## 1. Spillovers from the Syria Crisis ## Source details **Canonical URL:** [1. Spillovers from the Syria Crisis](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14237.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14237.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14237.pdf.json) --- ### Context, scale, and political environment - Refugee inflows and humanitarian pressure: - Over 1 million refugees have arrived in Lebanon since the onset of the conflict (about one quarter of Lebanon’s population). - Refugees have settled in more than 1,600 locations; in some areas refugees outnumber hosts. - Humanitarian support substantial, but regional and international support to the government and affected host communities has so far been significantly below the authorities’ estimated needs. - Political developments and uncertainty: - It took eleven months to form and ratify (in March) a national unity government. - Parliament failed to elect a new president within the constitutional deadline of May 25; this vacuum could last several months. - Parliamentary elections in November (already postponed from June 2013) add to 2014 uncertainty. - Domestic impasse disrupting legislation, including a debated public sector salary increase causing repeated strikes. ### Macroeconomic vulnerabilities and opportunity - Fiscal and debt pressures: - Public debt on upward trajectory since 2012; public debt one of the highest in the world as a share of GDP. - Fiscal performance worsened; primary balance turned into deficit in 2012. - Financial stability buffers and risks: - Deposit inflows have held up, feeding into commercial banks’ foreign exchange deposits with the Banque du Liban (BdL). - Sovereign–bank nexus (banks hold most government debt and support reserves) provides stability but could amplify shocks. - Policy opportunity: - Improved security conditions recently achieved; stronger fiscal and structural reforms needed to promote sustainable and equitable growth. ### Key statistics (preserved exactly) - Refugee inflows: over 1 million refugees (about one quarter of population). - BdL gross reserves at end-April: $35 billion (about 11 months of imports or 25 percent of broad money). --- ### Real sector, inflation, external balance, and labor market ### Real sector and inflation - Economic growth: - 2012: 2.5 percent - 2013: 1.5 percent - Causes: downturn since 2011; spillovers from the Syria crisis affecting real estate-related activities, construction, and tourism. - Inflation: - Average official CPI for the last two years: 4 percent - Measurement issues: rents not regularly surveyed until recently; rent increases reportedly at least 20 percent last year in areas with refugee settlement. - External current account: - About 13 percent of GDP in both 2012 and 2013. - Trade balance broadly unchanged as imports and exports contracted; exports affected by drop in gold exports and lower exports to the region. - Service balance affected by drop in tourism receipts from the GCC, partly offset by additional spending by non-resident Syrians. - Net current transfers picked up, reflecting significant humanitarian assistance and lower outflows due to Syrian workers supporting relatives in Lebanon. ### Labor market and social impact (Box 1) - Pre-crisis job creation: - Some 3,800 jobs generated per year in 2005–09 (one for every six new entrants to the labor market). - Unemployment and informality: - 2011 unemployment rate: 11 percent (slightly above MENA average of 10 percent). - Youth unemployment: over one third of labor force participants aged 15–24 are unemployed. - Informal sector: around half of the labor force employed in the informal sector. - Impact of refugees on labor: - Labor supply expected to rise by about 50 percent by end-2014. - Refugee unemployment roughly 30 percent. - More than 60 percent of refugees work in low-skilled sectors (agriculture, personal services and construction), accepting much lower wages and putting downward pressure on wages and displacing Lebanese workers. - Unemployment projections and scenarios: - Baseline (assuming gradual return of refugees and 30 percent remaining in 2019): unemployment reduced only marginally, to around 18–19 percent. - Employment elasticity assumptions: - Baseline elasticity: 0.2 - Higher elasticity: 0.5 - Growth assumptions: - Baseline growth: 1.2% average for 2012–14, 3.7% average for 2015–19 - Higher growth: +1.3% for 2015–19 - Finding: higher growth (5–6 percent) would help reduce unemployment but may not bring it significantly below the baseline unless employment elasticity improves. --- ### Fiscal developments, public wages, and electricity ### Fiscal developments and refugee fiscal costs - Fiscal imbalances and debt: - 2012: primary deficit of ¼ percent of GDP (first primary deficit since 2006); public debt-to-GDP ratio increased to 134 percent of GDP. - 2013: public debt rose to 141 percent of GDP; primary deficit reached 1 percent of GDP. - Policy decisions contributing to deterioration: - Introduction of a VAT exemption on gasoil with estimated annual impact of ½ percent of GDP. - Cost of living adjustment for public sector wages with annual cost of 1¼ percent of the 2012 GDP. - Refugee-related fiscal costs: - World Bank estimated overall fiscal impact of the Syria crisis at a cumulative $2.6 billion over 2012–14 (about 6 percent of the 2013 GDP). - An additional $2.5 billion estimated to return public services to their pre-crisis quality. ### Public sector wages (Box 2) — components and fiscal implications - Components of the 2012 wage increase: - (i) increase in the minimum wage; - (ii) application of a cost of living adjustment; - (iii) adoption of a new salary scale (still not passed by parliament). - Minimum wage: - Increased to LL675,000 from LL500,000 (equivalent to $448 and $332, respectively). - Potential fiscal impact if new salary scale approved as per latest draft: - Would add another LL970 billion annually (1.3 percent of the 2014 GDP) to the wage bill. - Wage bill characteristics: - Wage bill absorbs more than 30 percent of government revenue. - Central government employees receive about twenty different allowances and indemnities in addition to basic salary; on average these represent about one third of basic salary spending. - Over 2003–12, allowances and indemnities amounted to an average of 2.7 percent of GDP, bringing total personnel costs to around 10 percent of GDP. - Pension implications: - Pensions adjusted in line with salary increases granted to those in active duty and not just to reflect cost of living adjustments. - Pension benefits also granted to surviving spouses and unmarried, divorced or widowed daughters of retirees if unemployed. - Measures proposed to mitigate costs: - Revenue measures (discussed elsewhere). - Increase working hours in the public administration from 32 to 35 per week. - Other measures originally proposed (reducing maximum overtime hours; capping bonuses and benefits; revising years of service for retirement eligibility) currently not under consideration. ### Electricity sector (Box 4) — size of subsidy and reform implications - EdL transfers and performance: - Government transferred 4.5 percent of GDP to Electricité du Liban (EdL) in 2013. - Tariffs unchanged since 1996 (when the price of oil was $23 per barrel). - Installed generating capacity: 2,019 MW; peak demand: 3,195 MW. - Supply covers some 18 hours per day on average. - Close to half of total electricity production costs are not recovered (15 percent in technical losses; about 30 percent in non-technical losses). - Seventy five percent of Lebanese firms identify electricity as a major constraint to business operations (compared to 52 percent in the MENA region). - Reform and projections: - Plan to increase production to 4,000 MW by 2014 (estimated cost $6.5 billion) with government and private funding. - Transfers to EdL (In percent of GDP): 2013: 4.5; 2014: 4.3; 2015: 4.0; 2016: 3.7; 2017: 3.2; 2018: 3.0; 2019: 2.9 - Potential average tariff increase from 9 cents/kwh to 15 cents/kwh would change transfers by -0.9, -0.8, -0.8, -0.8, -0.8 (across projection years). - Switching to gas would generate savings of 0.2 percent of GDP. - Policy conclusion: - Raising average EdL tariff toward cost recovery levels would reduce transfers by an additional 0.8 percent of GDP in a sustainable way. - Ministry of Energy and EdL prepared a tariff simplification and protection proposal (with World Bank assistance) that would safeguard lower-end consumers; proposal has not been acted upon. --- ### Financial sector, BdL actions, and sovereign financing ### BdL operations and financial-market indicators - BdL and government financing: - BdL continued to attract banks’ foreign exchange deposits, keeping gross reserves at $35 billion at end-April. - On the pound side, BdL offered banks long-term deposits with yields generally matching T-bills and channeled liquidity to cover demand shortfalls in T-bill auctions. - On the foreign currency side, BdL increasingly provided funding to the government, impacting its net foreign exchange position; government overdraft with BdL reached $6.6 billion at end-April (about 14 percent of GDP). - BdL stimulus and credit support: - BdL provided $1 billion in low-cost funds to banks to on-lend to specific sectors. - BdL launched another stimulus plan of about $800 million and a new scheme for banks of about $400 million to invest in start-ups. - Financial indicators and ratings: - Deposits growth: 7–8 percent a year, with occasional outflows. - Dollarization: declined in 2012, then on an upward trend reaching 65.8 percent at end-April. - Eurobond spreads moved in line with regional averages and stand at levels similar to end-2011. - Standard & Poor’s upgraded the outlook in April from negative to stable, maintaining the sovereign and three largest banks at B-. ### Sovereign financing needs (IMF staff estimates and projections) - Fiscal and external financing needs (Est. 2013; Proj. 2014; Proj. 2015): - Fiscal financing needs 1 (In percent of GDP): 5.3, 6.5, 5.6 - Fiscal financing needs 1 (In percent of GDP) — alternative row: 11.9, 13.8, 11.1 - Fiscal financing needs 2 (In percent of GDP): 13.5, 14.9, 14.8 - Fiscal financing needs 2 (In percent of GDP) — alternative row: 30.0, 31.5, 29.2 - External financing needs 3 (B+C) (In percent of GDP): 69.0, 75.0, 80.3 - External financing needs 3 (B+C) (In percent of GDP) — alternative row: 153.3, 158.4, 158.5 - Current account deficit B (In percent of GDP): 5.8, 5.9, 6.2 - Amortization scheduled C (In percent of GDP): 63.2, 69.1, 74.2 - of which: Nonresident deposits (In percent of GDP): 53.9, 60.2, 65.1 ### Banking sector resilience and policy recommendations - Banking sector conditions: - Banks resilient but environment increasingly challenging. - Nonperforming loans (NPLs) slightly increased but remain low; loans under watch have increased; provisioning on NPLs has decreased. - Banks’ profitability deteriorated, with average return on assets about 1 percent. - Liquidity buffers, including large deposits with the BdL, are strong. - Banks’ exposure to the sovereign continued to increase; banking sector almost fourfold the size of GDP. - Regulatory recommendations: - Capital buffers should be further strengthened given banks’ large exposure to the sovereign. - BdL requires by end-2015 an additional capital buffer of 1.5 percent on top of the Basel III minimum plus a 2.5 percent conservation buffer. - Improve loan classification and restructuring rules (tighter rules on NPL classification, re-aging of overdrafts and arrears). - Continue to enhance supervision (e.g., supervisory colleges for cross-border supervision). - BdL auction and reserve recommendations: - Staff encouraged BdL to gradually withdraw from T-bill auctions to encourage banks to invest in government paper. - Regularize issuances of T-bills with maturities longer than 7 years; make the T-bill auction process more transparent. - Maintain a high level of reserves but address strained BdL balance sheet from reserve accumulation and sterilization costs. --- ### Staff scenarios, proposed adjustment, and debt dynamics ### Staff’s Proposed Adjustment Scenario — fiscal adjustment and debt path - Main features: - Bulk of adjustment would come from revenue—particularly from under-tapped VAT potential—while spending remains broadly unchanged as a share of GDP but rebalanced toward higher capital and social spending. - Primary position would turn into surplus as early as 2015, and reach 2½-3 percent of GDP over the medium term. - Confidence effects would drive a rebound in private investment; higher-quality spending and electricity reform would enhance medium-term prospects. - Public debt would be put on a downward path, though would still remain above 130 percent of GDP by 2019. - Key fiscal statistics under Staff's Proposed Adjustment Scenario (In percent of GDP; 2011–2019): - Revenue, of which: 22.8 22.3 20.9 20.9 23.1 23.2 24.4 24.7 24.8 - VAT revenues: 5.5 5.1 4.9 4.9 6.1 6.1 7.3 7.4 7.5 - Total spending: 29.1 31.1 30.2 31.5 31.5 31.5 31.1 31.5 31.2 - Capital spending: 1.6 1.6 1.8 2.6 2.7 2.6 2.9 3.1 3.3 - Overall balance: -5.9 -8.6 -9.2 -10.6 -8.4 -8.3 -6.7 -6.9 -6.3 - Primary balance: 3.5 -0.2 -0.8 -1.9 0.8 1.0 2.7 2.3 2.9 - Public debt: 134 134 141 145 144 142 138 135 132 - Memorandum: Real GDP growth rate: 2.0 2.5 1.5 1.8 3.0 4.5 4.5 5.0 5.0 ### Debt sustainability assessments and stress tests (Annex I & II) - Public debt and financing risks: - Public debt already exceeding 140 percent of GDP and gross financing needs around 30 percent of GDP create significant risks. - Baseline: public debt-to-GDP rises from 141 percent in 2013 to 155 percent in 2019. - Gross financing needs rise to 40 percent of GDP in 2017 and exceed 30 percent of GDP over