## _cr15190

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### Macroeconomic and growth context
- Syrian crisis is the key determinant of Lebanon’s outlook; refugees comprise over one-quarter of the population.
- Staff estimate GDP growth at about 2 percent in 2014 and project a similarly modest rate for 2015.
- Return to potential growth (4 percent) is now unlikely before 2019.
- Inflation declined sharply in 2014 and is expected to return to a trend rate of about 3 percent in 2015.
- Nominal GDP rising despite negative consumer inflation end-2014 due to GDP deflator dynamics and terms-of-trade gains (notably lower oil/import prices and a stronger U.S. dollar).

### Fiscal outcomes, public debt, and fiscal sustainability
- 2014 primary surplus: 2½ percent of GDP, largely reflecting:
  - unusually high telecom transfers (part estimated at about 1 percent of GDP to be transferred to municipalities in 2015),
  - non-implementation of a public-sector salary increase,
  - and withheld and delayed payments.
- Staff project the primary balance will deteriorate to almost 1¼ percent of GDP in 2015 without repetition of one-off factors.
- Public debt projected to remain high at 132 percent of GDP (2015 est.); baseline projects debt-to-GDP reaching 143 percent in 2020.
- Public gross financing needs: 2015: 24.2 (percent of GDP); peak around 2018: 29.4; 2019: 38.9; 2020: 33.9/38.9 (table entries).
- Contribution to change in debt (cumulative 2015–20): Change in gross public sector debt cumulative: 9.2; Identified debt-creating flows cumulative: 7.4; Primary deficit cumulative: -4.7; Automatic debt dynamics cumulative: 12.1; Residual, including asset changes cumulative: 1.9.
- Debt vulnerabilities and stress tests:
  - Growth shock (one standard deviation for 2016–17) → debt-to-GDP almost 160 percent in 2020; financing needs almost 45 percent of GDP in 2020.
  - Interest-rate shock → debt-to-GDP almost 150 percent by end projection; financing needs exceed 40 percent of GDP.
  - Combined macro-fiscal shock → debt-to-GDP exceeding 170 percent; financing needs almost 50 percent of GDP in 2020.
  - Contingent liability shock (10 percent of financial sector assets) → debt-to-GDP exceeding 175 percent; financing needs exceed 45 percent of GDP in 2020.
- Staff objective: deliver sustained primary surpluses comfortably above the debt-stabilizing level of 2.3 percent of GDP and reduce public debt ratio.

### Fiscal policy recommendations and scenarios
- Immediate priority: pass an appropriately ambitious budget for 2015—the first in a decade.
- Revenue and tax policy recommendations:
  - Broad-based revenue measures, including increases in fuel taxation.
  - Staff call for a modest increase in the VAT rate by one percentage point, to 11 percent.
  - Baseline package assumptions: corporate income tax rate increase from 15 to 17 percent; introduction of a capital gains tax on real estate; increase in tax rate on interest income from 5 to 7 percent; new stamp duties and fees.
  - Staff note a one percentage point VAT rate increase would yield ½ percent of GDP.
  - Remove the VAT exemption on diesel (VAT exempt since 2012) and increase gasoline excises; gasoline currently subject to 10 percent VAT and excises at less than 20 U.S. cents per liter.
- Spending and transfers:
  - Rebalance spending away from transfers to the electricity company toward capital projects and social programs.
  - Manage telecom transfers transparently by replacing ad-hoc transfers with regular transfers.
  - Place EdL on a sound financial footing; ideally eliminate transfers and move tariffs toward cost recovery while protecting lower-income consumers.
- Public-sector salary adjustment:
  - Implement only if funded by credible revenue measures, phased in gradually, without retroactive payments, and accompanied by public-sector reform (e.g., lengthening working hours from 32 to 35 a week and capping overtime and benefits).
- Alternative fiscal scenario:
  - Starting from adjustment scenario (scenario a), capital expenditure could be further increased by 1 percent of GDP funded in a budget neutral way by additional VAT revenue (scenario b).
- Risks of delaying payments: staff advise against using withheld/delayed payments as a lasting fiscal-compression strategy.

### Electricity sector (priority reform) and fiscal impact
- Finding: households and businesses rely on very expensive private generation; government bears large EdL transfers.
- Cabinet recommendation: urgently implement electricity improvements to boost productivity, competitiveness, growth, and equity.
- Central government transfers to EdL (in billions of Lebanese pounds): 2013: 3,361; 2014: 3,021; 2015 estimate: 3,157; projections: 2016: 2,321; 2017: 1,794; 2018: 2,036; 2019: 2,200; 2020: 2,350.
- Transfers to EdL (2020 projection alternate): 2.3 (percent of GDP).
- Staff aim for gradual reduction and eventual elimination of EdL transfers as tariffs and collection improve.

### External finances, reserves, and monetary policy
- Current account deficit estimated at around 25 percent of GDP in 2014 (including official transfers); projected to narrow to 15 percent of GDP by 2020.
- BdL gross reserves: around $38 billion as of end-March 2015 (107 percent of the Fund’s composite metric); gross reserves (year-end, billions USD): 2014: 37.3; 2015 est.: 37.3; 2016 proj.: 40.7; 2017 proj.: 44.4; 2018 proj.: 48.4; 2019 proj.: 51.9; 2020 proj.: 55.8.
- Directors commended BdL for supporting macro stability and maintaining adequate international reserves; monetary policy should remain geared to supporting the U.S. dollar peg.
- Lebanon’s nominal effective exchange rate appreciated considerably reflecting the strength of the U.S. dollar; CPI-based REER remained unchanged over the past 12 months due to CPI deflation from lower oil prices.

### Banking sector, financial stability, and supervision
- Banking system remains a critical pillar with high access relative to region and peers; deposits to total liabilities remain high (2014: 87.4).
- Banking indicators (selected, end-of-period):
  - Regulatory capital to risk-weighted assets: 2010: 13.4; 2011: 11.6; 2012: 13.0; 2013: 14.5; 2014: 14.0.
  - Regulatory Tier 1 capital to risk-weighted assets: 2010: 11.4; 2011: 11.0; 2012: 12.1; 2013: 13.5; 2014: 12.8.
  - Nonperforming loans to gross loans: 2010: 4.3; 2011: 3.8; 2012: 3.8; 2013: 4.0; 2014: 4.0.
  - Return on assets (after tax): 2010: 1.2; 2011: 1.1; 2012: 1.0; 2013: 1.0; 2014: 1.0.
  - Foreign-currency-denominated loans to total loans: 2010: 78.4; 2011: 77.4; 2012: 76.5; 2013: 75.8.
- Risks and recommendations:
  - Banks’ capital buffers are modest given exposure to zero-weighted local-currency sovereign debt.
  - NPLs increased slightly; provisioning has decreased for specific provisions though total provisioning (specific + general) increased as a share of total NPLs per authorities.
  - Staff recommend strengthening regulatory framework: increase capital buffers, improve loan classification and restructuring rules, adopt IFRS 9-consistent provisioning, enhance AML/CFT frameworks, and update the FSAP (scheduled for 2016).
  - Staff recommended BdL gradually scale back intermediary role between banks and sovereign to allow more market-determined benchmark T-bill yields.
- BdL quasi-fiscal activities and balance-sheet concerns:
  - BdL subsidized credit schemes account for about 20 percent of total outstanding loans and close to 75 percent of housing loans in 2014; staff called for gradual withdrawal.
  - Nonresident deposits account for about 23 percent of total deposits (depositors classified as nonresidents only if they lack a Lebanese address).

### Refugee crisis, humanitarian impact, and social consequences
- UNHCR: Syrian refugees exceeded 1.4 million in January 2015; combined with estimated 0.4 million Palestinians, refugees exceed one third of Lebanon’s resident population.
- UNHCR projects Syrian refugees will surpass 1.8 million by end-2015.
- World Bank (2013) estimated direct fiscal impact over 2012–14 at $2.6 billion (5½ percent of GDP); restoring public-service provision to pre-crisis levels would require an additional $2.5 billion.
- UNDP estimated humanitarian-aid multiplier ~1.6; aid inflows in 2014 added 1.3 percent to overall GDP growth.
- Social impacts:
  - Poverty increased by 4 percentage points to 32 percent.
  - Labor force rose by an estimated 50 percent compared to 2011.
  - Income inequality has widened.
- Humanitarian assistance: direct assistance targeting refugees exceeded $1 billion in 2013 and almost reached that level in 2014.
- WFP card voucher scheme: $30 per month targeted for around 883 thousand refugees; coverage increased from 28 percent of eligible refugees in 2013 to about 40 percent in 2014; due to funding shortfalls, support often below targeted levels, at less than $20 per month per refugee.
- Lebanon Crisis Response Plan (LCRP) targets 1.5 million refugees and 1.9 million vulnerable Lebanese; required under plan: $2.14 billion, with some $400 million available. Kuwait III pledging led to pledges of $3.8 billion to fund the Regional Refugee and Resilience Plan 2015–16.

