendations.
- Reform of the statistical system
  - Bank: TA on preparation of social statistics (health and education) with poverty analysis focus; assist implementation of a statistical master plan and legal framework reform.
  - Fund: TA focus on national accounts, monetary, price and balance of payments statistics.

### Information-sharing requests
- Fund requests: be kept informed of progress in the Bank’s work in macrocritical structural reform areas. Timing: when milestones are reached (and at least semi-annually).
- Bank requests: be kept informed of the Fund’s assessments of macroeconomic policies and prospects, as well as Fund TA in the reform areas. Timing: in the context of Article IV Consultation and other missions (and at least semi-annually).

### Planned activities and timing (July 2010–June 2011) — selected entries
- Bank work program highlights
  - Country Assistance Strategy: Board Discussion expected in August 2010.
  - Assistance to the Electricity Sector: possible investment lending; Board discussion in April 2011.
  - Technical assistance on public financial management (EFMIS): Implementation through September 2011; project started in May 2009.
  - Survey-Based Investment Climate Assessment (ICA) Update: Completed; Draft report to government in the second half of 2010.
  - Statistics TA (social statistics, poverty analysis): Initiation mission in September 2010; assistance in implementing the statistical master plan; implementation throughout FY2011–12 and FY2010–11 as indicated.
- Fund work program highlights
  - Article IV Consultation: May–June 2010; July 2010.
  - TA missions on Tax Administration, Tax Policy Options, Public financial management, Statistics (national accounts, BOP, PPI), Banking Supervision: April 2010; April–May 2010; ongoing; ongoing; June 2010; June 2010 respectively.
- Joint work program
  - FSAP Update (tentative): timing TBD.

### Annex III — Statistical issues (as of July 2, 2010): assessment of data adequacy
- General assessment
  - Data provision has serious shortcomings that significantly hamper surveillance.
  - Serious weaknesses: national accounts, employment, general government and rest of nonfinancial public sector, and balance of payments.
  - No national data on wages and real estate activity and prices.
  - Poverty and income distribution data are patchy.
  - Recommendation: firm government commitment, high-level support, and allocation of sufficient resources to the Central Administration of Statistics (CAS).
- National accounts
  - Only annual data available, currently until 2008.
  - Compilation is done by a team in the Prime Minister’s office using mostly administrative sources and methods not conforming to best practices.
  - Transfer of national accounts compilation to the CAS and launch of comprehensive economic surveys scheduled for 2011.
  - STA is assisting CAS to build capacity and incorporate the 2004 economic survey data.
- Price statistics
  - Since May 2008 CAS compiles and disseminates a monthly Consumer Price Index (CPI) following internationally accepted methodology.
  - CPI dissemination: within three weeks after the end of the reference month.
  - Geographical coverage expanded to all areas in Lebanon; new CAS index adopted as primary CPI since 2009.
  - Need to develop regular and timely producer prices, wages, and real estate prices statistics.
  - METAC mission scheduled for July 2010 to assist CAS in compiling a producer price index.
- Government finance statistics
  - Coverage is not comprehensive; published monthly central government budgetary accounts omit widespread extra-budgetary activities by public entities, certain transfers, financing data, foreign-financed capital expenditure, and arrears.
  - Some treasury spending is identified only ex-post with lagged economic classification.
  - Government finance statistics are on a cash basis, with a modified cash-basis for budgetary expenditure data corresponding to payment orders.
- Monetary and financial statistics
  - Monetary statistics are adequate.
  - Sectoralization of institutional units and classification of financial instruments reported to STA fall short of Standardized Report Forms (SRFs) requirements.
  - Reporting of monetary data to STA is irregular with a three- to four-month lag, though MCD country team receives it timely.
  - Banque du Liban (BDL) does not publish externally audited financial statements and reporting practices not fully compliant with IFRS.
  - Lack of reliable classification of deposits by residency complicates balance of payments analysis.
- Balance of payments
  - BOP statistics are weak: deficiencies in current account (unrecorded exports; uncertainty in private sector services and workers’ remittances; irregularities in income account), capital account (grants), and financial account (FDI, equity investment in nonbank private sector, and corporate borrowing abroad).
  - BdL implementing new FDI survey forms and amending reporting requirements for banks and non-banks to include more comprehensive BOP breakdowns.
  - Main impediments: lack of effective interagency cooperation and staff constraints at BdL and CAS.

### Data standards and quality
- Participation: General Data Dissemination System since January 2003.
- Metadata and plans for improving real and fiscal statistics need updating.
- No data ROSC is available.