the projection period. - Stress test outcomes (selected): - Growth shock (one standard deviation decline in growth for 2015 and 2016): debt-to-GDP ratio reaches almost 172 percent in 2019. - Interest rate shock (200 basis points): debt-to-GDP ratio reaches 164 percent at end of projection horizon; financing needs reach 44 percent of GDP in 2019. - Combined macro-fiscal shock: debt-to-GDP ratio exceeds 187 percent at end of horizon; financing needs reach 50 percent of GDP in 2019. - Contingent liability shock (10 percent of financial sector assets): debt-to-GDP ratio exceeds 190 percent at end of horizon; financing needs exceed 45 percent of GDP in 2019. - External debt (Annex II) key findings: - External debt estimated at 174 percent of GDP at end-2013. - Bulk of external debt (about 77 percent) accounted for by short-term nonresident deposits in the banking sector. - Baseline: external debt increases to 181.4 percent of GDP by 2019. - Gross external financing needs (in percent of GDP): 2013: 154.2; 2014: 158.8; 2015: 158.7; 2016: 159.7; 2017: 162.4; 2018: 163.8; 2019: 166.2 - Sensitivity to exchange rate shocks: - A one-time real depreciation of 30 percent in 2015 would raise debt level on impact to 276 percent of GDP. --- ### Structural reforms, data, AML/CFT, and policy recommendations ### Structural reforms and growth priorities - Overarching objective: - Advance structural reforms to raise growth potential, create jobs, and reduce poverty. - Staff recommendations: - Lower the cost of doing business, improve services (particularly electricity), promote jobs, and strengthen social safety nets. - Modernize labor market legislation over time and improve compliance to limit informality. - Increase private sector participation in infrastructure; passage of PPP framework law awaiting parliament. - Immediate poverty measures: cash-for-work programs, micro-finance, local economic development plans for affected communities. ### AML/CFT and financial-sector integrity - Staff encouraged progress on AML/CFT regime: - Better understanding of source of deposits and identification of beneficial owners. - Take legislative steps to bring AML law and related legislation in line with revised international standards. - Authorities’ view: - Authorities considered Lebanon’s AML/CFT regime in practice fully compliant and noted active cooperation by the Special Investigation Commission. ### Data and statistical capacity - Progress and shortcomings: - CAS released a new CPI index in March with Fund assistance; national accounts production transferred to CAS; quarterly national accounts under preparation. - Significant shortcomings remain in national accounts and external sector statistics; fiscal data release delays. - Monetary statistics adequate but sectoralization and classification issues exist; BdL does not publish externally-audited financial statements and reporting not fully IFRS-compliant. - Staff recommendations: - Address delays in fiscal data release; ensure adequate and stable funding and high-level support for CAS; improve inter-agency cooperation; strengthen balance of payments and IIP data. ### IMF staff high-level policy priorities (summary) - Fiscal: - Adopt comprehensive, balanced, multi-year fiscal strategy to achieve sustainable debt reduction; reestablish primary surpluses. - Contain salary scale adjustment costs (phase in increases, no retroactive payments, tie to performance, factor pension costs). - Rebalance spending away from EdL transfers into capital and social outlays; broaden tax base; strengthen revenue collection; combat evasion and corruption. - Monetary and BdL: - Maintain peg-supporting monetary stance and high reserves. - As fiscal consolidation proceeds, BdL should gradually withdraw from T-bill auctions; increase T-bill rate flexibility and transparency. - Strengthen BdL balance sheet and address sterilization and quasi-fiscal costs. - Financial sector: - Strengthen capital buffers; improve loan classification and restructuring rules; enhance AML/CFT framework. - Structural and social: - Urgently implement electricity sector reform, including tariff moves toward cost recovery with protection for vulnerable groups. - Advance structural reforms to unlock growth and address social needs. - Refugee crisis: - Renew efforts to secure donor assistance; formulate a comprehensive refugee strategy; strong government policies and fiscal discipline to mobilize budget support. --- ### Risk Assessment Matrix — selected high-probability threats and recommended responses - Continued spillovers from Syria crisis and prolonged refugee crisis: - Likelihood/Time Horizon/Expected Impact: High/Short to Medium Term/High - Recommended response: Secure donor assistance; formulate comprehensive refugee strategy; strengthen fiscal transparency and undertake fiscal consolidation; maintain high reserves; strengthen banks’ capital buffers. - Further weakening of public finances: - Likelihood/Time Horizon/Expected Impact: High/Short Term/High - Recommended response: Secure parliamentary approval of 2014 budget consistent with generating primary fiscal surpluses; reinvigorate electricity sector reform; gradually increase tariffs while protecting lower-tier consumers; maintain high reserves; strengthen banks’ capital buffers. - Global risk — surges in global financial volatility: - Likelihood/Time Horizon/Expected Impact: High/Medium Term/Medium - Recommended response: Strengthen fiscal discipline; maintain high reserves; strengthen banks’ capital buffers. --- *Source: IMF staff summary and excerpts from content unit _cr14237 (IMF staff report excerpts).* ### 1. Spillovers from the Syria Crisis ___________________________________________________________________6 ### 1. Spillovers from the Syria Crisis ### Context and scale of the shock - Over 1 million refugees have arrived in Lebanon since the onset of the conflict, amounting to about one quarter of Lebanon’s population. - Refugees have settled throughout the country in more than 1,600 locations; in some areas the number of refugees is now larger than the host population. - Security has been severely affected; local communities and public services have been strained. - Humanitarian support for refugees has been substantial, though regional and international support to the government and affected host communities has so far been significantly below the authorities’ estimated needs. ### Political environment - It took eleven months to form and ratify (in March) a national unity government. - Parliament failed to elect a new president within the constitutional deadline of May 25; this vacuum could last several months. - Parliamentary elections in November (already postponed from June 2013) add to the uncertainty in 2014. - Domestic political impasse is disrupting efforts to pass legislation, including a much debated public sector salary increase that is causing repeated strikes. ### Macroeconomic vulnerabilities and opportunity - Fiscal performance has worsened; public debt—already one of the highest in the world as a share of GDP—has been on an upward trajectory since 2012. - Deposit inflows have held up, feeding into commercial banks’ foreign exchange deposits with the Banque du Liban (BdL)—the main source of reserves—and helping to fund the government. - The sovereign–bank nexus (banks hold most government debt and support reserves) continues to provide stability but could amplify shocks. - The government has an opportunity to change course: improved security conditions have been achieved recently, but stronger fiscal and structural reforms are needed to promote sustainable and equitable growth. ### Key statistics (preserved exactly as in source) - Refugee inflows: over 1 million refugees (about one quarter of population). - BdL gross reserves at end-April: $35 billion (about 11 months of imports or 25 percent of broad money). ### IMF/mission framing - The 2014 Article IV Consultation discussed the multi-faceted and prolonged pressures and identified areas for change. --- ### Real sector, inflation, and external balance - Economic growth: - 2012: 2.5 percent - 2013: 1.5 percent - Causes: downturn since 2011; spillovers from the Syria crisis affecting real estate-related activities, construction, and tourism. - Inflation: - Average official CPI for the last two years: 4 percent - Measurement issues: rents were not regularly surveyed until recently; rent increases reportedly at least 20 percent last year in areas with refugee settlement. - External current account deficit: - About 13 percent of GDP in both 2012 and 2013. - Trade balance broadly unchanged as a share of GDP as imports and exports contracted (exports affected by a drop in gold exports and lower exports to the region). - Service balance affected by a drop in tourism receipts from the GCC countries, partly offset by additional spending by non-resident Syrians. - Net current transfers have picked up, reflecting significant humanitarian assistance and lower outflows due to Syrian workers supporting relatives in Lebanon. --- ### Fiscal developments and pressures - Fiscal imbalances: - 2012: primary deficit of ¼ percent of GDP (first primary deficit since 2006); public debt-to-GDP ratio increased to 134 percent of GDP. - 2013: public debt rose to 141 percent of GDP; primary deficit reached 1 percent of GDP. - Policy decisions contributing to deterioration: - Introduction of a VAT exemption on gasoil with an estimated annual impact of ½ percent of GDP. - A cost of living adjustment for public sector wages with an annual cost of 1¼ percent of the 2012 GDP. - Refugee-related fiscal costs: - World Bank estimated overall fiscal impact of the Syria crisis at a cumulative $2.6 billion over 2012–14 (about 6 percent of the 2013 GDP). - An additional $2.5 billion estimated to return public services to their pre-crisis quality. --- ### Labor market and social impact (Box 1) - Pre-crisis job creation: some 3,800 jobs were generated per year in 2005–09 (one for every six new entrants to the labor market). - Unemployment: - 2011 unemployment rate: 11 percent (slightly above MENA average of 10 percent). - Youth unemployment: over one third of labor force participants aged 15–24 are unemployed. - Informal sector: around half of the labor force employed in the informal sector. - Impact of refugees: - Labor supply expected to rise by about 50 percent by end-2014. - Refugee unemployment roughly 30 percent. - More than 60 percent of refugees work in low-skilled sectors (agriculture, personal services and construction), accepting much lower wages and putting downward pressure on wages and displacing Lebanese workers. - Unemployment projections and scenarios: - Under the baseline scenario (assuming gradual return of refugees and 30 percent remaining in 2019), unemployment would be reduced only marginally, to around 18–19 percent. - Scenarios show that higher growth (5–6 percent) would help reduce unemployment but may not bring it significantly below the baseline unless employment elasticity improves. - Baseline elasticity: 0.2 - Higher elasticity: 0.5 - Baseline growth: 1.2% average for 2012–14, 3.7% average for 2015–19 - Higher growth: +1.3% for 2015–19 --- ### Financial markets, BdL actions, and sovereign financing - T-bill and yield developments: - Government raised interest rates on T-bills with maturity shorter than 7 years in March 2012 by 50 basis points. - Government has kept rates on existing maturities unchanged afterward, resorted to infrequent issuances of longer-term higher-yielding T-bills and relied on BdL purchases on the primary market. - BdL operations and balance sheet effects: - BdL continued to attract banks’ foreign exchange deposits, keeping gross reserves at $35 billion at end-April. - On the pound side, BdL offered banks long-term deposits with yields generally matching T-bills with similar maturities and channeled liquidity to cover demand shortfalls in T-bill auctions. - On the foreign currency side, BdL increasingly provided funding to the government, impacting its net foreign exchange position. - BdL supported private sector credit (still growing at an annual rate of 10 percent) by providing $1 billion in low-cost funds to banks to on-lend to specific sectors. - BdL launched another stimulus plan of about $800 million and a new scheme for banks of about $400 million to invest in start-ups. - Financial indicators and ratings: - Deposits growth: 7–8 percent a year, with some occasional outflows. - Dollarization: declined in 2012, then on an upward trend reaching 65.8 percent at end-April. - Eurobond spreads moved in line with regional averages and stand at levels similar to end-2011. - Standard & Poor’s upgraded the outlook in April from negative to stable, maintaining the sovereign and three largest banks at B-. --- ### Public sector wages (Box 2) - Components of the 2012 wage increase: - (i) increase in the minimum wage; - (ii) application of a cost of living adjustment; - (iii) adoption of a new salary scale (still not passed by parliament). - Minimum wage: - Increased to LL675,000 from LL500,000 (equivalent to $448 and $332, respectively). - Potential fiscal impact if the new salary scale is approved as per the latest draft: - Would add another LL970 billion annually (1.3 percent of the 2014 GDP) to the wage bill. - Public wage bill characteristics: - Wage bill absorbs more than 30 percent of government revenue. - Central government employees receive about twenty different allowances and indemnities in addition to basic salary; on average these represent about one third of basic salary spending. - Over 2003–12, allowances and indemnities amounted to an average of 2.7 percent of GDP, bringing total personnel costs to around 10 percent of GDP. - Pension implications: - Pensions are adjusted in line with salary increases granted to those in active duty and not just to reflect cost of living adjustments. - Pension benefits are also granted to surviving spouses and unmarried, divorced or widowed daughters of retirees if unemployed, extending the period over which pension benefits are drawn. - Measures proposed to mitigate costs: - Revenue measures (discussed elsewhere in the text). - Increase working hours in the public administration from 32 to 35 per week. - Other originally proposed measures (reducing maximum overtime hours; capping bonuses and benefits as a share of total monthly salaries; revising years of service for retirement eligibility) are currently not under consideration. --- ### Summary findings and implications - The Syria crisis has produced substantial humanitarian and economic spillovers in Lebanon, including: - Large refugee inflows (over 1 million) with material fiscal, labor market, and public service impacts. - Worsening fiscal balances and a re-acceleration of public debt (134 percent of GDP in 2012; 141 percent of GDP in 2013). - Weak growth: 2.5 percent in 2012 and 1.5 percent in 2013. - A large external current account deficit of about 13 percent of GDP in both 2012 and 2013. - Despite strains, financial stability indicators have shown resilience supported by deposit inflows and BdL interventions; however BdL operations have further weakened its balance sheet. - Policy trade-offs: addressing public sector wage pressures and refugee-related fiscal needs against limited fiscal space, high public debt, and the need to preserve macro-financial stability. *Source: IMF staff summary of “1. Spillovers from the Syria Crisis” (content unit: _cr14237 - 1. Spillovers from the Syria Crisis).