LEBANON The ECONOMIC MONITOR Deliberate Depression Fall 2020 Middle East and North Africa Region Lebanon Economic Monitor The Deliberate Depression Fall 2020 Global Practice for Macroeconomics, Trade & Investment Middle East and North Africa Region LEBANON ECONOMIC MONITOR Document of the World Bank The Delibera Depressi TABLE OF CONTENTS Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix ‫الموجز التنفيذي‬ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii 1.  The Policy Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2.  Recent Macro-Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Output and Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Fiscal Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Money and Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 The Average Exchange Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Pass Through Effects on Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 The External Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 3.  Global Crises Comparators: Fundamentals Matter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Output . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 Fiscal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 External Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 Overall . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.  Outlook and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 Special Focus: A Reform Agenda to Turn the Country Around – Proposal for Discussion . . . . . . . . . .27 Governance Failure and Causes of Policy Inaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 A Reform Agenda for Stabilization, Economic Efficiency and Restoration of Trust . . . . . . . . . . . . . . . . . . . . .29 Pillar I: Macroeconomic Stabilization: A Necessary, But Not Sufficient, Condition to Growth . . . . . . . . . . . . 32 Pillar II: A Governance and Accountability Reform Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Pillar III: Infrastructure Development Reform Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 iii Pillar IV: An Economic Opportunities Reform Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Pillar V: A Human Capital Development Reform Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Key BdL Circulars since October 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61 Monetary and Exchange Rate Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Socio-Economic Support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62 Banking Sector Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 Averaging Lebanon’s Multiple Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 VAR Estimations of Impact of Currency Devaluations on Economic Activity. . . . . . . . . . . . . . . . . . . . . . . . . . .65 Global Financial Crises Episodes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66 The Asian Financial Crisis of 1997–98 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 The Argentinian Financial Crisis of 2001–02 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67 The Iceland Financial Crisis of 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Crises in the European Monetary Union 2008–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 The Irish Financial Crisis of 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 The Greece Financial Crisis of 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 The Cyprus Financial Crisis of 2011–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 List of Figures Figure 1 While the Contraction in Real GDP Commenced in 2018, It Is Heavily Concentrated in 2020 . . . 4 Figure 2 Net Exports Are Expected To Be the Sole Positive Contributor to Real GDP . . . . . . . . . . . . . . . . . . 4 Figure 3 Large Shortfalls in Revenues Will Induce a Significant Deterioration in the Fiscal Position . . . . . . 7 Figure 4 Valuation Effects from Exchange Rate Depreciations Will Pressure the Debt-to-GDP Ratio . . . . . .7 Figure 5 Triple-Digit Inflation Rates Driven by Basic Consumption Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Figure 6 Heavy Deleveraging of Assets (private loans) and Liabilities (private deposits) in Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Figure 7 A Steady and Sharp Deterioration in Credit Performance as Measure by NPL Ratio for Banks 10 Figure 8 AER Simulations under Assumption of Stability of Black-Market Rate by end-2020 . . . . . . . . . . . 11 Figure 9 AER Simulations under Assumption of Instability of Black-Market Rate through 2021 . . . . . . . . .11 Figure 10 Under Sc1a, the Inflation Rate Abates toward the End of 2021, Whereas … . . . . . . . . . . . . . . . . . .12 Figure 11 ... in Sc1b, It Remains Elevated Driven by the Continued Depreciation of the Exchange Rate 12 Figure 12 CPI-Parallel Exchange Rate Pass through at 30 Percent for Upper Middle-Income Countries 13 Figure 13 CPI-Parallel Exchange Rate Pass through at 67 Percent for Lower Income Countries . . . . . . . . . 13 Figure 14 A Steady Depletion in the Gross Foreign Exchange Position at BdL . . . . . . . . . . . . . . . . . . . . . . . . 14 Figure 15 Ratios of C1, C2 Luxury and other Imports Were Stable until Period Leading to Crisis … . . . . . . 14 Figure 16 … when Ratios of C1 and C2 Imports, Rose at the Expense of those for Luxury and other Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Figure 17 Real GDP for G1 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Figure 18 Real GDP for G2 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Figure 19 CPI Indices for G1 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 20 CPI Indices for G2 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 21 Overall Fiscal Balance for G1 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 23 Gross Debt for G1 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 22 Overall Fiscal Balance G2 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 iv LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION Figure 24 Gross Debt for G2 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 25 Current Account Balance for G1 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Figure 26 Current Account Balance for G2 Global Crises Comparators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 27 Main Reasons Why Accessing Food and other Basic Needs Was Challenging, July–August 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Figure 28 Labor Force Participation Status in August 2020 and pre Lockdown (Feb 2020) . . . . . . . . . . . . .23 Figure 29 Main Income Sources Over the Past 12 Months in July . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 30 Reform Pillars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 List of Tables Table 1  MIDAS Forecasts for 2020 and 2021 Real GDP Growth for Baseline and COVID-19 Scenarios . 5 Table 2 Selected Macroeconomic Indicators for Lebanon; 2015–2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Table 3 High Priority: 7-Actions, 5-Programs and 3-Reviews . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Table 4  Empirical Evidence Behind Lebanon’s Pre-Crisis Economic Slowdown . . . . . . . . . . . . . . . . . . . . . 36 Table 5 Summary of Reform Matrix, by Pillar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Table 6 VAR Results on the Impact of Currency Devaluations on Main Economic Variables. . . . . . . . . . .66 List of Boxes Box 1. Nowcasting and Forecasting Economic Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Box 2. Results from m-VAM Vulnerability and Food Security Assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 TABLE OF CONTENTS v PREFACE T he Lebanon Economic Monitor provides prepared the Special Focus , based on contributions an update on key economic developments from the Lebanon Country Team. The Lebanon and policies over the past six months. It also Economic Monitor has been completed under the presents findings from recent World Bank work on guidance of Eric Le Borgne (Practice Manager). Lebanon. It places them in a longer-term and global Zeina Khalil (Communications Officer) is the lead on context and assesses the implications of these communications, outreach and publishing. developments and other changes in policy on the The findings, interpretations, and conclusions outlook for Lebanon. Its coverage ranges from the expressed in this Monitor are those of World Bank macro-economy to financial markets to indicators of staff and do not necessarily reflect the views of the human welfare and development. It is intended for a Executive Board of The World Bank or the govern- wide audience, including policy makers, business ments they represent. leaders, financial market participants, and the For information about the World Bank and its community of analysts and professionals engaged in activities in Lebanon, including e-copies of this publi- Lebanon. cation, please visit www.worldbank.org.lb. The Lebanon Economic Monitor is a product To be included on an email distribution list of the World Bank’s Lebanon Macroeconomics, for this Lebanon Economic Monitor series and Trade and Investment (MTI) team. It was prepared by related publications, please contact Alain Barakat Wissam Harake (Senior Economist), Ibrahim Jamali (abarakat@worldbank.org). For questions and com- (Consultant) and Naji Abou Hamde (Economic ments on the content of this publication, please Analyst) with contributions from Lars Jessen (Lead contact Wissam Harake (wharake@worldbank.org) Debt Specialist) and Haocong Ren (Senior Financial or Christos Kostopoulos (ckostopoulos@worldbank. Sector Economist). Christos Kostopoulos (Lead org). Questions from the media can be addressed to Economist) and Mohammad Al Akkaoui (Consultant) Zeina Khalil (zelkhalil@worldbank.org). vii EXECUTIVE SUMMARY F or almost a year, Lebanon’s macroeconomy supply chain. Foreign exchange (FX) shortages are has been assailed by compounded being reflected in a multiple exchange system that crises, beginning with an economic and has discounted the Lebanese Lira (LL) by as much financial crisis, followed by COVID-19 and lastly as 80 percent, albeit with heavy fluctuations. The the explosion at the Port of Beirut. By October Eurobond default precludes access to international 2019, the economy plunged into a financial crisis markets for foreign financing, while the domestic brought about by a sudden stop in capital inflows, banking system is severely impaired. Informal and which precipitated systemic failures across banking, ad hoc capital controls have implied a lack of harmo- debt and the exchange rate.1 This included, on nization of restrictions between banks, and between March 7, 2020, a Government default on a $1.2 customers within and across banks, generating billion Eurobond redemption, marking the first ever considerable popular backlash against banks and sovereign default for Lebanon. Eleven days later, the the central bank, the Banque du Liban (BdL). Government declared a State of General Mobilization Real GDP growth is projected to sharply imposing a lockdown to counter COVID-19, including decelerate to –19.2 percent in 2020, on the the closure of the borders (airport, sea and land), and back of a –6.7 percent contraction in 2019. In public and private institutions. Lastly, on August 4, a large part due to COVID-19, the tourism sector 2020, a massive explosion rocked the Port of Beirut has been particularly hit; tourist arrivals fell by 71.5 (PoB), destroying much of the port