Wishing for a miracle

Omar Karami

“I trust Lebanon and its beloved people to God Almighty.” While Rafik Hariri’s resignation flourish may have had more than its share of melodrama, one has to question whether the end of his 12-year “reign” – punctuated as it was with a Hoss-led INTER-REGNUM – will mark the end of an era characterized by donor conferences, a Solidere-dominated Beirut Central District, rampant construction projects and inflows of Saudi money. Certainly Omar Karami’s government is faced with a daunting task and, which he admits, “cannot do miracles.”

That may prove to be an understatement. The formation of the new cabinet was fraught with in-fighting and it remains to be seen how its final composition will bring about constructive changes, especially in light of the fact that former finance minister Fouad Siniora made it perfectly clear in his 2005 draft budget that Lebanon’s situation is desperate. The budget deficit

What Siniora’s budget achieved, (Siniora probably knew he would not be around to implement it) was to unveil the true state of the Lebanese government finances. He also reiterated that taxes have been taken to the highest level possible and custom duties can’t be raised. Few methods to increase government revenues remain available. The cost of living has reached almost unbearable levels and raising taxes to boost government revenues is not an option. The Hariri government had tried every trick in the book to reduce expenditures in previous years, such as the cost of debt, pruning MEA, and improving efficiency at state-owned assets such as the Port of Beirut, Ogero and Libanpost. With no room remaining to cut any more, Siniora came up with radical cost-cutting measures never before attempted by any government. It is through the arguably over-ambitious cost-cutting measures that Siniora aimed to reduce the deficit in the new plan. The 2005 budget foresees total expenditures of LL9,575 billion, significantly lower than then LL10,150 billion budgeted for 2004 – incidentally, total expenditures had already reached LL7 billion by August of 2004.

It is not, however, the magnitude of the cost-cuts that have labeled the new budget “overambitious,” but rather the means to achieve such targets. The unorthodox methods include the following:

– Cancellation of all perks provided to cabinet ministers and members of parliament, such as petrol allowances, discounts on utility and telephone bills, custom duties on vehicles, and other bonuses.

– Increase in the working hours of all public institutions, in addition to a 3% reduction in salaries of public sector employees.

– Cancellation of the State Security apparatus, reduction of the number of army personnel from 65,000 to 25,000, and that of the police from 30,000 to 17,000.

– Reduction of the length of the compulsory military service to 6 months, from the current 12.

– Cancellation of the ministry of the displaced, the Council of the South and its associated fund.

On the revenue side of what was labeled a “reformist bombshell,” not much has changed from the plans and strategies presented in 2004. Maintaining an opinion that the Lebanese people have suffered enough to support the budget deficit over the years, Siniora insisted that no additional taxes would be levied, nor would there be any increases in government fees and duties. Total revenues are expected to reach LL7,160 billion for 2005, compared to the LL6,850 billion budgeted for 2004.

So the focus falls back to government expenditures and how to reduce them. Government expenditures include debt servicing and other expenditures. Debt servicing has successfully been reduced in 2004, thanks to the efforts of the last Hariri government. Will the Karami government be able to maintain such achievements? It is difficult to foresee, especially since interest rates have already started heading upwards since President Emile Lahoud’s controversial extension. Should the government be able to achieve such revenue and expenditure targets, the overall deficit would be expected to fall to LL2,415 billion (25% of expenditures), significantly below the deficit of LL3,300 budgeted for 2004 (32% of expenditures).

Reforms introduced through Siniora’s draft budget

While such measures would undoubtedly significantly reduce government expenditures, they have not been well received by other cabinet ministers, the military, or members of parliament. Elsewhere, as part of an attempt to force desperate reforms, the draft also includes the establishment of two internal units within the ministry of finance, one to monitor the performance of the ministry, while the other would be solely dedicated to manage the public debt at the ministry. That in addition to radical changes in the social security, merging public schools and reducing the number of teaching staff, and other measures.

Finally, the minister intends to tackle what represents undoubtedly the greatest drain on government finances: Electricite du Liban. Currently, the government spends an estimated $300 million a year to cover the losses of EDL, which result mainly from mismanagement and poor bill collection, factors exacerbated by high fuel prices globally. Almost a third of the $33 billion public debt results from funds spent to cover EDL losses over the past decade.