* ### Box 3. Policies Since the 2011 Article IV Consultation ### Box 3. Policies Since the 2011 Article IV Consultation ### Macroeconomic policy and structural reform implementation - Macro policies partly followed staff advice: 2011 consultation called for fiscal discipline (preserving a primary surplus) and reducing the public debt-to-GDP ratio. - Fiscal position deteriorated substantially starting in 2012: - A primary deficit was recorded in 2012 for the first time since 2006, reflecting weak growth and expansionary measures (reduction of excises, removal of VAT on gasoil, public sector wage increases). - In line with staff recommendations, in 2012 the authorities raised interest rates on T-bills with maturities less than seven years to reduce the budget’s reliance on BdL financing. - Structural reform progress: - Positive: approval of the capital markets law; continued strong bank supervision; initial steps toward exploring offshore oil and gas reserves. - Institutional: Ministry of Finance established a macro-fiscal unit (produced a medium-term expenditure framework) and a public debt directorate (developed a Medium-Term Debt Strategy). - Electricity sector: some progress implementing the comprehensive electricity sector strategy; investment to increase capacity is welcome but will require future tariff increases toward cost recovery to reduce subsidies once provision rises. - Slow or weak: telecommunication reform, the global income tax, Treasury Single Account, and statistical information provision (though some progress in areas). ### Outlook and risks - Principal risk: Lebanon’s exposure to developments in Syria; risks would be amplified by a lack of corrective policies. - Staff baseline assumptions for projections: - Without a resolution in Syria, growth likely to linger at around 2 percent in the near term. - For projection purposes, staff assumes the Syria conflict will be resolved by 2016, when growth will return to potential: a moderate 4 percent, and refugees will start gradually returning to Syria. - Inflation is projected to pick up later this year and next year, reflecting the impact of a planned wage increase. - Current account deficit projected to decline only slightly over the medium term as a rebound in exports will be largely offset by higher imports. - Financing needs would remain high, reflecting large fiscal and current account deficits. - Downside risks (Risk Assessment Matrix): - Syria-related spillovers are the most serious threat. - Domestic risks: further weakening of fiscal policies; delays in structural reforms. - External risks: higher-than-expected increase in global interest rates. - Possible outcomes of materialized risks: dampened growth; higher government financing costs; adverse effects on debt dynamics; loss of confidence feeding negative loops to deposits, dollarization, and reserves. - Additional concerns: prolonged refugee crisis straining public services (added budget costs, pressure on labor and housing markets, law and order); failure to address infrastructure bottlenecks reducing competitiveness and growth potential; higher global rates forcing tighter domestic monetary policy and raising financing costs for government and banks. - Authorities’ views: - Broadly shared staff’s outlook and risks; agreed Syria spillovers are the most serious risk. - High concern about refugee impacts, especially if significant donor budget support fails to materialize; noted lack of government strategy on refugees and discussions on revisiting the open border policy. - Authorities remained confident in Lebanon’s resilience: stable deposits and BdL’s large reserve buffer; noted upside potential from Lebanon’s possible involvement in Syria’s post-conflict reconstruction. ### Financing needs and key indicators (selected IMF staff estimates and projections) - Fiscal and external financing needs (Est. 2013; Proj. 2014; Proj. 2015): - Fiscal financing needs 1 (In percent of GDP): 5.3, 6.5, 5.6 - Fiscal financing needs 1 (In percent of GDP) — alternative row: 11.9, 13.8, 11.1 - Fiscal financing needs 2 (In percent of GDP): 13.5, 14.9, 14.8 - Fiscal financing needs 2 (In percent of GDP) — alternative row: 30.0, 31.5, 29.2 - External financing needs 3 (B+C) (In percent of GDP): 69.0, 75.0, 80.3 - External financing needs 3 (B+C) (In percent of GDP) — alternative row: 153.3, 158.4, 158.5 - Current account deficit B (In percent of GDP): 5.8, 5.9, 6.2 - Amortization scheduled C (In percent of GDP): 63.2, 69.1, 74.2 - of which: Nonresident deposits (In percent of GDP): 53.9, 60.2, 65.1 - Sources: National authorities; and IMF staff calculations. - Notes: - 1/ General government fiscal deficit (excl. grants) plus general government external amortization. - 2/ General government fiscal deficit (excl. grants) plus general government domestic and external amortization. - 3/ Current account deficit plus total external amortization (incl. nonresident deposits). - Lebanon: Main Fiscal Indicators Under Baseline Scenario (In percent of GDP; selected rows, 2011–2019) - Revenue, of which: 22.8, 22.3, 20.9, 20.8, 21.8, 21.9, 22.0, 22.2, 22.1 - Income tax on profits: 1.7, 1.6, 1.4, 1.4, 1.6, 1.6, 1.6, 1.6, 1.6 - Income tax on interest income: 1.1, 1.0, 1.0, 1.0, 1.4, 1.5, 1.6, 1.7, 1.8 - VAT revenues: 5.5, 5.1, 4.9, 4.8, 4.8, 4.8, 4.8, 4.8, 4.8 - Excises: 2.3, 2.2, 2.0, 1.9, 2.0, 2.0, 2.0, 2.0, 2.0 - Total spending: 29.1, 31.1, 30.2, 32.0, 33.7, 33.2, 32.9, 33.1, 33.4 - Current spending, of which: 27.5, 29.5, 28.4, 29.4, 31.1, 31.1, 30.8, 30.9, 31.2 - Personnel costs: 9.2, 10.4, 9.5, 10.2, 11.5, 11.5, 11.5, 11.5, 11.5 - Transfers to the EdL: 4.2, 5.2, 4.5, 4.3, 4.0, 3.7, 3.2, 3.0, 2.9 - Interest payments: 9.4, 8.4, 8.4, 8.7, 9.4, 9.7, 10.1, 10.4, 10.7 - Capital spending: 1.6, 1.6, 1.8, 2.6, 2.7, 2.2, 2.2, 2.2, 2.2 - Overall balance: -5.9, -8.6, -9.2, -11.1, -11.9, -11.4, -11.0, -10.9, -11.3 - Primary balance: 3.5, -0.2, -0.8, -2.4, -2.5, -1.7, -0.9, -0.6, -0.5 - Public debt: 134, 134, 141, 145, 148, 149, 151, 153, 155 - Memorandum items: - Real GDP growth rate: 2.0, 2.5, 1.5, 1.8, 2.5, 4.0, 4.0, 4.0, 4.0 - GDP deflator growth rate: 3.4, 4.6, 3.2, 3.4, 4.4, 2.9, 2.3, 2.3, 2.4 - Sources: Lebanese authorities; and IMF staff estimates. ### Fiscal pressures and policy discussion - Main near-term spending pressures: - Salary scale adjustment for the public sector with estimated cost (excluding pensions) of 1.3 percent of the 2014 GDP on a permanent basis. - Staff assumed the salary increase will start being paid in the second half of 2014, with retroactive payment as of July 1, 2014 and no installments, as proposed by the latest parliamentary committee. All accompanying revenue measures would be implemented on January 1, 2015. - Ongoing capital projects in the electricity sector: about 1 percent of GDP. - Additional social spending related to Syrian refugees: about 0.3 percent of GDP through 2016. - Transfers to EdL projected to decline largely on account of lower oil prices, but staff cautioned these savings are uncertain and not a reliable offset without electricity sector reforms and tariff increases (tariffs unchanged since 1996). - Revenue measures approved to date and estimated yield: - Measures include: (i) increase in interest income tax rate from 5 to 7 percent; (ii) increase in corporate income tax rate from 15 to 17 percent; (iii) new capital gain tax on real estate transactions; (iv) increases in tobacco excises; (v) increases in various stamps and fees. - Staff estimated the measures’ annual yield at around 1 percent of the 2015 GDP. - Other options under discussion: increases in the VAT rate from 10 to 11 percent, and to 15 percent for selected luxury items; application of penalties on illegal seashore buildings. - Public debt trajectory on current policies (staff scenario): - Budget deficit would rise to about 12 percent of GDP in 2015, largely reflecting the salary scale adjustment, and remain broadly at that level afterwards. - Primary position would reach a deficit of 2.5 percent of GDP in 2015, then gradually improve but remain negative. - Under this scenario, debt and financing needs would continue to rise, reaching 155 percent and 40 percent of GDP, respectively. ### Electricity sector (Box 4) — role in fiscal outlook and reform options - Size of electricity subsidy and performance: - The government transferred 4.5 percent of GDP to Electricité du Liban (EdL) in 2013. - Electricity tariffs have remained unchanged since 1996 (when the price of oil was $23 per barrel). - EdL’s production inefficiencies and insufficiencies: - Close to half of total electricity production costs are not recovered (15 percent in technical losses; about 30 percent in non-technical losses). - Installed generating capacity: 2,019 MW; peak demand: 3,195 MW. - Supply covers some 18 hours per day on average, with frequent blackouts. - Back-up private generators cost about three times the level of EdL tariffs. - Seventy five percent of Lebanese firms identify electricity as a major constraint to business operations (compared to 52 percent in the MENA region). - Reform history and actions: - 2011 “Policy Paper for the Electricity Sector” aimed to increase production to 4,000 MW by 2014, estimated cost $6.5 billion, to be funded equally by government and private sector; plan included generation/transmission/distribution upgrades, fuel diversification to natural gas, new tariff structure, and legal revisions including corporatization. - Some progress: building a new power plant; rehabilitating existing ones; launching a Liquefied Natural Gas Public-Private Partnership; three private distribution service providers started operations; two power barges rented to supplement production. - Refugee demand estimated to equal roughly the electricity supplied by the barges, offsetting expected supply improvements. - Projections and reform impact: - On current policies, transfers to EdL expected to decline due to decreasing oil prices; these declines account for a large reduction in transfers (0.6 percent of GDP in the medium term) but are not sustainable savings. - Transfers to EdL (In percent of GDP): 2013: 4.5; 2014: 4.3; 2015: 4.0; 2016: 3.7; 2017: 3.2; 2018: 3.0; 2019: 2.9 - Change in EdL transfers, of which: -0.2, -0.5, -0.8, -1.3, -1.4, -1.5 (across projection years) - Effect of fuel type switch: 0.0, 0.0, 0.0, -0.2, -0.2, -0.2 - Effect of changes in oil prices: 0.0, -0.1, -0.3, -0.5, -0.6, -0.6 - Effect of changes in GDP deflator: -0.1, -0.3, -0.4, -0.5, -0.6, -0.7 - Memorandum: Potential average tariff increase from 9 cents/kwh to 15 cents/kwh would change transfers by -0.9, -0.8, -0.8, -0.8, -0.8 (across projection years); switching to gas would generate savings of 0.2 percent of GDP. - WEO oil prices (selected projection values): 104.1, 104.2, 97.9, 93.0, 90.0, 88.1, 86.6 (across years shown). - Policy conclusion on electricity: - Raising the average EdL tariff toward cost recovery levels would reduce transfers by an additional 0.8 percent of GDP—and in a more sustainable way. - Ministry of Energy and EdL prepared a tariff simplification and protection proposal (with World Bank assistance) that would safeguard lower-end consumers; the proposal has not been acted upon. ### IMF staff recommendations and policy priorities - Fiscal framework and transparency: - Passing a budget is a necessary initial step to anchor fiscal policy; staff welcomed Ministry of Finance’s renewed efforts to close earlier accounts as a precondition for parliamentary consideration of a 2014 budget. - Containing salary scale adjustment costs: - At minimum, phase in salary increases in installments and without retroactive payments, and base increases on clear performance measures. - Factor in all costs of the scale adjustment, including on pensions. - Adopt measures to increase public sector productivity; pursue civil service reform, recognizing it will take time and political will. - Electricity sector reform: - Reforming electricity tariffs is key to sustainably reducing transfers to EdL. - Staff endorsed tariff reform (simplify structure, increase average level toward cost recovery while protecting lower-tier consumers) and urged proper funding, monitoring, and execution of gas-switching and generation projects. - Noted tariff reform implementation is subject to cabinet decision and could proceed regardless of parliamentary schedule. - Rebalancing spending: - Scope to increase capital spending to support growth and reduce infrastructure gaps, starting with planned electricity projects. - Increase social spending, including via the National Poverty Targeting Program, to reduce poverty and address social needs. - Revenue policy: - Revenue measures should be equitable and minimize distortions. - Staff welcomed efforts to broaden tax bases; regretted that removal of the VAT exemption on gasoil was not pursued. - Advised against multiple VAT rates to avoid complicating tax administration. - Proposed a gradual increase of the overall VAT rate to 12 percent in 2015 and 15 percent in 2017, in line with past Fund advice. - Noted the VAT’s sizeable tax base (consumption is about 90 percent of GDP), its efficiency, and ease of administration. - Recommended avoiding double taxation and limiting reliance on fees and stamps, which likely generate low yields and complicate the tax system. *Source: Box 3. Policies Since the 2011 Article IV Consultation, IMF staff report excerpt.