and severely percent, year-on-year (yoy), over the first five months damaging the dense residential and commercial of 2020 (5M-2020). Further, the BLOM-PMI index, areas within 1- to 2-mile radius. Beyond the human which captures private sector activity, averaged 40.4 tragedy, the economic impact of the explosion is over January–September 2020 (9M-2020) (<50 rep- notable at the national level despite its geographical resents a contraction of activity), the lowest recorded. concentration. Meanwhile, construction permits and cement deliv- Of the three crises, the economic crisis has eries, which are indicators of construction activities, by far had the largest (and the most persistent) negative impact. Exchange market pressures stifle trade and corporate finance in the highly dollarized 1 We shall henceforth refer to these systemic macro- economy, constraining the importation of capital and financial failures and their real economy and social final goods, and inducing disruptions all along the implications as simply the economic crisis. ix suffered yoy declines of 60 and 52 percent, respec- In the lead up to the economic crisis point, tively, in the first half of 2020 (H1-2020). Lebanon’s macroeconomic fundamentals were Crises conditions have weighed heavily weak compared to select groups of global crises on Lebanon’s already precarious fiscal position. comparators.2 As such, we expect the adjustment Revenues are expected to decline sharply as both process to be more painful and to take longer, even tax and non-tax revenues tumble due to the sharp with optimal policy measures in place. In fact, one contraction in economic activity. However, this is year into the economic crisis, such policies have more than offset by a sharp decline in interest expen- not yet been decided, let alone implemented, which ditures, driven by Government’s arrest of payment on further pushes out the expected bottoming out of the its commercial foreign debt (a major share of its total economy and its recovery. Therefore, and as things expenditure), and a favorable deal with the central stand, Lebanon’s economic crisis is likely to be both bank to halt coupon payments on Treasury bonds deeper and longer than most economic crises. held by the latter. Overall, in 2020, the fiscal balance The burden of the ongoing adjustment/ is projected to improve by 4.7 percentage points deleveraging in the financial sector is highly (pps) to reach –5.9 percent of GDP. regressive, concentrated on smaller depositors, Exchange rate pass through effects on the local labor force and smaller businesses. De prices have led to high inflation. The 12-month facto lirafication and haircuts on dollar deposits are inflation rate has risen steadily and sharply from 10 ongoing despite BdL’s and banks’ official commit- percent in January 2020, to 46.6 percent in April, 89.7 ment to safeguarding deposits. The burden of the percent in June, and most recently in August, 120 ongoing adjustment/deleveraging is regressive and percent. Inflation is a highly regressive tax, affecting concentrated on the smaller depositors, who lack the poor and vulnerable disproportionately, as well as other source of savings, the local labor force, that people on fixed income, such as pensioners. is paid in LL, and smaller businesses. The banking The sharp economic contraction implied sector is advocating for mechanisms that incorporate a commensurate drop in imports, and conse- state owned assets, gold reserves, and public real quently, an anticipated narrowing of the current estate in order to overhaul their impaired balance account deficit. During the first eight months of sheets. This constitutes a bailout of the financial sector 2020 (8M-2020), merchandize imports shrank by 50 and is inconsistent with the restructuring principles percent, which drove a 59 percent decrease in the that protect taxpayers. These principles include bail trade-in-goods deficit. We expect the current account in solutions based on a hierarchy of creditors, starting deficit to contract, falling by 7 pps to reach 14.4 with banks shareholders. Government can also apply percent of GDP in 2020, compared to a medium-term a wealth tax (on financial and real assets) as a tool to (2013–2018) average deficit of 22.8 percent of GDP. progressively restructure the financial sector. Nonetheless, the sudden stop in capital inflows has The LEM Special Focus presents one implied a steady depletion of FX reserves at BdL, approach to designing a comprehensive reform which will further exacerbate constraints on imports. agenda aimed at addressing the root causes of Poverty in Lebanon is likely to continue to worsen, surpassing half of the population by 2021. A contraction of the Lebanese GDP per 2 We compare Lebanon’s macroeconomic fundamentals capita in real terms and two-digit inflation in 2020 will to two groups of global crises comparators: group 1 undoubtedly result in substantial increase in poverty (G1) includes the Asian crisis countries of 1997-98: Thailand, Malaysia, Indonesia, Philippine and South rates affecting all groups of population in Lebanon Korea; group 2 (G2) assembles a more eclectic set of through different channels such as loss of productive crises that occurred in the 2000’s: Argentina (2001), employment, decline in real purchasing power, stalled Greece (2008), Ireland (2008), Iceland (2008) and international remittances and so forth. Cyprus (2012). x LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION the economic crisis. The purpose of the reform macroeconomic stabilization. The reform agenda agenda is to help set the stage for a more equi- presented is meant to feed into an open discussion table, more efficient and more resilient economy. among the citizens of Lebanon and between them It puts governance reforms at the fore, alongside and their government. Executive Summary xi ‫الموجز التنفيذي‬ ‫يا واسع النطاق ضد املصارف التجارية‬ ‫با شعب ً‬‫مم أثار غض ً‬ ‫عىل عمالئها‪ّ ،‬‬ ‫عام تقري ً‬ ‫با‪،‬‬ ‫رض االقتصاد الكيل يف لبنان ألزمات مضاعفة عىل مدى ٍ‬ ‫تع َّ‬ ‫ومرصف لبنان املركزي‪.‬‬ ‫را بجائحة كوفيد‪ ،-19‬وصوالً إىل‬ ‫ية‪ ،‬مرو ً‬ ‫ءا من األزمة االقتصاديّة واملال ّ‬ ‫بد ً‬ ‫يُتوقَّع أن يرتاجع منو إجاميل الناتج املحيل الفعيل بشكل كبري إىل‬ ‫إنفجار مرفأ بريوت‪ .‬بحلول ترشين األول‪/‬أكتوبر ‪ ،2019‬غرق االقتصاد يف‬ ‫‪ -19.2‬يف املئة يف العام ‪ 2020‬إثر انقباض قدره ‪ -6.7‬يف املئة يف العام ‪.2019‬‬ ‫مم سبّب‬ ‫أزمة مالية بسبب التوقّف املفاجئ يف تدفقّات رؤوس األموال‪ّ ،‬‬ ‫تأث ّر قطاع السياحة بشكل خاص‪ ،‬بسبب جائحة كوفيد‪ -19‬بشكل كبري؛ فرتاجع‬ ‫يا شامالً يف مجال سعر الرصف‪ ،‬والدين‪ ،‬والقطاع املرصيف‪ 3.‬يف‬ ‫إخفاقًا نظام ً‬ ‫عدد املسافرين الوافدين إىل لبنان بنسبة ‪ 71.5‬يف املئة‪ ،‬عىل أساس سنوي‪،‬‬ ‫هذا السياق‪ ،‬أعلنت الحكومة يف ‪ 7‬آذار‪/‬مارس‪ ،‬عن عدم سداد سندات‬ ‫جل‬ ‫خالل األشهر الخمسة األوىل من العام ‪ .)5M-2020( 2020‬إىل ذلك‪ ،‬س ّ‬ ‫مم شكّل أول عجز‬ ‫اليوروبوندز البالغة قيمتها ‪ 1.2‬مليار دوالر أمرييك‪ّ ،‬‬ ‫مؤش مديري املشرتيات التابع لبنك لبنان واملهجر (‪ )BLOM-PMI‬الذي‬ ‫ّ‬ ‫ما‪ ،‬أعلنت‬ ‫عن سداد الديون السيادية يف تاريخ لبنان‪ .‬بعد مرور ‪ 11‬يو ً‬ ‫يعكس نشاط القطاع الخاص متوسطاً قدره ‪ 40.4‬يف فرتة كانون الثاين‪/‬يناير –‬ ‫ما ملكافحة جائحة كوفيد‪،-19‬‬ ‫الحكومة حالة تعبئة عامة وفرضت إغالقًا تا ً‬ ‫عا يف النشاط)‪،‬‬ ‫أيلول‪/‬سبتمرب ‪( )9M-2020( 2020‬تشكّل نسبة دون ‪ 50‬تراج ً‬ ‫مبا يف ذلك إغالق الحدود (الجويّة‪ ،‬والبحريّة‪ ،‬والربيّة) واملؤسسات العامة‬ ‫يات‬ ‫ّ‬ ‫وعمل‬ ‫البناء‬ ‫رضت تراخيص‬ ‫جلة‪ .‬يف موازاة ذلك‪ ،‬تع ّ‬ ‫مس ّ‬ ‫وهي أدىن نسبة ُ‬ ‫ز انفجار ضخم مرفأ بريوت‪،‬‬ ‫ريا‪ ،‬يف ‪ 4‬آب‪/‬أغسطس ‪ ،2020‬ه ّ‬ ‫والخاصة‪ .‬وأخ ً‬ ‫تسليم االسمنت‪ ،‬وهي من مؤرشات أنشطة البناء‪ ،‬إىل تراجع سنوي قدره‬ ‫ً‬ ‫را جسيمة يف املناطق السكنيّة‬ ‫را الجزء األكرب من املرفأ وملحقًا أرضا ً‬ ‫مً‬‫مد ّ‬ ‫‪ 60‬و‪ 52‬يف املئة عىل التوايل‪ ،‬يف النصف األول من العام ‪.)H1–2020( 2020‬‬ ‫والتجاريّة الواقعة يف نطاق دائرة يبلغ شعاعها ميالً إىل ميلني من موقع‬ ‫الهش أصالً يف‬‫أرخت األزمات املتعاقبة بظاللها عىل الوضع املايل ّ‬ ‫االنفجار‪ .‬باإلضافة إىل املأساة البرشيّة‪ ،‬يُعترب األثر االقتصادي لالنفجار‬ ‫ية‬‫ّ‬ ‫الرضيب‬ ‫لبنان‪ .‬ويُتوقَّع أن ترتاجع االيرادات بشكل حاد‪ ،‬مبا أن االيرادات‬ ‫ملحوظًا عىل املستوى الوطني بالرغم من متركزه الجغرايف‪.‬‬ ‫وااليرادات غري الرضيبيّة ترتاجع بسبب االنقباض الحاد يف النشاط‬ ‫رض لبنان لها‪ ،‬كانت األزمة‬ ‫من األزمات الثالث التي تع ّ‬ ‫وض عن ذلك تراجع حاد يف نفقات الفائدة‪ ،‬بسبب‬ ‫االقتصادي‪ .‬لكن‪ ،‬ع ّ‬ ‫سلبية وخطورةً‪ .‬ففي اقتصاد مدولر‬ ‫ً‬ ‫االقتصاديّة ذات األثر األكرب واألكرث‬ ‫توقّف الحكومة عن سداد ديونها األجنبيّة التجارية (وهي حصة كبرية من‬ ‫بشكل كبري‪ ،‬تخنق ضغوط سوق الرصف متويل املؤسسات والتجارة ‪،‬‬ ‫إجاميل نفقاتها) واتفاق تفضييل مع املرصف املركزي إليقاف سداد الفوائد‬ ‫بب‬ ‫ية ويس ّ‬ ‫ية والسلع النهائ ّ‬ ‫مم يفرض قيودًا عىل استرياد السلع الرأسامل ّ‬ ‫ّ‬ ‫عىل سندات الخزينة التي بحوزة املرصف‪ .‬بشكل عام‪ ،‬يف العام ‪،2020‬‬ ‫اضطرابات عىل طول سلسلة اإلمداد‪ .‬وتنعكس حاالت قصور العمالت‬ ‫يتحسن الرصيد املايل بنسبة ‪ 4.7‬نقاط مئويّة لببلغ ‪ -5.9‬يف املئة‬ ‫يُتوقَّع أن ّ‬ ‫ية ‪ 80‬يف املئة من‬ ‫دد أفقد اللرية اللبنان ّ‬ ‫الصعبة يف نظام رصف متع ّ‬ ‫من إجاميل الناتج املحيل‪.‬‬ ‫را إىل تخلف الحكومة عن سداد‬ ‫قيمتها‪ ،‬وإن كانت التقلّبات كبرية‪ .‬ونظ ً‬ ‫أدّى انتقال تغريات سعر الرصف إىل األسعار إىل ارتفاع التضخّم‪.‬‬ ‫سندات اليوروبوندز‪ ،‬مل يعد باإلمكان الحصول عىل التمويل األجنبي‬ ‫را بشكل ثابت وحاد‪ ،‬فارتفع من‬ ‫دل التضخّم عىل مدى ‪ 12‬شه ً‬ ‫ازداد مع ّ‬ ‫عن طريق األسواق الدوليّة‪ ،‬بينام النظام املرصيف املحيل مشلول إىل‬ ‫‪ 10‬يف املئة يف كانون الثاين‪/‬يناير ‪ 2020‬إىل ‪ 46.6‬يف املئة يف نيسان‪/‬أبريل‬ ‫ية غياب االتساق‬ ‫ية غري الرسم ّ‬ ‫د بعيد‪ .‬كام ولّدت القيود الرأسامل ّ‬ ‫حّ‬ ‫را إىل ‪ 120‬يف املئة يف آب‪/‬‬ ‫خً‬‫وإىل ‪ 89.7‬يف املئة يف حزيران‪/‬يونيو‪ ،‬ومؤ ّ‬ ‫بني املصارف (وحتى بني فروع املرصف الواحد) يف القيود املفروضة‬ ‫د كبري‪ ،‬تؤث ّر عىل الفقراء‬ ‫ية إىل ح ّ‬ ‫عتب التضخّم رضيبة تنازل ّ‬ ‫أغسطس‪ .‬يُ َ‬ ‫بشكل كبري‪ ،‬كام عىل ذوي الدخل الثابت‪ ،‬عىل غرار املتقاعدين‪.‬‬ ‫يرتتب عن اإلنكامش اإلقتصادي الحاد انخفاضاً متناسباً يف‬ ‫ية الشاملة يف املجال املاكرو مايل‬ ‫نُشري بالتايل إىل هذه االخفاقات املنهج ّ‬ ‫‪3‬‬ ‫عا يف عجز الحساب الجاري‪ .‬خالل األشهر‬ ‫عا متو ّ‬ ‫قً‬ ‫الواردات‪ ،‬وبالتايل‪ ،‬تراج ً‬ ‫وانعكاساتها االقتصاديّة واالجتامعيّة الفعليّة باألزمة االقتصاديّة بكل بساطة‪.‬‬ ‫‪xiii‬‬ ‫واقعاً‪ ،‬بالرغم من االلتزام الرسمي‪ ،‬من جانب املصارف التجاريّة ومرصف‬ ‫الثامنية األوىل من العام ‪ ،)8M-2020( 2020‬تقلّصت واردات السلع‬ ‫عتب عبء تقليص املديونية املالية‪/‬‬ ‫لبنان املركزي‪ ،‬بحامية الودائع‪ .‬يُ َ‬ ‫مم أدّى إىل تراجع بنسبة ‪ 59‬يف املئة يف عجز التجارة‬ ‫بنسبة ‪ 50‬يف املئة‪ّ ،‬‬ ‫يا ومركّزا ً عىل املودعني األصغر‬ ‫ًّ‬ ‫تنازل‬ ‫التعديل الجاري يف القطاع املايل‬ ‫يف السلع‪ .‬ونتوقّع تقلّص عجز الحساب الجاري‪ ،‬مرتاجعاً بـ ‪ 7‬نقاط مئويّة‬ ‫الذين يفتقرون إىل أي مصدر آخر للمدخرات‪ ،‬واليد العاملة املحليّة‬ ‫ة‬‫ليبلغ ‪ 14.4‬يف املئة من إجاميل الناتج املحيل يف العام ‪ ،2020‬مقارن ً‬ ‫حجم‪.‬‬ ‫ية‪ ،‬واملؤسسات األصغر ً‬ ‫التي تتقاىض أجورها ورواتبها باللرية اللبنان ّ‬ ‫مبتوسط العجزعىل املدى املتوسط (‪ )2018–2013‬البالغ ‪ 22.8‬يف املئة من‬ ‫ّ‬ ‫يدعو القطاع املرصيف إىل اعتامد آليّات تأخذ بعني االعتبار األصول التي‬ ‫إجاميل الناتج املحيل‪ .‬لكن اإلنهيار يف التدفقات الرأساملية الوافدة أدى إىل‬ ‫متلكها الدولة‪ ،‬واحتياطيات الذهب‪ ،‬والعقارات العامة من أجل تصحيح‬ ‫استنفاذ احتياطي العمالت األجنبية لدى مرصف لبنان املركزي‪ ،‬مام يؤدي‬ ‫ميزانيات املصارف الضعيفة‪ ،‬مام يُشكّل إنقاذا ً للقطاع املايل ال يتامىش مع‬ ‫إىل تفاقم القيود عىل الواردات‪.‬‬ ‫مبادئ إعادة الهيكلة التي تحمي دافعي الرضائب‪ .