Dancing around the International Monetary Fund

Last March, Lebanon requested to use $77 million (25% of itsquota) of IMF financing as Emergency Post-ConflictAssistance (EPCA) for the first time since it joined thisinternational financial institution on April 14, 1947. TheIMF’s principal function is to provide balance of paymentssupport, particularly when reserves fall to a critical levelthat could jeopardize financial stability, and to monitorreform commitment that supports use of its resources.

The IMF Board in May approved the government’s request whichcoincided with a level of reserves close to $12 billion,equivalent to 20% of deposits; certainly one of the highestin the world in relation to the size of the economy. Thisamount can hardly make a dent in the above quantity ofreserves.

Clearly, the incentive for the arrangement is two-fold: tohave a solid commitment from the government toward itsreform agenda and to provide assurance to donors thatmacro-economic adjustment are adhered to and monitored bythe fund. EPCA then constitutes a catalytic part of ParisIII financing and (if implemented successfully) paves theway for future IMF financing under the standard and morestringent Stand-By arrangement.

Measures require prudence and governance

The risk to the government is that a failure to fulfillits commitment would engender doubt in donors and jeopardizetheir willingness to continue providing financial support aspart of their Paris III pledges of $7.6 billion in thecoming years. These risks for the duration of the programthrough 2007 are revealed in the quantitative programtargets: preserve foreign reserves at $11.5 billion, limitthe primary deficit to LP1.3 trillion ($870 million), anddebt accumulation to LP 2 trillion ($1.3 billion). All thesethree targets are inferior to the outcome of 2006. A fourthquantitative target is to repay LP 2 trillion ($1.3 billion)to the Central Bank. The other hurdle in the program is aset of administrative measures — “Monitorable Actions” —covering fiscal measures, electricity reform, andprivatization. None of these measures requires belttightening, but rather prudence and governance, and a timelydisbursement by donors of pledged resources. This isnormally the case of IMF EPCA programs, setting the pace forthe challenges ahead. The demanding reform will ensue in2008 and beyond. The monetary program is limited tomaintaining a high level of liquid foreign assets combinedwith a an exchange rate peg without creating an imbalancebetween the central bank’s liquidity injections — emanatingfrom its balance sheet cash losses — and money demand.

In the words of the IMF, “the authorities program for 2007 …focuses on maintaining financial stability and containingthe primary deficit while accommodating reconstruction andrelief spending. Keeping the excise rates on gasolineproducts at the levels prevailing in March will be a keymeasure to achieve the deficit objective. EPCA will thusprovide a transition to 2008, when the demanding fiscaladjustment is envisaged to commence. Then, it is perceivedthat the government will be able to embark on acomprehensive economic program that could be supported byfurther IMF financing in the context of upper credit tranchearrangement (Stand-By) arrangements.”

Problems fulfilling promises

What are the inherent risks then? Certainly, the politicalrisk, very well recognized by the IMF, remains the primeimpediment to government capacity to fulfill its commitmentunder EPCA. First, almost one year after the devastating warlast summer the economy remains in a recession. A nominalgrowth rate of 4.5% in economic activity envisaged in theprogram for this year is already beyond reach. While thegovernment met all end-March targets under EPCA, except forthe ceiling on government borrowing from the central bank,the outlook for the rest of the year is bleaker. June andSeptember targets are more foreboding in the ongoingpolitical stalemate and recurrent outbreak of violence.Attaining the revenue target (a 16% rise by the secondquarter) is very unlikely. And the government is alreadyburdened by rising spending to improve security. Failure tocontain the primary deficit to the set target in the secondquarter (by end-June) will in turn necessitate preaching theceiling on government borrowing from the central bank for asecond time. Commercial banks were hesitant to roll overmaturities in the first quarter, and a change in the banks’outlook is unforeseen. The deadline for fulfilling most(four out of six) monitored actions was due by the end ofJune as well, and with parliament not convening, these(including the budget) are yet to be approved. The reform isstumbling at the beginning of the race; to regain momentumit will need exceptionally favorable circumstances, and anend to the political stalemate.

Dr. Mounir Rached is a senior IMF economist and afounding member of the Lebanese Economic Association. The views in this article are those of theauthor and do not represent those of the IMF.