* ### 25. Staff’s proposed adjustment would reverse the debt dynamics. The bulk of the ### _cr14237 - 25. Staff’s proposed adjustment would reverse the debt dynamics. The bulk of the ### Fiscal adjustment and debt dynamics - Staff’s proposed adjustment would reverse the debt dynamics. - The bulk of the adjustment would come from revenue—and particularly from the still under-tapped VAT potential—while spending would remain broadly unchanged as a share of GDP, though with a composition rebalanced in favor of higher capital and social spending. - The primary position would turn into surplus as early as 2015, and reach 2½-3 percent of GDP over the medium term. - Expected growth dividends from the adjustment: - Confidence effects would drive a rebound in private investment. - Medium-term enhancement from higher-quality spending and electricity sector reform. - Public debt trajectory under the scenario: - Public debt would be put on a downward path, though would still remain above 130 percent of GDP by 2019. ### Key fiscal statistics under Staff's Proposed Adjustment Scenario (In percent of GDP; unless otherwise indicated) - Period labels: 2011 2012 2013 2014 2015 2016 2017 2018 2019 (Act. Act. Est. Proj. Proj. Proj. Proj. Proj. Proj.) - Revenue, of which: 22.8 22.3 20.9 20.9 23.1 23.2 24.4 24.7 24.8 - Income tax on profits: 1.7 1.6 1.4 1.4 1.6 1.6 1.6 1.7 1.8 - Income tax on interest income: 1.1 1.0 1.0 1.0 1.3 1.4 1.5 1.6 1.6 - Income tax on capital gains and dividends: 0.4 0.5 0.3 0.3 0.5 0.5 0.5 0.5 0.5 - VAT revenues: 5.5 5.1 4.9 4.9 6.1 6.1 7.3 7.4 7.5 - Excises: 2.3 2.2 2.0 1.9 2.3 2.3 2.3 2.3 2.3 - Other taxes 1/: 0.8 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 - Total spending: 29.1 31.1 30.2 31.5 31.5 31.5 31.1 31.5 31.2 - Current spending, of which: 27.5 29.5 28.4 28.9 28.9 28.9 28.2 28.4 27.9 - Personnel costs: 9.2 10.4 9.5 9.5 10.2 10.4 10.4 11.1 10.7 - Transfers to the EdL: 4.2 5.2 4.5 4.3 3.1 2.8 2.0 1.8 1.8 - Other current 2/: 4.7 5.5 6.0 6.3 6.3 6.3 6.3 6.3 6.3 - Interest payments: 9.4 8.4 8.4 8.7 9.3 9.3 9.3 9.2 9.2 - Capital spending: 1.6 1.6 1.8 2.6 2.7 2.6 2.9 3.1 3.3 - Overall balance: -5.9 -8.6 -9.2 -10.6 -8.4 -8.3 -6.7 -6.9 -6.3 - Primary balance: 3.5 -0.2 -0.8 -1.9 0.8 1.0 2.7 2.3 2.9 - Public debt: 134 134 141 145 144 142 138 135 132 - Memorandum items: - Real GDP growth rate: 2.0 2.5 1.5 1.8 3.0 4.5 4.5 5.0 5.0 - GDP deflator growth rate: 3.4 4.6 3.2 3.1 4.0 2.9 3.2 3.2 2.4 - Sources: Lebanese authorities; and IMF staff estimates. - Footnotes: - 1/ Includes various stamps and fees. - 2/ Includes social spending. ### Government financing, foreign currency borrowing, and reserves - Need for a more transparent government financing framework: - Last year, the government reached the cap on new foreign currency borrowing. - Gap between foreign currency payments and receipts has been widening due to temporary factors (delays in transfers from Telecom) and structural deterioration (increase in foreign currency payments). - Government increasingly borrowing in foreign currency from the BdL in overdraft, which has reached $6.6 billion at end-April (about 14 percent of GDP). - Staff welcomed authorities’ effort to seek parliamentary approval to raise the cap on new foreign currency borrowing to reduce reliance on the BdL; recommended returning to regular and timely Telecom transfers to the budget. - Reserves and reserve adequacy: - Official foreign exchange reserves are adequate, at 110 percent of the reserve metric at end-2013. - Reserve coverage is larger—at 147 percent—if commercial banks’ estimated foreign liquid net assets are considered as an additional buffer. - With bank deposits expected to remain the main source of reserves, a deposit growth rate of about 8 percent would be sufficient to broadly maintain the reserve coverage while meeting fiscal and external financing needs under current policies. - Staff underscored the need to maintain high reserves but noted reserve accumulation and associated sterilization costs have weakened the BdL’s balance sheet. - BdL’s role in government financing and recommended actions: - Banks have shied away from T-bills with maturity shorter than 7 years; BdL has offered long-term deposits (7-year or higher) to mop up banks’ pound liquidity and cover T-bill auction shortfalls. - BdL recently reduced by 26 basis points the interest rate it pays on banks’ deposits. - Staff encouraged the BdL to gradually withdraw from T-bill auctions to encourage banks to invest in government paper instead. - Staff recommended regularizing issuances of T-bills with maturities longer than 7 years and making the T-bill auction process more transparent, including providing more detailed auction results. - Staff cautioned against adverse effects of a rise in global interest rates and again recommended maintaining a high level of reserves and strengthening banks’ capital buffers. ### Prospective gas resources and fiscal framework for a commodity producer - Timing and scale: - Recent seismic surveys suggest Lebanon’s oil and gas resources could be in excess of 25 trillion cubic feet (tcf). - Size remains uncertain and production is not expected to begin before 2020. - Bidding process for exploration scheduled for August (after repeated delays). - Staff’s guidance on managing prospective gas resources: - Gas resources represent an asset of the whole country; strong policies and institutions are needed to manage the revenue stream sustainably and equitably. - First step: define a fiscal regime that ensures a fair revenue share while encouraging investors’ participation. - Call for a proper macro-fiscal anchor and strong institutions to manage gas wealth responsibly and transparently. - Caution that discussions on a sovereign wealth fund are premature; earmarking different revenue sources to specific uses would lead to fiscal fragmentation. - Box 5 — Options and principles: - Fiscal regime objectives and principles: - The state should receive an appropriate share of the economic rents from exploiting natural resources. - Tax rules for extractive industries should be set out clearly in legislation to avoid negotiating project-specific fiscal arrangements. - Government’s take should adjust to price and cost fluctuations. - Fiscal regime should avoid distorting investment incentives, especially in initial production stages. - Tax regimes should be competitive, simple to comply with and to administer. - Macro-fiscal anchor: - Conservatively assume a short reserve horizon given uncertainty. - Fiscal policy guided by resource exhaustibility considerations and anchored in a saving strategy for intergenerational equity. - PIH-based frameworks and related frameworks (Modified PIH and Fiscal Sustainability) can be useful and may allow scaling up expenditure for specific needs while ensuring long-term sustainability. - Institutions: - Strong PFM system to ensure transparent presentation of oil revenue, sustainable long-term fiscal strategy, transparent appraisal and prioritization of investment projects. - Adopting a fiscal responsibility law could strengthen fiscal discipline. ### Staff recommendations on fiscal management and administration - Need for stronger fiscal management: - Ongoing capacity building at the ministry of finance welcomed. - Importance of adhering to a budget calendar and pursuing a medium-term budget framework. - Need for greater transparency of government spending and its funding. - Strengthen cash management—particularly transparency and timeliness of transfers to and from the budget. - Strengthen revenue administration and combat reportedly pervasive tax evasion and corruption to generate considerable gains. ### Authorities’ views (summarized) - Acknowledged the need to revert the debt dynamics, but political uncertainty overshadows policy decisions and adjustment could only come over time. - Reaffirmed commitment to putting in place a budget for 2014; noted work on closing past accounts was almost complete and passing a budget would send a strong signal. - Large degree of uncertainty regarding parameters of the salary scale adjustment; implementation uncertainties related to the presidential vacuum. - Authorities confident proposed revenue measures would more than offset salary increases; stressed sectors outside the tax net should share the adjustment burden. - Disagreed with mission’s assessment that fees and stamps would generate only limited yield; noted a large and broad-based VAT increase could disproportionately affect lower segments of the population and be politically difficult. ### Banking sector resilience and financial system recommendations - Current conditions and risks: - Banks resilient but environment increasingly challenging. - Regional instability has halted banks’ expansion in neighboring countries. - Nonperforming loans (NPLs) have slightly increased but remain low; loans under watch have increased; widespread use of overdraft facilities. - Provisioning on NPLs has decreased. - Banks’ profitability deteriorated, with average return on assets now about 1 percent. - Liquidity buffers, including large deposits with the BdL, are strong. - Banks’ exposure to the sovereign has continued to increase. - Capital and regulatory recommendations: - Capital buffers should be further strengthened given banks’ large exposure to the sovereign. - BdL requires by end-2015 an additional capital buffer of 1.5 percent on top of the Basel III minimum plus a 2.5 percent conservation buffer. - Staff urged a consistent approach to banks’ exposures to the government and the central bank in accordance with the Basel capital adequacy framework. - Staff called for improvement of loan classification and restructuring rules, including tighter rules guiding classification of NPLs and restructuring of loans, re-aging of overdrafts and arrears. - Encouraged vigilance for signs of further asset deterioration domestically and abroad. - Noted positive steps to enhance supervision by establishing supervisory colleges to strengthen cross-border supervision of the largest banks. *Source: IMF staff estimates and Lebanese authorities as presented in the content unit.* ### 43. Staff encouraged progress on the Anti-Money Laundering and Combating the ### _cr14237 - 43. Staff encouraged progress on the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) regime ### AML/CFT and financial-sector integrity - Staff encouraged progress on the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) regime. - Key gaps and actions recommended: - Better understanding of the source of deposits and adequate identification of beneficial owners to allow more effective monitoring of transactions and strengthening of risk-based supervision. - Strengthen the AML/CFT regime by taking the necessary legislative steps to bring the existing AML law and other related legislation in line with the revised international standards. - Authorities’ view: - Authorities considered that Lebanon’s AML/CFT regime is in practice fully compliant with international standards and noted active cooperation by the Special Investigation Commission with foreign counterparts. - Authorities regretted that banks had become overly-cautious by refusing to open accounts to some foreign nationals instead of classifying them as high-risk for increased scrutiny. ### Banking sector structure, deposits, and sovereign exposure - Observations and recommendations: - Over time, banks could be encouraged to reconsider a business model that currently revolves around channeling deposits to the public sector. - Staff estimates that a deposit growth rate of about 8 percent would cover the economy’s financing needs while keeping reserves high. - Banks should avoid returning to the double-digit deposit growth rate experienced in previous years, which would generate high sterilization costs for the BdL. - Banks could lower deposit spreads (relative to international rates) to help slow deposit growth—if and when needed. - There is a need to reduce over time banks’ reliance on the sovereign; banks might have to consider downsizing their balance sheets if public financing needs decline significantly and regional opportunities remain limited. - Key factual points: - The banking sector is almost fourfold the size of GDP. ### Capital markets and supervision - Progress and cautions: - Preliminary steps to develop capital markets are welcome; the insurance sector and the stock market remain underdeveloped. - The newly established Capital Markets Authority (CMA) issued its first regulations in June 