### Table of Common Indicators Required for Surveillance (as of June 15, 2010) — selected entries (dates preserved)
- Exchange Rates: Date of Latest Observation 06/14/10; Date Received 06/15/10; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation 04/2010; Date Received 05/2010; Frequency M M M.
- Reserve/Base Money: 04/2010; 05/2010; M M M.
- Broad Money: 04/2010; 06/2010; M M M.
- Central Bank Balance Sheet: 04/2010; 05/2010; M M M.
- Consolidated Balance Sheet of the Banking System: 04/2010; 06/2010; M M M.
- Consumer Price Index: 04/2010; 05/2010; M M M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: 03/2010; 05/2010; M M M.
- Stocks of Central Government and Central Government-Guaranteed Debt: 03/2010; 04/2010; M M M.
- External Current Account Balance: Q4/2009; 05/2010; Q Q Q.
- Exports and Imports of Goods and Services: Q4/2009; 05/2010; Q Q Q.
- GDP/GNP: 2008; 4/2010; A A A.
- Gross External Debt: 12/2009; 03/2010; M M M.
- Notes on frequencies: D = Daily; W = Weekly; M = Monthly; Q = Quarterly; A = Annually; I = Irregular; NA = Not Available.

*Statement by the Staff Representative on Lebanon, Executive Board Meeting, July 30, 2010.*

### 1.      This statement reports on most recent developments and their impact on the

### This statement reports on most recent developments and their impact on the economic outlook.

### Recent developments and outlook
- The statement complements information in the staff report for the 2010 Article IV Consultation (SM/10/199), issued on July 15, 2010, and does not change the thrust of the staff appraisal.
- Real GDP growth: "Real Gross Domestic Product (GDP) grew by 9 percent last year" and "growth is now expected to reach at least 8 percent this year."
- Inflation: "CPI inflation dropped to 3.5 percent year-on-year in June (May: 4.9 percent)."
- Staff view on interest rates: "Staff remains of the view that the authorities should maintain a pause in the interest reduction cycle to allow pass-through of earlier policy interest cuts." If strong deposit growth persists, "there could be room for a further gradual reduction in policy rates."

### Fiscal developments and recommendations
- Changes to 2010 budget prior to cabinet approval:
  - "The proposed asset revaluation tax was dropped and some minor expenditure increases were added."
  - With these changes, "full implementation of the 2010 budget would imply a primary balance close to zero (instead of a 0.5 percent of GDP surplus, as noted in the staff report)."
- Staff recommendation: "Staff continues to advise the authorities to target a primary balance of at least 2 percent of GDP, which could be achieved by cautiously implementing the budget and saving any revenue overperformance."
- Fiscal performance to date:
  - "The primary balance of the government in the first four months of 2010 reached a surplus of about 1 percent of GDP, more than three times the level achieved in the same period of 2009."
  - Surplus drivers: "substantial tax revenue increases (+16 percent year-on-year) and lower transfers to Electricité du Liban."
  - Fiscal outlook: "Available data indicates that fiscal performance remained strong in May, suggesting that the primary balance floor of 2 percent of GDP recommended by staff for the full year is within reach."
- Executive Directors’ fiscal guidance:
  - "Encouraged the authorities to execute current spending prudently and to save revenue over-performance with the objective of achieving a larger primary surplus in 2010."
  - "Lowering the debt burden... will require a combination of expenditure rationalization and socially balanced tax measures."
  - Specific recommendations: "reduce budgetary transfers to the electricity sector and consider tax measures, including income tax reform and broadening of the VAT."

### Monetary, reserve, and banking sector developments
- Deposits and reserves:
  - "Following a period of substantial moderation, deposit growth picked up in the first half of July, increasing by $1.3 billion (1.3 percent)."
  - "International reserves (excluding gold) reached around $29.7 billion in mid-July, an increase of nearly $400 million since end-June."
  - Historical reserves: "Buoyant capital inflows allowed the Banque du Liban to raise international reserves to record levels (over $29 billion)."
- Monetary policy stance:
  - Authorities have "markedly reduced policy interest rates (by more than 400 basis points since mid-2008 on 5-year Treasury-bills/BdL Certificates of Deposit)."
  - Both staff and Directors "concurred that a pause in interest rate reduction would be advised given the imperfect policy transmission mechanism and uncertain lags in Lebanon."
  - Directors also "supported the recent policy interest rate reductions that moderated the pace of deposit inflows."
- Banking sector soundness:
  - Banks are "profitable, well-capitalized, and highly liquid, with adequate provisions and declining non performing loans (NPL) ratios."
  - 2009 deposit surge: "Commercial bank deposits surged by 23 percent in 2009 and deposit dollarization dropped below 64 percent."
  - Directors called for "continued vigilance, with a focus on preventing excessive risk-taking as high liquidity and declining interest rates are leading banks to increase private sector credit and expand their activity."
  - Cross-border supervision: "BdL and the Banking Control Commission have indeed reinforced cross-border supervision and measures aimed at strengthening the oversight of Lebanese affiliates abroad."