‬تشمل هذه املبادئ‬ ‫ءا‪ ،‬ليتجاوز عدد‬ ‫ً‬ ‫سو‬ ‫لبنان‬ ‫يف‬ ‫الفقر‬ ‫مستوى‬ ‫من املتوقع أن يزداد‬ ‫ءا من مساهمي‬ ‫حلول اإلنقاذ الداخيل باإلستناد إىل هرميّة الدائنني‪ ،‬بد ً‬ ‫الفقراء نصف عدد السكان مع حلول العام ‪ .2021‬ال شك يف أن انكامش‬ ‫يكن للحكومة أن تفرض رضيبة عىل الرثوة (عىل األصول‬ ‫املصارف‪ .‬كام ُ‬ ‫وتضخم ثنايئ الرقم يف‬ ‫ً‬ ‫إجاميل الناتج املحيل اللبناين الفعيل للفرد الواحد‬ ‫املالية والحقيقية) كأداة إلعادة هيكلة القطاع املايل بشكل تقدمي‪.‬‬ ‫دالت الفقر التي تؤث ّر عىل‬ ‫العام ‪ 2020‬سيؤدّيان إىل ازدياد ملحوظ يف مع ّ‬ ‫يعرض املوضوع الخاص لهذا العدد من مرصد لبنان االقتصادي‬ ‫ية كلّها يف لبنان‪ ،‬من خالل قنوات مختلفة‪ ،‬عىل غرار فقدان‬ ‫الفئات السكان ّ‬ ‫جا إلعداد أجندة إصالحية شاملة تهدف إىل معالجة جذور أسباب‬ ‫نه ً‬ ‫العاملة اإلنتاجيّة‪ ،‬والرتاجع يف القوة الرشائيّة الفعليّة‪ ،‬وتعليق الحواالت‬ ‫ية هذه إىل اقرتاح متهيد‬ ‫ّ‬ ‫اإلصالح‬ ‫األجندة‬ ‫تهدف‬ ‫االقتصادية‪.‬‬ ‫األزمة‬ ‫الدولية‪ ،‬إلخ‪.‬‬ ‫ة وأكرث قدرة عىل‬ ‫ة وأكرث كفاء ً‬ ‫الطريق من أجل بناء اقتصاد أكرث مساوا ً‬ ‫يف سياق املقارنة‪ ،‬كانت أساسيات االقتصاد الكيل يف لبنان يف‬ ‫الصمود‪ .‬تضع الخطة إصالحات الحوكمة يف سلم األولويّات‪ ،‬إىل جانب‬ ‫ية‬ ‫ة مع أزمات عامل ّ‬ ‫الفرتة التي سبقت األزمة االقتصادية ضعيفة مقارن ً‬ ‫استقرار االقتصاد الكيل‪ .‬كام تهدف هذه األجندة إىل إثراء نقاش مفتوح‬ ‫مختارة‪ .4‬وبالتايل‪ ،‬نتوقّع أن تكون عمليّة التعديل أصعب وأطول‪،‬‬ ‫سابقة ُ‬ ‫يني وحكومتهم‪.‬‬ ‫يني ويف ما بني املواطنني اللبنان ّ‬ ‫يف صفوف املواطنني اللبنان ّ‬ ‫ية‪ .‬يف الواقع‪ ،‬بعد مرور عام عىل األزمة‬ ‫ّ‬ ‫مثال‬ ‫سياسة‬ ‫تدابري‬ ‫ّر‬ ‫ف‬‫تو‬ ‫مع‬ ‫حتى‬ ‫مم‬ ‫االقتصاديّة‪ ،‬مل يتم بعد تحديد هذه السياسات‪ ،‬ناهيك عن تنفيذها‪ّ ،‬‬ ‫ددًا‪.‬‬ ‫يؤخّر بشكل أكرب الخروج من األزمة االقتصاديّة وإنعاش االقتصاد مج ّ‬ ‫‪ 4‬نُقارن مبادئ االقتصاد الكيل يف لبنان إىل مجموعتَني من عوامل مقارنة األزمات‬ ‫جح أن تكون األزمة االقتصاديّة التي‬ ‫وبالتايل‪ ،‬وكام هي الحال اآلن‪ ،‬يُر َّ‬ ‫ية‪ :‬تشمل املجموعة األوىل (‪ )G1‬دول األزمة اآلسيويّة يف العام ‪–1997‬‬ ‫ية األزمات االقتصاديّة‪.‬‬ ‫ّ‬ ‫غالب‬ ‫مع‬ ‫ترضب بلبنان أخطر وأطول مقارن ً‬ ‫ة‬ ‫العامل ّ‬ ‫‪ :1998‬تايلند‪ ،‬وماليزيا‪ ،‬والفيلبني‪ ،‬وإندونيسيا‪ ،‬وكوريا الجنوبية؛ وتضم املجموعة‬ ‫يُعترب عبء تقليص املديونية املالية‪/‬التعديل الجاري يف القطاع‬ ‫محدّدة من األزمات التي وقعت يف العقد األول من‬ ‫الثانية (‪ )G2‬مجموعة ُ‬ ‫يركّز عىل املودعني األصغر‪ ،‬واليد العاملة‬ ‫يا إىل حدّ بعيد‪ ،‬حيث ُ‬ ‫املايل تنازل ًّ‬ ‫القرن الحادي والعرشين‪ :‬األرجنتني (‪ ،)2001‬واليونان (‪ ،)2008‬وايرلندا (‪،)2008‬‬ ‫عتب تحويل الودائع بالدوالر‬ ‫ية‪ ،‬واملؤسسات األصغر حجامً‪ .‬وبالتايل‪ ،‬يُ َ‬ ‫املحل ّ‬ ‫وايسلندا (‪ ،)2008‬وقربص (‪.)2012‬‬ ‫ية واالقتطاع من الودائع يف الدوالر األمرييك أمرا ً‬ ‫ّ‬ ‫اللبنان‬ ‫اللرية‬ ‫إىل‬ ‫األمرييك‬ ‫‪xiv‬‬ ‫‪LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION‬‬ 1 THE POLICY CONTEXT O n April 30, 2020, the (then) cabinet and modality of restructuring that would be needed endorsed a long-awaited financial recovery in the financial sector (banks plus BdL). A key plan that aimed to regain macro-financial motivation for this disagreement has been the need stability for Lebanon. The Government’s program for public debt restructuring, which would result in rested on central and interrelated pillars, including: heavy losses in the financial system, given the large (i) exchange rate adjustment; (ii) comprehensive debt holdings of public debt by BdL and banks. Eventually, restructuring; (iii) comprehensive financial sector the Government resigned, and with efforts to form a restructuring; (iv) a phased fiscal adjustment; (v) successor government having failed so far, progress growth enhancing reforms; (vi) social sector reforms; awaits the formation of new Government. Meanwhile, (vii) anti-corruption agenda; (viii) environmental the economy keeps shrinking and the social cost of reforms; and (ix) international financial assistance. the crisis rises and widens. Lebanese authorities and the IMF began dis- The banking sector is advocating for cussions in May 2020. The discussions eventually mechanisms that incorporate state owned assets stalled as differences and inconsistencies emerged (SOEs), gold reserves, and public real estate in within the Lebanon team regarding the Government’s order to overhaul their impaired balance sheets. financial recovery program. Key members on the This constitutes a bailout of the financial sector and authority’s team subsequently resigned from posi- is inconsistent with the restructuring principles estab- tion, amid highly publicized differences between lished in the wake of the Global Financial Crisis of Government and BdL (especially on debt; losses in the financial sector; banking sector restructuring). BdL and the banking sector at large have 5 The Government’s plan identifies LL 62 trillion ($50 billion at the plan’s assumed exchange rate $1=LL expressed serious disagreements with the 3,500) in aggregated losses in BdL’s balance sheet, Government’s plan and analysis, in particular, which when added to losses in the banking sector and the identified losses in the financial sector.5 This netting out equity, result in LL 154 trillion ($44 billion) in is a critical component as it determines the extent impaired liabilities for the financial sector. 1 2008 to protect taxpayers when financial institutions spilled over to street action even under COVID-19 fail. These principles include bail in solutions based conditions; internal political discord and fragmenta- on a hierarchy of creditors, starting with banks share- tion continues; and geopolitical tensions complicate holders. Government also has the prerogative and solutions. In consequence, high skilled labor is increas- legal jurisdiction to apply a wealth tax on deposits as ingly likely to take up potential opportunities abroad, a tool to restructure the financial sector. A wealth tax constituting a permanent social and economic loss applied on financial and real assets can be very pro- for the country. gressive tool for needed macro-financial restructuring. Lebanon needs to urgently adopt and imple- A year into the economic crisis, there have ment a credible, comprehensive and coordinated been limited policy responses by the authori- macro-financial stability strategy, within a medium ties as Lebanon faces a dangerous depletion term macro-fiscal framework. This strategy would of resources, including human capital with be based on: (i) a debt restructuring program toward brain drain an increasingly desperate option. achieving debt sustainability over the medium term; In fact, Lebanon lacks a fully-functioning executive (ii) a comprehensive financial sector restructuring authority and is currently in the process of forming toward regaining solvency of the banking sector; (iii) a its third Government in less than a year. Following new monetary policy framework aimed at regaining the failure of Moustapha Adib to form a Government, confidence and stability in the exchange rate; (iv) a PM Saad Hariri was designated to be the next Prime phased fiscal adjustment aimed at regaining confi- Minister by President Aoun upon consultations with dence in fiscal policy; (v) growth enhancing reforms; Parliamentarians. Meanwhile, social discontent has and (vi) enhanced social protection. 2 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION 2 RECENT MACRO-FINANCIAL DEVELOPMENTS Output and Demand first five months of 2020 (5M-2020), compared to an increase of 5.5 percent in the same period in The compounded crises, namely, the economic 2019. While the decline in tourist arrivals has been crisis, COVID-19 and the PoB explosion, have in effect since October 2019 due to economic crisis had staggered impacts on output and with conditions, it was highly concentrated from Spring differentiated magnitudes. Due to insufficient high 2020 and onwards due to COVID-19. Further, the frequency data, precise identification of each of BLOM-PMI index, which captures private sector those impacts is a challenging task. In order to draw activity, averaged 40.4 in 9M-2020 (<50 represents empirical conclusions, we resort to a combination of methodologies and models, explained below and in the Annex. To gauge the impact of economic and 6 World Bank projections of real GDP growth back in financial crisis along with COVID-19 effects, we use Spring 2020 indicated a contraction of 11 percent Mixed-Data Sampling (MIDAS) methods (or models) in 2020. However, we now consider this contraction to assess the state of the economic cycle using significantly understated due to (i) deteriorating available higher frequency measures of economic economic and financial conditions since then (i.e., sharp depreciations in the black-market exchange rate, very activity (see Box 1). The findings indicate that the high inflation rates, etc.) as well as an underestimation impact of the economic crisis on output has been of COVID-19 duration. by far the largest of the three crises, followed by 7 World Bank (2020), Beirut Rapid Damage and Needs that of COVID-19.6 The economic impact of the PoB Assessment, August 2020. explosion has been estimated for the Rapid Damage 8 According to the RDNA, the disaster event is estimated and Needs Assessment (RDNA).7,8 to cause (i) up to 0.4 and 0.6 percentage point (pp) declines in the growth rate of real GDP in 2020 and Real GDP is projected to decline by 19.2 2021, respectively, due to losses in the stock of physical percent in 2020 (Figure 1). The tourism sector in capital; plus potentially (ii) import constraints that could Lebanon has been particularly hit; tourist arrivals subtract an additional of 0.4 and 1.3 pps from growth in fell by 71.5 percent, year-on-year (yoy), over the 2020 and 2021, respectively. 3 FIGURE 1 • While the Contraction in Real GDP Commenced in 2018, It Is Heavily Concentrated in 2020 Real GDP Growth (%) 20 16.4 15 11.3 10.8 9.3 9.1 10.2 8.0 10 8.1 6.4 7.5 3.8 3.9 3.9 3.4 2.7 1.5 2.5 3.8 2.5 5 1.7 1.1 0.9 0.2 1.5 0.9 0 –0.8 –1.9 –5 –10 –6.7 –15 –20 –19.2 –25 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Sources: CAS and WB staff calculations. FIGURE 2 • Net Exports Are Expected to Be the Sole Positive Contributor to Real GDP 30 20 10 0 10 20 30 40 50 2011 2012 2013 2014 2015 2016 2017 2018 2019e 2020f Private consumption Government consumption Gross fixed capital investment Net exports Statistical discrepancy Lebanon RGDP growth Sources: CAS and WB staff calculations. a contraction of activity), compared to 46.8 for purchases.9 On the other hand, construction permits 9M-2019. Even as the PMI index has indicated a and cement deliveries, which are more accurate persistent contraction of activity since 2013, the indicators of construction activities in the real estate year it was first published, the 9M-2020 average is market, suffered yoy declines of 60 and 52 percent, the lowest recorded. Similarly, the Byblos/AUB con- respectively, in H1-2020. This comes on the heels sumer confidence index registered a yoy decline of of significant contractions in H1-2019 amounting to 60.6 percent in H1-2020. Meanwhile, the real estate 30.8 and 32.4 percent, respectively. sector has been subject to two offsetting factors; on the one hand, facilitation by the financial sector to allow real estate purchases using pre-October 9 Some of these purchases involved real estate collateral 2019 dollar deposits under conditions of capital held on badly performing loans. Hence, this effectively controls (and therefore, a lack of alternatives to get constituted a netting out effect of assets and liabilities on those deposits out) has led to an increase in such banks’ balance sheets. 