2013; the transfer of part of supervision from the BdL to the CMA is under way. - Developing capital markets to complement the banking sector could promote growth, but tight regulation and supervision of the financial system are essential to avoid excessive risk taking. - Authorities’ view: - A few success stories (e.g., large companies listing) could allow the stock market to take off. - Authorities were confident capital markets could develop but acknowledged current conditions may hold development back. ### Structural reforms for stronger and more equitable growth - Overarching objective: - Advancing structural reforms is key to raising Lebanon’s growth potential and improving labor market and social conditions. - Challenges identified: - Traditional growth drivers (real estate, construction, tourism) are exposed to security and political conditions. - The refugee crisis has amplified economic and social challenges and shifted the economy toward lower-productivity sectors. - Perception that past high-growth episodes disproportionately benefited selected sectors or groups; future growth needs to be more inclusive, create jobs, and reduce poverty. - Staff recommendations: - Lower the cost of doing business, improve services—particularly electricity provision—and promote jobs while also strengthening social safety nets. - Given the currency peg, pushing structural reforms forward is essential to improving competitiveness and correcting the moderate real exchange rate misalignment. - Immediate measures to tackle poverty: cash-for-work programs, micro-finance initiatives, and local economic development plans for the most affected communities. - Over time, modernize labor market legislation and improve compliance with labor laws to limit the informal labor market. - Increase private sector participation in infrastructure investment; passage of the framework law for Public Private Partnerships (PPPs) awaiting parliament approval would clarify the legal framework and pave the way for better governance and transparency of public projects. - Authorities’ view: - Agreed on the importance of structural reforms and saw potential from increased private sector participation in infrastructure projects, while noting political constraints may impede progress. ### Electricity sector and immediate reform priorities - Staff view: - Urgent need to strengthen electricity provision and lower its cost. - Transfers to EdL absorb a sizeable share of government resources; inefficient and inadequate electricity provision adds to the cost of doing business. - Increases in average electricity tariffs viewed as the main measure to sustainably address these problems, with social impact to be properly mitigated. - A more reliable EdL service would price out expensive private generators even after tariff increases and contribute to broader efficiency gains. - Recommendations to improve transmission and distribution systems to reduce inefficiencies and minimize losses due to theft and inadequate collections. - Recommend improving governance of the energy sector; past reform attempts stalled by vested interests and lack of political resolve. - Staff noted disappointment that the salary scale adjustment debate missed an opportunity to put electricity tariff increases and sector reform on the agenda. ### Real exchange rate (REER) assessment and external position - Key empirical points: - Lebanon’s CPI-based real effective exchange rate (REER) has appreciated slightly since 2011. - Over a longer horizon, the REER has appreciated by about 9 percent from the level in 2008. - Lebanon’s external current account deficit is estimated at 12¾ percent of GDP in 2013. - The current account deficit is projected to narrow to about 10½ percent of GDP over the medium term. - CGER-type assessment results (as presented): - CA norm-9.7-7.2 - Underlying CA balance-10.4-10.4 - CA gap-0.7-3.2 - Exchange rate overvaluation (In percent)2.29.8 - Exchange rate overvaluation adjusted for multilateral consistency (In percent) 13.011.9 - Methodology notes: - Two standard approaches—the macroeconomic balance (MB) and external sustainability (ES)—are estimated using a new toolkit. - MB approach result: REER overvalued by 2.2 percent (CA norm -9.7 percent of GDP; underlying CA balance -10.4 percent of GDP; CA gap -0.7 percent of GDP). - ES approach result: REER overvalued by 9.8 percent (current account balance that would stabilize NEAP at end-2012 level of -122 percent of GDP is 7.2 percent of GDP). - Adjusting for multilateral consistency produces larger REER overvaluation, but discrepancy between estimates calls the validity of that adjustment into question. ### Data issues and statistical capacity - Progress noted: - Central Administration of Statistics (CAS) released a new CPI index in March with Fund assistance; production of national accounts transferred to CAS; quarterly national accounts are under preparation. - Ongoing efforts to improve balance of payments statistics and plans to release international investment position data. - Staff recommendations: - Address longer delays recently experienced in the release of fiscal data. - Ensure adequate and stable funding and high-level support for CAS and enhance cooperation with other agencies. - Improve data to underpin communication and monitoring of government economic plans, enhancing transparency and surveillance. - Authorities’ view: - Frustration with challenges in data compilation, inadequate cooperation from other institutions, and need for policymakers to better appreciate importance of reliable statistics. - Notable datapoint: - Footnote: The CPI was not compiled during January–May last year reflecting lack of funding due to disputes between CAS and the prime minister’s office; funding to CAS and data compilation resumed last summer under strong Fund pressure. ### Staff appraisal — summary of risks, priorities, and policy recommendations - Situation and risks: - Lebanon’s resilience is being severely tested by spillovers from the Syria crisis and political paralysis: growth sharply decelerated, primary fiscal balance turned into deficit, public debt on an upward trend, refugee population straining economic and social structures, and rising unemployment and poverty. - Outlook remains weak without decisive action; persistent imbalances expose Lebanon to large downside risks and subdued potential growth absent strong policies and reforms. - Fiscal policy recommendations: - Adopt a comprehensive, balanced, and multi-year fiscal strategy to achieve sustainable debt reduction. - Stop urgently the fiscal deterioration and reestablish primary surpluses. - Fiscal adjustment should include both revenue and spending measures, tilt spending away from EdL transfers into capital and social outlays, broaden the tax base, strengthen revenue collections, and combat evasion and corruption. - Authorities’ plan to pass a budget is a welcome first step. - The budgetary impact of the proposed salary scale adjustment should be contained: any salary adjustment should be implemented in installments, with no retroactive payments, and in conjunction with productivity-enhancing measures. - Resume a regular budget calendar and seek parliamentary approval for new borrowing in foreign currency to reduce reliance on the BdL. - Monetary and central bank recommendations: - Monetary policy should remain geared to supporting the peg; the BdL should continue to maintain high reserves. - As fiscal consolidation gains ground, the BdL should gradually withdraw from T-bill auctions. - Increase over time the flexibility of T-bill rates and the transparency of T-bill auctions to achieve interest rates that better reflect government funding costs and better allocation of banks’ assets—without jeopardizing financial stability. - BdL’s balance sheet needs to be strengthened; reserve accumulation, government financing and quasi-fiscal credit schemes and associated sterilization costs have strained BdL finances and a strategy is needed to improve them. - Financial-sector regulation and supervision: - Continue efforts to enhance bank regulation and supervision. - Strengthen capital buffers given banks’ large exposure to the sovereign. - Improve loan classification and restructuring rules. - Further enhance the AML/CFT framework to bring it in line with international standards by taking necessary legislative steps and strengthening related risk-based banking supervision. - Proper regulation and supervision are key to avoiding excessive risk taking and fostering balanced development of capital markets. - Structural and social priorities: - Progress on structural reforms would unlock growth potential and address social inequalities. - Electricity sector reform could yield immediate benefits: strengthen generation capacity, switch to natural gas, and increase average electricity tariffs toward cost recovery levels while protecting more vulnerable consumers—implement without further delay. - Strengthen social safety nets and reduce unemployment. - Refugee crisis: - Tackling the extremely large refugee crisis requires strong international support; absent additional support, needs of Lebanese communities and refugees will not be met. - Sound government policies and a concerted policy framework on refugee issues, together with fiscal discipline, will help mobilize needed budget support. - Data and statistics: - Despite ongoing progress, data remain inadequate in some areas; reliable and timely statistics are necessary for effective, transparent, and accountable policymaking. - High-level support for CAS and cooperation across institutions will help secure continued progress. *From the IMF staff report excerpt provided.* ### 68. Staff proposes to hold the next Article IV consultation on the standard 12-month ### Staff proposes to hold the next Article IV consultation on the standard 12-month cycle. ### Risk Assessment Matrix — Domestic and Regional Risks - Continued spillovers from Syria crisis and prolonged refugee crisis - Likelihood/Time Horizon/Expected Impact: High/Short to Medium Term/High - Main threats: strain on host communities; increased economic and budgetary costs; weakened public service provision; pressure on labor and housing markets; deterioration in security and fiscal position could undermine confidence, affect deposit flows and reserves, raise dollarization, and lead to tighter fiscal and external financing conditions and lower growth. - Recommended policy response: Renew efforts to secure donor assistance to cover humanitarian costs related to refugees; formulate a comprehensive strategy to deal with the refugee crisis; strengthen fiscal transparency and undertake fiscal consolidation to create fiscal space; maintain a high level of international reserves; further strengthen banks’ capital buffers. - Further weakening of public finances - Likelihood/Time Horizon/Expected Impact: High/Short Term/High - Main threats: higher current spending and weaker revenue administration or tax cuts would increase the fiscal deficit, government financing needs, and public debt; could undermine confidence, affect deposit flows and reserve, raise dollarization, and tighten financing conditions and lower growth. - Recommended policy response: Secure parliamentary approval of a 2014 budget consistent with generating primary fiscal surpluses; reinvigorate electricity sector reform to reduce transfers to Electricité du Liban (EdL); gradually increase electricity tariffs consistent with cost recovery while protecting lower-tier consumers; maintain high international reserves; strengthen banks’ capital buffers. - Delays in structural reforms - Likelihood/Time Horizon/Expected Impact: High/Short to Medium Term/Medium - Main threats: infrastructure bottlenecks (particularly electricity) and ad-hoc enforcement of regulations could reduce competitiveness and growth potential; protracted low growth could worsen debt dynamics and unemployment and threaten social stability. - Recommended policy response: Shift spending composition away from EdL subsidies into capital and social spending; increase electricity production efficiency through electricity sector reform. ### Risk Assessment Matrix — Global Risks - Side-effects from global financial conditions (surges in global financial market volatility) - Likelihood/Time Horizon/Expected Impact: High/Medium Term/Medium - Main threats: higher-than-expected increases in global interest rates could push Lebanon into a tighter monetary policy stance; rising financing costs could negatively affect the government and banking sector; declines in sovereign debt prices could impact banks' balance sheets. - Recommended policy response: Strengthen fiscal discipline; maintain a high level of international reserves; further strengthen banks’ capital buffers. - A sharp increase in geopolitical tensions surrounding Russia/Ukraine that creates significant disruptions in global financial, trade and commodity markets - Likelihood/Time Horizon/Expected Impact: Medium/Short Term/Low - Main threats: higher costs of fuel imports would lead to higher electricity subsidies with negative effects on the fiscal balance. - Recommended policy response: Increase electricity production efficiency through electricity sector reform. ### Real Sector Developments (Figures and Trends) - Real GDP Growth (2002–2013): notable deceleration; staff chart shows Real GDP Growth (In percent) declining across the period. - Byblos Bank Consumer Confidence index and Coincidence Indicator (Jan-06 to Jan-14): large swings with recent declines in confidence. - Tourism: Tourist arrivals (y-o-y growth) and Hotel occupancy rate tracked Jan-06 to Jan-14 with declines; tourism impacted by security incidents and travel advisories. - Real estate: Property sales value, Number of property transactions, and