The Budget draft law for 2022 that has been submitted to the Council of Ministers, projects 55.2 trillion Lebanese pounds in expenditures with revenues of 39.1 trillion. The need for a 2022 Budget is required sanctioning spending and its approval by the cabinet has been a precondition for negotiations with the International Monetary Fund.
However, the Budget of 2022 reveals most disturbingly, the absence of any profound and comprehensive reforms. It is merely a continuation of past policies with an inflation adjusted factor. The Budget does not state objectives for growth, an inflation target and the balance of payments, nor how it can contribute to resolving the crisis.
First disturbing sign: multiple fixed exchange rates
The continued provision of applying multiple fixed exchange rates under the 2022 Budget is by itself a setback for reform. A regime of multiple currency exchange rates (MCR) is not only unjust but an infringement of the constitution. It exhibits the intention to gradually deplete banks of a substantive amount of deposits to reduce their losses at the BDL. Either the intentions of the government and BDL are being concealed or it is not understood that fixed rates constitute a large loss for depositors and for the economy. Actually, it was this multiple rate policy that has in recent years completely eroded the little remaining trust and confidence in the management of the system.
The frequently stated excuse that unifying and liberalizing the exchange rate is inflationary is a false argument. To the contrary, the current multiple rate policy has the ingredients for a continued decline in the parallel (free) exchange rate and persistence of inflation. The free unified market rate leads to equilibrating the financial markets – and allows depositors to regain the value of their dollar deposits and absorb their LBP deposit losses.
Given that many banks are being influenced/controlled by the political elite that is involved in Budget law decisions, it’s not surprising that the Budget draft law prescribes a multiple rate system. However, the fixed and multiple exchange rate policy that is being sponsored is very likely to preclude reaching an agreement with the IMF that has been all along preaching freeing the exchange rate – a staunch policy of the IMF.
While the persistence of a multiple rate system proposition is void of reform intentions, the central bank’s unsustainable currency intervention to prop up banks seems designed to provide a false signal that reform is coming. The fact that Banque du Liban has been able to convert most of its SDR holdings into a reserve currency (probably a gesture from a friendly economy) does not change the fact that this intervention in the exchange market has been facilitated temporarily.
The second worrying signal
Apart from the draft’s stipulation for continued multiple exchange rate practices, the Budget in its current draft also does not show intent for serious reform; it is rather a collection of fragmented measures of tax rates, excises and spending.
Total spending in the Budget surpasses LBP 55 trillion, including the credit extended to Electricite du Liban. Support to EDL cannot be classified as a loan (and thus excluded from budget spending) because the utility is unable to pay back its existing loans that have exceeded $ 20 billion. Fiscal support of EDL is a subsidy, was classified as such and included in spending for many years. Even the case of a loan was to be made, the budgeted expenditure should be classified as an increase in acquiring non-financial assets, and the counterpart classified as an increase in financial assets in financing (a loan) of the Budget; thus increasing the deficit and increasing the financing needs by an additional LBP 5.2 trillion.
Another notable Budget item relates to wages and salaries, where an expenditure increase of a full month salary is stipulated in addition to increased transportation support. Counter to a standard recipe for administrative and fiscal reforms, the Budget fails to reveal any structural reform in the civil service. The apparent preference is to retain a large civil service body which is much larger than that of any peer country. In summary of the 2022 Budget, its current components are dominated by wages and salaries (12.3 percent), civil servants’ benefits (16.6 percent), EDL subsidies (10 percent), and domestic and foreign debt service cost (13.8 percent combined).
Also, notably, in the context of analyzing the Budget, the allocation of LBP 9.2 trillion to civil servants includes LBP 7.0 trillion of social spending allocated to government employees (نفقات اجتماعية غير محددة) without providing a clearly defined purpose. For both domestic and international debt service interest payment, it’s not specified whether these amounts are based on a debt rescheduling agreements or not. The capital Budget on the other hand remains low at 4% of total spending and is not growth oriented.
Revenues, however, add up only to LBP 39 thousand billion. This side of the fiscal plan reflects primarily tax increases on interest earned to 10 percent (from 7 percent in the previous budgets), and hikes in the tax rate on wage incomes where the new maximum rate is 25 percent on upper income brackets (from 21 percent) , and wage bracket increases for all tax rate ranges. In addition, revenues are assumed to improve on basis of increased customs rates in combination with the new exchange rate applied on customs receipts.. Depending on what exchange rate is used, the imposition of a new customs regime could lead to customs increases – with the real size of the increase depending on how the market reacts to these changes.
A full exemption from tax on interest is introduced on new dollar deposits for 5 years from the time of approval of this Budget law. Other tax relief measures include rescheduling of due taxes and excises for a 3 -year period, resettling of VAT and income tax arrears on large tax payers, and transferring losses one year forward.
The beneficial effects of the proposed tax relief measures and hiking of customs levies are highly uncertain. The tax exemption on fresh dollar deposits is unlikely to attract financial inflows as the risk factors remain dominant in repelling inflows. The proposal to set a broad 3 percent customs rate on most imports may incur a conflict with trade partners who can demand adherence to existing trade protocols. The same issue may arise with applying a 10 percent customs rate on imports for which domestic substitutes exist. The Budget revenue draft thus represents an inward-looking approach to trade.
The main observation of revenue items in the 2022 Budget is that indirect taxes (which are regressive) dominate the picture. VAT is the largest source of revenue. Adding in fees and charges on trade, indirect taxes on goods and services are the largest source of government receipts at 50.3 percent of all fiscal income.
The Budget is attempting to generate revenues in foreign currencies by stipulating that wage taxes should be based on the currency that salaries and other receipts are paid in. The same principle could be applied to other sources of income but with a high danger that such a policy will raise public opposition and at the same time see as justification for using foreign currencies as a local legal tender.
The Ministry of Finance (MoF) is, surprisingly, being given a discretionary power to set the exchange rate for the purpose of collecting customs and VAT on imports, and other taxes. This implies a continued absence of transparency, as no basis for such decisions has been provided in the draft law. In addition, the policy in the current budget gives the MoF the discretionary power of determining certain tax exemptions and discounts on un-specified income taxes and fees.
The 2022 Budget draft law, reviewed here before its finalization by the Council of Ministers, is subject to debate and approval by the Lebanese Parliament. Many details will be discussed and adjusted. However, there are many fundamental questions that are not addressed in the draft and remain to be answered. The people of Lebanon have the right to receive answers on two fundamental issues on which the current draft is silent, namely the question of how the budgeted deficit of nearly LBP 15 .4 trillion could be financed and the equally important question is to what extent the Budget is in compliance with IMF demands.
There are vital questions (listed below) that could make the start of Lebanon’s long journey of rebuilding the economy. In addition to the strategy for economic recovery and the faith of public deposits, is there consistency between the recovery plan and the Budget? Furthermore, the question on every economist’s mind relates to the sources of financing the Budget, and yet ignores the losses of people’s savings through the banking system and its holding of T- bills and Eurobonds. Thus we need to know: does the domestic market (banks and non-banks) have the will to provide financing to the government? By my understanding this is very doubtful. We also ask: is there any intention to compensate, at least partially, depositors for the losses linked to bank-held T- bills and Eurobonds? The Budget cannot remain silent on this.