Paris Meeting Paper: Supporting Lebanon's economic reform strategy
Memorandum of economic policies

Tuesday February 27, 2001

Introduction

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The Lebanese political system, to a large extent, is quite similar to the political systems in Europe. Its judicial system and various codes are also similar to those found in Europe, in addition to a constitution that safeguards a democracy that guaranties liberty and human rights.

The Lebanese government plans to bring Lebanon, a country at the heart of the Arab world, as close as possible to European social, economic and political values. To this end, Lebanon has already set in motion the necessary measures leading to signing of the Euro-Med Agreement before the end of 2001.

Additionally, Lebanon possesses several comparative advantages including:

• Low corporate tax environment,

• Low personal income tax rates,

• Low social security rates,

• Highly skilled and relatively low cost labor force, and a

• Key geographic location between Europe and the Arab world.

In light of the above, the Government has started implementing a comprehensive economic strategy in order to attract investments into various productive sectors, including health, tourism, trade and IT. Our economic strategy is reinforced by the country’s liberal environment where freedom of speech and civil liberties are entrenched values.

Nevertheless, Lebanon is facing a series of social, political and economic challenges, which our government is committed to tackle. The economic challenge is mainly fiscal in nature, where the debt to GDP ratio has reached 140%, the deficit to expenditure ratio in the 2001 budget is expected to reach 51%, and where the debt service component of the budget amounts to 43% of expenditures.

Given the above imbalances, the government finds it essential to address the fiscal stance and reverse the debt dynamics. Nevertheless, the current financing requirements of successive deficits and increasing debt have raised the cost of borrowing, not only to the public sector but also to the private sector, contributing largely to slowing down of the economy.

In order to contain this situation, the government intends to initiate a privatization program encompassing the water, power and telecom sectors, proceeds of which will entirely go towards domestic debt retirement.

Moreover, the government has initiated a structural reform program, that liberalizes the economy and reduces the imbalances in the budget (reduces expenditures and increases revenues).

Lebanon is seeking to reinforce this initiative by calling on the international financial community for supporting its program of reforms and in particular to help reduce the debt service burden that has accumulated over the past twenty five years, and thereby ameliorating the fiscal stance and allowing the private sector to regain its leading role in the economic revival of the country.

New Economic Vision and Recent Measures:

The way forward

The Lebanese government has commenced implementing a comprehensive economic strategy based on three fundamental pillars: (1) reviving and modernizing the economy and placing it on a sustainable growth path by inducing the private sector to act as the engine of growth and integrating Lebanon in the global economy, (2) pursuing a sustained effort of fiscal consolidation and structural improvement in public sector finances which is necessary to reduce the growing burden of the public debt on the economy, (3) maintaining monetary, financial, and price stability.

To this end, the government is calling for international support to enable it to lower the debt service component of its budget and is committed to undertake the necessary measures.

I- Modernizing the Economy

The objectives of the following reforms are three-fold: (1) to facilitate and encourage international trade in the context of integrating Lebanon with the global economy, (2) to facilitate the environment for the private sector to develop, thrive, and contribute to the national economy's sustainable growth, and (3) to provide further incentives for the private sector through decreasing costs of production.

1. Liberalization and global integration:

During the last three months, the Lebanese government has adopted the following measures:

A. Reactivated the negotiations for concluding the Euro-Mediterranean Partnership Agreement before the end of the current year.

B. Continued preparations for the accession to the World Trade Organization,

C. Finalized the third dismantlement phase (10 percent annually) of the Great Arab Free Trade Area,

D. Reduced customs duties from an average of 12 percent to an average of 6 percent on 5,400 items out of a total of 5,700 items.

E. Adopted the new customs law (WTO compatible), which mainly simplifies and expedites customs procedures, adopts international standards.

F. Eliminated other non-tariff barriers such as un-necessary and costly formalities.

G. Adopted an open skies policy and facilitated the issuance of entry visas.

2. Reforming the social security and pension systems:

The Lebanese government is currently implementing the following reforms:

A. Social Security system: the National Social Security Fund recently ratified the government’s proposal to significantly reduce employers’ contributions to the fund from 38.5% of an employee’s wage to 23.5%.

B. Pension reform: A coordinated program of reform to the end-of-service indemnity to be replaced by a capitalization system.

3. Other real sector measures:

During the last three months, the Lebanese government has adopted the following measures:

A. Approved a draft law aimed at encouraging foreign investment in Lebanon, reorganizing the Investment Development Authority of Lebanon (IDAL), granting it the authority to award licenses to new investments and to market Lebanese products.

B. Extended support to the development of small and medium enterprises through the following schemes: subsidized loans and guarantee scheme for loans (Kafalat).

