Lebanese unity Cabinet expected to boost confidence in economy

BEIRUT: In its first comment since the formation of Lebanon’s unity Cabinet, the Institute of International Finance indicated that the creation of the government is expected to improve confidence in the Lebanese economy and maintain strong growth of about 7 percent. It also talked about the likelihood of implementing key reform measures included in the Paris III agenda, such as fiscal adjustment and privatization of the telecom sector. 

The report was published by Lebanon This Week, the economic publication of the Byblos Bank Group. 

The IIF warned, however, that significant fiscal challenges remain over the long term. 

It said that there is currently a consensus in the new Cabinet on the need for further fiscal adjustment and renewed willingness to explore privatization of the telecom sector. 

It added that the government may consider raising the VAT gradually from 10 percent to 12 percent, and use the additional revenues to increase its investments in infrastructure, including building more power plants. 

These measures, together with the restructuring and reform of Electricité du Liban itself, should reduce significantly the amount of government transfers to Electricité du Liban, and lead to larger primary surpluses, which is needed for a more rapid decline in the government debt-to-GDP ratio. 

The IIF noted that while the public debt declined from 179 percent of GDP in 2006 to 152 percent of GDP at end-October 2009, it remains one of the highest in the world, with interest payments alone accounting for 11 percent of GDP in 2008. 

It added that the high government debt poses less risk on a net basis, given the large foreign assets of the central bank, while financing is supported by a highly liquid banking system. Further, external debt continued to decline from 116 percent of GDP in 2007 to 107 percent of GDP at end-October 2009. 

It noted that if the foreign assets of the central bank and commercial banks are considered, the net external debt would be close to zero. 

It calculated external debt on the conventional basis of residency instead of currency, and included nonresident holdings of government debt, mainly Eurobonds, and foreign liabilities of commercial banks and the nonbank private sector based on Bank of International Settlements reporting banks. 

It excluded the foreign currency obligations of the government to commercial banks. 

The IIF conducted a simulation showing that the primary balance should have posted a surplus of 4.4 percent of GDP in order to stabilize the debt-to-GDP ratio during the 1998-2002 period. 

However, the actual results show a primary deficit of 1.5 percent of GDP during the same period, which explains the rapid increase in the debt-to-GDP ratio during that period. In parallel, the primary balance could have posted a deficit of up to 4.9 percent of GDP to stabilize the debt-to-GDP ratio in 2007-09, but posted a primary surplus of 1.6 percent of GDP. 

This resulted in a significant decline in the debt-to-GDP ratio, supported by high annual growth rate of 7.3 percent and relatively lower real interest rates. 

It noted that the real interest rates on government debt have declined recently and are expected to remain relatively low over the next few years. 

It estimated that the primary balance may post a deficit of between 2 percent and 3 percent of GDP to stabilize the debt-to-GDP ratio, assuming an annual real GDP growth of 5.3 percent in 2010-2014, which is the average annual economic growth rate of the past 15 years. 

The IIF added that, given the consensus in the new Cabinet on economic reforms, it projected that the debt-to-GDP ratio could decline rapidly from 152 percent of GDP in 2009 to around 120 percent of GDP by end-2014 without privatization, and regress to 110 percent of GDP if privatization takes place. It added that this would require the primary surplus to increase gradually to 4.5 percent of GDP by 2013. 

The IIF added that this objective is attainable under the assumption of fiscal reforms, including raising the VAT from 10 percent to 12 percent and rehabilitating the energy sector, adding that privatization alone would contribute to a reduction in the burden of debt of about 10 percent of GDP over the next two years. 

The IIF warned, however, that if major fiscal reforms and privatization do not take place, the debt-to-GDP ratio would decline modestly to 138 percent of GDP by end-2014, which is still considered very high and is much higher than the current government debt-to-GDP ratios of Greece, Italy, and Portugal. – The Daily Star