### Structural reforms and policy priorities
- Priority reform areas identified by authorities: "electricity, water, telecoms, urban transport, local development, environment, public education, and social protection."
- Electricity sector:
  - Authorities developed an "electricity sector policy note, which was endorsed by the Cabinet in June 2010," including "an action plan to improve the performance of the sector and to lay the foundation for financial sustainability."
  - World Bank involvement: "The World Bank’s new Country Partnership Strategy will provide technical and financial support to help the government implement its electricity sector strategy, and the authorities plan to mobilize concessional donor support for it."
- Public financial management and transparency:
  - 2010 draft budget law includes "provision in the 2010 draft budget law to cast future budgets in a multi-year framework."
  - Ministry of Finance actions: "preparing a decree to activate the debt management unit" and issuance of "the Quarterly Debt and Debt Markets’ report since Q2 2007."
- Directors’ structural reform guidance: "modernizing tax administration and public financial management, and reforming the electricity, water, and telecommunications sectors" and "underscored the importance of strengthening the Banque du Liban’s balance sheet."

### Executive Board assessment and risks
- Overall assessment: Directors "welcomed Lebanon’s strong economic and financial performance during the global recession" but "cautioned that the underlying vulnerabilities remain large."
- Main vulnerabilities noted:
  - "The fragile political system split along confessional lines" and regional tensions.
  - "The government’s debt remains among the highest in the world, and almost half of it is denominated in foreign currency."
  - "The large banking system depends on short-term deposit inflows from nonresidents to roll over its large exposure to the sovereign."
  - "High loan dollarization" and exposure to "unhedged borrowers."
- Reserve adequacy and costs:
  - Reserve ratios cited: "Lebanon’s ratio of reserves-to-broad money—at about 28 percent in 2009—was below the emerging market median of 33 percent."
  - "The reserve coverage of short-term external debt, currently at 56 percent, remains well-below the 100 percent Greenspan-Guidotti threshold, and the 153 percent median for emerging countries."
  - Directors recommended assessing the pace of reserve accumulation "paying due regard to the need to continue to ensure confidence, while considering the costs of sterilization."

### Key economic indicators (selected figures from 2007–09 table)
- Real GDP (market prices) annual percentage change: 7.5, 9.3, 9.0 (for 2007, 2008, 2009 respectively as presented).
- Consumer prices (period average): 4.1, 10.8, 1.2.
- Central government finances (in percent of GDP):
  - Revenue (including grants): 24.0, 23.8, 24.6.
  - Expenditure: 34.9, 33.4, 32.7.
  - Budget balance (including grants): -10.8, -9.6, -8.1.
  - Primary balance (including grants): 1.7, 1.4, 3.0.
  - Total government debt: 168, 157, 148.
- Monetary sector:
  - Credit to the private sector (annual percentage change): 15.8, 18.5, 15.1.
  - Broad money: 10.9, 15.5, 23.2.
- Interest rates (period average, in percent):
  - Three-month treasury bill yield: 5.2, 5.2, 5.0.
  - Two-year treasury bill yield: 8.7, 8.6, 7.6.
- External sector (in percent of GDP unless otherwise indicated):
  - Current account (excluding official transfers): -7.6, -9.7, -9.7.
  - Foreign direct investment: 7.5, 8.8, 10.7.
  - Total external debt: 194, 172, 171.
  - Gross reserves (excluding gold), in billions of U.S. dollars: 11.5, 18.8, 27.4.
  - In percent of short-term external debt: 29.7, 45.7, 55.2.
  - In percent of total banking system deposits: 17.1, 24.1, 28.6.
- Memorandum items:
  - Nominal GDP (in billions of U.S. dollars): 25.1, 29.9, 34.5.
  - Commercial bank total assets: 328, 315, 334.
  - Local currency per U.S. dollar (period average): 1507.5, 1507.5, 1507.5.
  - Real effective exchange rate (annual average, percent change): -1.0, -3.0, 7.1.
  - Stock market index: 1454, 1182, 1566.
  - EMBI Global - Lebanon (spread; basis points): 493, 794, 293.

*Public Information Notice (PIN) No. 10/139 — IMF Executive Board Concludes 2010 Article IV Consultation with Lebanon*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10306.pdf_