### External sector assessment and data uncertainty
- Current account deficit: 2014 estimate about 25 percent of GDP; baseline projection narrows to 15 percent of GDP by 2020.
- Box 1 on current-account data revisions:
  - Authorities’ 2012 deficit estimates revised repeatedly; recent staff estimate around 24½ percent of GDP in 2012 and 26¾ percent in 2013 (adjusted for income flows).
  - Revisions driven by corrected services-account reporting following IT upgrades; large data uncertainty and possible ongoing reporting issues with banks.
- CGER-type methodologies suggest exchange rate overvalued under baseline; ERER not applied due to missing labor productivity/employment data.

### Data, statistical capacity, and reporting shortcomings
- Serious shortcomings hinder surveillance: national accounts, external sector, fiscal, social, and labor-market statistics weak and delayed.
- National accounts: only annual data compiled and disseminated; data available through 2013; plans to publish quarterly data but priority to improve annual estimates first.
- CPI improvements: new CPI released March 2014; monthly collection of rent prices; CPI disseminated within three weeks of reference month.
- Government finance statistics (GFS): delays persist; published monthly central government budgetary accounts omit certain transfers, financing data, and arrears; GFS on modified cash basis for some items.
- Monetary and financial statistics: sectorization and instrument classification shortfalls; BdL does not publish externally-audited financial statements and reporting not fully IFRS-compliant.
- Balance of payments: significant challenges remain (unrecorded flows, services, remittances, investment income); frequent large revisions hamper assessment; IIP progress slow.
- CAS constraints highlighted: CAS budget was $2.7 million in 2012; limited resources, heavy reliance on other agencies for source data, and access difficulties for enterprise-level data.

### Program of Fund and World Bank support; joint work and coordination
- Fund and Bank to coordinate on macro framework and reform areas; Fund engaged in Systematic Country Diagnostic and Country Partnership Framework for FY16–21.
- Selected Fund TA and work program items:
  - Article IV Consultation Staff Report — April–May 2015 — June 2015.
  - TA: public accounting, public financial management reform, statistics (National Accounts, CPI, BoP, IIP), cross-border banking supervision, nonbank financial institutions supervision — ongoing 2015; Capital Gains Tax TA if requested — 2016.
  - FSAP Update — 2015/2016.
- Selected Bank work program (selected projects with expected delivery dates) includes Urban Transport Development Project ($134.7 m) — 12/31/2015; Education Development Project II ($40 m) — 12/31/2016; Greater Beirut Water Supply ($200 m) — 6/30/2016; and numerous other projects and TA items with dates through 2024.
- Information exchange: Fund and Bank teams request semi-annual updates on milestones and assessments; closer coordination on macroframework and Country Partnership Strategy.

### Authorities’ views (summarized)
- Authorities agree reducing the debt ratio is main priority but note political difficulty and protracted 2015 budget passage.
- Views split on salary adjustment; some favor tighter hiring controls and differentiated increases, others emphasize need for higher salaries to secure decent living and reduce corruption.
- Authorities welcome focus on growth and fairness and Fund TA on broadening tax bases and strengthening compliance.
- Authorities defend BdL actions and role; cite BdL schemes and strengthened supervision; express confidence in AML/CFT effectiveness and pending draft laws.

*International Monetary Fund staff report (Lebanon): Staff Report for the 2015 Article IV Consultation.*

### 2.5 percent of GDP largely resulted from exceptional telecom transfers and, to some extent, from

### _cr15190 - 2.5 percent of GDP largely resulted from exceptional telecom transfers and, to some extent, from

### Macroeconomic and growth context
- The Syrian crisis remains the key determinant of Lebanon’s short-term outlook and longer-term prospects; refugees comprise over one-quarter of the population.
- Growth has decelerated: staff estimate Lebanon’s GDP growth at about 2 percent in 2014 and project a similarly modest rate for 2015.
- Lebanon’s return to potential growth (4 percent) is now unlikely before 2019.
- Inflation declined sharply in 2014 and is expected to return to a trend rate of about 3 percent in 2015.

### Fiscal outcomes and public debt
- The 2014 primary surplus was 2½ percent of GDP, largely reflecting:
  - unusually high telecom transfers (part of which, estimated at about 1 percent of GDP, will be transferred to municipalities in 2015),
  - the non-implementation of a much-awaited salary increase for the public sector,
  - and, to some extent, withheld and delayed payments.
- Without repetition of these one-off factors, staff project the primary balance will deteriorate to almost 1¼ percent of GDP in 2015.
- Public debt is projected to remain high at 132 percent of GDP.

### External finances, monetary policy, and financial sector
- Foreign-exchange and financial markets remain resilient despite sizable external financial requirements.
- Inflows remain large, particularly from non-resident deposits.
- In the context of Lebanon’s currency peg to the U.S. dollar, the Banque du Liban (BdL) has maintained an adequate level of gross foreign exchange reserves.
- Directors commended the central bank for supporting macroeconomic stability and maintaining adequate international reserves; monetary policy should remain geared to supporting the U.S. dollar peg.
- Directors highlighted the need to strengthen the regulatory framework: increase capital buffers, improve loan classification and restructuring rules, and enhance anti–money laundering and counter–terrorism financing frameworks.

### Refugee crisis and humanitarian impact
- UNHCR reported Syrian refugees exceeded 1.4 million in January 2015; combined with an estimated 0.4 million Palestinians, refugees now exceed one third of Lebanon’s total resident population.
- UNHCR expects the number of Syrian refugees will surpass 1.8 million by the end of the year.
- World Bank (2013) estimated the direct fiscal impact of the crisis over 2012–14 at $2.6 billion (5½ percent of GDP) and suggested restoring public-service provision to pre-crisis levels would require an additional $2.5 billion.
- A UNDP study estimated the multiplier associated with humanitarian aid at around 1.6; aid inflows in 2014 added 1.3 percent to overall GDP growth.
- Social impacts: poverty increased by 4 percentage points to 32 percent; the labor force has risen by an estimated 50 percent compared to 2011; income inequality has widened.
- Humanitarian assistance directly targeting refugees exceeded $1 billion in 2013 and almost reached that level in 2014.
- WFP card voucher scheme: $30 per month targeted for around 883 thousand refugees; coverage increased from 28 percent of eligible refugees in 2013 to about 40 percent in 2014. Due to funding shortfalls, support often below targeted levels, at less than $20 per month per refugee.
- Lebanon Crisis Response Plan (LCRP): targets 1.5 million refugees and 1.9 million vulnerable Lebanese; of the $2.14 billion required under the plan, some $400 million has been made available. Kuwait III pledging led to pledges of $3.8 billion to fund the Regional Refugee and Resilience Plan 2015–16.

### Policy priorities and key recommendations
- Immediate priorities:
  - Pass an appropriately ambitious budget for 2015—the first in a decade—as a signal that the fiscal situation is under control.
  - Start well-known reforms in the electricity sector to remove a large drain on public finances and improve productivity, competitiveness, growth, and equity.
- Short-term fiscal strategy:
  - Deliver a credible policy mix with sustained adjustment and a falling public debt ratio.
  - Revenue measures should be broad-based, starting from increases in fuel taxation.
  - Spending composition should move away from transfers to the electricity company toward capital projects and social programs.
  - Fiscal adjustment would reduce the financial and institutional burden on the Banque du Liban and ultimately promote interest rate flexibility.
- Medium-term structural priorities:
  - Job-rich and sustainable growth supported by a sound financial system and reforms to improve competitiveness and equity, starting from pension scheme reform.
  - Strengthen social safety nets and reform the pension system to improve equity and fiscal sustainability.
  - Advance labor reforms, improvements in public service provision, and legislation to reinvigorate private investment, including in the oil and gas sector.
- Financial sector oversight:
  - Continue vigilance and strengthen the regulatory framework, increase capital buffers, improve loan classification and restructuring rules, and enhance anti–money laundering and terrorism financing frameworks.
  - Update assessment under the Financial Sector Assessment Program.

### Key dates and mission
- Discussions took place in Beirut during April 28–May 12, 2015.
- Report dated June 11, 2015.

*International Monetary Fund staff report (Lebanon): Staff Report for the 2015 Article IV Consultation.*

### Box 2. Can Nominal GDP Increase with Falling Prices and Stagnant Growth?

### Box 2. Can Nominal GDP Increase with Falling Prices and Stagnant Growth?

### Mechanics: CPI vs GDP deflator and the role of terms of trade
- CPI and the GDP deflator typically move together, but can diverge when export and import prices move in different directions.
- The CPI basket includes imports, but not exports; the GDP deflator includes exports, but not imports.
- The discrepancy often stems from movements in a country’s terms of trade (the ratio of export prices to import prices).
- Exact relationship presented in source:
  - GDP deflator = "Domestic prices"ൈߙ൅export prices െ	ߚൈ import prices
  - where α and β are the relative importance of exports and imports, respectively, as a proportion of GDP.
- If terms of trade improve—either through rising export prices or falling import prices—the deflator will tend to rise faster than the CPI, boosting nominal GDP even if consumer prices are subdued and real growth is modest.

### Findings and analysis relevant to Lebanon
- Despite weak real growth and falling consumer prices (inflation actually negative at end-2014), Lebanon’s nominal GDP is rising.
- Staff have recently scaled back their real GDP growth estimates, amidst falling inflation; nominal GDP projections have actually increased due to deflator dynamics driven by terms-of-trade gains.
- WEO projections imply a significant improvement in Lebanon’s terms of trade in 2015, owing in large part to the recent drop in oil (import) prices, and reflecting also the strengthening U.S. dollar.
- These factors will boost nominal GDP growth, despite subdued consumer prices and modest real growth.