4 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION BOX 1. NOWCASTING AND FORECASTING ECONOMIC ACTIVITY Despite its importance for policymaking, GDP is typically observed at low frequencies, and in the case of Lebanon, with a long lag.a As such, central banks and policymakers endeavor to assess the state of the economy via higher frequency measures of economic activity. Since the important contribution of Ghysels, Santa-Clara and Valkanov (2004),b Mixed-Data Sampling (MIDAS) methods (or models) have gradually become essential tools at the disposal of central banks and policymakers for nowcasting GDP. A key advantage of MIDAS models is that they allow the combination of low frequency GDP data with higher frequency economic activity data in their estimations. As such, the use of MIDAS models has rapidly gained traction among policymakers and central bankers for nowcasting GDP.c On the other hand, a caveat is that under crisis dynamics, linear relationships might not hold along tail end conditions. Indeed, MIDAS regressions assume a linear relation between GDP growth and the high frequency indicators. Nonetheless, the Almon lag specification used to relate the high frequency indicator to GDP growth can take various shapes using only a few parameters (Ghysels and Marcellino, 2018).d By estimating the weights that relate the high frequency indicators to real GDP growth, MIDAS regressions partially account for nonlinearity in the relationship. Unlike bridge equations in which observations on the high frequency indicators are weighted equally, the MIDAS approach allows for flexible weighting of the monthly observations on the high frequency indicators. As such, the MIDAS approach captures well the steep downward trend in the high frequency indicators in the latter part of the sample, i.e. the 2020 monthly observations on the high frequency indicators.e The high frequency indicators used to nowcast and forecast Lebanon’s real GDP growth are, namely, yoy growth rates in: claims of the commercial banking sector on resident customers (cl), outstanding lines of credit for imports (lc), non- resident (nr) and resident (r) deposits; all sourced from BdL. That is, in the MIDAS setup, our vector of high frequency indicators is x tH =(cl ,lc ,nr ,r ) We aggregate information from the four high frequency indicators using principal components analysis. More specifically, we extract the first principal component from the four indicators and use it to nowcast or forecast real GDP growth. The MIDAS model, which uses the first principal component of the four indicators, is referred to as the factor augmented MIDAS model. The low frequency variable of interest in the nowcasting or forecasting exercises is y tL =(gdpg ) where gdpg is the annual growth rate in GDP. In forecasting Lebanon’s GDP growth in 2020 and 2021, two setups are entertained. The first is referred to as the baseline setup and does not control for COVID-19 economic effects, whereas the pandemic is incorporated into the second setup. More specifically, the AR(1) model used to forecast the high frequency indicator is augmented with an indicator (i.e., dummy) variable taking the value one from April 2020 (i.e., at the start of the lockdown period) through first half of 2021 (H1-2021). In such a way, we are able to gauge the marginal impact of COVID-19 on growth. High data for frequency variables are available through May 2020, while the GDP data are available only until 2018. The dynamic (i.e., multi-step-ahead) forecasts of real GDP growth rates for 2020 and 2021 are generated using ADL-MIDAS model. The results are provided in Table 1. It should be noted that the forecast of real GDP growth for 2021 is subject to considerably more uncertainty than that for 2020. The reasons for the uncertainty are twofold: (i) unlike 2020, the data for the high frequency indicators are not yet available; and (ii) the forecast of real GDP growth for 2021 builds on the forecast of real GDP growth of 2020. MIDAS Forecasts for 2020 and 2021 Real GDP Growth for Baseline and COVID-19 Scenarios TABLE 1 •    2020 2021   Baseline COVID Baseline COVID Non-resident deposit growth –11.0% –13.0% –7.5% –8.6% Resident deposit growth –16.7% –18.1% –11.4% –12.5% Claims on the resident sector –14.7% –16.2% –16.3% –16.9% Lines of credit for imports –16.8% –21.5% –10.2% –11.0% Factor Augmented MIDAS –18.9% –22.4% –11.3% –12.8% Average (excl. min & max) –16.1% –18.6% –11.0% –12.1% (continued on next page) Recent Macro-Financial Developments 5 BOX 1. NOWCASTING AND FORECASTING ECONOMIC ACTIVITY (CONTINUED) Average estimates of growth projections for 2020 and 2021 are 18.6 percent and 12.1 percent, respectively. Results from Table 1 also suggest that the estimated COVID-19 impact averages 2.5 pp of GDP in 2020 and 1.1 pp of GDP in 2021. A couple of factors can help understate the COVID-19 impact, specifically, (i) that the high frequency indicators used are more optimal for financial crisis dynamics, which is the largest of the three crises that the country is facing, that for COVID; and (ii) that the sample period used to estimate the MIDAS model is through May 2020, leaving only 2 months to account for the COVID-19 effects in Lebanon. As such, the COVID-19 impact estimation is likely to change (increase) as more data come in. The results for 2020 ad 2021 can be updated as more data come in for the high frequency indicators. a Lebanese GDP data are collected and disseminated by the Central Administration of Statistics (CAS). b Ghysels, E., Santa-Clara, P., & Valkanov, R. (2004), The MIDAS Touch: Mixed Data Sampling Regression Models, Discussion paper UNC and UCLA. c A comparative assessment of the nowcasting ability of MIDAS and bridge equations is provided in: Schumacher, C. (2016), A Comparison of MIDAS and Bridge Equations, International Journal of Forecasting, 32(2), 257–270. d Ghysels, E., and Marcellino, M. (2018), Applied Economic Forecasting using Time Series Methods, Oxford University Press. e Further, the existing literature shows that the predictive ability of nonlinear model is not superior to that of linear models (Clements, Franses and Swanson, 2004). This is particularly true for forecasting GDP growth and inflation (Marcellino, 2008). The data limitations in Lebanon (in particular, the historical availability of GDP data) as well as the unprecedented large movements in the high frequency indicators complicate estimation and prediction from nonlinear models. Clements, M. P., Franses, P. H., & Swanson, N. R. (2004), Forecasting Economic and Financial Time-Series with Non-Linear Models, International Journal of Forecasting, 20(2), 169–183. Marcellino, M. (2008); A linear benchmark for forecasting GDP growth and inflation? Journal of Forecasting, 27(4), 305–340. On the demand side, private, and to a lesser percent of GDP. This will be driven by declines in extent public, consumption and investments are primary expenditures—due almost exclusively to the expected to contract sharply, with consumption denominator-led effect—and lower interest payments historically constituting more that 100 percent on debt. Overall, in 2020, the fiscal balance is forecast of output (Figure 2). Net exports, on the other hand, to improve by 4.7 pps to reach –5.9 percent of GDP is expected be the sole positive contributor to GDP, (Figure 3). On the other hand, the primary balance driven by falling imports; according to Customs data, is expected to endure a clear deterioration and is the total value of merchandize imports declined by 50 projected to be –3.6 percent of GDP, compared to a percent in 8M-2020, compared to the same period in (2013–2018) average of 0.7 percent. 2019, while merchandize exports fell by 8.3 percent. Partial-year fiscal data confirm severe fiscal stresses. Over the 6M-2020 period, total revenues declined by 19.8 percent (yoy), driven by 49.8, 44.4 Fiscal Developments and 32.4 percent yoy decreases in VAT, telecoms and customs revenues, respectively. We note that income Crises conditions have further deteriorated tax and VAT are the two largest revenue sources for Lebanon’s already precarious fiscal position. the Government, followed by transfers from telecoms Revenues are expected to decline sharply as both and taxes on international trade (of which customs tax and non-tax revenues tumble in absolute value is a component). The sharp fall in VAT and customs due to the sharp contraction in economic activity. As are tempered by much smaller declines in other taxes a percentage to GDP, a sizable increase in nominal so that total tax revenues fell by 27.9 percent over GDP (in LL), driven by a high GDP deflator (due to 6M-2019. On the non-tax side, treasury transaction rising prices), will further reinforce the falling revenue resources (revenues) increased by 183 percent due ratio via a denominator-led effect. Total revenues to the “others” category, also helping to partially offset in 2020 are thus projected to decrease by around the sharp decline in telecom transfers. Total expen- 9 pps to reach 11.5 percent of GDP, compared ditures over 6M-2020 have also decreased by 16.2 to an average (2013–2018) of 20.7 percent. On percent. This, however, is largely due to cuts in interest the expenditure side, total spending is forecast payments on debt. In fact, over 6M-2020, interest to decline by almost 14 pps to be at around 17.3 payments on foreign debt fell by 87.6 percent (yoy), 6 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 3 • Large Shortfalls in Revenues Will Induce a Significant Deterioration in the Fiscal Position Fiscal Aggregates (% of GDP) 5 3 0 –3 –5 –8 Percent (%) –10 –13 –15 –18 –20 –23 –25 –28 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Overall fiscal balance Primary fiscal balance, excluding interest payments Sources: Lebanese authorities and WB staff calculations. FIGURE 4 • Valuation Effects from Exchange Rate Depreciations Will Pressure the Debt-to-GDP Ratio Gross Public Debt 100 250 90 80 200 70 Percent (%) US$ Billion 60 150 50 40 100 30 20 50 10 0 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 External public debt (US$ bln) Gross public debt (US$ bln) Domestic public debt (US$ bln) Gross public debt as a percentage of GDP (rhs, %) Sources: Lebanese authorities and WB staff calculations. a result of the default decision on Eurobonds early in outstanding stock of foreign currency-denominated March 2020, while that on domestic debt decreased debt was 37 percent in April 2020, mostly held by by 26.1 percent. The latter is due to an agreement domestic banks. Of course, taken at the higher with the central bank, by which BdL would not receive average exchange rate in the economy, this share coupon payments on Treasury bonds it holds as part of increases dramatically (a doubling or tripling would be fiscal relief for the Government.10 Meanwhile, primary spending remained largely unvaried in nominal terms (but fell sharply in real terms as inflation has spiked). 