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Last two years 'exceptionally challenging' for Lebanon, says IMF

May 10, 2014

In its latest report on Lebanon, the International Monetary Fund (IMF) said, "The last two years have been exceptionally challenging for Lebanon. The Syria crisis has created unprecedented inflows of refugees, now estimated at about a quarter of the population. Security has been severely affected and local communities have been strained. Given the political impasse, the lack of reforms has amplified the macroeconomic imbalances. The fiscal position, in particular, has worsened, with adverse consequences for public debt. 2014 has come at a delicate juncture, with upcoming presidential and parliamentary elections. It is therefore important to urgently strengthen policies and make progress on key structural reforms."

Lebanon's economic growth has been low at 2 percent on average, significantly below pre-Syria crisis levels. The traditional drivers of growth—real estate-related activity, construction and tourism—have been impacted by the deteriorating security and increasing uncertainty. Inflation has been contained at an average of four per cent, while the external current account deficit has remained large.

The IMF said, "Lebanon has been open to receiving large inflows of refugees, with profound impact on host communities. The refugees have settled throughout the country; and in some areas, the number of refugees is now larger than the Lebanese population. Unemployment and poverty have increased.

Fiscal imbalances have widened

"The primary fiscal position turned negative in 2012 and deteriorated further in 2013, reflecting spending pressures and revenue declines from weak economic activity, as well as policy decisions (such as the introduction of a VAT exemption on gasoline and the implementation of a cost of living adjustment for public sector wages). As a result, public debt reached 141 per cent of GDP in 2013.

"The Banque du Liban (BdL) has been actively seeking to maintain stability. It has continued to finance the government and accumulate reserves—gross international reserves stood at a comfortable $35 billion at end-February. It has also supported credit to the private sector by providing low-cost funds to banks to on-lend to specific sectors.

"Foreign exchange and financial markets have been largely resilient. Deposits have continued to grow at 7-8 per cent a year, while Eurobond spreads have moved in line with regional averages, and now stand at levels similar to end-2011. A successful Eurobond rollover/exchange was concluded in April. Standard & Poors has recently upgraded the outlook from negative to stable."

While noting that there has been substantial direct humanitarian assistance from the international community targeting Syrian refugees, reaching more than $800 million in 2013, donor support for the budget and the Lebanese communities, however, was minimal despite repeated appeals, including in the context of the International Support Group for Lebanon and the multi-donor trust fund established by the World Bank. There are pressures on government spending reflecting strains on hospitals, schools, electricity, and other utilities and public services. Absent financial support from the international community, the needs of both the Lebanese communities and the refugees will not be met.

Urgent need for strong policies

Outlining the requirements for the right policies, the IMF said, "Growth is likely to remain at around 2 percent this year, reflecting significant domestic and regional risks. The limited policy space should be used to stop the current deterioration and start addressing the underlying weaknesses in public service provision, labour markets and social safety nets brought to the fore by the refugee crisis but predating it. These policies would send strong signals to the markets and donors to anchor confidence and mobilise financial support, paving the way for stronger and sustainable growth that benefits all." Highlights of the IMF's recommendations are set out below:

Ensuring fiscal sustainability

"Lebanon's fiscal policy priority should be to put public debt on a sustainable downward path. As growth is projected to return gradually to a modest 4 percent over the medium term, debt reduction would have to come from sustained primary surpluses underpinned by strong and credible fiscal adjustment. Absent such adjustment, no other policy could reverse public debt dynamics in a sustainable way.

"Passing a budget for 2014 is a necessary and credible initial step to anchor fiscal policy. The last officially approved budget dates back to 2005. A sound budget—covering all government expenditure and revenue plans—would crystallize the government's policy intentions and restore credibility in fiscal policy. There is a need to move away from the current fragmented approach to fiscal policymaking—as shown by the proposal on the salary scale adjustment for the public sector—and consider fiscal measures in the context of a comprehensive budgetary framework.

"Measures underpinning fiscal consolidation should cover both revenue and spending, be anchored in a multi-year strategy, and support growth. The ongoing debate on the salary scale adjustment has diverted attention away from the budgetary strategy and the need for broader fiscal consolidation."

Preserving financial stability

"Foreign exchange reserves are adequate. Maintaining large reserve buffers relative to total deposits has served Lebanon well during times of uncertainty and is still warranted under the current uncertain environment. At the same time, the continued reserve accumulation and the associated sterilization costs have weighed on the BdL's balance sheet; going forward, there is a need for an action plan to strengthen it.

"Monetary policy should pave the way for increased interest rate flexibility over time. The BdL has recently reduced by 26 basis points the interest rates it pays on banks' deposits—a welcome step to encourage banks to reduce their excess pound reserves with the BdL and invest in government paper instead. The BdL should build on this recent step and gradually withdraw from T-bill auctions, which would be facilitated by fiscal consolidation over time. Providing more detailed auction results would enhance the transparency of the T-bill auction process. Such actions would lead to interest rates that better reflect the cost of funding the government.

"Banks should maintain large liquidity and strengthen capital buffers. Banks have been largely resilient despite the difficult environment. Regional instability has halted their expansion in neighbouring countries, and opportunities for credit to the private sector are currently limited. Nonperforming loans have marginally increased and profitability ratios have declined. Still, liquidity buffers remain large and the quality of capital is high. Capital buffers should be re-assessed in relation to the large exposure to the sovereign in accordance with Basel III. The BdL requires by end-2015 an additional capital buffer of 1.5 percent on top of the Basel III minimum plus the 2.5 percent conservation buffer. Finally, there is a need to improve loan classification and restructuring; stay vigilant for signs of further asset deterioration; and further strengthen the AML/CFT regime, in particular by approving the pending amendments to the existing AML/CFT law and the new related draft laws.

"Preliminary steps to develop capital markets are welcome. The newly established Capital Market Authority (CMA) issued its first regulations last year, and the transfer of supervision from the BdL to the CMA is under way. Developing capital markets to complement the banking sector could promote growth. Proper regulation and tight supervision of the financial system are essential to avoid excessive risk taking."

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Source: CPI Financial

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