Paris III provides some relief but debt situation still perilous

Lebanon’s economy still in trouble

The exuberant Paris III conference provided $7.6 billion in concessional pledging; certainly, a positive outcome as concessional loans—loans with flexible terms for the borrower—are more favorable than market borrowing in terms of debt service cost. The donors pledged $1.3 billion in private sector loans reflecting their concern that the sector has been constrained by stringent high-cost financing. A key issue is how these pledges, when they are realized, will impact government finances.

Taking away the $1.3 billion earmarked for the private sector through the voluntary intermediation of the private domestic banking sector and $750 million in grants, leaves $5.6 billion available for government financing between now and 2011.

Preliminary reports indicate that out of the $5.6 billion, budgetary support (funds not requiring conditionality) is not expected to exceed $1.3 billion. Of remainder of the financing, $4.3 billion will be tied to the donors’ reform package, implying a rise in spending by an equivalent amount to implement the conditions set by donors.

Debt accumulation with Paris III assistance is therefore expected to reach at least $11.8 billion by 2011 to finance the rise in fiscal deficits reflecting the increased capital spending associated with reform (excluding the additional interest payments associated with debt service). As a result, the total debt could rise to $52 billion and the debt ratio to 167% unless a significantly higher growth rate is realized. Alternatively, debt accumulation without Paris III financing was expected to reach $49 billion, 158% of GDP, as a result of cumulative projected deficits over the same period.

Yes, Paris III disbursements may not necessarily mitigate the debt burden and could indeed make it bigger. However, this is still certainly much better than what would be anticipated without the implementation of a reform program, which would see the debt increase to an unsustainable 180%. This highlights the significance of the reform program, and the need for higher grants in the aid package. Privatization and mobile licensing could further enhance the debt outlook through debt write-offs and enhanced growth potential.

Paris III financing, however, provides added benefits: debt maturity structure and debt service will improve in comparison to alternative sources of financing, mainly market borrowing. Further debt diversification by the government—by practically doubling the official debt—would reduce exposure to market pressure, secure better credit rating on international markets and possibly reduce the vulnerability of the banking sector as the government seek recourse to alternative financing.

The tax and expenditure package designed to bring revenue and expenditure to 25% and 27% of GDP respectively by 2011 is also step in the right direction. The higher VAT and higher receipts from Global Income Tax could compensate for the revenue loss resulting from the European Free Trade Agreement (EFTA) sequenced tax reduction—12% annually to be eliminated completely by 2015— on selected imports originating in the EU. However, VAT needs to be streamlined to preclude tax cascading. Most of the gain in expenditure decline could be generated from terminating transfers to EDL, which make up 3.5% of GDP alone.

The tax on interest income earned by residents and non-residents, estimated to raise revenues by 0.5% of GDP, deserves a careful review as it lowers the effective interest rate earned and may lead investors to reconsider keeping their funds in Lebanon.

Other elements in the recovery documents, such as pension reform, are positive and reassuring, but there are governance and accountability concerns in other areas that are themselves issues earmarked for reform. A well-articulated plan with a comprehensive timetable for all reform is needed if a reform plan is to be held up for public accountability.

The main challenge for the government is to proceed rapidly in implementing the proposed reforms with a high priority placed on accountability, governance and transparency. Allowing access and monitoring by independent citizens’ oversight groups is one way to regain public confidence and ensure a credible and effective implementation of reforms.

Dr. Mounir Rached is a senior IMF economist and founding member of the Lebanese Economic Association. The views in this article are those of the author and don’t represent those of the IMF.