10 As of August 2020, BdL held 60 percent of gross local The economic crisis has led to a sharp dete- currency public debt. rioration in Lebanon’s public debt ratio, which has 11 The default on the Eurobonds implies uncertainty over the final nominal value of foreign debt, whose new terms long been on an unsustainable path. By end-2020, (i.e. face value, maturity, grace period etc.) need to be the debt-to-GDP ratio is projected to reach 194 per- negotiated with foreign creditors. For our purposes, we cent, compared to 171 percent end-2019 (Figure 4).11 assumed no principal and coupon payments take place Taken at the official exchange rate, the share of for Eurobonds in 2020 and 2021. Recent Macro-Financial Developments 7 FIGURE 5 • Triple-Digit Inflation Rates Driven by Basic Consumption Items Drivers of 12-Months Headline Inflation 175 150 125 100 Percent (%) 75 50 25 0 –25 –50 Jun-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dic-19 Jun-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Food & non-alcoholic beverages Alcoholic beverages & tobacco Clothing & footwear Actual rent Owner occupied Water, electricity, gas and other fuels Furnishings, household equipment Health Transportation Communication Education Other Headline inflation growth Sources: CAS and WB staff calculations. consistent with some of the current various exchange yoy inflation rate over the first 8 months of 2020 (8M- rates in use in the country). Historically, interest cost 2020) for food and non-alcoholic beverages was 170.3 has consumed about half of government revenues, percent, while that for clothing and footwear was averaging 9 percent of GDP over 2013–2018. 195.4 percent, and 240.1 percent for furnishing and household equipment (Figure 5). The severe restrictions on capital outflows Money and Banking have increased the monetary space for monetary authorities. From October 2019 to August 2020, Monetary conditions mirror the state of economic BdL lowered interest rates on banks’ LL and dollar and financial crisis centered around exchange deposits by 556 and 533 basis points (bps), respec- market pressures that triggered triple-digit inflation tively. Banks’ lending rates in LL have mirrored this rates. Acute exchange market pressures in Lebanese effect, falling by 405 bps over the same period, while markets are reflected by heavy fluctuations in the rates for dollar loans have fallen by only 251 bps. black-market exchange rate,12 which has breached BdL has issued a series of circulars that LL 10,000 per US$, before falling back down. This is reflect the central bank’s vision of a crisis man- within the context of a multiple exchange rate system, agement strategy, along with some key political which includes the official exchange (LL 1,507.5/ US$) economy priorities. These initiatives can be divided as well BdL-backed lower rates for critical imports. into three main categories: (i) monetary and Subsequently, exchange rate pass through effects on exchange rate policies; (ii) socio-economic support; prices have resulted in surging inflation; the 12-month and (iii) financial sector regulations. Annex A lists key inflation rate has risen steadily and sharply from 10 circulars along with a description of main stipulations. percent in January 2020, to 46.6 percent in April, Lebanon’s monetary system is fragmented 89.7 percent in June, and most recently in August, with multiple and segmented arrangements with 120 percent. Inflation is a highly regressive tax, variable pricing and exchange rates. This includes: disproportionally affecting the poor and vulnerable, and more generally, people living on fixed income like 12 The black market has become a main supply channel for pensioners. This is especially so in Lebanon’s case dollars for both real and financial activity, as commercial where key basic items of the consumption basket are banks heavily restricted withdrawals and transfers of primary drivers of overall inflation. In fact, the average customers’ dollar deposits. 8 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 6 • Heavy Deleveraging of Assets (Private Loans) and Liabilities (Private Deposits) in Financial Sector Banks' Deposits and Loans (% yoy change) 30 20 10 Percent (%) 0 –10 –20 –30 –40 –50 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19 May-19 Jul-19 Sep-19 Nov-19 Jan-20 Mar-20 May-20 Jul-20 LBP credit outstanding to private sector FX credit outstanding to private sector Private sector deposits in LBP Private sector deposits in FX Sources: BdL and WB staff calculations. cash as the economy became heavily cash based a. The pre-crisis dollar deposits in commercial in LL; and (ii) conversions to dollars as evidenced banks. These electronic dollars are subject by an increasing dollarization rate, which by August to severe capital controls and can only be 2020 reached 81 percent, compared to 77.3 percent (i) withdrawn in LL at the e-board rate and in by end-2019. Private dollar deposits, on the other limited quantities; (ii) transferred within the hand, declined by a much lower 5.7 percent over domestic banking system; (iii) cashed out in 8M-2020. Hence, the higher dollarization was more informal and nontransparent schemes though than offset by a combination of outflows, dollar bank middlemen at large discounts. note hoarding and, importantly, the settlement of b. The dollar banknote and new dollar deposits outstanding private sector loans in dollars. Regarding (fresh dollars). This is traded at the black-market the latter, BdL and the Banking Control Commission rate. Most businesses need to access this dollar (BCC) facilitated the settlement of outstanding private in order to import consumption and capital goods. sector loans using pre-crisis dollar deposits in a c. The Lebanese lira bank note. Limited economic netting out effect of assets and liabilities of banks’ utility for electronic dollars, along with scarcity balance sheets. As a result, commercial banks’ total of dollar bank notes, and minimum incentives credit to the private sector fell by 22.1 percent over to save in LL, all rendered the economy heavily 8M-2020, amounting to a decline of US$ 12.5 billion cash-based in local currency. By August 2020, (at the official exchange rate). the stock of currency in circulation increased by Commercial banks’ net foreign assets posi- 294 percent (yoy), even as M2 and M3 declined tion has continued to deteriorate. As of August by 17.1 and 7 percent, respectively. 2020, the banking sector, as a whole, had US$ 4.4 bil- lion in placements at non-resident financial institutions Heavy deleveraging in the financial sector. (FIs), while its liabilities to non-resident FIs amounted Total private sector deposits in commercial banks to US$ 7.5 billion, a net foreign asset position of US$ shrank by 10.2 percent, amounting to US$ 17.2 –3.1 billion (compared to a net foreign asset position billion (at the official exchange rate), over 8M-2020, of US$ –2.1 billion end-2019). with distinct dynamics driving LL and dollar deposits The credit portfolio of the banking sector (Figure 6). The former declined by 25.6 percent over has substantially deteriorated during recent the same period, dragged by both (i) demand for months. Wholesale and retail trade and processing Recent Macro-Financial Developments 9 FIGURE 7 • A Steady and Sharp Deterioration in heavily consumption based,13 a good proxy would Credit Performance as Measure by be an average exchange rate calculated using NPL Ratio for Banks consumption-based weights, henceforth denoted as Total credit portfolio AER. As Annex B details, AER is calculated from the following prevailing exchange rates: o/w consumption o/w housing o/w financial intermediation • The official exchange rate—LL 1507.5 per US$— o/w retail trade which remains an anchor to many contracted o/w wholesale trade prices in the economy and at which BdL is o/w contracting and construction o/w processing industries backing up the importation of highly critical 0% 10% 20% 30% 40% 50% goods, namely, fuel, medicines and wheat. Oct-19 Mar-20 Jun-20 • The e-board exchange rate—LL 3,900 per US$—used for the importation of critical goods Sources: BdL and WB staff calculations. identified in the list of (FX-backed) items issued by Ministry of Economy and Trade (MoET) as well as the rate at which lirafication is taking place. Its industries, among other economic sectors were level is administratively determined. severely affected, causing business closing and job • The more volatile, market-determined, black- losses/reduced salaries. Non-performing loan (NPL) market exchange rate. ratio (gross NPLs including unearned interests as a percentage to total loans) stood at 28.3 percent as To project 2020 AER, we consider bad of June 2020, compared to 13.3 percent at end-June and worse case scenarios (a good case scenario 2019 and 16.8 percent at the beginning of the crisis in remains unjustified in the current policy making October 2019. NPL ratio for construction, wholesale environment). In the bad case scenario, denoted and retail trade, and processing industries stood at as Sc1a, we assume that the black-market rate 47, 40 and 42 percent, respectively, at the end of continues deteriorating to reach LL 10,000 per US$ June (Figure 7). With the devastating impact of the by January 2021, stabilizing thereafter. In the worse explosions on the economy, continued deterioration case scenario, denoted as Sc1b, we assume that in the quality of the LL 70 trillion credit portfolio (US$ the black-market rate deteriorates throughout 2021 47 billion at official exchange rate and two-thirds to reach LL 15,500 per US$ by December 2021. We denominated in USD) would be expected. emphasize that both scenarios should be considered as illustrative and not projections, since high volatility in the black-market rate in current panic conditions The Average Exchange Rate implies very high uncertainty. The results show that the estimated AER The fixed exchange rate regime, which has stabilizes in Sc1a, but continues to deteriorate nominally held at Lebanese lira (LL) 1,507.5 in Sc1b, in reflection of our assumptions (Figures to the US dollar ($) from 1997 to 2019, is de 8 and 9). Specifically, 2020 AER averages LL 3,550 facto dislodged in favor of a system of multiple per US$ in both Sc1a and Sc1b, depreciating by 129 exchange rates. The average exchange rate in the percent compared to 2019. In 2021, the AERs for Sc1a economy is a key parameter for macroeconomists in and Sc1b diverge; for the former the AER depreciates their analyses and estimations, and its identification by 49 percent to average around LL 5,303 per US$, in a multiple exchange rate system is not a straightforward exercise. This is particularly so in the case of Lebanon due to a lack of high frequency 13 Private consumption amounted to an average of 89 transactions data across multiple exchange percent of GDP over the 2004–2018 period, while public rates. Nonetheless, since Lebanon’s economy is consumption averaged an additional 15 percent of GDP. 10 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 8 • AER Simulations under Assumption of Stability of Black-Market Rate by end-2020 12,000 10,000 8,000 LL/ US$ 6,000 4,000 2,000 0 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Official rate Black market rate, Sc1a Highly critical imports exchange rate Critical imports exchange rate AER, Sc1a Sources: WB staff calculations based on data from authorities. FIGURE 9 • AER Simulations under Assumption of Instability of Black-Market Rate through 2021 18,000 16,000 14,000 12,000 LL/ US$ 10,000 8,000 6,000 4,000 2,000 0 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Official rate Black market rate, Sc1b Highly critical imports exchange rate Critical imports exchange rate AER, Sc1b Sources: WB staff calculations based on data from authorities. whereas it continues deteriorating in the latter scenario, rapidly in Sc1a than in Sc1b, in reflection of our by 82 percent, to