Real estate loans show contraction in recent years. - Inflation: Contribution to Headline Inflation by categories (Jan-09 to Jan-14) shows subdued inflationary pressures. - External sector: Current account balance remains elevated; charts indicate exports stagnated while imports increased modestly. ### Fiscal Sector Developments (Figures and Trends) - Revenue has slowed while spending has not adjusted; transfers to EdL remain elevated, crowding out capital spending. - Total revenue and grants vs Total expenditure (2006–2013) show expenditures above revenues. - Transfers to EdL and Capital Expenditure (In percent of GDP): transfers elevated relative to capital spending. - Tax revenue and total expenditure comparisons: Tax revenue remains below emerging markets while spending is closer to comparators. - Tax composition (2013): scope to increase reliance on indirect taxes and income taxes; Corporate Income Tax Rates, 2013 vary across comparators. ### Key Economic Indicators, 2011–19 (Table 1 selected entries; values preserved exactly) - Real GDP (market prices): 2011 Act. 2.0; 2012 2.5; 2013 1.5; 2014 Est. 1.8; 2015 Proj. 2.5; 2016 Proj. 4.0; 2017–2019 Proj. 4.0, 4.0, 4.0. - GDP deflator: 2011 3.4; 2012 4.6; 2013 3.2; 2014 3.4; 2015 4.4; 2016 2.9; 2017 2.3; 2018 2.3; 2019 2.4. - Consumer prices (end-of-period): 2011 5.4; 2012 6.3; 2013 1.3; 2014 4.5; 2015 3.5; 2016 2.5; 2017 2.5; 2018 2.5; 2019 2.5. - Gross capital formation: 2011 26.9; 2012 24.9; 2013 24.6; 2014 24.5; 2015 23.8; 2016 24.2; 2017 24.9; 2018 25.8; 2019 26.9. - Gross national savings: 2011 14.1; 2012 12.1; 2013 11.8; 2014 11.9; 2015 11.6; 2016 12.5; 2017 13.8; 2018 15.0; 2019 16.5. - Central government finances (cash basis) — Revenue (including grants): 2011 22.8; 2012 22.3; 2013 20.9; 2014 20.9; 2015 21.9; 2016 21.9; 2017 22.0; 2018 22.2; 2019 22.1 (In percent of GDP). - Central government finances — Expenditure: 2011 28.7; 2012 31.0; 2013 30.1; 2014 32.0; 2015 33.7; 2016 33.2; 2017 33.0; 2018 33.1; 2019 33.4 (In percent of GDP). - Budget balance (including grants): 2011 -5.9; 2012 -8.6; 2013 -9.2; 2014 -11.1; 2015 -11.9; 2016 -11.4; 2017 -11.0; 2018 -10.9; 2019 -11.3 (In percent of GDP). - Primary balance (including grants): 2011 3.5; 2012 -0.2; 2013 -0.8; 2014 -2.4; 2015 -2.5; 2016 -1.7; 2017 -0.9; 2018 -0.6; 2019 -0.5 (In percent of GDP). - Total government debt: 2011 134; 2012 134; 2013 141; 2014 145; 2015 148; 2016 149; 2017 151; 2018 153; 2019 155 (In percent of GDP). - Credit to the private sector (annual % change): 2011 12.9; 2012 10.5; 2013 9.6; 2014 7.1; 2015 6.9; 2016 7.0; 2017 6.3; 2018 6.4; 2019 6.5. - Broad money (M5) growth (year-on-year): 2012 7.2; 2013 7.9; 2014 9.0; 2015 8.0; 2016 8.0; 2017 8.0; 2018 8.0; 2019 8.0. - Deposit dollarization (level): 2011 66.1; 2012 64.9; 2013 66.2; 2014 66.2; 2015 65.5; 2016 65.0; 2017 64.5; 2018 64.0; 2019 64.0. - Gross reserves (in billions of U.S. dollars, excl. gold and encumbered assets): 2011 31.6; 2012 32.2; 2013 33.9; 2014 35.0; 2015 36.3; 2016 38.5; 2017 41.6; 2018 45.6; 2019 49.6. - Gross international reserves (including gold), in billions of U.S. dollars: 2012 46.0; 2013 47.5; 2014 45.0; 2015 45.4; 2016 46.9; 2017 49.3; 2018 52.6; 2019 56.9; 2020 (not provided). ### Central Government Overall Deficit and Financing (Tables 2 & 3 — selected figures) - Revenue and grants (in LL billions): 2013 Act. 13,769; 2014 Act. 14,462; 2015 Act. 14,199; 2016 Proj. 14,887; 2017 Proj. 16,690; 2018 Proj. 17,869; 2019 Proj. 19,104; 2020 Proj. 20,518; 2021 Proj. 21,811. - Tax revenue (LL billions): 2013 9,885; 2014 10,185; 2015 10,115; 2016 10,627; 2017 12,168; 2018 13,047; 2019 13,995; 2020 15,103; 2021 16,069. - VAT revenues (LL billions): 2013 3,300; 2014 3,276; 2015 3,296; 2016 3,463; 2017 3,703; 2018 3,921; 2019 4,191; 2020 4,482; 2021 4,739. - Total expenditures (LL billions): 2013 17,590; 2014 20,143; 2015 20,512; 2016 22,851; 2017 25,771; 2018 27,168; 2019 28,650; 2020 30,636; 2021 32,916. - Transfers to EdL (LL billions): 2013 2,565; 2014 3,361; 2015 3,021; 2016 3,062; 2017 3,045; 2018 2,993; 2019 2,783; 2020 2,819; 2021 2,881. - Interest payments (LL billions): 2013 5,665; 2014 5,465; 2015 5,720; 2016 6,220; 2017 7,169; 2018 7,945; 2019 8,751; 2020 9,592; 2021 10,575. - Overall balance (checks issued, LL billions): 2013 -3,822; 2014 -5,681; 2015 -6,313; 2016 -7,965; 2017 -9,081; 2018 -9,300; 2019 -9,546; 2020 -10,118; 2021 -11,104. - Primary balance (checks issued, LL billions): 2013 1,843; 2014 -216; 2015 -593; 2016 -1,745; 2017 -1,912; 2018 -1,354; 2019 -796; 2020 -525; 2021 -530. - Total government gross debt (LL billions): 2013 80,887; 2014 86,959; 2015 95,692; 2016 103,705; 2017 112,785; 2018 122,085; 2019 131,631; 2020 141,749; 2021 152,851. ### Government Debt Composition (Table 4 — selected figures) - Net debt (in millions of U.S. dollars): 2013 Act. 51,407; 2014 Act. 54,457; 2015 Act. 59,112; 2016 Proj. 64,428; 2017 Proj. 70,452; 2018 Proj. 76,621; 2019 Proj. 82,953; 2020 Proj. 89,665; 2021 Proj. 97,030. - Gross debt by holder (in millions of U.S. dollars): 2013 53,656; 2014 57,684; 2015 63,477; 2016 68,793; 2017 74,816; 2018 80,985; 2019 87,318; 2020 94,029; 2021 101,393. - Banking system holdings (in millions of U.S. dollars): 2013 39,786; 2014 43,637; 2015 48,153; 2016 52,403; 2017 57,152; 2018 62,105; 2019 67,187; 2020 72,537; 2021 78,379. - Eurobonds (in millions of U.S. dollars): 2013 12,975; 2014 16,318; 2015 17,684; 2016 19,289; 2017 21,068; 2018 22,812; 2019 24,704; 2020 26,737; 2021 28,916. - Total government gross debt (in percent of GDP): 2013 134; 2014 134; 2015 141; 2016 145; 2017 148; 2018 149; 2019 151; 2020 153; 2021 155. ### Monetary Survey (Table 5 — selected figures) - Net foreign assets (in trillions of Lebanese pounds): 2012 96.2; 2013 99.8; 2014 98.2; 2015 101.8; 2016 107.1; 2017 113.9; 2018 122.5; 2019 132.6; 2020 143.0. - Broad money (M5, in trillions of Lebanese pounds): 2012 179.0; 2013 193.2; 2014 210.6; 2015 227.4; 2016 245.6; 2017 265.3; 2018 286.5; 2019 309.4; 2020 334.2. - Deposits in foreign currency (in trillions of Lebanese pounds): 2012 116.3; 2013 123.1; 2014 136.8; 2015 147.7; 2016 157.9; 2017 169.3; 2018 181.4; 2019 194.5; 2020 210.1. - Reserve money (in trillions of Lebanese pounds): 2012 13.4; 2013 19.8; 2014 20.5; 2015 22.0; 2016 25.1; 2017 29.3; 2018 34.0; 2019 37.4; 2020 39.2. - Gross international reserves (including gold, in billions of U.S. dollars): 2012 46.0; 2013 47.5; 2014 45.0; 2015 45.4; 2016 46.9; 2017 49.3; 2018 52.6; 2019 56.9; 2020 61.2. - Share of foreign currency deposits in total private sector deposits (percent): 2011 66.1; 2012 64.9; 2013 66.2; 2014 66.2; 2015 65.5; 2016 65.0; 2017 64.5; 2018 64.0; 2019 64.0. ### Balance of Payments (Table 6 — selected figures, in millions of U.S. dollars) - Current account (excl. official transfers): 2011 -5,142; 2012 -5,469; 2013 -5,776; 2014 -5,947; 2015 -6,162; 2016 -6,332; 2017 -6,429; 2018 -6,660; 2019 -6,803. - Goods (net): 2011 -13,927; 2012 -14,713; 2013 -15,504; 2014 -16,216; 2015 -16,533; 2016 -16,972; 2017 -17,522; 2018 -18,090; 2019 -18,677. - Exports, f.o.b.: 2011 5,426; 2012 5,627; 2013 5,117; 2014 5,227; 2015 5,528; 2016 5,884; 2017 6,274; 2018 6,714; 2019 7,172. - Imports, f.o.b.: 2011 -19,354; 2012 -20,340; 2013 -20,621; 2014 -21,443; 2015 -22,061; 2016 -22,856; 2017 -23,796; 2018 -24,805; 2019 -25,849. - Services (net): 2011 7,300; 2012 8,006; 2013 7,952; 2014 8,315; 2015 8,591; 2016 8,955; 2017 9,562; 2018 10,102; 2019 10,616. - Current account balance (in percent of GDP, including official transfers): 2011 -12.8; 2012 -12.7; 2013 -12.8; 2014 -12.6; 2015 -12.2; 2016 -11.7; 2017 -11.1; 2018 -10.8; 2019 -10.4. - Gross reserves (excl. gold, year-end): 2011 31,588; 2012 32,177; 2013 33,892; 2014 34,993; 2015 36,348; 2016 38,481; 2017 41,617; 2018 45,599; 2019 49,551. ### Financial Soundness Indicators for the Banking Sector (Table 7, end of period) - Regulatory capital to risk-weighted assets: 2011 11.6; 2012 13.0; 2013 12.2 (percent). - Regulatory Tier 1 capital to risk-weighted assets: 2011 11.0; 2012 12.1; 2013 11.4 (percent). - Non-performing loans net of provisions to capital: 2011 5.2; 2012 5.2; 2013 6.1 (percent). - Non-performing loans to gross loans: 2011 3.8; 2012 3.8; 2013 4.0 (percent). - Claims on the public sector (BdL excluded) to total assets: 2011 20.8; 2012 20.5; 2013 22.9 (percent). - Placements with the BdL to total assets: 2011 33.6; 2012 34.6; 2013 33.0 (percent). - Return on assets: 2011 1.1; 2012 1.0; 2013 1.0 (percent). - Return on equity: 2011 14.5; 2012 12.8; 2013 11.9 (percent). - Deposits to total liabilities: 2011 87.9; 2012 87.9; 2013 87.5 (percent). - Liquid assets to total assets: 2011 22.7; 2012 23.2; 2013 22.7 (percent). - Foreign-currency-denominated loans to total loans: 2011 78.4; 2012 77.4; 2013 76.5 (percent). - Foreign-currency-denominated liabilities to total liabilities: 2011 66.2; 2012 65.1; 2013 65.5 (percent). - Net open FX position to regulatory capital: 2011 16.9; 2012 13.9; 2013 11.8 (percent). *International Monetary Fund staff report (Lebanon) — excerpted content unit.* ### Annex I. Public Debt Sustainability Analysis ### Annex I. Public Debt Sustainability Analysis ### Summary assessment and main risks - Public debt already exceeding 140 percent of GDP and gross financing needs around 30 percent of GDP create significant risks to public debt sustainability. - Under the baseline scenario: - Public debt-to-GDP ratio rises from 141 percent in 2013 to 155 percent in 2019. - Gross financing needs rise to 40 percent of GDP in 2017 and exceed 30 percent of GDP over the projection period. - Key sources of risk: - Macroeconomic shocks (growth and interest rate). - Contingent liability shocks. - Important mitigating factors: - Large liquidity buffers. - A captive investor base (debt largely held by domestic financial institutions and the BdL). ### Baseline scenario assumptions - Conflict in Syria resolved by 2016. - Real GDP growth: - 2013–2014: projected to stay below 2 percent (impact of conflict in Syria). - 2015: 2.5 percent. - 2016 onward: return to potential estimated at 4 percent. - Inflation (GDP deflator): decelerates from 4.6 percent in 2012 to 2.9 percent on average in 2015–19. - Primary balance: further worsens in 2014 and 2015, but gradually improves starting in 2016; projections based on: - (i) estimate of the salary scale adjustment; - (ii) gradual reduction in subsidies to Electricité du Liban (EdL); - (iii) higher capital spending; - (iv) tax measures on income and profits, capital gains, selected excises, and some stamp fees and charges. - Debt maturity structure and financing: - Average maturity around 3 years for domestic debt and 5 years for foreign debt. - Upward financing needs trajectory primarily driven by large fiscal deficits and relatively short average maturity on debt. ### Fiscal and debt projections (selected numeric outcomes) - Public debt-to-GDP: - 141 percent in 2013 → 155 percent in 2019 (baseline). - Gross financing needs: - Around 30 percent of GDP currently; forecast to exceed 30 percent over projection period; increase to 40 percent of GDP in 2017. - Public debt-to-broad-money ratio: - Decreased from 66 percent in 2003 to 45 percent in 2012; forecasted to stay below 50 percent over the projection horizon. - Government deposits: - Average figure points to around 20 percent of GDP (with government foreign exchange account in overdraft by around 5 percent on average in recent years). ### Stress test scenarios and impacts - Growth shock (one standard deviation decline in growth for 2015 and 2016): - Debt-to-GDP ratio reaches almost 172 percent in 2019. - Financing needs exceed 40 percent of GDP in 2017 and remain at this level until the end of the projection horizon. - Interest rate shock (200 basis points): - Debt-to-GDP ratio reaches 164 percent at the end of the projection horizon. - Financing needs reach 44 percent of GDP in 2019. - Combined macro-fiscal shock (simultaneous shocks to growth, interest rate, and primary balance): - Debt-to-GDP ratio exceeds 187 percent at the end of the projection horizon. - Financing needs reach 50 percent of GDP in 2019. - Contingent liability shock (standardized shock of 10 percent of financial sector assets): - Debt-to-GDP ratio exceeds 190 percent at the end of the projection horizon. - Financing needs exceed 45 percent of GDP in 2019. - Large effect due to the significant size of Lebanon’s banking sector relative to the economy. ### Structural weaknesses and risk indicators - External financing needs are well above the upper risk-assessment benchmark. - Public debt in foreign currency is above the lower risk-assessment benchmark, indicating vulnerability to exchange rate and reserve pressures. - Bond spreads are above the lower risk-assessment benchmark but have been relatively stable in times of stress. - Public debt held by nonresidents is only slightly above the lower risk-assessment benchmark. - Level of, and change in, short-term debt are below lower risk-assessment benchmarks, substantially reducing refinancing risk. ### Mitigating factors and buffers - Investor base: - Debt largely held by domestic financial institutions regulated in net open positions and investment strategies. - Captive investor base reinforced by low private sector credit demand and limited regional investment opportunities. - Domestic institutions fund positions from deposits largely held by nonresidents; these deposits have shown resilience in stress. - Significant share of domestic debt held by the BdL. - Debt financing profile: - Large external financing needs partly reflect payments related to debt and sizable nonresident short-term deposits. - Excluding nonresident deposits reduces external financing needs to around 40 percent of GDP over the projection horizon. - Debt denominated in foreign currency (>40 percent of total public debt) is mostly held by domestic financial institutions and supported by sizeable external buffers. - Other buffers: - High level of gross international reserves. - Banks’ net foreign assets (NFA) represent a substantial buffer. - Government cash cushions (deposits) around 20 percent of GDP imply a significantly lower public debt-to-GDP ratio on a net basis and coverage of financing needs for more than half a year. ### Assessment of baseline realism and authorities’ views - Staff view baseline assumptions as realistic: - Lebanon’s forecast track record is not systematically biased (median forecast errors for real GDP growth and inflation during 2004–12 are generally in line with other countries). - Median forecast error for the primary balance and its projected level are consistent with experiences of fiscal adjustments in surveillance countries. - The cumulative change in the primary balance is viewed as ambitious but within reach, as it is based on both revenue and expenditure measures. - Authorities broadly concurred with staff’s analysis: - Noted challenges in formulating a credible medium-term fiscal framework. - Emphasized mitigating factors to debt sustainability risks and noted that large external financing needs may not capture Lebanon’s specific circumstances well. *Source: IMF Staff (Annex I. Public Debt Sustainability Analysis).