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What's at Stake as Lebanon Tries to Put Finances in Order

What's at Stake as Lebanon Tries to Put Finances in Order

Tuesday, 21 May, 2019 - 14:00
Public sector workers hold Lebanese flags during a protest against any cuts to their salaries in the budget in downtown Beirut, Lebanon April 17, 2019. REUTERS/Mohamed Azakir/File Photo
Beirut- Asharq Al-Awsat
Lebanon, which has one of the world’s heaviest public debt burdens, is finalizing a budget to rein in its deficit after years of inaction.

The prime minister has said failure to pass a “realistic” budget would be tantamount to a “suicide operation” against the economy. The president has urged Lebanese to be ready to make sacrifices to rescue the country from financial crisis.

HOW DID THE PUBLIC FINANCES GET THIS BAD?
The causes are years of heavy spending and lax tax collection in a country with weak rule of law. The state is riddled with corruption and waste.

Its main expenses are a bloated public sector, interest payments on the public debt and transfers to the loss-making power generator. These alone have ranged from $1 billion to $2 billion a year, varying with the oil price.

Public sector employment is one of the means used by Lebanese politicians from various religious sects to shore up their support. In 2017, ahead of a parliamentary election, the government approved a big public sector pay rise.

As a result, personnel costs associated with the public sector climbed 22 percent in the first 11 months of 2018, said Nassib Ghobrial, chief economist at Byblos Bank. Public sector employment went up by 31,000 in the last four years, he said.

WHY NOW?
Lebanese leaders have dragged their feet on reforms for years. But their statements today suggest greater seriousness and urgency. Hariri has said that while Lebanon is far from bankruptcy, it faced “catastrophe” without changes.

Foreign governments have been leaning on Lebanon to enact reform. Some $11 billion in project financing was pledged to the country last year, conditional on reforms.

The backdrop is years of low economic growth, partly a result of regional turmoil including the Syrian war.

For investors, one concern has been a slowdown in the growth of deposits in the banking system. Hard currency deposited in the banks by the large diaspora has for years been used to meet the economy’s financing needs, chiefly the budget deficit and the huge gap between imports and exports.

The central bank, beginning in 2016, boosted foreign currency reserves through a series of operations known as financial engineering. But its net foreign assets have been on the slide: they stood at $37.3 billion on May 15, down from $42.9 billion a year earlier.

Moody’s in January cut Lebanon’s credit rating to Caa1, denoting a higher probability of a sovereign “default event”. The government says it is committed to paying its maturing debt obligations and interest payments on time.

A credible budget will boost market confidence. Hariri has said it should also lead institutions to revise their ratings.

WHERE IS THE PUSHBACK?
The prospect of austerity measures has triggered protests and strikes by public sector workers and retirees. But with all the main parties agreeing on the need for reform, politicians believe any blowback will be manageable.

Retired soldiers have been particularly vocal. On Monday, security forces used water cannon against some of them as they protested outside the government headquarters.

Defence Minister Elias Bou Saab warned of the risks of a failure to enact reform. “If the budget is not good, if the economy is subjected to any crisis, what use is it if the salaries stay the same and the price of the pound changes, for example,” he said.

The Lebanese pound has been pegged at its current level against the dollar for two decades. The central bank has said the exchange rate is stable and will remain so.

The budget has generated some friction between the government and banks, which objected to a tax hike on interest payments that includes the money they earn on treasury bonds.

WHERE DOES HEZBOLLAH FIT IN?
The heavily armed Shiite group “has been very realistic like everyone else” on the need for reform, said a source familiar with cabinet talks.

“They understand clearly and like everyone else that they can’t afford to have the country fall down on their heads.”

A Western diplomat said Hezbollah “have not been the most forward-leaning, but they are not pulling things apart”. “If it all falls apart, they lose less than others, but they still lose.”

Hezbollah, in its public comments, has put the onus on the banks, saying they should help by reducing the cost of debt servicing. Other parties share the view that the domestic banks should play a role. Hariri has said they are willing to help.

The government has planned to shave some 1 trillion Lebanese pounds ($660 million) from debt servicing costs through issuing treasury bonds at an interest rate of 1% in coordination with the banks, the finance minister told Reuters on Saturday.

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