average around LL 6,465 per US$. assumptions. Specifically, the inflation rate averages 72 percent in 2020 for both Sc1a and Sc1b, but Pass Through Effects on Prices 14 To calculate exchange rate pass-through effects on inflation, we divided the inflation rate by the AER Prices of goods and services have surged as a depreciation rate for the same month and multiply by result of the depreciating exchange rate and in 100. This generates a series of pass-through rates for reflection of the high import component of the the time period August 2019 to August 2020, which consumption basket. A simple calculation based we averaged out. We also tested lagging effects by on the AER and actual inflation data from September generating two more series where (i) the inflation rate is divided by the AER depreciation rate in the previous 2019 to August 2020 suggest an exchange rate-pass month; and (ii) the inflation rate is divided by the two through rate of 52 percent.14 months prior AER depreciation rate. We calculated the The results, which are presented in Figures standard deviation for the three series and chose the 10 and 11 show inflation abating much more series with the lower standard deviation, which was that Recent Macro-Financial Developments 11 FIGURE 10 • Under Sc1a, the Inflation Rate Abates toward the End of 2021, Whereas … 500 140% 450 120% 400 350 100% 300 80% 250 200 60% 150 40% 100 50 20% 0 0% Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Black market rate, Sc1a (yoy) AER, Sc1a (yoy) Inflation rate, Sc1a (yoy, rhs) Sources: WB staff calculations based on data from authorities. FIGURE 11 • ... in Sc1b, It Remains Elevated Driven by the Continued Depreciation of the Exchange Rate 500 140% 450 120% 400 350 100% 300 80% 250 200 60% 150 40% 100 50 20% 0 0% Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Black market rate, Sc1b (yoy) AER, Sc1b (yoy) Inflation rate, Sc1b (yoy, rhs) Sources: WB staff calculations based on data from authorities. diverges in 2021, so that it falls to an average of 38 exchange rate to prices pass through rate is estimate percent in the former scenario, but is more sticky at at 30 percent, while that for low income countries it is 53 percent in the latter scenario. A caveat to highlight estimated at 67 percent. is that we do not model/incorporate dynamics in inflation expectations,15 which could make these expectations self-fulfilling and a main driver of macro- economic instability. generated from dividing the inflation rate by the same The above estimated exchange rate-to- month AER depreciation rate. The estimated exchange prices pass through rate for Lebanon is analogous rate pass-through rate will likely change as more actual to global comparators. Figures 12 and 13 illustrate data are populated. With longer time series, we can use exchange rate to prices pass through rates for upper more sophisticated econometrics, which would also help capture lagging effects. middle income and low income countries, respectively, 15 Firms and consumers who have been “fooled”/surprised calculated as the correlation between changes in the once by the depreciation of the local currency and/or exchange rate and changes in the consumer price spike in inflation, look to protect themselves in the future index (CPI). For upper middle-income countries, the and expect high inflation rates in the proceeding periods. 12 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 12 • CPI-Parallel Exchange Rate Pass FIGURE 13 • CPI-Parallel Exchange Rate Pass through at 30 Percent for Upper through at 67 Percent for Lower Middle-Income Countries Income Countries 16% TUR 25% Percent to previous period, CPI Percent to previous period, CPI 14% LBR 20% 12% SLE 10% 15% MWI 8% HTL JOR 10% GAB MEX GIN 4% BGR DZA GMB 5% GMB MDG 2% ALB MNE CRI RUS TZA NPL PER BFA AZE RWA 0% MYS 0% –10% –5% 0% 5% 10% 15% 20% 25% 30% –5% 0% 5% 10% 15% 20% 25% Percent to previous period, offical exchange rate Percent to previous period, offical exchange rate Sources: WB staff calculations based on WDI data. Sources: WB staff calculations based on WDI data. The External Sector from its net reserves (i.e., FX reserves at the central bank net of FX liabilities to others); BdL, contrary to The sharp economic contraction—in the heavily other central banks, does not publish net reserves. consumption- and import-based economy—is BdL’s gross position includes US$ 5 billion in naturally concentrated on imports, which is Lebanese Eurobonds and an unpublished amount lent projected to lead a narrowing of the current out to banks since October 2019, leaving much of the account deficit. In fact, over 8M-2020, a 50 percent remainder as required reserves on banks’ customer FX decline in merchandize imports, drove a 59 percent deposits, which is estimated at US$ 17.5 billion. decrease in the trade in goods deficit. Meanwhile, A high import ratio for the consumption net remittances, which accounted for 6 percent of basket, along with the shortage of dollars in the GDP in 2019, is subject to offsetting dynamics in market suggest an implicit tradeoff between 2020; on the one hand, remittances inflows will be (i) importation of goods and services and negatively impacted by an impaired banking sector— (ii) BdL’s stock of foreign exchange reserves. the traditional conduit for such transfers—and by This compelled authorities to prioritize imports. the COVID-19 global impact. On the other hand, First, and early on in the crisis, BdL identified a list remittances inflows can increase due to the well of highly critical goods, C1—namely, fuel, medicine documented “insurance”16 and other countercyclical17 and wheat—to be backed by its stock of foreign behaviors observed in countries with large diasporas. Meanwhile, the change in remittances outflows from Lebanon is expected to be clearly in one direction—a 16 The “insurance” behavior suggests that diaspora increases remittances back home in case of natural significant decline. Overall, we expect the current disasters. That is expected to be reinforced by a account deficit in 2020 to contract, falling by 7 pps to change in policy by the central bank following the PoB reach 14.4 percent of GDP, compared to a medium- explosion, allowing transfers via non-banking financial term (2013–2018) average of 22.8 percent of GDP. institutions (money transfer companies) to be paid out The sudden stop in capital inflows has in dollars. Just prior to the disaster, BdL mandated that implied a steady depletion of FX reserves at BdL these transfers were to be disbursed in LL after being converted at a below market exchange rate, in effect, (Figure 14). As of end-September, 2020, BdL’s gross imposing a large tax on remittances. foreign asset position (excluding gold reserves) 17 During economic hardships in the home country, reached $25.9 billion, declining by $11.3 billion since expatriates can also boost transfers back home in end-2019. The gross position, however, differs widely support of family. Recent Macro-Financial Developments 13 FIGURE 14 • A Steady Depletion in the Gross total imports are presented annually from 2011 and Foreign Exchange Position at BdL monthly over 2019–20 in Figures 15 and 16, respec- 50,000 tively. The former illustrates relative stability in the 45,000 respective shares until 2019. Indeed, the 2011–18 40,000 average value shares of C1, C2, luxury and other 35,000 30,000 imports were 29, 12, 13 and 46 percent, respectively. US$ mln 25,000 Meanwhile, as foreign exchange constraints became 20,000 binding, the ratios of C1 imports, and to a lesser 15,000 10,000 extent C2 imports, rose at the expense of those for 5,000 luxury and other goods (Figure 16); over the 2019–20 0 period, average value shares of C1, C2, luxury and Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18 Jan-19 May-19 Sep-19 Jan-20 May-20 other imports became 36, 15, 10 and 39 percent, respectively. We expect this trend to persist. Foreign currencies Foreign securities Gross FX reserves Compulsory FX reserve Importers from across the economy compete for access to these FX-backed facilities. However, Sources: BdL and WB staff calculations. Note: Compulsory FX reserves are World Bank estimates based on published data, and less transparent demand is also well-documented in a 15 percent required reserve ratio on FX deposits in commercial banks. countries with capital controls and multiple exchange rate systems; specifically, corruption and misclassifica- tion of imports to benefit from cheap foreign exchange. As importers adapt to capital controls and more depre- exchange reserves at the official exchange rate.18 ciated black-market rates, this incentive will grow. The Government followed suit in July 2020 with a list of other critical goods, C2, issued by the Ministry of Economy and Trade, which BdL agreed to back up at 18 BdL set up a mechanism via commercial banks whereby the e-board rate (LL 3,900 per US$). importers of highly critical goods can exchange LL for An examination of historical and recent dollars at the official exchange rate for 85 to 90 percent trends for C1 and C2 imports are revealing. of the cost of their imports, while sourcing the remaining The shares of C1, C2, luxury and other imports to 15 to 10 percent from the market at the black market rate. Ratios of C1, C2 Luxury and other FIGURE 15 •  FIGURE 16 • … when Ratios of C1 and C2 Imports, Imports Were Stable until Period Rose at the Expense of those for Leading to Crisis … Luxury and other Goods % of Value of Total Imports by Sector % of Value of Total Imports by Sector 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Critical 1 Critical 2 Luxury Other Critical 1 Critical 2 Luxury Other Sources: Customs, MOET, BdL and WB staff calculations. Sources: Customs, MOET, BdL and WB staff calculations. 14 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION 3 GLOBAL CRISES COMPARATORS: FUNDAMENTALS MATTER T o help further inform on the outlook for group 2 (G2) assembles a more eclectic set of crises Lebanon, we compare the country’s that occurred in the 2000’s: Argentina (2001), Greece economic fundamentals with those of (2008), Ireland (2008), Iceland (2008) and Cyprus other crises countries, henceforth referred to as (2012). Both G1 and G2 episodes are expounded on global crises comparators. Inherent to any crisis in Annex D. We cross compare Lebanon’s economic episode is the large uncertainty on the outlook, fundamentals with those for G1 and G2 countries as economic indicators diverge significantly from over the years leading to the crisis point and observe medium-term averages. Earlier in the LEM, we attempt dynamics in years that followed. Specifically, we to ground our outlook using country-specific models present two charts for each macroeconomic indi- and econometrics. Further guidance can be construed cator: (i) Lebanon with G1 countries; and (ii) Lebanon from evidence offered by global crises comparators. with G2 countries.19 As we shall see below, strong Critically, macroeconomic fundamentals leading up to differences in macroeconomic fundamentals is an the crisis can provide insight on post-crisis dynamics. important feature that distinguishes G1 from G2, and That is, the state of the pre-crisis macroeconomy their recovery process. identifies resources and buffers that are available for the economy as it emerges from the crisis. In turn, this can inform on the scale and scope of the economic 19 In these charts, the indicator is plotted from 3 years prior challenges ahead. It is important to note, however, that to crisis year (t–3), to 5 (or 6) years post-crisis (t+5 or t+6), each crisis episode involves strong idiosyncrasies, of course going through crisis year (t). In such a way, and that global crises comparators are not a perfect even when crisis years differ (say 2008 for Greece and set of episodes. 