* ### Annex II. Lebanon: External Debt Sustainability Analysis ### Annex II. Lebanon: External Debt Sustainability Analysis ### Key findings on external debt level and composition - External debt is estimated at 174 percent of GDP at end-2013. - External debt bottomed at 163 percent of GDP at end-2010 and rose thereafter. - The bulk of external debt (about 77 percent) is accounted for by short-term nonresident deposits in the banking sector. - Nonresident deposits account for about 80 percent of gross external financing needs over the projection horizon. - External non-deposit liabilities of banks and the full amount of external debt of nonbanks (about 10 percent of gross external financing needs over the projection horizon) are treated as short-term in this analysis due to lack of maturity information, implying gross annual financing needs and short-term external debt are likely overestimated. ### Baseline projections (2009–2019) and dynamics - Baseline projection: external debt slightly increases to 181 percent of GDP by 2019 (baseline shows 181.4 in 2019 in table). - Baseline Table highlights (debt in percent of GDP): - 2009: 166.1 - 2010: 163.1 - 2011: 169.2 - 2012: 168.2 - 2013: 174.3 - 2014: 177.3 - 2015: 177.4 - 2016: 177.5 - 2017: 178.5 - 2018: 179.9 - 2019: 181.4 - Change in external debt (line 2) shows an increase of 1.5 in both 2018 and 2019. - Identified external debt-creating flows (line 3) and components: - Current account deficit, excluding interest payments (line 4): 2013 = 8.3, 2014 = 7.6, 2015 = 6.4, 2016 = 4.8, 2017 = 3.2, 2018 = 1.2, 2019 = 0.3 (all in percent of GDP). - Net non-debt creating capital inflows (negative, line 8): 2013 = -6.7, 2014 = -7.1, 2015 = -7.7, 2016 = -7.9, 2017 = -8.2, 2018 = -8.5, 2019 = -8.8 (in percent of GDP). - Automatic debt dynamics (line 9): 2013 = -2.3, 2014 = 2.5, 2015 = 1.9, 2016 = 0.9, 2017 = 2.3, 2018 = 3.9, 2019 = 4.5 (in percent of GDP). - Contribution from nominal interest rate (line 10): 2013 = 5.4, 2014 = 5.4, 2015 = 6.1, 2016 = 7.5, 2017 = 9.0, 2018 = 10.6, 2019 = 11.3 (in percent of GDP). - Contribution from real GDP growth (line 11): 2013 = -2.4, 2014 = -2.9, 2015 = -4.1, 2016 = -6.6, 2017 = -6.7, 2018 = -6.7, 2019 = -6.8 (in percent of GDP). - External debt-to-exports ratio (in percent) increases across projections: - 2013: 315.2 - 2014: 322.4 - 2015: 325.6 - 2016: 330.4 - 2017: 332.5 - 2018: 337.4 - 2019: 343.2 ### Gross external financing needs - Gross external financing need (in billions of US dollars): - 2009: 44.6 - 2010: 54.4 - 2011: 58.7 - 2012: 65.2 - 2013: 69.4 - 2014: 75.2 - 2015: 80.4 - 2016: 86.6 - 2017: 93.7 - 2018: 100.6 - 2019: 108.7 - Gross external financing need (in percent of GDP): - 2009: 127.1 - 2010: 143.2 - 2011: 146.5 - 2012: 151.7 - 2013: 154.2 - 2014: 158.8 - 2015: 158.7 - 2016: 159.7 - 2017: 162.4 - 2018: 163.8 - 2019: 166.2 ### Sensitivity and stress tests (bound tests and scenarios) - A one-time real depreciation of 30 percent of the exchange rate in 2015 would raise, on impact, the debt level to 276 percent of GDP (Figure 1, panel 6). - Individual permanent shocks (one-half standard deviation) relative to the baseline raise the debt ratio by 2019 as follows: - Interest rate shock: raises debt ratio to 186 percent of GDP by 2019 (Figure 1, panel 2). - Growth rate shock: raises debt ratio to 197 percent of GDP by 2019 (Figure 1, panel 3). - Noninterest current account balance shock: raises debt ratio to 193 percent of GDP by 2019 (Figure 1, panel 4). - Combined permanent shock (1/4 standard deviation applied to interest rate, growth rate, and noninterest current account balance) raises debt ratio to 198 percent of GDP by 2019 (Figure 1, panel 5). - These tests indicate debt dynamics are sensitive to macroeconomic shocks, particularly exchange rate shocks, underscoring the exchange rate peg's importance. ### Key macroeconomic assumptions underlying the baseline - Real GDP growth (in percent): 2013 = 1.5; 2014 = 5.2; 2015 = 3.6; 2016 = 1.8; 2017–2019 = 2.5, 4.0, 4.0 respectively in projections (table lists a sequence including historical and projection years). - GDP deflator in US dollars (change in percent): 2013 = 3.2; 2014 = 3.3; 2015 = 3.5; 2016 = 3.4; 2017 = 4.4; 2018 = 2.9; 2019 = 2.3. - Nominal external interest rate (in percent): 2013 = 3.3; 2014 = 4.4; projections show increases to 6.7 by 2019 (table sequence includes 3.3, 3.7, 4.5, 5.4, 6.3, 6.7 across projection years). - Growth of exports (US dollar terms, in percent): 2013 = -0.4; 2014 = 11.7; 2015 = 13.7; subsequent projected growth rates remain positive. - Growth of imports (US dollar terms, in percent): 2013 = 2.7; 2014 = 10.7; 2015 = 12.6; subsequent projected growth rates remain positive. - Current account balance, excluding interest payments (in percent of GDP): 2013 = -8.3; 2014 = -4.9; 2015 = -7.6; 2016 = -6.4; 2017 = -4.8; 2018 = -3.2; 2019 = -1.2; baseline 2019 projection of -0.3 appears in table footings for long-run stabilizing balance calculations. ### Mitigating factors and caveats - Mitigating factors: - Large share of nonresident deposits are owned by the Lebanese diaspora and have been relatively stable during past stress episodes. - Treatment of many liabilities as short-term (due to lack of maturity data) likely overestimates short-term external debt and gross annual financing needs. - Caveats: - Debt dynamics remain sensitive to shocks, especially exchange rate shocks that would be amplified given the de-facto peg to the U.S. dollar. - The analysis treats certain liabilities conservatively as short-term because of data limitations. *Prepared by Hajime Takizawa (SPR); Annex II. Lebanon: External Debt Sustainability Analysis.* ### 4. The teams have the following requests for information from their counterparts: ### 4. The teams have the following requests for information from their counterparts: ### Information exchange requests and coordination - Fund team requests to be kept informed of progress in the Bank’s work in the above macrocritical structural reform areas. Timing: when milestones are reached (and at least semi-annually). - Bank team requests to be kept informed of the Fund’s assessments of macroeconomic policies and prospects, as well as of Fund’s TA in the above reform areas. Timing: in the context of Article IV Consultation and other missions (and at least semi-annually). - The two teams will continue to exchange views on the macroframework and the results of an upcoming update for the Economic and Social Impact Assessment of the Syrian Conflict (planned for September 2014). ### Bank work program (selected items, 2014–15) - IBRD Lending Program: Urban Transport Development Project ($134.7 m) — Ongoing — Expected Delivery Date: 12/31/2015. - Education Development Project II ($40 m) — Ongoing — Expected Delivery Date: 12/31/2016. - Greater Beirut Water Supply ($200 m) — Ongoing — Expected Delivery Date: 06/30/2016. - Grants/Trust Funds and TA (selected): - Emergency Social Protection Imp. Support 2 ($6m – Trust Fund for Lebanon) — Ongoing — Expected Delivery Date: 08/31/2014. - Displaced People in LB ($0.9 m – SPBF) — Ongoing — Expected Delivery Date: 01/31/2015. - Improve Capacity for Environmental Compliance ($0.3 m – IDF) — Ongoing — Expected Delivery Date: 10/7/2016. - Capital Markets Regulation & Development TA ($0.48 m – FIRST) — Ongoing — Expected Delivery Date: 08/31/2014. - Development of National Payments Systems Strategy TA ($0.18 m – FIRST) — Ongoing — Expected Delivery Date: 08/31/2014. - Support to Gas Unit for LNG at Ministry of Energy and Water TA ($0.2 m – PPIAF) — Ongoing — Expected Delivery Date: 09/30/2014. - Wind Energy Resource Mapping TA ($0.12 m – ESMAP) — Ongoing — Expected Delivery Date: 10/31/2016. - Fiscal Management Reform 2 ($5.2 m) — Ongoing — Expected Delivery Date: 09/16/2016. - Other Bank products and timing: - Update of Economic and Social Impact Assessment of the Syrian Conflict — Ongoing — Sept. 2014. - Systematic Country Diagnostic — Ongoing — Dec. 2014. - Lebanon Investment Climate Assessment (2014) — Planned — 05/09/2015. - Country Partnership Framework — Planned — June 2015. - Social Protection and HD Strategy — Ongoing — 06/30/2014. - Toward Universal Health Coverage: A Comprehensive Review of the Health Financing Systems in Jordan and Lebanon — Ongoing — 06/23/2014. - Wind Power Development Study — Completed — 04/19/2014. ### Fund work program (selected items, 2014–15) - Article IV Consultation Staff Report — April–May 2014 — Expected Delivery Date: June 2014. - Technical assistance (TA) on: - Public Accounting — Ongoing — 2014. - Capital Gain Tax — If requested — 2015. - Public Financial Management Reform — Ongoing — 2014. - Budget System Law — Ongoing — 2014. - Statistics (National Accounts, CPI, BoP) — Ongoing — 2014. - Direct Investment Survey — Ongoing — 2014. - Cross Border Banking Supervision — Completed — 2014. - Nonbank Financial Institutions Supervision — Ongoing — 2014. - Oil and Gas Taxation and Revenue Administration — Ongoing — 2014. - FSAP Update — If requested, 2015 — Expected Delivery Date: 2015. ### Joint work program - Fund and Bank teams will coordinate on the macroeconomic framework for the update of the Economic and Social Impact Assessment of the Syrian Conflict — 2014 — Expected Delivery Date: Sept. 2014. ### Statistical issues — Assessment of data adequacy for surveillance (key findings) - General: Data provision has serious shortcomings that significantly hamper surveillance, particularly in national accounts and external sector statistics. - National accounts: - Only annual data publicly available, currently until 2011; plans to start publishing quarterly data. - Responsibility transferred to the Central Administration of Statistics (CAS) in 2012 for publication of 2011 accounts. - Data sources mostly administrative; compilation methods do not conform to best practices. - Fund’s Statistics Department (STA) will assist CAS in reviewing methodology and data collection and start compilation of quarterly national accounts. - Price statistics: - New Consumer Price Index (CPI) released in March 2014 by CAS with Fund assistance. - Since May 2008, CAS has compiled and disseminated a monthly CPI following internationally-accepted methodology; CPI disseminated within three weeks after reference month. - CPI was not compiled during January–May last year due to funding dispute; funding and compilation resumed last summer. - Housing prices now surveyed monthly; need to develop regular and timely statistics on producer prices, wages, and real estate prices. - Government finance statistics: - Significant delays in release of fiscal data. - Published monthly central government budgetary accounts do not cover certain transfers, financing data, foreign-financed capital expenditure, and arrears. - Some treasury spending identified only ex post and presented in economic classification with a lag. - GFS data for budgetary central government based on GFSM 2001 are published yearly in GFS Yearbook; only transactions covered, no balance sheet data reported. - 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 requirements. - Banque du Liban (BdL) does not publish externally-audited financial statements and reporting not fully IFRS-compliant. - Lack of reliable classification of deposits by residency (due in part to bank secrecy) complicates balance of payments analysis. - Financial sector surveillance: - Regular reporter of Financial Soundness Indicators (FSIs): all core and eight encouraged FSIs reported quarterly, except two capital adequacy indicators reported semi-annually. - Compilation of FSIs for other sectors (other financial corporations, non-financial corporations, households, real estate markets) is needed. - Balance of payments: - Challenges in compiling reliable BoP data: unrecorded exports and imports, uncertainty in private sector services, workers’ remittances, and investment income. - Capital account issues: grants; financial account issues: foreign direct investment, equity investment in nonbank private sector, corporate borrowing abroad. - FDI survey in progress; International Investment Position (IIP) statement completed but not yet published. - Amendments to reporting forms in January 2010 and more recently to include more detailed BoP breakdowns. - Lack of effective inter-agency cooperation and data sharing between BdL, CAS, and ministry of finance impede progress. ### Data standards, reporting, and