The National of the UAE reported that Lebanon’s debt-to-GDP ratio could balloon to 180% by 2023 if the government does not undertake reforms to narrow its fiscal deficit, which may reach 10 per cent of GDP amid the current geopolitical tensions, the IMF said.
Lebanon needs to start implementing reforms that address its funding needs and tackle its debt, currently at 150 per cent of GDP, which is exacerbated by political uncertainty, internal disagreements and the burden of hosting about 1 million Syrian refugees, which represent about a quarter of the population. Prime Minister Saad Al Hariri’s sudden resignation in November, which he rescinded later, plunged the country into political uncertainty.
Out of the 26 points of the IMF’s Key messages, only 7 of them are reproduced below for their relevance, pertinence as well as their potential applicability to all countries of the MENA with however some country specific customisation.
February 12, 2018
The reform agenda needs to focus on three areas:
- First, fiscal policy needs to be immediately anchored in a consolidation plan that stabilizes debt as a share of GDP and then places it on a clear downward path. Any scaling up of public investment will need to be grounded in such an adjustment plan and must be preceded by strengthening the public investment management framework.
- Second, financial stability risks should be contained, including by incentivizing banks to gradually strengthen their buffers and by taking further actions designed to strengthen credit quality.
- Third, to promote sustainable growth and improve equity and competitiveness, the electricity sector needs to be reformed and the anti-corruption regulatory framework should be enhanced and made effective.
- The underlying economic situation has not changed and remains challenging, with high public debt, current account deficit, and funding needs. Public debt is estimated above 150 percent of GDP at end-2017, and is expected to rise rapidly with a budget deficit above 10 percent over the forecast horizon. The current account deficit is expected to remain above 20 percent. The funding environment has been affected by the political crisis of November 2017. Without a significant reduction in the economy’s funding needs or an increase in deposit inflows (and given the global interest rate outlook), the Banque du Liban (BdL) will need to increase interest rates or use its sizable gross reserves to meet the funding needs of the economy. The budget of 2018 and preparation for the upcoming Paris conference could provide key platforms to initiate the much-needed economic reforms.
The Economic Backdrop
- Growth remains low. We estimate growth to be at about 1–1.5 percent for 2017 and 2018. The traditional drivers of growth in Lebanon—tourism, real estate, and construction—remain slow and a strong rebound is unlikely soon. According to the BdL, real estate prices declined by over 10 percent over 2017, while the purchasing managers’ index indicates that private sector confidence continues to be weighed down by political uncertainty. Inflation in 2017 reached 5 percent, likely due to a rise in the costs of imports, notably oil, and a weaker U.S. dollar.
- The fiscal situation remains very difficult and poses significant risks. In July 2017, the Lebanese parliament approved an across-the-board increase in the salary scale of public sector employees and pensions of retired civil servants. A range of tax and fee increases was approved during the second half of the year. While the net fiscal impact is expected to be broadly neutral in 2018, higher personnel and interest costs will be main contributors to further deteriorating fiscal position over the projection horizon. The overall budget deficit in 2017 is expected at 7.3 percent of GDP, with a primary balance of 2.4 percent—in part due to one-off revenues from taxing higher bank profits due to BdL financial operations. In addition, subsidies to Electricité du Liban (EdL) are increasing, in part due to rising oil prices.
- External imbalances are large and persistent. The nominal effective exchange rate appreciated sharply in recent years, while the real effective exchange rate (REER) also strengthened in 2017 by 2.8 percent. The current account deficit is projected to have remained above 20 percent in 2017. Goods exports as a share of GDP continue to decline, while imports remain strong, in part due to cheap credit made available by several BdL subsidy schemes and higher oil prices. The persistently large current account deficit and other imbalances are evidence of a significant REER overvaluation.
- In response, the BdL continues to expand its unconventional financial operations. The BdL has introduced several new financial operations since summer 2016 that offer large incentives to domestic commercial banks to invest in BdL’s dollar-denominated term deposits. Consequently, the increase in bank exposure to the BdL has accelerated since summer 2016. While these operations have boosted the gross reserves of the BdL and the capital of banks, they have come at a cost to the BdL’s balance sheet and net FX position, and have been regressive. In addition, the BdL introduced a new operation in December 2017 to incentivize banks to secure longer maturity local-currency deposits, by increasing the interest rate on existing BdL long‑term instruments held by banks by 2–3 percentage points.
- Lebanon’s outlook remains uncertain. Under our baseline scenario, growth will gradually rise close to 3 percent as external demand picks up due to a global recovery. Inflation is expected to remain around its trend of 2.5 percent. Overall fiscal balances are expected to reach well above 10 percent of GDP and public debt close to 180 percent of GDP by 2023. The current account deficit will remain large. Under the baseline assumption of no reforms or increase in interest rates, Lebanon’s reserve adequacy position is projected to deteriorate over the medium term. But the projection is subject to both upside and downside risks. On the upside, Lebanon’s outlook is linked closely to developments in Syria. In the event of an early resolution, Lebanon would be well placed to benefit from the reconstruction effort, as well as from the reestablishment of trade and an improvement in regional investor confidence. This would have significant and positive implications for local incomes and growth, though not enough to restore debt sustainability without adjustment. On the downside, tensions in the region could lead to escalation of conflicts or trigger security incidents, higher oil prices could increase Lebanon’s funding needs, or deposit inflows could decelerate putting pressure on foreign exchange reserves.
- Lebanon needs urgent action to preserve confidence in the system and take advantage of international support. Over the past several years, Lebanon has maintained a policy mix of loose fiscal policy, and high real rates on bank deposits combined with cheap private sector credit through various quasi-fiscal subsidy schemes. However, given rising vulnerabilities, the need to establish a policy framework that places the economy and public debt on a more sustainable path has only increased. The increased engagement by some donor countries also offers an opportunity to secure their support for a reform and investment plan. The reform agenda needs to focus on three areas.