2001 for Argentina), plotting in reference to a crisis point rather than the calendar year superimposes the same We divide our set of global crises com- indicator for Lebanon with global crises comparators parators into two groups. Group 1 (G1) includes on one chart. This allows us to cross-compare how the the Asian crisis countries of 1997–98: Thailand, macro indicator developed as the crisis is approached, Malaysia, Indonesia, Philippine and South Korea; and how it evolved afterwards. 15 Real GDP for G1 Global Crises FIGURE 17 •  Real GDP for G2 Global Crises FIGURE 18 •  Comparators Comparators Real GDP Growth: Group1 Real GDP Growth: Group2 15 15 10 10 5 5 Percent (%) Percent (%) 0 0 –5 –5 –10 –10 –15 –15 –20 –20 –25 –25 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t+6 Thailand '97 Malaysia '97 Indonesia '97 Iceland '08 Ireland '08 Greece '09 Lebanon '19 Philippines '97 Korea '97 Cyprus '11 Argentina '01 Lebanon '19 Sources: WDI, CAS and WB staff calculations. Sources: WDI, CAS and WB staff calculations. Output difficult as it suffered 6 years of consecutive reces- sions (from t–1 to t+4), growing marginally in t+5, Lebanon’s growth faltered since 2011 and before falling back into recessions for two more years. compares poorly with growth in G1 and G2 The contraction in Lebanon’s real GDP is countries in the lead to the crisis point; only already one of the worst among crisis countries, Argentina’s pre-crisis growth is comparable. despite not having reached the trough yet. Crisis In fact, G1 countries demonstrated robust growth peak to trough changes in the real GDP (P-T) were from t–3 until t–1, consistent with their medium-term much milder for the G1 countries that G2 countries; performance at the time (Figure 17). The Asian financial specifically, P-T changes in the real GDP ranged crisis occurred in 1997 (t), with a recession ensuing in from –0.6 percent in the Philippines, to –5.5 percent 1998 (t+1) for all G1 countries, the most severe being in Korea, –7.4 percent in Malaysia, –10.2 percent in in Indonesia. For G2 countries, Ireland and Iceland Thailand, to –13.1 percent in Indonesia.20 As for G2 replicate the Asian countries’ performance in the years countries, P-T changes in real GDP registered –9.3 just prior to the crisis, exhibiting robust growth that is percent in Ireland, –10 percent in Iceland, –11.5 also consistent with their medium-term performance percent in Cyprus, –18.4 percent in Argentina, and at the time (Figure 18). Meanwhile, growth in Greece –26.5 percent in Greece.21 Latest GDP projections and Cyprus fluctuated as they approached crisis for t+1 (2020) for Lebanon suggest that the real GDP year, with the latter falling into a recession in t–2, would contracted by 26.1 percent since its peak in recovering somewhat in t–1. Argentina is the closest t–3 (2017), making the country already one of the comparable to Lebanon as it experienced a strong worst performers among crisis countries even though recession starting in t–2 and t–1; Lebanon, which has the crisis is still in its worsening phase. been in sluggish growth since 2011, has been in an outright recession since t–1 (2018). G1 countries rapidly regained growth, 20 G1 countries’ real GDP peaks and troughs occurred, while performances in most G2 countries lagged respectively, in t and t+1 for each of The Philippines, with Greece standing out as a particularly painful South Korea, Malaysia and Indonesia, and in t-1 and t+1 in Thailand. episode. Only Argentina from the G2 countries was 21 G2 countries’ real GDP peaks and troughs occurred, able to achieve robust growth immediately following respectively, in, t–1 and t+1 in Ireland, t and t+2 in the crisis, while Ireland, Iceland and Cyprus took a few Iceland, t and t+3 in Cyprus, t–3 and t+1 in Argentina, years to recover. Greece’s experience was particularly and t–1 and t+5 in Greece (taking only the 6-year span). 16 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 19 • CPI Indices for G1 Global Crises FIGURE 20 • CPI Indices for G2 Global Crises Comparators Comparators CPI; Group 1 CPI; Group 2 300 190 170 250 150 Index: 100 at t Index: 100 at t 200 130 150 110 90 100 70 50 50 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 Thailand '97 Malaysia '97 Indonesia '97 Iceland '08 Ireland '08 Greece '09 Philippines '97 Korea '97 Lebanon '19 Cyprus '11 Lebanon '19 Sources: WDI, CAS and WB staff calculations. Sources: WDI, CAS and WB staff calculations. Inflation Here again, G1 countries enjoyed fiscal surpluses prior to the crisis as part of a more general policy Lebanon’s inflation was subdued since the early of macroeconomic stability, while G2 countries nineties;22 this is in reflection of exchange rate displayed variation (Figures 21 and 22). Of the latter, stability, which was also a factor in G1 and G2 Argentina, Cyprus and Greece, in increasing order, countries. Mild inflation and exchange rate stability entered the crisis with a deficit position. in G1 countries (Figure 19) stemmed from general Crises typically induce a significant wors- macroeconomic stability that was part of the Asian ening of the fiscal position, with some mitigation growth model at the time. This stability persisted in from high inflation. Even G1 countries experienced the recovery phase, except for Indonesia, where in a deterioration in the fiscal balance in the aftermath of t+1, the exchange rate depreciated by 244 percent the crisis. This typically stems from sharper declines and inflation spiked to almost 60 percent. As for G2 in tax and non-tax revenues—due to economic hard- countries, Ireland, Greece and Cyprus successfully ship—than declines in expenditure which can involve retained membership of the Euro monetary area, countercyclical fiscal stabilizers. Other relevant fiscal helping to contain inflation (Figure 20). While official dynamics can be illustrated by a couple of notable inflation data for Argentina for that period is lacking, cases here, specifically: (i) Indonesia, whose fiscal the failure of the currency board rendered inflation a balance as a ratio to GDP deteriorated only margin- main vulnerability in the post-crisis period. Iceland, on ally, mitigated by high inflation; and (ii) Iceland where, the other hand, exhibited a classical price adjustment; despite high inflation, the fiscal balance ratio did in t and t+1, the Krona depreciated by 37 and 41 deteriorate sharply, driven by higher cost of debt.23 percent, respectively, while inflation reached about Hence, while inflation can help correct fiscal imbal- 12 percent in both years, with pressures on the ances, it can be offset by either higher interest rates exchange rate and inflation subsiding thereafter. (i.e., due to exchange market pressures), or valuation Fiscal 22 This is the case since the last exchange rate collapse, which saw the currency depreciate by over 400 percent Lebanon’s overall fiscal balance stands out from January 1990 until Fall of 1992. as a main vulnerability in the lead to the crisis, 23 Interest payments surged from 2 percent of GDP or less comparable to, but even worse than, Greece’s. in the pre-crisis period, to 5.6 percent of GDP in t+1. Global Crises Comparators: Fundamentals Matter 17 FIGURE 21 • Overall Fiscal Balance for G1 Global FIGURE 22 • Overall Fiscal Balance G2 Global Crises Comparators Crises Comparators Overall Fiscal Balance (% GDP); Group 1 Overall Fiscal Balance (% of GDP); Group 2 6 10 4 5 2 0 (% of GDP) 0 –5 (% of GDP) –2 –10 –4 –15 –6 –20 –8 –25 –8 –30 –12 –35 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t–4 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t+6 Thailand '97 Malaysia '97 Indonesia '97 Iceland '08 Ireland '08 Greece '09 Philippines '97 Korea '97 Lebanon '19 Cyprus '11 Argentina '01 Lebanon '19 Sources: WDI, MoF and WB staff calculations. Sources: WDI, MoF and WB staff calculations. FIGURE 23 • Gross Debt for G1 Global Crises FIGURE 24 • Gross Debt for G2 Global Crises Comparators Comparators Debt to GDP (% GDP); Group 1 Debt to GDP (% GDP); Group 2 250 250 200 200 (% of GDP) (% of GDP) 150 150 100 100 50 50 0 0 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 Thailand '97 Malaysia '97 Indonesia '97 Iceland '08 Ireland '08 Greece '09 Philippines '97 Korea '97 Lebanon '19 Cyprus '11 Argentina '01 Lebanon '19 Sources: WEO and WB staff calculations. Sources: WEO and WB staff calculations. effects on the foreign currency-denominated compo- the Philippines.24 However, in all cases, except for nent of public debt as a result of an exchange rate possibly Malaysia and the Philippines, the debt-to-GDP depreciation. ratio deteriorated significantly, even for Greece which benefitted from a large haircut on its public debt. Debt External Position Public debt in Lebanon has consistently been one of the highest globally, and as a result, a key A deteriorating current account balance was a source of macroeconomic instability, comparable common factor to G1 and G2 countries in the lead to only Greece among the G1 and G2 countries. Leading to the crisis year, the public debt-to-GDP ratio 24 The 60 percent of GDP is the debt ceiling identified by was below 60 percent for both G1 and G2 countries the Maastricht Treaty, which set macroeconomic targets (Figures 23 and 24), with the exception of Greece and for countries to qualify for the Euro membership. 18 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 25 • Current Account Balance for G1 FIGURE 26 •  Current Account Balance for G2 Global Crises Comparators Global Crises Comparators Current Account Balance (% GDP); Group 1 Current Account Balance (% GDP); Group 2 20 15 15 10 10 5 5 0 (% of GDP) 0 (% of GDP) –5 –5 –10 –10 –15 –15 –20 –20 –25 –30 –25 t–4 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t+6 –30 t–4 t–3 t–2 t–1 t t+1 t+2 t+3 t+4 t+5 t+6 Thailand '97 Malaysia '97 Indonesia '97 Philippines '97 Korea '97 Russia Iceland '08 Ireland '08 Greece '09 Brazil Lebanon '19 Cyprus '11 Argentina '01 Lebanon '19 Sources: Customs, MOET, BdL and WB staff calculations. Sources: Customs, MOET, BdL and WB staff calculations. to the crises (Figures 25 and 26). This is a classic Argentina and to a lesser extent Iceland both shared dynamic in emerging economies where a worsening a similar adjustment mechanism. This channel, of the external position raises risk exposures to however, was not available for Greece, Ireland and external shocks and increases dependence on more Cyprus, as their strategic objective was to remain volatile portfolio financing. In the late eighties, South in the Eurozone. Instead, for the Euro countries, the Korea, Malaysia and the Philippines experienced correction in the external position occurred as a result years of positive current account balances, of an internal adjustment mechanism, typically more consistent with the Asian export-based growth model. painful and prolonged. This was not the case for Thailand and Indonesia, whose economies maintained a more structural external deficit position. From early to mid-nineties, Overall current account balances for all G1 countries were