frequency (selected points) - Lebanon joined the General Data Dissemination System in January 2003; metadata and plans for improvement need updating. No ROSC for data dissemination available. - Reporting to STA: - Lebanon currently reports annual data based on GFSM 2001 to be published in the Government Finance Statistics Yearbook; data suffer from limited coverage. - CAS does not currently report any data to STA. - BdL started regular submission of core FSI data and metadata in September 2011; data for 2013 were posted on the IMF website. - Table of Common Indicators Required for Surveillance (selected latest observations and frequencies): - Exchange Rates — Date of Latest Observation: 28/05/14 — 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: 31/03/14 — Date Received: 02/05/14 — Frequency of Data: M — Frequency of Reporting: M — Frequency of Publication: M. - Reserve/Base Money — Date of Latest Observation: 31/03/14 — Date Received: 02/05/14 — Frequency: M / M / M. - Broad Money — Date of Latest Observation: 31/03/14 — Date Received: 02/05/14 — Frequency: W/M — Frequency of Reporting: W/M — Frequency of Publication: M. - Consumer Price Index — Date of Latest Observation: 30/04/14 — Date Received: 21/05/14 — Frequency: M / M / M. - Revenue, Expenditure, Balance and Composition of Financing – Central Government — Date of Latest Observation: 31/12/13 — Date Received: 26/02/14 — Frequency: M / M / M. - Stocks of Central Government and Central Government-Guaranteed Debt — Date of Latest Observation: 30/4/2014 — Date Received: 31/3/2014 — Frequency: M / M / M. - External Current Account Balance — Date of Latest Observation: 31/12/12 — Date Received: 26/04/2014 — Frequency: Q / Q / Q. - GDP/GNP — Date of Latest Observation: 31/12/11 — Date Received: 21/10/13 — Frequency: A / A / A. - Gross External Debt — Date of Latest Observation: 30/4/14 — Date Received: 26/5/14 — Frequency: M / M / M. - International Investment Position — N/A across latest observation, date received, frequency of data, reporting, and publication. ### Press Release summary — IMF Executive Board Concludes 2014 Article IV Consultation with Lebanon (Press Release No. 14/376, July 31, 2014; Article IV concluded June 26, 2014) - Macroeconomic context and near-term outlook: - Growth: 2.5 percent in 2012; decelerated to 1.5 percent in 2013 due to weakening real estate-related activity, construction and tourism. - Inflation appears contained; reported pressures on housing prices. - External current account deficit about 13 percent of GDP in 2012–13. - Without a resolution in Syria, growth likely subdued at around 2 percent in 2014, returning only gradually to potential of a moderate 4 percent. - Inflation could pick up with the planned salary increase. - Financing needs would remain high due to large fiscal and current account deficits. - Impact of Syrian crisis: - Refugee influx, according to United Nations figures, has reached one quarter of the population, fueling unemployment and poverty, straining local communities and public services, and exacerbating political uncertainties. - Fiscal developments and public debt: - Primary fiscal position turned negative in 2012 and deteriorated to about 1 percent of GDP in 2013. - Public debt reached 141 percent of GDP in 2013. - Factors: spending pressures, revenue declines from weak activity, VAT exemption on gasoil, cost-of-living adjustment for public sector wages in 2012, and costs of hosting refugees. - Central bank and reserves: - Banque du Liban continued to finance the government and attract commercial banks’ foreign currency deposits, bringing international reserves to US$35 billion at end-April. - BdL supported credit to private sector by providing low-cost funds to banks to on-lend to specific sectors. - Financial sector: - Banks’ profitability deteriorated; high exposure to the sovereign increased. - Nonperforming loans remain low; provisioning has declined and overdraft use is widespread. - Deposits continued to grow at 7–8 percent a year; liquidity buffers are strong. - Eurobond spreads moved in line with regional averages and similar to levels at end of 2011. ### Executive Board assessment — key messages and policy recommendations - Key risks and priorities: - Conflict in Syria and domestic political uncertainty add stress; growth subdued, fiscal imbalances widening, public debt rising. - Commitment to sound macroeconomic policies and structural reforms essential to foster strong and sustainable growth and improve social conditions. - Fiscal policy recommendations: - Implement a credible and balanced fiscal adjustment strategy to prevent further fiscal deterioration, reestablish primary surpluses, and put public debt on a sustainable path. - Urged caution in implementing the planned salary scale adjustment for public sector employees. - Encourage revenue-enhancing measures such as broadening the tax base and strengthening collection, ensuring measures are equitable and minimize distortions. - Reform the electricity sector by raising average tariffs toward cost recovery while mitigating impact on the poor and rebalancing freed-up resources toward capital and social spending. - Strengthen fiscal management by adhering to a budget calendar and pursuing a medium-term budget framework. - Monetary policy and central bank: - Monetary policy should remain geared towards maintaining adequate foreign exchange reserves and supporting the exchange rate peg. - Encourage scaling back government reliance on central bank financing as fiscal consolidation advances and measures to further strengthen the central bank’s balance sheet. - Financial sector policies: - Further strengthen capital buffers and improve loan classification and restructuring rules. - Encourage further strengthening of the AML/CFT framework. - Structural reforms and social policies: - Undertake structural reforms to unlock growth potential and improve social conditions, including lowering the cost of doing business and improving services starting from electricity provision. - Enhance labor markets and support job creation while strengthening social safety nets. - Take further steps to improve Lebanon’s statistical system, building on ongoing progress. ### Selected economic indicators, 2011–15 (as presented) - Output and prices (Annual percentage change) - Real GDP (market prices): 2011 Act. 2.0; 2012 Prel. 2.5; 2013 Projections 1.5; 2014 1.8; 2015 2.5. - GDP deflator: 2011 3.4; 2012 4.6; 2013 3.2; 2014 3.4; 2015 4.4. - Consumer prices (period average): 2011 7.2; 2012 5.9; 2013 3.2; 2014 3.1; 2015 4.0. - Central government finances (cash basis) (In percent of GDP) - Revenue: 2011 22.8; 2012 22.3; 2013 20.9; 2014 20.9; 2015 21.9. - Expenditure: 2011 28.7; 2012 31.0; 2013 30.1; 2014 32.0; 2015 33.7. - Budget balance: 2011 -5.9; 2012 -8.6; 2013 -9.2; 2014 -11.1; 2015 -11.9. - Primary balance: 2011 3.5; 2012 -0.2; 2013 -0.8; 2014 -2.4; 2015 -2.5. - Total government debt: 2011 134; 2012 134; 2013 141; 2014 145; 2015 148. - Monetary sector (Annual percentage change, unless otherwise indicated) - Credit to the private sector: 2011 12.9; 2012 10.5; 2013 9.6; 2014 7.1; 2015 6.9. - Broad money 1/: 2011 7.2; 2012 7.9; 2013 9.0; 2014 8.0; 2015 8.0. - Interest rates (period average, in percent): - Three-year Treasury bill yield: 2011 6.0; 2012 6.5; 2013 6.6; 2014 6.7; 2015 7.0. - Five-year Eurobond yield: 2011 5.2; 2012 5.0; 2013 5.4; 2014 5.7; 2015 6.1. - External sector (In percent of GDP, unless otherwise indicated) - Exports of goods (in US$, percentage change): 2011 0.1; 2012 2.0; 2013 -1.0; 2014 4.7; 2015 5.2. - Imports of goods (in US$, percentage change): 2011 1.0; 2012 1.9; 2013 1.9; 2014 4.7; 2015 4.1. - Current account balance: 2011 -12.8; 2012 -12.7; 2013 -12.8; 2014 -12.6; 2015 -12.2. - Foreign direct investment: 2011 6.8; 2012 6.7; 2013 6.7; 2014 7.1; 2015 7.7. - Total external debt 2/: 2011 169; 2012 168; 2013 174; 2014 177; 2015 177. - Gross reserves (in billions of U.S. dollars) 3/: 2011 31.6; 2012 32.2; 2013 33.9; 2014 35.0; 2015 36.3. - In percent of short-term external debt 4/: 2011 53.8; 2012 51.5; 2013 49.6; 2014 47.6; 2015 45.9. - In percent of total banking system deposits: 2011 27.3; 2012 25.7; 2013 24.9; 2014 23.8; 2015 22.8. - Exchange rate — Real effective exchange rate (annual average, percentage change): 2011 -1.2; 2012 -0.1; 2013 4.0; 2014 -0.4; 2015 1.4. *Content derived from IMF staff documents and statements in _cr14237.* ### 1. On behalf of the Lebanese authorities, I would like to thank staff for the valuable ### _cr14237 - 1. On behalf of the Lebanese authorities, I would like to thank staff for the valuable ### Recent Developments and Outlook - The Lebanese economy faces difficult challenges associated with the conflict in Syria, which exacerbate already difficult domestic conditions. - Since the onset of the Syrian crisis in early 2011, Lebanon has maintained an open border policy and has permitted refugees to freely settle across the country. - Registered Syrian refugees account for about 25 percent of Lebanon’s pre-crisis population; including unregistered refugees raises this ratio to about 35 percent of the population. - The refugee influx has negatively impacted security and put serious pressures on virtually all aspects of the economy. - Growth is expected to be subdued in 2014 and the fiscal deficit and public debt are expected to increase. - On the positive side: - Security conditions have recently improved since the formation of the government. - Deposit capital inflows remain resilient. - Foreign exchange reserves are high. - Reflecting these developments, Standard & Poor’s upgraded Lebanon’s outlook from negative to stable last March. ### Fiscal Policy and Reforms - The authorities are committed to policies that ensure macroeconomic stability while addressing infrastructure bottlenecks and improving social conditions. - Lebanon does not have the fiscal space to address the impact of the Syrian refugee crisis on the economy and local communities; dealing with the refugee crisis requires strong international support. - The authorities are committed to putting in place a budget for 2014 aimed at balancing essential spending needs with stability goals. - The fiscal impact of the Syrian crisis is extensive: - Negative impacts on investor and consumer confidence and disruption in trade routes for exports and imports of goods, tourism, and financial services are placing downward pressure on government revenues. - Rising demand for public services due to the large refugee influx further damages public finances. - The World Bank envisaged an immediate negative fiscal impact of $2.6 billion in 2012–14 (about 6 percent of 2013 GDP) through lower revenue and higher expenditure. - The World Bank estimated the stabilization needs to be an additional $2.5 billion. - Large uncertainties surround the salary scale adjustment, which is still under parliamentary consideration. - The authorities are confident that the revenue measures they envisaged, if passed by parliament in a timely manner, would be sufficient to offset the cost of the salary scale adjustment. These measures include: - an increase in the interest income tax rate from 5 to 7 percent; - an increase in the corporate income tax rate from 15 to 17 percent; - a new capital gain tax on real estate transactions; - increases in tobacco excises; - increases in various stamps and fees. - The authorities note staff’s work on a fiscal adjustment strategy that would reverse the debt dynamics, and consider that broadening the tax base and addressing tax loopholes are preferable to a large increase in VAT. - The authorities do not share staff’s assessment that commitment to fiscal discipline will help mobilize budget support to deal with the refugee crisis; they emphasize that fiscal discipline is necessary to avoid loss of market confidence and to put debt on a sustainable path, but reiterate their call for international support to deal with the refugee crisis and its repercussions. ### Monetary and Exchange Rate Policies - Monetary policy helped maintain confidence in the Lebanese financial system, with the exchange rate peg providing a firm anchor for financial stability. - The authorities share staff’s view on the importance of maintaining a high level of reserves. - The authorities are keen on reducing the Treasury’s reliance on central bank financing and agree with staff that this will have to be accompanied by a strong fiscal consolidation effort. - The central bank remains open to further gradual reductions in the deposit remuneration rates and to increases in the Treasury-bill rates if and when conditions permit. ### Banking Sector - The banking sector remains resilient despite the challenging environment, which has limited credit opportunities to the private sector and the banks’ expansion in neighboring countries. - The authorities consider that staff’s assessment does not sufficiently acknowledge ongoing progress in the regulatory and supervisory framework. - Regulatory and supervisory measures include: - the central bank required banks to hold by end-2015 a supplementary capital buffer of 1.5 percent on top of the Basel III minimum, in addition to a 2.5 percent conservation buffer; - establishment of colleges to strengthen the cross-border supervision of the largest banks. - Efforts to assess capital adequacy with respect to banks’ cross-border exposures through stress tests are ongoing. - Lebanon’s AML/CFT regime is in practice fully compliant with international standards, and Lebanon’s financial intelligence unit, the Special Investigation Commission, actively cooperates with its foreign counterparts. *Source: _cr14237 - 1. On behalf of the Lebanese authorities, I would like to thank staff for the valuable* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14237.pdf_