Balancing act

The challenges in meeting the 2004 budget

At the press conference in which he outlined the 2004 budget, minister of finance, Fouad Siniora, began by justifying why the 2003 budget was missed by such a sizeable margin. According to figures for the first nine months of 2003, the deficit stood at around 38%, compared to almost 40% for the same period last year, thus registering a modest improvement. While revenues seem to be on target for the year, and may reach the budgeted LL6.475 billion by year-end, expenditures remain high. Current expenditures (excluding debt servicing) grew almost 8% between January and September 2003, compared to the same period last year, reaching LL3.4 billion against a full year budget of LL4.2 billion. On the other hand, debt servicing, which was expected to be capped at LL4 billion for the year, has already exceeded LL3.4 billion by September, and remains the main factor behind the government’s failure to trim the deficit further. In an effort to justify this performance, Siniora stressed that failure to implement structural reforms in the public sector was to blame for the government’s inability to trim current expenditures and meet its targets, while debt servicing targets set for 2003 were primarily dependent on the proceeds from privatization of state assets, a move yet to be implemented.

In doing so, Siniora absolved his ministry from failing to meet the budget for 2003, placing the blame primarily on the political bickering that has hampered the implementation of structural reforms and the progress of privatization. That done, Siniora moved on to sketch the main highlights of the government’s draft budget for the coming year, repeating the importance of structural reforms in the public sector, and their critical role in achieving any target set for 2004.

He said that the new budget would take into consideration the current and expected burdens on the ministry and the treasury. No new taxes would be levied, nor would there be any modifications to existing taxes, including the famed Value Added Tax, expected to remain at 10%.

On the revenue side, total proceeds were expected to remain stable at around LL6.4 billion, yielding an initial surplus in the budget of LL1.45 billion – until debt servicing comes into play.

Setting the debt-servicing burden aside, total expenditure by the government is expected to stretch by almost 8% to reach LL4.95 billion. Around 69%, or LL3.4 billion of such expenditures are allocated to salaries and wages for the workers of the public sector. With the national debt holding steady at current levels, total interest on the debt for the year 2004 is expected to reach at least LL4.3 billion, constituting 46% of total expenses, 67% of total revenues, and yielding a net deficit for the budget of LL2.85 billion, or 30.8% of spending.

As such, wages and salaries, in addition to debt servicing costs, amount to a staggering LL7.7 billion, or 84% of total expenditures. The remaining 16% of expenditures, or LL 1.9 billion, are allocated among various ministries as normal operating expenses for government entities. While such “discretionary” costs may be trimmed, it would conceivably be difficult to significantly improve efficiencies on that front with no radical structural reforms.

On the other hand, if privatization plans do materialize early in 2004, and if proceeds from such efforts are up to expectations, total debt servicing for the year may drop to LL3.9 billion. Such a drastic improvement would reduce the deficit to LL2.45 billion, or 27.7% of spending. The ability of the government to meet even the high end of the deficit for 2004 remains to be assessed, however, as it still marks a significant improvement over the numbers seen in the second half of 2003, where the deficit reached 38% of spending. In fact, as it has been clearly outlined by Siniora, prospects for additional cost-cutting outside debt servicing are bleak, while revenues are expected to remain flat. On the revenue side, options appear to be very limited, or so the government would want us to believe. Income taxes are already being levied on companies and individuals alike. Consumer taxes are being levied through a 10% Value Added Tax system being applied to almost every type of good or service. Custom duties are still applied to almost all import, including unfortunately raw materials and semi-finished goods for industrial use. From this perspective, it does seem that there is virtually no room for improvements. Any additional or higher taxes and the already high cost of living in Lebanon would squeeze consumption, investments, and subsequently economic growth.