### Related macro-financial context and salient figures from the source
- The current account deficit is estimated at around 25 percent of GDP in 2014.
- BdL gross reserves stood at around $38 billion as of end-March 2015 (107 percent of the Fund’s composite metric).
- Lebanese Eurobond spreads are broadly at pre-crisis levels (400 bps).
- In February (2015), a $2.2 billion Eurobond issue by the Treasury was significantly oversubscribed.
- S&P maintained the rating unchanged at B- level in March 2015.

### Policy implications (as reflected in surrounding analysis)
- Improved terms of trade can raise measured nominal GDP even when consumer prices fall; policymakers should interpret nominal GDP dynamics in light of deflator composition and terms-of-trade movements.
- Fiscal and macroeconomic policy should take into account that nominal revenue increases driven by terms-of-trade gains may not reflect domestic consumer-price-driven inflation or stronger underlying real activity.
- Continued monitoring of external price developments (notably oil/import prices) and exchange-rate movements (strengthening U.S. dollar) is important for assessing nominal GDP and fiscal metrics.

*Source: _cr15190 - Box 2. Can Nominal GDP Increase with Falling Prices and Stagnant Growth?*

### 19. The case for fiscal adjustment is also grounded in

### _cr15190 - 19. The case for fiscal adjustment is also grounded in

### Fiscal sustainability and fairness
- Without fiscal adjustment, interest payments will soar to some 12 percent of GDP, or about 40 percent of total spending, crowding out essential social programs and infrastructure and largely benefitting public debt holders at the expense of the less-privileged.
- Lack of fiscal adjustment is therefore described as both costly and inequitable.

### Baseline projections and downside risks
- Under the baseline scenario, staff assume the salary scale adjustment for the public sector will be implemented as part of a package that includes the following revenue measures:
  - an increase in the corporate income tax rate (from 15 to 17 percent);
  - the introduction of a capital gains tax on real estate;
  - an increase in the tax rate on interest income (from 5 to 7 percent);
  - new stamp duties and fees.
- Staff projections assume the salary increase will be implemented as of January 1, 2015, while the revenue measures will become effective as of January 1, 2016.
- The proposed package generates moderate primary surpluses but would not be sufficient to tackle Lebanon’s deteriorating debt dynamics. Debt is projected to reach 143 percent of GDP by 2020, with its trajectory subject to significant downside risks.

### Objectives of the staff’s proposed adjustment strategy
- Deliver a sustained reduction in the public debt ratio by targeting primary surpluses comfortably above the debt-stabilizing level of 2.3 percent of GDP.
- Promote more fair fiscal policies by targeting a broad-based increase in taxation.
- Mitigate the procyclical impact of fiscal adjustment by increasing productive spending.

### Policy recommendations and measures
- Increase taxation fairly across all economic sectors by broadening tax bases and strengthening compliance; staff analysis indicates Lebanon’s tax capacity remains largely under-utilized.
  - Lebanon’s tax effort is estimated at only 50 percent; i.e., at maximum effort, Lebanon might be able to double tax revenues to around 30 percent of GDP.
  - Staff endorsed the authorities’ planned measures (with the caveat that double taxation on incomes be avoided) and cautioned against optimistic yield projections.
  - Staff called for a modest increase in the VAT rate by one percentage point, to 11 percent.
- Reform fuel taxation while oil prices are low:
  - Remove the VAT exemption on diesel introduced in 2012 and increase gasoline excises (excises were lowered significantly in 2011).
  - Rationale: promote efficient fuel use, mitigate pollution and congestion costs, and raise revenue.
- Manage telecom transfers transparently by replacing ad-hoc transfers with a system of regular transfers.
- Place the state-owned Electricité du Liban (EdL) on a sound financial footing to reduce government transfers:
  - Ideally, transfers should be eliminated.
  - Tariffs (unchanged since 1993) should be increased toward cost recovery levels while protecting lower-income consumers as service provision improves.
- Implement the salary scale adjustment only if funded by credible revenue measures, phased in gradually and without retroactive payments:
  - Accompany salary changes with comprehensive public-sector reform (e.g., lengthening working hours from 32 to 35 a week and capping overtime and benefits) to align remuneration with productivity.
- Increase capital and social spending:
  - Capital outlays have been cut well below modest regional averages; staff propose rebalancing the spending mix to mitigate procyclicality.
  - Starting from the adjustment scenario (scenario a), capital expenditure could be further increased by 1 percent of GDP (funded in a budget neutral way by additional VAT revenue, scenario b), resulting in a more growth-friendly fiscal package.
- Avoid delaying payments as a method to compress spending; increased delayed payments are not a lasting strategy and could create future obligations and weaken economic activity.

### Fuel taxation: rationale and impacts (Box 4 summary)
- Retail fuel prices declined by about 30 percent in 2014; taxes on fuel products remain unchanged at very low levels.
- Current taxation specifics:
  - Gasoline is subject to 10 percent VAT and low excises, at less than 20 U.S. cents per liter.
  - “Green” and “red” diesels are totally tax free (VAT exempt since 2012 and never subject to excises).
- Fiscal and distributional consequences:
  - The VAT exemption on diesel was originally estimated to cost some ½ percent of GDP; consumption increases since 2012 suggest losses are probably larger.
  - Distributional incidence: the poorest 20 percent of the population receives only 6 percent of the fuel subsidy, while the richest 20 percent receives 55 percent.
- Efficiency and externalities:
  - Low fuel taxes encourage over-consumption and add to global environmental damage, local air pollution, congestion, accidents, and roadway wear and tear.
  - Higher fuel taxes could improve public health, lower environmental costs, reduce congestion, and promote more efficient fuel use.
- Policy guidance:
  - An optimal-pricing tool suggests at minimum excises on gasoline should be increased and the VAT on diesel should be re-instated.
  - Fuel-tax reforms could be framed within a broader strategy addressing public transport and infrastructure shortcomings; compensating measures for the less well-off should be considered.

### Fiscal scenarios and numerical signals
- Staff note a one percentage point VAT rate increase would yield ½ percent of GDP.
- Staff estimate that a 1 percentage-point reduction in deposit inflow growth would require 2½ percent of GDP in fiscal adjustment, other things equal.

### Implications for the Banque du Liban (BdL) and market interest rates
- Fiscal adjustment would reduce reliance on foreign deposit inflows and rollover risks:
  - Banks hold over half of Lebanon’s T-bills and Eurobonds, funded primarily by deposits, with a sizable portion coming from non-resident inflows.
  - Nonresident deposits account for about 23 percent of total deposits (noting depositors are classified as nonresidents only if they lack a Lebanese address).
- Fiscal adjustment would reduce the financial and institutional burden on the BdL:
  - The BdL has channeled FX resources from the banking system into international reserves and used some funds to meet government FX needs.
  - The BdL has introduced subsidized credit schemes accounting for about 20 percent of total outstanding loans and close to 75 percent of housing loans in 2014; staff called for a gradual withdrawal from such quasi-fiscal schemes.
  - There is a need to gradually strengthen the BdL’s balance sheet.
- Move toward market-determined interest rates:
  - The BdL has offered well-remunerated term deposits to banks and channeled proceeds to cover shortfalls in the T-bill market, effectively managing T-bill yields via rates on its own CDs.
  - Staff recommended that, as fiscal adjustment takes hold, the BdL scale back its role as intermediary between banks and the sovereign, paving the way for more market-based benchmark T-bill yields.

### Authorities’ views
- Authorities agreed reducing the debt ratio is the main priority but underscored a difficult political environment; passing the 2015 budget proved protracted.
- Views were split on the salary adjustment package:
  - Some favored tighter hiring controls and differentiated salary increases across public-sector categories.
  - Others argued higher salaries were needed to secure a more decent living for public servants and mitigate corruption.
- Authorities welcomed the emphasis on growth and fairness and the Fund’s technical assistance on boosting tax capacity through broadening tax bases and strengthening compliance.
- Authorities generally accepted the need to rebalance the policy mix to lighten the burden on the BdL, but disagreed that the BdL was actively intermediating flows between banks and the government and highlighted capital-market development goals for longer-term CDs.

### Financial stability and growth
- Sustained, broad-based growth requires a sound financial system; the banking system remains a critical pillar with high access relative to the region and peers.
- Financial Conditions Index (FCI) findings:
  - Financial conditions appear to have tightened over the past year, driven by lower deposit growth and an appreciating real exchange rate, offset in part by low global interest rates.
  - Key drivers of the FCI: LIBOR, deposit growth, and the real effective exchange rate (REER), with a more limited role for bank interest rate spreads.
  - Deposit growth has decelerated and is below its 20-year average; rising global interest rates are expected to further tighten local conditions.

