Paris II gives Lebanon time to reform

The government is increasingly confident that it can successfully guide Lebanon out of its economic difficulties. However the fundamentals have not changed and Lebanon is still on an unsustainable path.

Growth is weak, the country runs a recurrent trade and current account deficit, and public debt is high, nearly $30 billion or 190% of GDP. Nonetheless recent events have seen a significant reduction in the risk of a messy restructuring of the government's public debt.

The Paris II summit of international donors held in late November has given Lebanon time to put its house in order. At the conference donors pledged a total of $4.3 billion in financial support, the majority of which will be used to repurchase outstanding and higher interest bearing debt. The rating agencies have recognised the move, raising Lebanon's outlook from negative to stable, albeit at a very low B-.

The IMF has also released a cautiously optimistic report. The Paris II pledges have opened the way for other positive policy steps, most notably a quasi voluntary 'rescheduling' of payments on some $4 billion in government debt held by the commercial banks.

Under the agreement, which was concluded in the weeks after Paris II, each bank will forgo all interest on government debt they own up to the equivalent value of 10% of their deposit base (as measured at the end of October 2002). The agreement is expected to generate USD4bn in interest-free credit for the
government.

The central bank and state pension fund are also expected to write off some of the domestic debt they hold. Critically for the wider economy, improvement in domestic sentiment following Paris II has allowed the central bank to cut interest rates, which will support growth and further reduce the government's debt servicing costs.

The disbursement of specific project financing funds allocated under Paris II will also be a boost to the economy. Although some of this will be offset by tightening government spending. The most visible impact of recent events has been seen on the LBP.

For most of the past two years the central bank has had to intervene in order to maintain the currency peg to the dollar. This has been costly and net reserves were thought to have been negative ahead of the Paris II.

Since the conference, and as a result of the boost to domestic confidence, the currency has strengthened considerably and the central bank has been able to rebuild its reserves. Gross reserves are now $8.5 billion, up from $4.5 billion six months ago.

The prospects for 2003 are therefore much improved. However
considerable risks remain in the medium term. The funds promised at Paris II do not address the key problems facing Lebanon. Importantly the $4 billion takes the form of interest bearing loans and not debt relief or grants.

Such loans may ease Lebanon's immediate cash flow problems but what Lebanon needs is less debt not more. Furthermore the government has yet to demonstrate any determination to push through needed reforms in the face of opposition from entrenched interest groups.

The 2003 austerity budget has already been watered down, following public and political protest over spending cuts and the government has yet again delayed its flagship privatisation, the sale of the country's two mobile phone licences.

Even the privatisation minister, has publicly admitted that the government is unlikely to achieve its target of $5 billion in privatisation receipts until 2004. The original target had been 2002.

Paris II has given Lebanon more time but much work still needs to be done. Political agreement on the way forward remains a precondition for reform. Lebanon needs to rebalance its debt levels, slash government spending and revive a stalled economy.