Nevertheless, the case may not be as hopeless on that front as the government is painting it out to be. The government should be able to significantly improve its income not from increasing taxes and duties, but by simply improving tax collection. While no official records are kept on who pays what taxes, or at least no records are disclosed, the possibility of digging in that direction should be seriously considered because the current situation leaves no room for slacking off, especially with the World Bank and IMF breathing down the government’s neck. Improvements can be achieved through better tax collection on currently levied taxes, in addition to levying taxes on some job sectors to this day indemnified from paying taxes (medicine, law, etc…).

On the expenditure side, and apart from debt servicing, it was made clear by the government that the overwhelming majority of expenses (or 86%) is non-discretionary and cannot be significantly reduced. Furthermore, almost two thirds of all expenses are allocated to wages and salaries of public sector “servants”. The majority of members in the government and the parliament seem to believe that no cuts can be implemented on that front. Basic finance stipulates that reducing the debt servicing cost can be achieved by either trimming the amount of debt on the books, or negotiating lower interest rates on the existing loans. It appears that perhaps the easier solution is negotiating lower rates on existing loans, or replacing existing obligations with more suitable ones. However efforts in that direction are limited, with the benefits of Paris II beginning to dissipate as the country still fails to meet the requirement set during the summit last year. The government has failed to prove to potential lender/donor countries it ability to implement needed reforms and complete privatization.

As the current situation stands, on the other hand, reducing the overall debt level without privatization seems practically impossible. Severe drainage at the power company, a sizeable budget deficit, and increasing spending on social welfare are likely to force the government to continue borrowing over the near term. As such, the total public debt level is expected to breach the $33 billion level in the foreseeable future.

Therefore, we again realize that the fate of the country hinges on a matter debated so many times over the past five years: privatization of state assets. Three matters should be addressed with that regard:

– The importance of privatization and its impact on government finances

– The urgency of completing privatization plans

– The likelihood that privatization takes place in 2004.

The critical importance of privatization of state assets and its proceeds has been underlined so many times by various parties, including the World Bank, the IMF, international banks such as Citigroup, Merrill Lynch, and rating agencies such as Standards and Poor’s and Moody’s. The country’s economy is severely burdened by the level of debt, high debt servicing costs and the resulting deficits forcing the government to borrow more. Such factors have prompted a number of rating agencies to downgrade Lebanon’s sovereign rating yet again, stating the pace of reforms and privatization as the main factors behind such a move. Furthermore, the presidential elections to be held towards the end of 2004 are likely to stall any major moves on the part of the government.

Standard and Poor’s proceeded to revise Lebanon’s outlook from Positive to Stable due to fiscal consolidation delays. “The outlook revision reflects our view that the draft budget for 2004 implies a postponement in fiscal consolidation and hence delays the envisaged reduction in the government’s debt burden,” said S&P’s credit analyst Ala’a Al-Yousuf.

The only conceivable solution to reduce the level of debt is through the privatization of some state assets. The two profitable cellular operations should CONCEPTUALLY be easily sold. The power company, on the other hand, is a losing business, with accumulating debts and losses. Nevertheless, serious efforts should be undertaken to sell-off EDL, which by itself is burdening the treasury and forcing on more debts. Proceeds from privatization can range from $2 to $4 billion, and can substantially reduce the overall debt servicing cost by more than 10% in 2004 alone.

Moreover, the benefits of privatization are not limited to the use of proceeds to reduce debts, but such a move would considerably boost the government’s image on the international scene, prompting cheaper lending, more donations, and improve the overall foreign investment climate in the country.

However, as the political bickering has delayed privatization for almost 4 years, the value of the assets, to the contrary of the level of national debt, are certainly not rising. The longer the privatization is delayed, the less the proceeds of such a move will be, and the more damage the government’s already frail credibility will suffer.

The year 2004 is the presidential election year. President Emile Lahoud is eager to improve his public image, while Prime Minister Rafik Hariri is equally keen on meeting his economic targets. It remains to be seen, however, if their plans to improve their public image include a certain compromise on such critical issues as privatization, and how soon, if ever, such precarious steps are to be taken.