*Source: IMF staff analysis and estimates as presented in the content unit.*

### 31. But the current environment is particularly

### _cr15190 - 31. But the current environment is particularly

### Banking sector risks and outlook
- Banks’ capital buffers are modest given their significant exposure to zero-weighted local-currency sovereign debt.
- Net interest margins have been contracting (though from large levels) and profit growth is down.
- There is little evidence that credit growth in Lebanon is excessive, but the unfavorable outlook, limited private-sector lending opportunities, and already-large exposures to the government would affect banks’ medium-term profitability.
- Nonperforming loans (NPLs) have increased slightly, from a low base, while provisioning has decreased and the use of overdraft facilities is widespread.
- Staff noted that the low level of NPLs is potentially at odds with Lebanon’s slowing economy and will likely increase in the short-to-medium term.
- Staff reiterated that the risk weights applicable to foreign currency claims on the BdL and holdings of Eurobonds should be set in accordance with the Basel capital adequacy framework.

### Regulation, supervision, and supervisory enhancements
- Continued efforts to strengthen banking regulation and supervision are crucial.
- Loan-classification rules do not provide an explicit test of whether renegotiation or rescheduling of a loan could be concealing debt service problems.
- There is no written rule regarding the classification of high-balance overdrafts that are permanently rolled over.
- Staff welcomed the Banking Control Commission’s efforts to strengthen supervision of banking groups with cross-border operations and encouraged pursuing the establishment of supervisory colleges for Lebanese banking groups with significant operations abroad.
- The Banking Control Commission is progressively moving toward adoption of IFRS 9 norms that would require provisioning based on expected losses.
- Authorities noted the decline in the ratio of specific provisions to NPLs over the past year was due to a composition effect—NPLs include "substandard" loans, which had increased in importance, but do not require specific provisions. They stressed that total provisioning, including both specific and general provisions, had increased as a share of total NPLs.
- The authorities considered that NPLs would likely grow in the immediate future, but that banks had sufficient buffers to comfortably absorb any increase.

### Macroprudential measures and financial stability architecture
- Macroprudential policies can be helpful to limit systemic risk.
- Staff welcomed the creation of a Financial Stability Unit within the BdL to monitor financial risks.
- New macroprudential measures were introduced in 2014—though it is too early to assess their effectiveness.
- The authorities’ request for an FSAP update is most welcome; the update is scheduled for 2016 and should also tackle the development of capital markets to help promote a more diversified flow of resources to the economy.

### AML/CFT risks and policy actions
- Risks related to Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) issues remain.
- Existing legislation is not in line with revised international standards; a new AML/CFT Law has been pending in parliament since 2010.
- Staff called for adoption of the new law and for allocation of sufficient resources for its effective implementation.
- The BdL has strengthened monitoring requirements at the level of each banking branch.
- Efforts should focus on regulation of cross-border cash transactions, risk-based supervision of banks (and money remitters in particular), and developing a better understanding of the origin of non-resident deposits and their beneficial owners.
- Authorities expressed confidence in the effectiveness of Lebanon’s AML/CFT regime, noting three draft laws pending parliamentary approval and BdL requirements that Lebanese banks abide by stricter correspondent-bank regulations where applicable. Authorities cited reluctance or refusal of Lebanese banks to deal with small money remitters as evidence of awareness and stricter controls.

### Capital markets reform
- Reform of capital markets should continue.
- Staff recommended a rapid move to transforming the Beirut Stock Exchange into a joint-stock company—as foreseen in the law that established the Capital Markets Authority—to pave the way for its privatization.
- Authorities highlighted market consultations on capital markets regulations, with World Bank assistance, to marshal support and ownership of reforms; they regretted slow progress on transforming the Beirut Stock Exchange into a joint-stock company.

### Structural reform priorities
- Structural reform is essential for enduring and inclusive growth.
- Lebanon’s employment-growth elasticity is 0.2.
- Officially, unemployment is estimated at 11 percent (though more than 20 percent including the refugees).
- The reform agenda is well known but little has been done; traditional growth drivers have been hit by region-wide uncertainty and security concerns and have failed to provide high-quality, job-rich growth.
- Lebanon’s current account deficit suggests an underlying competitiveness problem; the sharp increase in the deficit is partly attributable to disruption of traditional trade relationships and elevated regional uncertainty, though the deficit is expected to improve (slowly) over the medium term.
- Action is needed to boost productivity, fight corruption, and address the cost of doing business.

Key structural priorities noted:
- Electricity reform: implement plans to strengthen generation capacity, switch to less-expensive natural gas, and improve transmission and distribution to reduce business and consumption costs and ensure more equitable access to essential services. Bring electricity tariffs more in line with cost recovery while protecting vulnerable consumers.
- Passage of pending legislation: approve the framework law for Public Private Partnerships (PPPs) (awaiting parliamentary approval for three years) and long-delayed decrees on gas resources to mobilize private-sector resources and signal readiness to investors, with attention to fiscal risks.
- Labor market and skills: arrest chronic de-skilling; create formal-sector employment opportunities for lower-skilled workers through special programs and targeted public work schemes; move toward higher-quality sectors to absorb highly-skilled job seekers.
- Pension reform: implement selected parametric changes and only limited indexation to salaries in the short term; over the longer term, consider a unified pension scheme for public and private sector employees to address sustainability and equity concerns.

### Fiscal and monetary policy priorities (staff appraisal)
- Passing a budget for 2015—the first in a decade—is the first priority to signal fiscal control.
- If a controversial public-sector salary scale adjustment is passed, it should be conditional on measures to mitigate its impact: a strong revenue package; no retroactive payments and with installments; and measures to increase public sector productivity.
- Urgent need to pass revenue measures regardless, including increased fuel taxation, broader tax bases, and strengthened compliance, to secure a sustainable primary balance and create fiscal space for more capital projects and social spending.
- Credible fiscal adjustment would allow monetary policy to refocus on supporting the peg (the key nominal anchor) rather than propping up the economy and ensuring adequate funding for the government.

### Data and statistical capacity
- Timely and reliable data are crucial for greater accountability.
- National and external accounts, fiscal, social, and labor-market statistics remain weak, undermining economic decision making, transparency, and policy effectiveness.
- Staff expressed concern about accumulating delays in provision of data to the public and increasing lack of cooperation and coordination among agencies.
- Steps are needed to restore and strengthen collaboration—along with adequate funding and high-level support for the Central Administration of Statistics (CAS)—to improve statistics.
- Box 6 highlights capacity constraints: CAS has limited resources, relies heavily on other government bodies for source data, and faces increasing difficulties accessing data (e.g., plan to compute a Producer Price Index hampered by lack of access to basic data on individual enterprises). CAS’s budget was $2.7 million in 2012.

### Security, refugees, and external support
- Lebanon hosts over 1 million refugees from Syria, increasing security and fiscal pressures.
- International support has helped but more is needed urgently, especially for hosting communities.
- Macroeconomic stability and shared prosperity are critical to anchoring longer-term security and defusing looming social tensions.

*Source: IMF staff report text provided in content unit _cr15190 - 31. But the current environment is particularly*

### 55. The second priority is the electricity sector. Households and businesses have long

### _cr15190 - 55. The second priority is the electricity sector. Households and businesses have long

### Electricity sector: priority and recommendations
- Finding: Households and businesses have long suffered from inadequate electricity provision, having (almost universally) to resort to very expensive private generation, while the government has been bleeding funds to support EdL.
- Recommendation: Cabinet should urgently implement electricity improvements—a game-changer—for productivity, competitiveness, growth, and equity.
- Fiscal context related to EdL support (from central government tables):
  - Transfers to EdL (2013): 3,361 (in billions of Lebanese pounds)
  - Transfers to EdL (2014): 3,021
  - Transfers to EdL (2015 estimate): 3,157
  - Transfers to EdL (2016 projection): 2,321
  - Transfers to EdL (2017 projection): 1,794
  - Transfers to EdL (2018 projection): 2,036
  - Transfers to EdL (2019 projection): 2,200
  - Transfers to EdL (2020 projection): 2,350
  - Transfers to EdL (2020 projection, alternate table): 2.3 (percent of GDP)

### Financial sector: supervision, buffers, and market deepening
- Finding: Authorities’ close oversight of the financial system is welcome but should be reinforced.
- Recommendations:
  - Strengthen supervision to support bank stability.
  - Increase capital buffers.
  - Improve loan classification and restructuring rules.
  - Further enhance the AML/CFT framework.
  - Privatize the Beirut Stock Exchange to help deepen financial markets, encourage start-ups to launch IPOs, and open the door for trading commodities.
- Related upcoming work: The forthcoming FSAP will add recommendations in this area.
- Banking-sector indicators (selected, end-of-period):
  - Regulatory capital to risk-weighted assets: 13.4 (2010), 11.6 (2011), 13.0 (2012), 14.5 (2013), 14.0 (2014)
  - Regulatory Tier 1 capital to risk-weighted assets: 11.4 (2010), 11.0 (2011), 12.1 (2012), 13.5 (2013), 12.8 (2014)
  - Non performing loans to gross loans: 4.3 (2010), 3.8 (2011), 3.8 (2012), 4.0 (2013), 4.0 (2014)
  - Return on assets (after tax): 1.2 (2010), 1.1 (2011), 1.0 (2012), 1.0 (2013), 1.0 (2014)
  - Deposits to total liabilities: 87.7 (2010), 87.9 (2011), 87.9 (2012), 87.5 (2013), 87.4 (2014)
  - Foreign-currency-denominated loans to total loans: 78.4 (2010), 77.4 (2011), 76.5 (2012), 75.8 (2013)

### Structural reforms to raise growth potential
- Findings:
  - Structural reforms remain essential to enhance Lebanon’s growth potential.
  - There is added pressure on the labor market from Syrian refugees.
- Recommendations:
  - Jump-start the legislative agenda, including:
    - New Petroleum Tax Law.
    - Exploration and Production Agreement for the oil and gas sector.
    - Public Private Partnership framework law to attract private investment.
  - Implement labor reforms to help create formal-sector employment opportunities for lower-skilled workers.
  - Improve public service provision and strengthen safety nets, starting with the pension system, to improve competitiveness and increase equity.

