The Socialist People’s Libyan Arab Jamahiriya—2009 Article IV Consultation, Concluding Statement of the Mission

June 1, 2009

The Socialist People’s Libyan Arab Jamahiriya —2009 Article IV Consultation Preliminary Conclusions of the IMF Mission¹

1. The Libyan authorities have launched a number of initiatives over the past few years to modernize the economy. Notable progress has taken place in bank privatization, state budget unification, and encouraging the private sector, domestic and foreign. These achievements have contributed to the favorable sovereign ratings assigned to the country earlier this year by international rating agencies. The authorities are aware of the many challenges that remain to be addressed in order to achieve their objectives of increasing non-oil growth and creating viable employment opportunities.

2. The impact of the global financial crisis on Libya has been thus far limited to the decline in oil revenue. This was due to the lack of exposure of domestic banks to the global financial system. In addition, Libya's foreign assets consist mainly of foreign reserves, which are highly liquid, and the portfolio of the Libyan Investment Authority (LIA). The LIA started operations in June 2007 and a large part of its assets consists of bank deposits.

3. Preliminary data indicate that real GDP grew by about 3.8 percent in 2008. This reflected strong growth in non-oil activities (8 percent). Oil output increased slightly in the first three quarters of the year then declined in the last quarter in line with OPEC’s decision to reduce quotas. As a result, production for the year as a whole was similar to its 2007 level. Inflation rose in 2008 to about 10 percent due to higher food prices and a marked increase in public expenditure.

4. The fiscal surplus remained at about 25 percent of GDP in 2008. Revenue increased by about 37 percent due to higher oil export prices and enhanced tax and customs administration. On the other hand, overall expenditure increased by an estimated 45 percent, reflecting 42 and 47 percent increases in current and capital outlays, respectively. Spending under the Wealth Distribution Program (WDP) was limited to LD 3.3 billion (equivalent to about 3 percent of GDP), compared to LD 4.6 billion approved in the budget.

5. The external current account surplus remained substantially high at about 41 percent of GDP in 2008. The rapid increase in imports (29 percent) was more than offset by a sharp rise in oil exports, resulting in a further build up of the net foreign assets of the Central Bank of Libya (CBL) and the LIA to about $136 billion.

II. Macroeconomic Outlook

A. Outlook: The Large Public Expenditure Will Moderate the Economic Slowdown

6. Real growth is projected to decelerate to about 2 percent in 2009, mainly reflecting an expected reduction in oil production by about 1.5 percent. However, non-oil activities are projected to grow at around 6 percent, which is high by regional and global comparison. Over the medium term, this performance is projected to continue to strengthen, while oil output is expected to recover and steadily grow with the planned expansion in production capacity. Inflation is expected to decelerate substantially in 2009 (to about 5 percent), in line with the decline in international commodity prices, and to moderate further over the medium term.

7. The overall fiscal position is expected to register a surplus of about 10 percent of GDP in 2009 despite the projected decline in oil revenue by almost 40 percent. This is due to prudent public expenditure plans, which are expected to result in a small decline in public outlays after the very large increases in recent years. This reflects a reduction in capital spending by 20 percent and a 25 percent increase in current outlays. The overall fiscal balance is expected to strengthen steadily over the medium term with the projected increases in oil output and prices, which exceed the planned increases in public expenditure.

8. In line with the above developments, the external current account surplus is projected to narrow to about 17 percent of GDP in 2009. As a result of OPEC’s output cuts and the sharp decline in oil prices, its exports are expected to fall by about 40 percent. Imports, on the other hand, are projected to increase by about 6 percent, broadly in line with non-oil GDP growth. Net foreign assets of the CBL and the LIA will continue to increase, albeit at a slower pace than recent years, to about $150 billion (equivalent to almost 250 percent of GDP) by end-2009. Further increases are projected over the medium term.

9. This medium-term outlook is subject to possible downside risks relating to a further worsening in global economic conditions or a wavering of the efforts to improve the quality of public expenditure. In particular, a more severe global recession could lead to a further reduction in both oil and non-oil growth. The prospects for inward foreign investment may also weaken. If these risks materialize, economic growth, as well as the fiscal and external balances, would be smaller than the above projections.

III. Policy Discussions

A. Fiscal Policy

10. The authorities’ overall fiscal stance strikes an appropriate balance between short and long term considerations. The small decline in public expenditure planned for 2009 is prudent. It is a clear break with the very large increases in recent years, which have raised concerns about expenditure quality. At the same time, it reflects an appropriate decision to not allow the sharp reduction in oil revenue to translate into an abrupt reduction in public expenditure, with adverse implications for domestic economic activity, vital social and economic development programs, and projects that have already been initiated, with large sunk investments.

11. The authorities should, however, focus on the quality and composition of expenditure. In this connection, they are encouraged to reconsider the planned increase in the wage bill in 2009. The 14 percent planned increase is in large part due to the return to the civil service payroll of a portion of the large number of public employees that were previously transferred to a central labor office for retrenchment to the private sector. This development goes against the intention to reduce the size of the government and encourage the private sector. Apparent increases in other current outlays mostly reflect either improvements in classification or increased external grants to lower income countries. For example, part of previously implicit subsidies have now become explicit.