C. Reactivated the real estate sector through (a) easing the legal limits on foreign ownership of property and eliminating any discrimination between Lebanese and foreigners, and (b) lowering real estate registration fees to 5% for both Lebanese and foreign investors.

II- Privatization

The objective of this reform is to foster economic development and reverse the debt dynamics. The privatization process will be conducted using the best-practice guidelines and international experience, ensuring competition and an equitable participation of the public at large.

Main measures:

1. Electricity privatization: On February 22, 2001, the Cabinet has decided to shortly proceed with Electricité du Liban (EDL)’s privatization process. To that effect, (1) the electricity privatization law will soon be prepared, (2) EDL will be converted into a joint stock company, and (3) an international competitive tender will be offered for the company’s 3-year management contract and its 10 percent equity share, as a first step in the privatization process.

2. Privatization of the telecommunication sector: The draft telecommunication law will be finalized by the end of March 2001. This law will re-organize and prepare the sector for privatization through its liberalization and improving its competitiveness. The law will also create Liban Telecom, an entity that will operate the country’s 750,000 landlines, Internet, and data networks. Liban Telecom is to be privatized and to become as well the third cellular phone operator. In addition, the government is currently negotiating to resolve outstanding issues with the two cellular phone operators and will convert BOT agreements into licenses.

3. Water privatization law: Parliament has adopted the law regulating the water sector in anticipation for its privatization. It is expected that both the Beirut and Tripoli water authorities will be totally privatized or through a long-term concession by end 2002.

4. Recent developments in the privatization process: IFC, which was appointed to advise on the privatization of Middle East Airlines (MEA), has already submitted a report as to the best means to restructure and privatize MEA. The government intends to carry through with the recommendations. Moreover, the Cabinet has taken the decision to corporatize the Beirut International Airport (BIA).

III. Redressing the Fiscal Situation

The Government has put in place a strategy to redress the fiscal imbalances and has started to implement it through three sets of measures: (1) real economy measures to increase growth thereby ameliorating government revenues and reducing government subsidies thus decreasing fiscal deficit, (2) a package of revenue measures and structural reforms to increase the ratio of revenues to GDP, (3) the rationalization of expenditures and their containment through better controls on budget execution and through privatization which will reduce debt service.

1. Revenue reforms and measures

1.1 Tax measures for 2001:

Professional flat tax: it is included in the 2001 budget proposal and is applied on corporations, individual companies and professionals. It is expected to yield more than LBP 40 billion.

Tax regularization law The government will be sending to parliament, a tax regularization law for previous years’ tax evasion and for parallel implementation of the statute of limitations. This tax will yield more than LBP 100 billion.

As a contingency plan, the government has included in the 2001 budget proposal the option to introduce new excises on some imported products, equal to the reduction in customs duties in line with international agreements signed with other countries.

1.2 On going reforms:

In parallel, the government is modernizing the tax system to widen the tax base through the introduction of the VAT in 2002 and the adoption of a comprehensive income tax.

1.2.1 VAT: The government is preparing for the introduction of the VAT by the end of 2001. Indeed, the VAT project is currently working along various fronts such as the finalization of the draft law expected to be approved by the Cabinet in the coming weeks, the briefing to the private sector, the preparation of technical and administrative issues.

The government considers the introduction of the VAT as a fundamental step in the fiscal adjustment scheme of the government. In fact, the VAT is intended to compensate the loss in revenues encountered by the reduction of the customs tariffs. The introduction of the VAT is expected to yield revenues of around 4% of GDP in the first year of implementation.

1.2.2 Comprehensive income tax: In order to unify declarations of all income generating activity into a single procedure and make universal declarations obligatory for citizens over eighteen years of age, the government will replace the currently existing scheduler income tax by a comprehensive (or global) income tax.

1.2.3 Tax administration: The government is giving high priority to improving tax compliance by reducing tax arrears, avoidance and evasion, through continuous efforts to modernize and strengthen the collection capabilities of the tax administration by introducing an operation control unit, the large taxpayer unit, etc.

2. Expenditure measures

The government has adopted universal measures to contain government spending in 2001 and beyond. These measures revolve around streamlining the civil service and improving its cost effectiveness, on reducing the debt service, decreasing subsidies, reforming public sector and rendering capital expenditures more productive.

2.1 Civil service reform:

On February 22, 2001, the government endorsed (1) the re-assignment of surplus government employees to the Civil Service Board in an attempt to re-allocate employees to currently vacant positions, (2) freeze employment in public institutions and ministries, and will contain the transfers to the non-civilian pension system.

2.2 Reform of public entities

The Government has decided to reform all public sector companies in its efforts to streamline and reduce unproductive public expenditures. The implementation has started by the decision taken by the government on February 22, 2001 to reform the state media through (1) laying off 500 workers from the state-run television station, Tele-Liban (TL), (2) canceling the workers’ collective bargaining contract, and (3) suspending TL’s broadcasting for 3 months in an attempt to restructure it.