### Data compilation, dissemination, and institutional cooperation
- Finding: National and external accounts, fiscal, social, and labor-market statistics remain weak despite improvements in some areas.
- Recommendation: Strengthen cooperation towards, and properly fund, data compilation and dissemination. Statistics cannot improve without better inter-agency cooperation and high-level support for the Central Administration of Statistics.

### Key macroeconomic and fiscal indicators (selected from tables)
- Output and prices:
  - Real GDP (market prices) (annual percent change): 2.8 (2012), 2.5 (2013), 2.0 (2014), 2.0 (2015 est.), 2.5 (2016 proj.), 3.0 (2017 proj.), 3.0 (2018 proj.), 4.0 (2019 proj.), 4.0 (2020 proj.)
  - Consumer prices (period average): 6.6 (2012), 4.8 (2013), 1.9 (2014), 1.1 (2015 est.), 2.8 (2016 proj.), 2.5 (2017 proj.), 2.5 (2018 proj.), 2.6 (2019 proj.), 3.0 (2020 proj.)
- Fiscal: central government (percent of GDP unless otherwise noted)
  - Revenue (including grants): 21.8 (2012), 19.8 (2013), 21.8 (2014), 19.2 (2015 est.), 20.4 (2016 proj.), 20.5 (2017 proj.), 20.6 (2018 proj.), 20.7 (2019 proj.), 20.7 (2020 proj.)
  - Expenditure: 30.2 (2012), 28.5 (2013), 27.8 (2014), 29.2 (2015 est.), 28.6 (2016 proj.), 29.6 (2017 proj.), 30.1 (2018 proj.), 30.7 (2019 proj.), 30.8 (2020 proj.)
  - Budget balance (including grants): -8.4 (2012), -8.7 (2013), -6.0 (2014), -10.0 (2015 est.), -8.3 (2016 proj.), -9.1 (2017 proj.), -9.5 (2018 proj.), -10.0 (2019 proj.), -10.0 (2020 proj.)
  - Total government debt (percent of GDP): 131 (2012), 133 (2013), 133 (2014), 132 (2015 est.), 135 (2016 proj.), 138 (2017 proj.), 140 (2018 proj.), 141 (2019 proj.), 143 (2020 proj.)
- External sector and reserves:
  - Current account (in percent of GDP, including official transfers): -24.3 (2012), -26.7 (2013), -24.9 (2014), -22.0 (2015 est.), -21.4 (2016 proj.), -20.7 (2017 proj.), -19.6 (2018 proj.), -17.4 (2019 proj.), -14.9 (2020 proj.)
  - Gross reserves (excluding gold, year-end, in billions of U.S. dollars): 32.2 (2012), 33.9 (2013), 37.3 (2014), 37.3 (2015 est.), 40.7 (2016 proj.), 44.4 (2017 proj.), 48.4 (2018 proj.), 51.9 (2019 proj.), 55.8 (2020 proj.)
  - Total external debt (year-end; in percent of GDP): 164 (2012), 164 (2013), 165 (2014), 162 (2015 est.), 166 (2016 proj.), 169 (2017 proj.), 172 (2018 proj.), 174 (2019 proj.), 175 (2020 proj.)

### Timing of next consultation
- Staff propose that the next Article IV consultation take place on the standard 12-month cycle.

*Source: IMF staff report excerpt (Lebanon).*

### Annex I. Public Debt Sustainability Analysis

### Annex I. Public Debt Sustainability Analysis

### Overview and key findings
- Public debt already exceeding 130 percent of GDP and gross financing needs around 25 percent of GDP in 2015.
- Under the baseline scenario:
  - Public debt-to-GDP ratio reaches 143 percent in 2020.
  - Gross financing needs reach 40 percent of GDP (peak around 2018).
- Debt dynamics and financing needs are highly sensitive to:
  - Growth shocks, interest-rate shocks, and contingent liability shocks.
- Large liquidity buffers and a captive investor base mitigate risks, but decisive policy actions are required to restore fiscal sustainability.

### Baseline assumptions and projections
- Baseline scenario timing:
  - Assumes the conflict in Syria will start to ease only in 2016.
- Macroeconomic assumptions:
  - Real GDP growth: not to exceed 2.5 percent until 2016; 3 percent in 2017; return to potential 4 percent from 2019 onward.
  - Inflation (GDP deflator): 5.3 percent in 2013; 2.8 percent in 2014; around 7 percent in 2015; around 2 percent on average in 2016–20.
  - Primary balance: projected to switch to small surpluses starting in 2016 based on salary scale adjustment, gradual reduction in EdL subsidies, and tax measures.
- Baseline projections (selected series, in percent):
  - Nominal gross public debt: 2013: 158; 2014: 133; 2015: 133; 2016: 132; 2017: 135; 2018: 138; 2019: 140; 2020: 141/143 (table lists 141 then 143 as final).
  - Public gross financing needs: 2013: 52.0; 2014: 27.8; 2015: 24.2; 2016: 28.0; 2017: 27.4; 2018: 29.4; 2019: 38.9; 2020: 33.9/38.9 (table shows 33.9 then 38.9).
  - Real GDP growth (in percent): 2013: 5.5; 2014: 2.5; 2015: 2.0; 2016: 2.0; 2017: 2.5; 2018: 3.0; 2019: 3.0; 2020: 4.0.
  - Inflation (GDP deflator, in percent): 2013: 3.7; 2014: 5.3; 2015: 2.8; 2016: 6.8; 2017: 1.9; 2018: 2.0; 2019: 2.3; 2020: 2.4.
  - Effective interest rate (in percent): 2013: 7.4; 2014: 6.6; 2015: 6.6; 2016: 7.1; 2017: 7.3; 2018: 7.6; 2019: 7.8; 2020: 8.1/8.3 (table lists 8.1 then 8.3).
- Contribution to change in debt (cumulative 2015–20):
  - Change in gross public sector debt cumulative: 9.2.
  - Identified debt-creating flows cumulative: 7.4.
  - Primary deficit cumulative: -4.7.
  - Automatic debt dynamics cumulative: 12.1.
  - Residual, including asset changes cumulative: 1.9.

### Sensitivity and stress-test results
- Growth shock:
  - A decline in growth by one standard deviation for 2016 and 2017 leads to debt-to-GDP reaching almost 160 percent in 2020.
  - Financing needs reach almost 45 percent of GDP in 2020 and remain high.
- Interest-rate shock:
  - A shock to the interest rate leads to debt-to-GDP reaching almost 150 percent at end of projection horizon.
  - Financing needs projected to exceed 40 percent of GDP.
- Combined macro-fiscal shock:
  - Simultaneous shocks to growth, interest rate, and primary balance result in debt-to-GDP exceeding 170 percent by end of projection horizon.
  - Financing needs reach almost 50 percent of GDP in 2020.
- Contingent liability shock:
  - Standardized shock of 10 percent of financial sector assets (hypothetical) leads to debt-to-GDP exceeding 175 percent at end of projection horizon.
  - Financing needs exceed 45 percent of GDP in 2020.
- Fan charts and distributional uncertainty:
  - Symmetric fan-chart width estimated at around 50 percent of GDP.
  - Asymmetric fan-chart constrains upside growth shock to zero, reflecting downside-skewed risks due to the Syria crisis.

### Debt profile vulnerabilities
- Indicators relative to risk-assessment benchmarks (2014):
  - External financing needs are well above the upper risk-assessment benchmark.
  - Public debt in foreign currency is above the lower risk-assessment benchmark.
  - Bond spreads are above the lower risk-assessment benchmark but have been relatively stable.
  - Public debt held by nonresidents is only slightly above the lower benchmark.
  - Level of, and change in, short-term debt are below lower risk-assessment benchmarks.

### Mitigating factors and buffers
- Investor base:
  - Debt largely held by domestic financial institutions with tight regulation of net open positions and investment strategies.
  - Domestic financial institutions fund positions from deposits largely held by nonresidents; these deposits have shown resilience in times of stress (around 120 percent of GDP).
  - Significant share of domestic debt is held by the BdL.
  - Public debt-to-broad money ratio decreased from 66 percent in 2003 to 45 percent in 2014 and is forecast to stay below 50 percent over the projection horizon.
- Debt financing profile:
  - Large external financing needs (around 160 percent of GDP) reflect debt payments and large 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 accounts for more than 40 percent of total public debt but is held mostly by domestic financial institutions.
  - Level and change in short-term debt are very low, reducing refinancing risk.
- Buffers:
  - High level of gross international reserves.
  - Banks’ NFA represent a substantial buffer.
  - Government deposits average around 20 percent of GDP (implying substantially lower public debt-to-GDP on a net basis and coverage of financing needs for around half a year).
  - Note: government’s foreign exchange account has been in overdraft over the past few years, reducing the size of the buffer.