12. It is crucial to continue to advance the effort to strengthen public finance management. In this regard, the recent merging of the ministries of planning and finance is a welcome step, which will help enhance public expenditure planning, monitoring, and control. It would be important in the period ahead to improve the legal and administrative framework governing the state budget, with a view to streamline and modernize procedures. This would reduce the need for implementing investment programs through funds outside the new ministry. The 2009 budget is already allocating the equivalent of about 5 percent of GDP to such funds. While these funds offer greater flexibility than budgetary expenditure, they increase the magnitude of quasi-fiscal operations. Furthermore, even though these funds are intended to operate on a commercial basis and engage in activities where the private sector is absent or has a minor involvement, they can become under pressure to deviate from such objectives. A further proliferation of such funds would complicate public expenditure management, increase the potential for losses and price distortions, and crowd out the private sector. Strategic projects that are not sought by the private sector should be implemented either through the state budget or in the context of public-private partnerships with adequate safeguards.

13. The mission welcomes the intention of streamlining the bank accounts of government entities. An establishment of a treasury single account (TSA) at the central bank would importantly support this effort. A TSA would substantially enhance the management of cash flows. Staff stands ready to provide detailed technical advice in support of establishing a TSA and of the efforts to enhance the classification of expenditure and casting the annual state budget within a medium term framework.

14. The mission welcomes the decision to postpone the WDP. If the WDP program goes forward, it should be limited in scope and replace to the extent possible existing subsidies with more efficient well-targeted transfers.

15. The transparent start of the LIA in 2007 was encouraging. The authorities continue to enhance the LIA’s operational and legal framework. In this connection, to best serve its core objectives, the focus of the LIA should be on conservative investments abroad on a commercial basis.

B. Monetary Policy and Financial Sector Reforms

16. It is crucial to address the factors behind the large liquidity in the banking system. In particular, on-lending of government funds by specialized credit institutions (SCIs) has been both hampering commercial banks’ ability to conduct financial intermediation and contributing to excess liquidity. Furthermore, in the absence of a TSA, there are very large balances of government entities in the banking system. These factors have contributed to a liquidity overhang as evidenced by the large excess reserves. Addressing them would help increase the effectiveness of monetary policy tools. It would also help enhance commercial banks’ financial intermediation and, thus, their role in promoting a viable private sector-led growth.

17. The introduction in May 2008 of CBL’s certificates of deposit (CDs) was an important step in modernizing the monetary policy framework. They are currently issued at a fixed interest rate and have a single maturity (91 days). The mission supports the CBL's plan to expand the range of maturities for the CDs (especially by adding shorter maturities) and to develop an auction mechanism for them.

18. The mission welcomes the reduction of the budget allocation to SCIs and the initiation of a study on reforming them. It would be important to substantially strengthen their supervision by CBL and to steadily roll back their size and scope of operation to the norm for development banks. Converting them into commercial banks would be very risky in view of their weak technical capacity and the potential size of their NPLs.

19. Ongoing efforts to modernize the CBL and to strengthen supervision are commendable. The recent establishment of a credit bureau and the forthcoming production of financial stability reports are particularly noteworthy. Further efforts are, however, needed in improving coordination between the off-site and on-site supervisory units and to build capacity through additional staffing of qualified personnel and training.

20. Bank restructuring and privatization are making progress. An asset management company to deal with some of the bad loans has been established, capital requirements are being raised, and smaller banks are being encouraged to seek well-established foreign strategic partners. The mission welcomes the CBL’s progress in selling its shares in banks.

C. The Exchange Rate

21. The dinar’s peg to the SDR has served the economy well. This arrangement provides a strong monetary anchor, while allowing some flexibility in the dinar’s exchange rate vis-à-vis individual major currencies. Preliminary econometric estimates indicate that the dinar’s real effective value against other currencies has shifted from a moderate undervaluation in 2008 to a moderate overvaluation in 2009, in line with the developments in oil prices. These estimates, however, are not reliable or accurately point to the appropriate level of the equilibrium rate. The mission does not recommend any change in the policy or level of the exchange rate.
D. Other Structural Reforms

22. Progress has been made in customs and tax administration. However, the “service fee” on imports has recently been increased from 4 to 10 percent, and other ear-marked fees remain in place. The mission welcomes the recent decision to streamline exemptions, and encourages the authorities to adopt low income and corporate tax and customs rates, with very few brackets and limited exemptions. Furthermore, it would be useful to modernize the taxation system, with a view to gradually moving to self-assessment and risk-based auditing.

23. It would also be important to further enhance the regulatory framework in order to improve the business climate. All the above reforms would support the growth of private sector, diversification, and the creation of viable employment opportunities.

24. The mission urges the authorities to continue to improve economic and financial statistics and accounting standards in line with international practices in order to better guide analysis and policy making. In this connection, it welcomes the completion of a household budget survey in 2008 and the recent steps made to improve inter-agency cooperation on external trade statistics. The staff stands ready to continue to support the ongoing reforms in the areas of its expertise.

¹ An IMF mission, led by Mr. Khaled Sakr, visited Libya during May 17–June 1, 2009 to conduct discussions for the 2009 Article IV consultation.This concluding statement summarizes the preliminary findings and recommendations of the mission. The mission would like to thank the authorities for their excellent cooperation and hospitality.