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Time to act

Lebanon must begin to implement credible fiscal management

by Annalisa Fedelino

Lebanon has been severely affected by the Syrian crisis that erupted in early 2011. The signs are evident everywhere, starting from a massive refugee presence, which is now more than one quarter of the population and outstrips the ratio of refugees-to-population in any other country inside and outside the region. But while refugees are fleeing to many countries, the spillover from the regional conflict runs far more deeply in Lebanon, further weakening the economic foundations of the country. Growth has sharply decelerated, from an average of 8 percent during 2008-2010, to less than 2 percent since, well short of potential. Prospects for a rapid recovery are not promising, as traditional growth drivers – real estate, construction and tourism – have been negatively impacted by overall security conditions and political uncertainty.

All of this has taken a toll on, among others, an already vulnerable fiscal position. Lebanon has been running large budget deficits and high debt ratios for many years; over the last decade, the overall fiscal deficit has hovered between 7 to 10 percent of gross domestic product (GDP).

A welcome exception came in 2014, when the budget deficit fell to 6 percent of GDP, though only on account of one-off extraordinary factors – such as exceptionally large revenue transfers from the Ministry of Telecommunications – that will not be easily repeated in the future. Despite these large fiscal deficits, there was a remarkable decline in the public debt ratio from a peak of 185 percent of GDP in 2006 to some 131 percent of GDP by 2012, largely driven by high growth and low real interest rates. However, with these factors removed, the public debt ratio has started to slowly rise again, remaining above levels that would not be advisable for other emerging markets.

Given the regional crisis and its impact on macroeconomic and political conditions, Lebanon’s fiscal deterioration since 2011 should not be too surprising. In fact, it is difficult to maintain good fiscal performance when the economy is not doing well; lower growth directly transmits into lower revenue, while spending tends to be more inelastic, almost automatically resulting in a worse budget position. And fiscal pressures are even more understandable given the significant shocks. The massive refugee presence, and its additional costs in terms of public service provision and security, need to be borne by the budget. 

What can be done?

But while Lebanon’s tough predicaments can be understood, they should not become an excuse for political inaction. Parliament has passed a package of laws in a show of unity and determination – largely triggered by the urgency to approve pending financial laws and expiring project loans. That same unity and determination should be marshaled into taking selected steps to stem adverse fiscal dynamics – with positive effects on confidence and the economy at large. Here are some suggestions.

1) Strengthen revenue collections. Tax revenues have significantly declined in the last four years, by some 3 percent of GDP. In addition to subdued economic activity and weakening tax compliance, this also reflects the lowering of select taxes (most notably, the decision to exempt gas oil from VAT in 2012). Initial measures by the Ministry of Finance to strengthen collections are welcome, but they should be built upon. And they should be flanked by policy actions, such as reinstating taxation of all fuel products and increasing fuel excises, which remain low by international standards. The current oil price environment provides the right opportunity to do so.

2) Contain spending. Spending composition is very rigid (about 80 percent is accounted for by interest payments, salaries and transfers to Electricité du Liban, EDL) and room to contain spending is limited without reform. EDL subsidies, which have recently declined on account of lower oil prices, would be a good place to start, also to create room for more productive and much needed infrastructure projects (Lebanon’s capital spending is one of the lowest in the region, at only 1.5 percent of GDP).

3) Promote more transparency in funding the government, especially in foreign currency. Public debt management is closely coordinated between the Ministry of Finance and Banque du Liban (BDL), Lebanon’s central bank, and the recent publication of auction calendars for government paper is welcome progress. At the same time, however, the government has been increasingly relying on BDL for its funding needs in foreign currency, given the cap on its FX borrowing. More market-driven funding mechanisms would enhance the transparency of fiscal operations and their costs.

4) Pass a long-overdue credible budget. Recent attempts to normalize spending and payments of salaries are positive, especially to avoid undue (and unwarranted) payment disruptions. However, these practices should not be a substitute for passing a comprehensive budget. Reliance on an official budget would also promote transparency by eliminating the need to execute spending through treasury advances – a problematic method of conducting fiscal operations in the absence of clear legislative spending limits.

The above steps can help promote credibility of fiscal management and put the debt back on a sustainable path, thus anchoring confidence. Targeted fiscal adjustment efforts and reform are needed now, as protracted low growth and increasing global interest rates – much expected over the coming months – will only contribute to worsen Lebanon’s weak fiscal position. Recent legislative successes suggest that progress can still be made, despite the many political constraints, when the consequences of parliamentary inaction are understood and shared. In the same vein – and in the same order of priority – fiscal measures should be high on the legislative agenda and be swiftly approved and implemented. Lebanon’s current vulnerabilities are not only fiscal, but fiscal is a good place to start addressing them.

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Annalisa Fedelino

Annalisa Fedelino is assistant director of the Middle East and Central Asia Department of the International Monetary Fund and mission chief to Lebanon

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