While the issue of privatization and securitization of state assets was once again brought up in the draft budget as a necessary and crucial step, the minister downplayed the chances of such measures being undertaken. Siniora, perhaps rightfully, claims that serious economic reforms, namely at EDL, among others, should be implemented prior to engaging in successful privatization schemes.

Lahoud’s previous attempt at controlling government expenditures by putting forward a cost-aware government under Selim Hoss backfired, paralyzing growth by blasting foreign investments and halting infrastructure projects and construction permits.

The public debt

One of the major tangible problems awaiting the new government is the massive public debt, a burden of around $35 billion sitting on the shoulders of every single Lebanese citizen making a living in the country. Surely enough, not much can be done on reducing the absolute value of the debt as it currently stands, since the Lebanese government is nowhere near having enough surplus funds to repay any loans.

In fact, assuming Lebanon would still have to pay a total of $800 million in interest between September and December of 2004 – which is somewhat of a conservative estimate – total debt servicing for the year would not exceed $2,600 million, which is significantly below the debt servicing burden of 2003, which reached $3,233 million (See public debt and debt servicing chart).

This reduction is total cost of debt, of around 19% between 2003 and 2004 was achieved thanks to many efforts by the Hariri government, which include cheaper loans from Paris II, 0% loans obtained through agreements with the banking sector in the country, in addition to some securities market gimmicks, such as the recently completed Eurobond swap. Would a new government led by Karami be able to pull off such achievements? While it is hard to say at this stage, it may be sensible to warn that not many people possess the weight of Hariri on the international scene, or the domestic financial scene for that matter. Time will tell if a government of so-called “technocrats” will be able to maintain the trend set by the previous government this year.

Interest Rates and the Lebanese Pound

Directly related to the public debt are interest rates. They have driven the cost of the public debt up and down over the past year. However their impact is not limited to this as interest rates typically make or break an economic comeback from recession anywhere in the world, fluctuating in relation to two main parameters: government borrowing and eco-political stability. Although the Hariri government continued to borrow in 2004, an improved economic and investment climate allowed it to reduce the cost of such borrowing. The country witnessed its best-ever tourism season, and money was flooding in from across the region and beyond.

However, the sensitivity to stability proved itself once again in the past 6 weeks, as political uncertainty following the extension of Lahoud’s term in power, the resulting UN resolution 1559 and US sanctions, and the departure of Hariri have all put upward pressure on interest rates (see interest rates chart). All such developments resulted in an increase in interest rates of 1% on the domestic currency by the central bank, a major increase by economic standards. Such a move, under the pretext of “defending the national currency,” as advocated by Riad Salemeh, is the first significant hike in rates in two years.

Defending the national currency, in fact, has always been a highly debated issue in Lebanon, as it has a tendency of draining the country’s foreign reserves, with not many tangible or directly visible benefits. The Hariri government had, however, successfully increased the country’s foreign exchange reserves to more than $12 billion, and has been able to maintain it above that level for most of the 2004. Things took a drastic turn for the worse, however, between September and October, following the extension of Lahoud’s term and the announcement of Hariri that he would not lead a new government. The ultimate result was massive pressure on the domestic currency, forcing significant intervention by the Central Bank, and ultimately leading to a drastic drop of almost $1 billion in foreign exchange reserves in less than three weeks (See Foreign Currency Reserves Chart). As Karami’s government is handed the reigns, a daunting task awaits it: keeping interest rates low, and alleviating pressure on the domestic currency so as to not erode reserves. For that, political and economic stability are a must. Although it may not be fair to judge from a first impression, Karami’s efforts to form a new government do not inspire much confidence, as such efforts have done nothing but further emphasize the divisions among the Lebanese, and each and everyone’s quest for power at the expense of everyone and everything else.

Yet again, time will tell if the Karami government will be able to inspire confidence in people to stop the pressure on the Lebanese pound and the widening interest differential between the domestic currency and foreign currencies.

So now what?

The Lebanese status quo is changing. Pressure is mounting on the lira, eroding reserves, US and UN sanctions hang overhead, fuel prices are rising and electricity power shortages are more frequent as Lebanon hits an all-time low standard of living… the picture does not look so good. The last time Karami held office, the lira fell through the floor.