2.3 Reduction of subsidies:

The government has also decided to cut official subsidies to the Sugar Beet office.

2.4 Activation of concessional loans:

The government is committed to accelerate the usage of funds available through concessional loans. The activation of these funds will help the government make significant steps towards sectoral reforms and public work programs.

2.5 New public accounting and procurement Laws

The Government has approved the amendment to the existing Public Accounting Law, which will play a large role in streamlining public expenditures. The government has prepared a new procurement law to increase transparency and accountability of practices.

IV. Debt Management

High interest rates have hampered the efforts of successive governments to apply fiscal stance and reduce budget deficits. Indeed, debt service to GDP ratios have increased during the previous decade (17 percent by the end of 2000) and are a major cause of the difficulty facing the Lebanese Government in its efforts to reverse the vicious circle of debt and deficit increases. In this respect, the debt management strategy of the Government will focus on reducing debt service and minimizing over the long term the cost of meeting the government’s financing needs, taking account of the risk, while ensuring that the debt management policy is consistent with the Central Bank’s monetary policy.

The Government is continuing to lengthen the average maturity (2.53 years in 2000) of its debt, and to reduce its debt service and refinancing risk by replacing high cost, short maturity domestic debt by lower cost and longer dated foreign debt. The Government is also activating the usage of existing concessional loans to finance capital expenditures.

On the Foreign market, the government is enlarging its investor base and promoting currency diversification and will tap new markets in order to access less costly sources of funding. The government will also develop the domestic debt market through streamlining the issuing strategy and creating benchmarks, increasing the depth and liquidity of the secondary market and introducing new debt instruments.

V. Maintaining Monetary and Financial Sector Stability

The government is implementing financial reforms aimed at further strengthening the regulatory and prudential framework of the financial system in order to ensure its consistency with international standards and best practices.

1. Banking system:

In order to maintain the strength of the banking sector (high capitalization, strong profitability, and liquidity coverage), the Central Bank is following a policy to improve capitalization. As a result, commercial banks' capital increased substantially, and by end-2000, their average capital adequacy ratio was approximately 15 percent, with total equity of the banking sector equal to USD 2.8 billion at present and with bank assets to GDP ratio of 246%.

The Banque du Liban is continuing its efforts to strengthen bank supervision. According to the IMF assessment in February 2001, Lebanon is currently compliant with 29 out of the 30 Basel Core Principles for Effective Banking Supervision.

2. Money laundering:

On February 22, 2001, the Council of Ministers approved a draft Law on Money Laundering compliant with the 40 recommendations of the Financial Action Task Force (FATF).

Other laws and decisions were taken to further reinforce the government’s decision to combat the possibility of Money Laundering and improve the soundness of the banking system.

Summary

The Government is fully aware of the challenges lying ahead. This is why it has decided to adopt a comprehensive economic program, enjoying broad political consensus, addressing the challenges of the real economy and the twin fiscal and debt issues. Indeed, the economic revival program of the Lebanese government hinges on its ability to contain the recurrent budget deficits. To do so it is obliged to reduce the debt service burden, on the one hand and undertake reforms to reduce other recurrent expenditure items.

Other than debt service, the treasury has suffered from severe expenditure requirements including army retirement benefits and loss generating public enterprises. To this end, has taken a number of measures: activating the usage of concessional loans, eliminating subsidies, restricting extra-budgetary transfers to the soon-to-be privatized electricity company, as well as restructuring the civil service through singling-out surplus government employees and reforming the state-run television company.

The government is also implementing a number of revenue-raising measures: tax reforms that introduce a VAT in 2002 and a global income tax, a broad based privatization program, introduction of a flat professional tax within the 2001 budget, taking a number of administrative measures to improve revenue collection, and enhancing the performance of profit generating public enterprises.

The government has already implemented well-focused real sector measures. It has simplified and reduced custom duties, adopted a new modernized customs law, embraced an open-skies policy, taken bold steps to encourage foreign ownership in the real estate sector, reinforced the role and prerogatives of the country’s investment authority, and decided to privatize the state-owned electricity company. The Government is also reforming the social security system. It is expected that these measures will be complemented by other reforms to help revive the economy and positively impact the fiscal situation.

The Government is fully aware of the delicate public finance stance. It has committed itself to, and has to date already taken many, of the difficult decisions to contain the hemorrhage from the system. The only expenditure item outside the control of the government is debt service. The Government, therefore, is requesting from the international financial community to provide assistance to Lebanon in the form of debt service reduction facilities. This, coupled with the extensive reform effort already under way will allow Lebanon to reverse the debt dynamics, resolve the public finance stance and instigate economic growth.