Press Release No. 17/20

Lebanon: IMF Executive Board Concludes Article IV Consultation

January 24, 2017

On December 12, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1] with Lebanon.

The protracted conflict in Syria continues to dominate Lebanon’s outlook, with registered refugees now comprising over one-quarter of the population. The refugee presence is straining local communities, adding to poverty and unemployment, and placing further pressure on the economy’s already-weak public finances and infrastructure.

Domestically, following a two-and-a-half-year impasse, Lebanon elected a president on October 31, 2016, and appointed a new prime minister soon thereafter. Consultations to form a new government are ongoing.

Growth remains subdued. Following a sharp drop in 2011, growth edged upward briefly to 2–3 percent, but has now slowed once again. IMF staff estimate that GDP increased by 1 percent in 2015 and project a similar growth rate in 2016. Lebanon’s traditional growth drivers—tourism, real estate, and construction—have received a significant blow and a strong rebound is unlikely based on current trends. In the absence of a turnaround in confidence, or a resolution of the Syrian conflict, growth is unlikely to return to potential (4 percent) soon. Inflation also declined sharply in 2016 on the back of lower oil prices, but should return to trend (about 2 percent) by early-2017.

On the fiscal side, low oil prices have helped secure a primary surplus of 1.4 percent of GDP in 2015, and staff project a similar surplus (1.1 percent) in 2016. But public debt is high (138 percent of GDP in 2015) and without decisive corrective action, Lebanon’s debt burden will increase further.

In the context of Lebanon’s fixed exchange rate regime, foreign exchange inflows slowed in the first half of 2016, resulting in a drop in official international reserves. In response, during May–October the Banque du Liban (BdL) engaged in an unconventional financial operation which, among other objectives, helped boost reserves to above 2015 levels. At the same time, the operation also created sizable excess Lebanese pound liquidity and increased commercial banks’ exposure to the sovereign.

Downside risks dominate the outlook, but there are also significant upside risks. If remaining political milestones are met quickly, the recent election of a president and appointment of a prime minister could pave the way for much needed reform and adjustment, boost the economy, and help correct macroeconomic imbalances. A resolution of the Syria conflict would also significantly boost Lebanon’s economy. On the downside, however, foreign exchange inflows could decelerate, excess Lebanese pound liquidity and reduced banks’ foreign exchange liquidity could put pressure on the foreign exchange reserves, growth might remain subdued, and fiscal imbalances could widen.

Executive Board Assessment^[2]

Executive Directors commended the authorities for preserving macroeconomic stability and market confidence in very difficult circumstances, especially the significant spillovers from the conflict in Syria, including refugee inflows. These spillovers have affected growth and overwhelmed the country’s already-strained public infrastructure and services. Directors recognized that, by hosting Syrian refugees, Lebanon is providing a global public good, and that the international community needs to be more supportive of Lebanon’s efforts.

Directors observed that the recent election of a president and appointment of a new prime minister could set the stage for a revitalization of Lebanon’s policymaking framework. In this context, they noted Lebanon’s rising vulnerabilities and underscored the need for a change in policy direction, to anchor confidence and help secure improved economic performance.

Directors stressed that a sustained and balanced fiscal adjustment is essential. They welcomed Lebanon’s primary surpluses, but observed that that, without further adjustment, Lebanon’s public debt burden will continue to rise, adding to existing vulnerabilities and ultimately crowding out essential public investment and social spending.

In this regard, Directors urged passage of a budget for 2017. They also stressed the immediate need for reform in the electricity sector, which remains a large drain on the budget and a key bottleneck to improved competitiveness and equity.

More broadly, Directors stated that it was critical to place public debt on a sustainable downward path. They observed that there is significant scope to increase revenue equitably, including by improving compliance and broadening the tax base, starting with fuel taxation.

Directors noted the challenges faced by monetary policy in the current environment of tighter international financial conditions and slowing inflows. They agreed that monetary policy should remain geared to supporting the peg, and commended the BdL for maintaining adequate international reserves. In this context, Directors underscored that, although the BdL’s recent financial operation has successfully bolstered BdL’s gross international reserves and banks’ capital, it was not a sustainable solution to Lebanon’s funding needs. They also called for a medium-term strategy to improve the BdL’s balance sheet.

Directors stressed the critical role of Lebanon’s banking system in securing sustained, broad‑based economic growth. Taking note of the findings of the recent FSAP, they appreciated the authorities’ close oversight of the financial system, but highlighted the need for continued vigilance. In particular, they stressed the benefits of measures that would introduce forward-looking capital planning; strengthen regulation and supervision by, among others, aligning loan classification rules and sovereign risk weights with international good practice; and support liquidity risk management. Directors noted that progress had been made since the last full assessment of Lebanon’s AML/CFT framework, but observed that some gaps remain and that the framework needs to be enhanced further.

Directors urged the authorities to advance structural reforms. In addition to electricity reform, they stressed the need for legislation to reinvigorate private investment, including in the oil and gas sector; and for better service provision and stronger safety nets. In this context, Directors pointed out that increased growth was also important in supporting Lebanon’s ability to cope with the recent refugee inflows.

Directors also urged the authorities to move decisively to improve Lebanon’s statistical system, building on ongoing progress.