### Policy implications and realism of assumptions
- The deteriorating debt outlook reflects modest fiscal consolidation and a positive interest rate–growth differential.
- Authorities broadly concur with staff analysis, noting challenges in formulating a credible medium-term fiscal strategy and highlighting mitigating factors.
- Staff view:
  - Real GDP growth, inflation, and primary balance projections are broadly plausible given forecast track record.
  - Projected fiscal adjustment is consistent with experiences of surveillance countries.
- Required policy action:
  - Decisive policy actions are required to restore fiscal sustainability (no specific measures beyond those in baseline assumptions are prescribed in this Annex).

*Source: IMF staff — Annex I. Public Debt Sustainability Analysis (Lebanon).*

### Annex II. External Sector Assessment

### Annex II. External Sector Assessment

### Real Effective Exchange Rate (REER) and prices
- Despite recent nominal appreciation, Lebanon’s CPI-based real effective exchange rate (REER) has remained unchanged over the past 12 months.
- The nominal effective exchange rate appreciated considerably, reflecting the strength of the U.S. dollar.
- Lebanon experienced a sudden bout of CPI deflation in recent months as lower oil prices were passed through to the domestic economy; this deflation offset the impact of the nominal appreciation, resulting in a relatively flat REER.
- Looking further backward, the REER has appreciated by around 20 percent since 2008, its lowest level in the past decade.
- Note on CPI sampling: Housing costs in Lebanon’s CPI were sampled only infrequently (every three years) prior to 2014. Staff smoothed the step increase associated with the infrequent sampling. Weights used for 2005 and subsequent years are different from the standard weights available in Information System’s Notice.

### Current account developments and data uncertainty
- The current account deficit widened significantly in the wake of the Syria crisis.
- The deficit in 2014 was 25 percent of GDP.
- The current account deficit increased sharply in 2012 from pre-crisis levels of 21 percent and 15 percent in 2010 and 2011, respectively—largely reflecting a significant drop in “other services” receipts (primarily business services) driven by the adverse impact of the Syria crisis on services trade.
- Goods exports and travel receipts (i.e., tourism) have also declined due to disrupted transit routes and heightened domestic and regional uncertainty; early signs point to a slight recovery of tourist receipts in 2014.
- Significant uncertainties remain regarding the accuracy of Lebanon’s current-account data.

Box 1 — Key points on current-account data revisions and uncertainty
- Authorities’ estimates of the current account deficit for 2012 have been revised repeatedly:
  - Authorities’ estimate during staff visit in March 2014: 7¾ percent of GDP (with an adjustment for income flows).
  - Authorities’ revised estimate by the time of the 2014 Article IV Consultation: 11¾ percent of GDP (owing to corrections by reporting banks of services-accounts data).
  - Late last year, authorities adjusted their estimated current account deficit upward by more than 10 percent of GDP after discovering materially incorrect data forwarded by reporting banks following an IT upgrade.
  - The net result was a sizable downward revision of the services account. The current account deficit is now estimated at around 24½ percent of GDP in 2012 and 26¾ percent in 2013 (adjusted again for income flows).
- Cautionary notes in Box 1:
  - The larger deficit likely reflects disruption of Syrian demand for travel and business services given Syria is Lebanon’s main trading partner for services.
  - Lebanon has had little difficulty financing its large current-account imbalances, with reserves increasing steadily even after the crisis; however, in light of the recent revision, a substantially larger portion is now funded by unrecorded inflows, which appear in net errors and omissions.
  - Data issues with reporting banks might be ongoing; combined with the recent surge of refugees and the rapidly changing market for Lebanon’s services, the accuracy of present estimates is somewhat uncertain.
- Staff and BdL differences: The staff’s estimate of non-resident depositors differs from that of the BdL, with implications for estimates of net income flows.

### Medium-term outlook for the external balance
- The current account deficit is projected to narrow over the medium term but will remain sizable—15 percent of GDP by 2020.
- The baseline projection assumptions include:
  - Exports of goods and services will recover as domestic and regional uncertainties start to dissipate.
  - The baseline nonetheless assumes the crisis will still influence the current account balance even over the projection horizon, with a majority (two thirds) of Syrian refugees still in Lebanon by 2020.
- The projected 10 percentage-point adjustment of the external balance is considered considerable, but the baseline retains persistent crisis effects.

### Exchange rate assessment
- Consultative Group on Exchange Rate (CGER)-type methodologies, applied to the baseline framework, suggest that Lebanon’s exchange rate is overvalued.
- This finding contrasts with results from the 2014 Article IV consultation and reflects:
  - The authorities’ recent revision to the current account balance.
  - A new (less optimistic) assumption regarding the persistence of the Syrian crisis’ impact on Lebanon’s balance of payments.
- The extent of actual misalignment is likely to be lower than indicated by the CGER-type calculation:
  - Abstracting from the temporary but highly persistent effects of the Syria crisis on the medium-term external current account projection, the REER would appear less overvalued.
- Methodological note:
  - A third approach—the Equilibrium Real Exchange Rate (ERER)—could not be applied because it relies on labor productivity data, not available for Lebanon as employment data are missing.

*Source: Annex II. External Sector Assessment, Lebanon — IMF staff report (2015).*

### 2015.  METAC has been providing assistance on balance of payments and

### _cr15190 - 2015.  METAC has been providing assistance on balance of payments and

### Overview and macroeconomic assessment
- Economic performance is expected to remain weak as a result of domestic and external uncertainty.
- The Syria crisis dominates Lebanon’s short-term outlook and longer-term prospects.
- Main short-term macroeconomic challenge: deliver a credible policy mix with sustained adjustment and a falling public debt ratio.
- Medium-term priority: embark on structural reform, starting immediately with the electricity sector, to achieve social stability and a job-rich, sustainable growth.
- Authorities need to strengthen capital buffers and continue efforts to strengthen banking regulation and supervision, particularly regarding loan classification and provisioning rules.

### Macrocritical structural reform areas (findings and rationale)
- Electricity sector reform:
  - Urgent need to strengthen and lower the costs of electricity provision, and reduce budgetary transfers to the Electricité du Liban (EDL).
  - Implement long-standing plans to: (i) reduce cost of production, including through reducing systems losses and the reliance on expensive fuel oil; (ii) increase revenue collection; (iii) enhance electricity supply by making necessary investments; and (iv) gradually adjust average tariff toward cost recovery levels, while protecting poor households.
  - Accompany measures with comprehensive reform of regulatory and institutional framework.
  - Rationale: Lebanon’s inefficient electricity supply is a major impediment to growth and large budgetary transfers to the sector (4.2 percent of GDP in 2014) undermine fiscal sustainability.
  - Ultimate goal: zero EdL transfers, freeing up fiscal resources for more productive uses.
- Tax reform:
  - Move toward an efficient and fair tax system by broadening tax bases, strengthening compliance and increasing tax rates on capital gains on real estate transactions, and withholding tax on interest income and corporate income tax.
  - Seize opportunity of low oil prices to remove the VAT exemption on diesel immediately, and increase gasoline excises.
  - Rationale: supports sustained and balanced fiscal adjustment.
- Public financial management (PFM) reform:
  - Key elements: (i) further strengthen macrofiscal unit in the Ministry of Finance; (ii) strengthen budget preparation, cash and debt management; (iii) strengthen accounting, payment and auditing functions, including by introducing a Government Financial Management Information System; (iv) complete coverage of the Treasury Single Account; (v) develop a system to account for arrears and increase transparency and regularity in treasury inflows and outflows; and (vi) set up a framework to assess the fiscal impact of the Syrian refugees on certain budget lines.
  - Rationale: improve management of public finances and reduce ad-hoc and discretionary adjustments.
- Social services and safety net reform:
  - Reforms recommended:
    - Health: rationalize health spending and expand health insurance coverage.
    - Pension systems: strengthen financial sustainability and administration of the National Social Security Fund, reform end-of-service indemnity, and ultimately introduce a unified and fairer pension system for public and private sector employees.
    - Education: improve quality of public education, strengthen higher education and vocational training, and enhance resources and capacity building at schools to accommodate Syrian students.
    - Social safety nets: improve targeting to the most needy, expand coverage and enhance the social assistance package of the National Poverty Targeting Program (NPTP) to Lebanese affected by the Syrian crisis and all Lebanese households under the extreme poverty line.
  - Rationale: increase efficiency of public spending; enhance workforce productivity and growth prospects; reduce inequalities and alleviate social tensions; generate political support for fiscal consolidation.
- Investment climate reform:
  - Address high costs of doing business arising from weaknesses in governance, regulatory systems, contract enforcement, and high cost and inefficient provision of utilities (electricity, water, transportation).
  - Rationale: improve competitiveness, decrease business costs and increase growth potential.
- Financial sector stability assessment:
  - Given very large financial sector and high dollarization, assess financial system stability via FSAP scheduled for early 2016.
  - Rationale: identify potential risks and provide suggestions for addressing them.
- Reform of statistical system:
  - Address fragmentation and limited capacity to provide timely and reliable data; accumulated delays and lack of cooperation/coordination among agencies.
  - Rationale: timely and reliable data needed to monitor economic and social developments, support decision making and greater accountability.

