Lebanon’s outlook with Cedre-Paris 4

Lebanon could face serious fiscal deterioration as a result of having access to Cedre pledges and other loans under the umbrella of the Global Concessionary Financing Facility (GCFF)

French President Emmanuel Macron (R) shakes hands with Lebanese Prime Minister Saad Hariri during the International CEDRE Conference on April 6, 2018 in Paris. / AFP PHOTO / POOL / LUDOVIC MARIN

The main weaknesses of the Lebanese economy are reflected in a stagnant economy, high unemployment and large trade, current account, and balance of payments deficits. Lebanon has an endemic trade deficit in the range of $ 13.5 billion (2016) with imports constituting nearly one-third of GDP while exports are equivalent to less than one-tenth. Capital flows and depletion of foreign reserves have been used to finance the rising current account deficit. The reserve cushion, however, remains adequate to avert a currency crisis.

Nonperforming loans (NPLs) have been rising to over 10 percent by end 2017, with the slowing real estate sector posing serious risks to banks (its share is over 35 percent of total credit).

Challenges facing the Lebanese economy

The large fiscal deficits and the consequential heavy debt are at the core of the poor overall economic performance. Ongoing deficits since the 90s, have resulted in large debt accumulation, prohibitive interest rates, and a large annual debt service burden, absorbing almost half of total revenues. The high interest rates and diversion of resources to the public sector are blocking private sector investment in all domains, and have disabled the economy from increasing its rate of growth and employment opportunities.

Fiscal performance ( in trillion LBP)
2014 2015 2016 2017 Estimates
2018
Revenues 16.4 14.4 15.0 17.5 18.8
Expenditures[i] 20.9 20.3 22.3 22.8 25.9
Deficit -4.5 -5.9 -7.3 -5.3 -7.1
(in percent of GDP) 6.3% 7.9% 9.5%

6.6%

8.2 %

 

Poor governance, planning and execution, have resulted in sectorial and structural bottlenecks.

Following across the board cuts in current and capital spending of 4 percent and 6 percent consecutively, instead of the much heralded 20 percent by Prime Minister Hariri, the current year’s budget is still 13.5 percent higher than that of 2017, and previous years with an estimated deficit of over 8.2 percent of GDP.

The high interest rates, as well, combined with a pegged exchange continue to induce short-term capital inflows with limited opportunities to employ them. This has led to a bubble in reserves (deposits of banks at the Central Bank-CB) reaching 48 percent of total bank’s assets at end 2017.

The idle reserves in turn are remunerated by the CB in order to maintain the inflow that is needed to finance the current account of the balance of payments and to preserve foreign exchange reserves of the banking system including those of the CB. The cost rate of excess reserves is about 4 percent, incurring a heavy burden on balance sheet of the CB.

The CB, on the other hand, has become the main holder of government debt in order to preserve its income position. This cycle of dependence has created doubts on the ability of the system to preserve its sustainability, and rightly so.

Cedre investment program implications

Lebanon could face serious fiscal deterioration as a result of having access to Cedre pledges and other loans under the umbrella of the Global Concessionary Financing Facility (GCFF). The policy approach is utterly in reverse of what is needed: deficit reduction and reform first before borrowing. Larger deficits, will no doubt, worsen Lebanon’s credit rating and raise interest rates further. Only cutting the deficit and consequently interest rates will allow investment and growth to resume their potential.

The IMF team in its last consultation visit in February noted that Lebanon could face a significant deterioration in its finance due to Cedre suggested massive capital investment program (CIP), with the deficit rising to 14 percent by 2023.

Fiscal deficits due to Cadre (in percent of GDP)
2018 2019 2020 2021 2022 2023
Without reform 11.3 12.6 12.7 13.0 13.5 14.0

 

The proposal of the government to undertake fiscal reform together with increased disbursement resulting in deficit reduction by 1 percent annually (assuming it occurs) will not enhance the fiscal outlook, as it will result, on net basis, in having a deficit of 9 percent instead of 14 percent; compared to a current rate of 6.6 percent of GDP. High deficits accompanied with inevitable high interest rates will choke the economy and exacerbate the recession rather than reverse it.

Further, the impact of Cedre on growth and employment can’t be immediate as being portrayed. Some of the pledges are overstated and have been ongoing before Cedre, such as those of the World Bank, the Kuwaiti Fund, Saudi Arabia pledge in military support, and the Islamic Development Bank. Actually, less than $5 billion are clean pledges. In fact, Lebanon has currently ongoing lines of credit exceeding $3 billion facing execution delays.

Considering the time it takes to turn pledges into solid commitments through the donors’ budget, legalizing them in Lebanon’s budget, designing projects, undertaking proper procurement, the initiation of execution will NOT take place before 2 to 3 years. Furthermore, initial execution will not have a growth impetus, until the projects are actually completed. It’s a very fictitious claim that employment opportunities will be created at high rates of 6 to 7 percent annually (that’s, one billion of investment in infrastructure generates 100 thousand jobs). The World Bank estimates that one billion generates 20 thousand jobs only. What is needed is actual reform and not political propaganda.

Lebanon is following very much the approach of Iraq, presenting hundreds of projects without formulating a reform plan, streamlining business regulations and presenting a feasible fiscal policy; a key to attracting clean private investment. That approach is still stumbling.

Furthermore, the concern of donors (on most projects) appears to provide conditions that allow Lebanon create an opportunity for the Syrian refugees to be absorbed in the Lebanese economy. Although this can be seen as a worthy humanitarian cause, but the benefits, then, have to be shared with the Syrian refugees, limiting its impact on local host communities (the Lebanese).

Recommendations

The fiscal outlook can be less damaging by restricting most of the loans to projects that the private sector refrains from undertaking, such as major road projects, water, and water sanitation. The investment program of Cedre can also have a more beneficial impact by having it replace portions of the budget investment program; in particular, projects that are under execution. This together with a careful budget reduction plan can reduce the fiscal risk.

Technically, a substantial decline in the deficit to reach a balance budget is feasible through a string of practical reforms within 4 to 5 years, and this should be done first.

  • Reforming the power sector through purchase of electricity from international producers, combined with a power tariff rate adjustment (to about 14.5 cent per kilowatt) can eliminate the large electricity fiscal subsidy, and save the consumers about a $ 1 billion.
  • In comparison with Cedre financing, the savings from the power sector over 6 years could exceed debt pledges from donors, and make Cedre redundant.
  • Other subsidy items in the budget can be streamlined and cut significantly.
  • Revenue enhancing measures including tapping into tax evasion, corporate income tax and restructuring value added tax can produce significant results.
  • Lebanon needs many other reforms and structural in nature.

The donor community and the public should be vigilant and not allow disbursements before a parliament is elected, and having reforms precede increased spending.

[i] Includes Electricity of Lebanon –EDL subsidy

Dr. Mounir Rached is the President of the Lebanese Economic Association. He is a Lecturer at the American University of Beirut and a former economist at the International Monetary Fund in Washington D.C.