### Division of labor between IMF (Fund) and World Bank (Bank)
- Electricity sector reform:
  - Bank to continue elaborating reform options and discuss with authorities; Country Partnership Strategy provides for technical and financial support to assist government in implementing strategic plan.
- Tax reform:
  - Fund and Bank providing TA on fiscal regime for oil and gas sector; Fund providing revenue administration TA in this sector and TA on implementing tax gap analysis for VAT.
  - Fund will provide TA on design and implementation of the capital gain tax and broadening tax bases and strengthening compliance if requested.
  - Bank could perform analytical studies on growth and welfare impact of fiscal policy options if requested.
- Revenue administration:
  - Fund providing TA to Lebanese Customs to support initiatives in its strategic plan; help strengthen performance of the Large Taxpayers’ Office (LTO) to develop audit programs based on sector-specific compliance risks.
- Public financial management reform:
  - Fund providing TA on (i) capacity building for the macro-fiscal department (with World Bank); (ii) improving transparency and accountability of public accounts; and (iii) improving cash management.
- Social services and safety net reform:
  - Bank to continue analytical work and provide prioritized policy recommendations through the “Emergency Social Protection Implementation Support Project”; expand coverage and enhance social assistance package of NPTP.
- Investment climate reform:
  - Bank planning to conduct assessment of investment climate with focus on large informal sector.
- Financial sector stability assessment:
  - Fund providing TA on supervision of nonbank financial institutions and cross-border supervision of banks, including establishing supervisory colleges.
  - Bank provided TA on development of insurance sector and capital markets.
  - Bank and Fund to cooperate closely under Financial Sector Assessment Program scheduled for early 2016.
- Reform of statistical system:
  - Fund to continue providing TA on consumer price index, national accounts, and balance of payments statistics.
  - Bank providing advisory services on national household income and expenditure survey.

### Information exchange requests and coordination
- Fund team requests to be kept informed of progress in the Bank’s work in the 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 reform areas.
  - Timing: in the context of Article IV Consultation and other missions (and at least semi-annually).
- Two teams will continue to exchange views on the macroframework and the Country Partnership Strategy.

### Bank work program (selected items, missions timing and expected delivery dates)
- IBRD Lending — Grants/Trust Funds (selected projects and expected delivery dates):
  - Urban Transport Development Project ($134.7 m) — Ongoing — 12/31/2015
  - Education Development Project II ($40 m) — Ongoing — 12/31/2016
  - Greater Beirut Water Supply ($200 m) — Ongoing — 6/30/2016
  - Water Supply Augmentation Project ($474 m) — Pending — 6/30/2024
  - Environmental Pollution Abatement ($15 m) — Pending — 3/31/2021
  - Fiscal Management Reform 2 ($5.2 m) — Pending — 3/31/2017
  - Social Promotion & Protection ($30 m) — Pending — 12/31/2018
  - Cultural Heritage & Urban Development ($58.5 m) — Ongoing — 12/31/2015
  - Mobile Internet Ecosystem ($6.4 m) — Pending — 12/31/2017
  - Supporting Innovation in SMEs ($30 m) — Ongoing — 6/30/2018
  - Improve Capacity for Environmental Compliance ($0.3 m – IDF) — Ongoing — 10/7/2016
  - Emergency Education System Stabilization ($32 m) / LSCTF — Pending — 6/30/2020
  - Emergency Primary Healthcare Restoration ($15 m)/ LSCTF — Pending — 12/30/2018
  - Municipal Services Emergency Project ($10 m) / LSCTF — Ongoing — 12/30/2017
  - PCB Management in the Power Sector ($2.54 m) / GEF — Pending — 3/31/2021
  - The National Volunteer Service Program ($2 m)/SPBF — Ongoing — 1/31/2016
  - Second Emergency Social Protection Imp. Support 2 ($6.6m – Trust Fund for Lebanon) — Ongoing — 12/31/2016
  - Emergency National Poverty Targeting Project ($8.2m) — Ongoing — 12/31/2017
- Technical Assistance / Economic & Sector Work (selected items and timing):
  - Systematic Country Diagnostic — Ongoing — TBA
  - Country Partnership Framework — Ongoing — Aug-15
  - MSME TA - Lebanon MSME TA Facility — Ongoing — 10/2/2017
  - Promoting Capacity Building and Knowledge Sharing to Improve Youth Employability — Ongoing — 9/30/2016
  - Compulsory Motor Insurance Regulation — Ongoing — 6/30/2016
  - Comprehensive Urban Resilience Project — Ongoing — 6/30/2016
  - Lebanon Jobs Program — Ongoing — 6/20/2016
  - TA for Poverty Measurement, Monitoring and capacity building in Lebanon — Ongoing — 6/6/2016
  - Capital Markets Regulation and Development — Ongoing — 12/31/2015
  - Development of National Payment Systems Strategy — Ongoing — 12/18/2015
  - Hydropower development in Lebanon — Ongoing — 10/30/2015
  - Public Pension Schemes for Lebanon — Ongoing — 9/30/2015
  - Land Administration System Modernization — Ongoing — 6/30/2015
  - Wind Energy Resource Mapping in Lebanon — Ongoing — 5/31/2015
  - Education Research Program for Lebanon — Ongoing — 10/19/2018
  - Education Public Expenditure Review — Ongoing — 10/15/2015

### Fund work program (selected items and timing)
- Article IV Consultation Staff Report — April–May 2015 — June 2015
- Technical assistance (TA) (status and timing where provided):
  - Public Accounting — Ongoing — 2015
  - Capital Gains Tax — If requested — 2016
  - Public Financial Management Reform — Ongoing — 2015
  - Budget System Law — Ongoing — 2015
  - Statistics (National Accounts, CPI, BoP, IIP) — Ongoing — 2015
  - Cross Border Banking Supervision — Ongoing — 2015
  - Nonbank Financial Institutions Supervision — Ongoing — 2015
  - Oil and Gas Taxation and Revenue Administration — Completed — 2014
  - Strengthening performance of the LTO to develop audit programs based on sector-specific compliance risks — Ongoing — 2015
  - VAT Gap Analysis — Ongoing — 2015
  - Lebanese Customs to support specific initiatives in its strategic plan — Ongoing — 2016
- FSAP Update — 2015 2016

*International Monetary Fund and World Bank team coordination note as presented in the source document.*

### 3. Joint Work

### 3. Joint Work

### Program
- Fund and Bank teams will coordinate on the macroeconomic framework.
- The Fund team was engaged in consultations on the Bank’s Systematic Country Diagnostic and is participating in those for the Lebanon Country Partnership Framework for FY16–21.
- Timeline mentions: 2015; 2016.

### Statistical Issues — Assessment of Data Adequacy for Surveillance (As of June 2, 2015)
- General:
  - Data provision has serious shortcomings that significantly hamper surveillance, particularly in national accounts and external sector statistics.
  - Lack of timely, comprehensive and reliable national accounts data and social and labor market indicators undermine accountability and economic analysis.
  - Fiscal reporting has recently been lagging and irregular treasury inflows and outflows undermine data compilation.
- National accounts:
  - Only annual data are compiled and disseminated at this time.
  - Data are available through 2013, with significant revisions to growth estimates for 2010–2012.
  - There are plans to start publishing quarterly data; however, the priority should be to improve the annual estimates before developing quarterly ones.
  - Responsibility of producing national accounts statistics was transferred to the Central Administration of Statistics (CAS) in 2012 for the publication of 2011 accounts.
  - Data sources are limited, mainly administrative data. Access to comprehensive business financial records maintained by the Ministry of Finance would greatly improve annual national accounts estimates and support the release of quarterly data.
  - The Fund’s Statistics Department (STA) started assisting CAS in reviewing the methodology and data collection for the annual national accounts, and starting the compilation of quarterly national accounts.
  - A resident national accounts expert will join METAC in September 2015.
- Price statistics:
  - A new Consumer Price Index (CPI) was released in March 2014 by the CAS with Fund assistance.
  - Improvements with the new CPI: dissemination of more detailed national level index data on the CAS website; publication of regional indexes; monthly collection of rent prices; improved index calculation methods.
  - The CPI covers all areas in Lebanon and is disseminated within three weeks after the end of the reference month.
  - The CPI was not compiled during January–May 2013 due to delays in funding provided by the prime minister’s office. Funding to CAS and data compilation resumed thereafter under strong Fund pressures.
  - Immediate need: develop regular and timely statistics on producer prices.
  - Medium- to long-term needs: data on wages and real estate prices.
- Government finance statistics (GFS):
  - Significant delays continue in the release of fiscal data.
  - Dissemination of central government GFS has improved in recent years, but coverage is not comprehensive.
  - Published monthly central government budgetary accounts omit items such as certain transfers, financing data, foreign-financed capital expenditure, and arrears; they include dues that should eventually be transferred to third parties (Telecom revenue due to municipalities).
  - Some (treasury) spending is only identified ex post, and presented in an economic classification with a lag.
  - These items are nonetheless provided to the Lebanon team in the context of surveillance activities.
  - GFS are on a modified cash basis for revenue (transfers from the Telecom) and budgetary expenditure data (issuance of payment orders).
  - The ministry of finance needs a framework to assess the fiscal impact of the Syrian refugees on certain budget lines.
  - GFS data for budgetary central government based on Government Finance Statistics Manual 2001 are published yearly in the Government Finance Statistics Yearbook; these data cover only transactions and no balance sheet data are reported.
- Monetary and financial statistics:
  - Sectorization of institutional units and classification of financial instruments reported to STA fall short of what is needed for compilation of Standardized Report Forms.
  - Reflecting in part restrictions imposed by domestic legislation, the Banque du Liban (BdL) does not publish externally-audited financial statements, and its reporting practices are not fully compliant with the International Financial Reporting Standards (IFRS).
  - Lack of a reliable classification of deposits by residency (also due to bank secrecy) complicates balance of payments analysis.
- Financial sector surveillance:
  - Lebanon is a regular reporter of Financial Soundness Indicators (FSIs).
  - All core and eight encouraged FSIs are reported on a regular quarterly basis, except for the two indicators on capital adequacy that are reported on semi-annual basis.
  - Compilation of FSIs for other sectors (other financial corporations, non-financial corporations, households, real estate markets) is needed to expand the list of FSIs compiled by Lebanon for macroprudential analysis.
- Balance of payments (BoP):
  - Efforts made to improve BoP statistics, including survey quality through better compliance.
  - Significant challenges remain to compiling reliable BoP data: data issues in the current account (unrecorded exports and imports, uncertainty in estimates of private sector services, workers’ remittances, and investment income); the capital account (grants); and the financial account (foreign direct investment, equity investment in the nonbank private sector, and corporate borrowing abroad).
  - Data are subject to frequent and very large revisions that hamper accurate assessment of Lebanon’s external sector position.
  - A Foreign Direct Investment (FDI) survey is currently in progress.
  - Progress toward compiling an IIP statement is slow despite TA missions. Forms and reporting requirements for banks and non-banks were amended in January 2010 and May 2013 to include more comprehensive and detailed breakdown of BoP components.
  - Lack of effective inter-agency cooperation and data sharing between the BdL, CAS, customs and the ministry of finance are among main factors impeding progress; there is a noted increase in lack of cooperation and coordination among various agencies on data sharing.

### Data Standards and Reporting
- Data Standards and Quality:
  - Lebanon joined the General Data Dissemination System in January 2003.
  - Metadata and plans for improvement need to be updated.
  - No Report on the Observance of Standards and Codes (ROSC) for data dissemination is available for Lebanon.
- Reporting to STA:
  - Lebanon currently reports annual data based on GFSM 2001 to be published in the Government Finance Statistics Yearbook (GFSY), but the data suffer from weaknesses, mainly limited coverage.
  - CAS does not currently report any data to STA.
  - Lebanon reports monetary statistics on a regular monthly basis, covering the Central Bank and commercial banks only. The monetary data are reported with a timeliness of approximately three months.
  - In September 2011, the BdL started regular submission of core Financial Soundness Indicators data and metadata, and data for 2013 were posted on the IMF website. 2014 data is available for posting—it is delayed for technical reasons.

### Table of Common Indicators Required for Surveillance (selected items and dates as reported)
- Exchange Rates: Date of Latest Observation 5/19/15; Date Received 5/19/15; 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 3/31/15; Date Received 5/4/15; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: 3/31/15; 5/4/15; M; M; M.
- Broad Money: 3/31/15; 5/4/15; W/M; W/M; M.
- Central Bank Balance Sheet: 3/31/15; 5/4/15; M; M; M.
- Consolidated Balance Sheet of the Banking System: 3/31/14; 5/4/15; M; M; M.
- Interest Rates: Date of Latest Observation 5/15/15; Date Received 5/18/15; Frequency W/M; Frequency of Reporting W/M; Frequency of Publication W/M.
- Consumer Price Index: 3/31/15; 4/21/15; M; M; M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: 12/31/14; 4/9/15; M; M; M.
- Stocks of Central Government and Central Government-Guaranteed Debt: 3/31/2015; 5/8/2015; M; M; M.
- External Current Account Balance: 12/31/14; 4/28/2015; Q; Q; Q.
- Exports and Imports of Goods and Services: 12/31/14; 4/28/2015; Q; Q; Q.
- GDP/GNP: 12/31/13; 12/11/14; A; A; A.
- Gross External Debt: 3/31/15; 5/8/2015; M; M; M.
- International Investment Position: N/A; N/A; N/A; N/A; N/A.

### Statement by Hazem Beblawi and Maya Choueiri (June 26, 2015) — Key Messages and Policy Points
- Context and refugee crisis:
  - Lebanon faces exceptional, force majeure, circumstances beyond its control, driven by the Syrian crisis entering its fifth year.
  - Since early 2011, over one million registered Syrians, about a quarter of the Lebanese population, have taken refuge in Lebanon.
  - The influx has put serious pressures on public finances, service delivery and the environment, increased poverty among Lebanese, and raised unemployment.
  - Despite the environment, economy remained resilient and growth is expected to hold up in 2015. Deposit inflows remain strong, foreign exchange reserves at a comfortable level, and the banking system robust.
  - International humanitarian support was extremely helpful but remains insufficient given the size of the problem; Lebanon does not have the fiscal space to address the impact alone.
- Risks to the outlook:
  - Economic assessment cannot abstract from regional developments, particularly the crisis in Syria, which have major implications for security and macroeconomic stability.
  - Authorities feel the staff report could have better embedded the refugee-related challenges in economic analysis and policy recommendations, including fiscal costs and challenges to launching structural reforms.
- Fiscal policy and reforms:
  - Despite the fiscal burden of the refugees, a primary surplus of 2.5 percent of GDP was achieved in 2014, which included larger than usual telecommunications transfers.
  - Authorities committed to fiscal discipline and consider passing a budget for 2015 an important signal; a draft 2015 budget was put forward in April aiming to balance essential spending needs with stability goals.
  - Revenue measures adopted earlier in 2015 included an increase in gasoline excises in January 2015 and efforts to tighten tax collections, particularly through better enforcement and oversight of VAT refund claims.
  - Draft budget debates reflect diverging views on public sector salary scale adjustment. Authorities are confident revenue measures would be sufficient to offset the cost of the adjustment.
  - Proposed revenue measures (in line with staff recommendations) include:
    - increase in the tax rate on interest income from 5 to 7 percent;
    - increase in the corporate income tax rate from 15 to 17 percent;
    - a capital gains tax on real estate transactions;
    - new stamp duties and fees.
  - The Economic and Social Impact Assessment led by the World Bank estimated the direct fiscal impact of the crisis over 2012–14 at US$2.6 billion (5½ percent of GDP) and suggested restoring public-service provision to pre-crisis levels would require an additional US$2.5 billion.
  - Authorities concur there is scope to increase taxation in a fair manner; they appreciated staff no longer recommending a VAT rate increase up to 15 percent.
  - Authorities suggested enhancing tax capacity by broadening tax bases, addressing tax loopholes, and strengthening compliance; they appreciate Fund technical assistance in these areas.
- Monetary and exchange rate policies:
  - Monetary policy helped maintain confidence in the financial system, with the exchange rate peg providing a firm anchor for financial stability.
  - Authorities continue to maintain a high level of reserves given the central role of the peg.
  - BdL introduced targeted subsidized schemes to support lending in key sectors; these schemes supported growth without resulting in a build-up of risks or a credit boom.
  - Authorities tightened macroprudential rules, namely the debt service to income and loan-to-value ratios, to avoid potential private sector leverage.
  - Authorities are confident BdL’s balance sheet would be strengthened over time, though conditions were not yet favorable for pursuing alternative policy actions in the short term.
- Banking sector and AML/CFT:
  - Banking sector remains resilient despite limited credit opportunities and banks’ expansion in neighboring countries.
  - BdL has strived to implement the Basel requirements ahead of deadlines and to require additional capital buffers on top of the Basel III minimum and conservation buffers.
  - Total provisioning, including both specific and general provisions, had increased as a share of total nonperforming loans (see paragraph 37 of the staff report).
  - Authorities expressed confidence in the effectiveness of Lebanon’s AML/CFT regime, which is in practice fully compliant with international standards.
  - Three draft laws await parliamentary approval; in the interim BdL requires Lebanese banks to abide by regulations in place in countries of their correspondent banks whenever these are stricter.
  - Lebanon’s financial intelligence unit, the Special Investigation Commission, actively cooperates with foreign counterparts.
- Structural reforms:
  - Structural reform implementation is difficult given political deadlock, but electricity sector reform remains high on the agenda due to large budgetary transfers to the sector.
  - Progress under the 2011 comprehensive strategy includes construction of a new power plant, rehabilitation of existing ones, three private distribution service providers starting operations, and two power barges rented to supplement power production while new plants are built.
  - Demand from refugees is estimated to absorb the electricity supplied by the barges, setting back expected supply improvements.
  - The Ministry of Finance started publication of a quarterly T-bill issuance calendar regularizing long-term issuances, and of an updated public debt strategy.
  - Authorities embarked on anti-corruption campaigns in the health sector and at customs.

*Source: _cr15190 - 3. Joint Work (PDF), IMF.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15190.pdf_