decidedly in the negative, with a clear deterioration The main distinctions between G1 and G2 in the years leading to the crisis. Only Ireland from countries concern macroeconomic fundamentals the G2 countries demonstrated a positive current and crisis geneses. G1 countries share a contagion account position consistently over the prior decade, effect as a cause to their crises; additionally, with the rest holding a structurally negative position. they can be regarded as having relatively strong Here again, a general deterioration in the external macroeconomic fundamentals on the eve of the crisis, position in the lead to the crisis is evident for all G2 notwithstanding certain vulnerabilities. G2 episodes episodes. have varying causes and suffer more obvious A clear implication of the crises on both macroeconomic vulnerabilities (with the possible G1 and G2 countries is a sharp correction in the exception of Ireland). As a result, recovery for the G1 external position. Variations between the sample group was much more swift and sustainable, whereas groups are notable. For G1 countries, the correction G2 recoveries suffered, to variable degrees, from in the current account balance occurred as a result long-term structural weaknesses; oversized and badly of sharp depreciations in the exchange rates, which regulated financial sectors in Iceland and Cyprus; a increased the competitiveness of their economies. non-transparent and unsustainable public sector in The Asian export-oriented growth model was well Greece; an over-valued rigid exchange rate regime in positioned to benefit from the repricing in its favor. Argentina. Global Crises Comparators: Fundamentals Matter 19 Lebanon’s fundamentals in the lead to the with optimal policy measures in place. As it currently crisis fared worse than that those for both G1 and stands, however, the absence of a comprehensive G2 countries. As such, we expect the adjustment and consistent adjustment strategy can only make process to be more painful and to take longer, even this more difficult. 20 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION 4 OUTLOOK AND RISKS S ubject to unusually high uncertainty, we the lack of accountability on non-compliance, and project real GDP to contract by a further the large discretionary space for banks to pursue 13.2 percent in 2021. Our projection ad hoc applications. Whereas most customers are assumes the following key factors: COVID-19 effects subject to severe (and increasing) restrictions on carry through H1-2021, macro policy responses dollar withdrawals and transfers, it is perceived that continue to be lacking, and limited reconstruction and some have managed to transfer large sums of money recovery efforts in the aftermath of the PoB explosion. out of the country since controls have been in place Lebanon’s recession is likely to be arduous (October 2019). There are vociferous demands for and prolonged given the lack of necessary policy- that money to be returned and for those engaged in making. Exchange market pressures will continue to such transfers be held to account. stifle trade finance and corporate finance in the highly The burden of the ongoing adjustment/ dollarized economy, constraining the importation of deleveraging in the financial sector is highly capital and final goods, and inducing disruptions all regressive, concentrated on smaller depositors, along the supply chain. This implies an inability to the local labor force and smaller businesses.. tap international markets for foreign financing, and De facto lirafication and haircuts on dollar deposits an impaired domestic banking system. As a result, are ongoing despite BdL’s and banks’ official com- capital controls will continue to be needed, but are mitment to safeguarding deposits. When paying out also expected to become less effective over time, in dollar deposits to customers—other than a minimal line with international evidence. (and diminishing) amount paid out in dollar bank In the absence of formal capital controls, notes—banks are exchanging at rates lower than the the lack of harmonization between banks, and black-market rate and paying it out in LL, thereby between customers within the same bank, has effecting lirafication. Haircuts occur to the extent that generated considerable popular backlash against the LL amount is being used to either purchase goods banks and the central bank. A key shortcoming of and services, whose prices are rising, or exchange current applications of informal capital controls is for dollars bank notes, both lead by the black-market 21 market rate. The burden of the ongoing adjustment/ Lebanon through different channels such as loss of deleveraging is regressive and concentrated on the productive employment, decline in real purchasing smaller depositors, who lack other source of savings, power, stalled international remittances and so forth. the local labor force, that is paid in LL, and smaller A World Food Programme (WFP) and World Bank businesses. (WB) survey28 illustrates sharply declining purchasing A steady depletion in FX reserves at BdL power, severely hampering the ability of Lebanese presents a realistic downside risk of an infla- households to meet essential needs such as food and tionary-depreciation spiral, which our baseline access to adequate healthcare services (Box 2). does not assume. BdL officials have made state- Lebanon needs to adopt and implement a ments to the effect that FX reserves levels will reach credible, comprehensive and coordinated macro- require reserves on banks’ customer FX deposits in financial stability strategy, within a medium term the next few months, at which point they will be unable macro-fiscal framework. This strategy would be to back up critical imports at lower exchange rates.25 based on: (i) a debt restructuring program toward This will dangerously stoke inflationary-depreciation achieving debt sustainability over the medium term; pressures. When BdL arrests its back up of critical (ii) a comprehensive financial sector restructuring goods, especially, energy products, medicine and toward regaining solvency of the banking sector; (iii) a food essentials, importers will fully revert to the black new monetary policy framework aimed at regaining market for the needed hard currency. This would exac- confidence and stability in the exchange rate; (iv) a erbate inflationary pressures with both flow and stock phased fiscal adjustment aimed at regaining confi- implications. On the flow side, inflationary pressures dence in fiscal policy; (v) growth enhancing reforms; arise due to a direct effect and to re-iterative effects. and (vi) enhance social protection.29 Through the direct effect, the inflation rate rises as prices for critical products will immediately reflect the full black-market exchange rate.26,27 Additionally, there 25 While BdL’s declaration suggests safeguarding FX reserves at levels of required reserves, it is more are also re-iterative effects as the increased demand symbolic than a credible re-assurance of solvency. for dollars in the black market further worsens the Liquidity and solvency issues are primarily determined exchange rate, fueling inflation. With surging infla- by the FX gap between assets and liabilities in BdL’s tion, the stock of narrow money increases, putting balance sheet. For example, banks’ total (LL and FX) increased pressure on the exchange rate. Moreover, deposits in BdL amount to over US$ 106 billion (July under panic conditions, inflation and exchange rates 2020, at official exchange rate). This is mainly sourced from the US$ 115 billion in FX deposits in commercial are key observables that drive sentiment, and their banks. Meanwhile, as mentioned earlier (Paragraph 27), deterioration re-enforces the inflationary-depreciation BdL’s foreign assets position is subject to key pressure cycle. Regarding stock implications, high inflation points and non-observables (BdL, contrary to other imposes a wealth effect via transfers from creditors to central banks, does not publish net reserves). As such, debtors; ceteris paribus borrowers would owe less— a credible audit of BdL is needed to identify the FX gap. and hence, creditors would receive less—in real terms 26 We note that energy products are final and intermediate goods, and changes to their prices impose economy- than what was determined at the time the contract wide effects. was signed. Consequently, public debt denominated 27 While this will naturally reflect on volumes imported— in local currency would be worth less in real terms, since consumers will cut down on purchases, and there providing a fiscal benefit. will be some substitutional effects for food products that Poverty in Lebanon is likely to continue can be manufactured locally (a process likely ongoing)— to worsen, surpassing half of the population being highly critical goods, they will still be demanded in substantial volumes. by 2021. A contraction of the Lebanese GDP per 28 WFP and WB (2020), Lebanon: m-VAM Vulnerability and capita in real terms and two-digit inflation in 2020 Food Security Assessment, July–August 2020. will undoubtedly result in substantial increase in 29 This can include, for example, scaling up the e-card poverty rates affecting all groups of population in food voucher of the National Poverty Targeting Program 22 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION BOX 2. RESULTS FROM m-VAM VULNERABILITY AND FOOD SECURITY ASSESSMENT The questionnaire was jointly developed by WFP and WB FIGURE 27 • Main Reasons Why Accessing and includes the following sections: i) demographics, Food and other Basic Needs Was ii) food consumption, iii) reduced coping strategy index, Challenging, July–August 2020 iv) access to food and markets, v) access to health services, vi) employment, vi) access to social protection services. Lack of money 49% Remote data collection through phone surveys started in High prices 19% Lebanon in July 2020 and continued until end of August. COVID-19 outbreak 9% The data collection methodology consists of a countrywide Travel restrictions 9% survey covering the eight governorates of Lebanon. The Markets closure 6% survey targets Lebanese nationals only and reached a Security issues 2% total of 2,335 household since the beginning of the data Beirut port blast 1% collection in July. Out of these, of 1,459 respondents were reached in August. The following are key findings. Sources: WFP and WB (2020). Deteriorated purchasing power is the main reason why households could not make ends meet, as 49 percent FIGURE 28 • Labor Force Participation Status in reported not to have enough money for their purchases and August 2020 and pre Lockdown another 19 percent stated goods were not affordable due to (Feb 2020) high prices (Figure 27). Unemployment rate amongst the respondents reached 49 percent in August compared to 37 percent in February. The 49% 43% highest increase was observed among respondents with 37% lower levels of education (Figure 28). 34% The reported median take-home income respondents earned in July was 900,000 LBP (a little over US$ 100 at the black- market exchange rate), representing an 18 percent increase compared to February 2020. Nevertheless, the level of Employed Unemployed increase in nominal wages was much lower than the steep increase in prices that have been observed in the last ten February 2020 August 2020 months, reflecting a sharp decline in real wages. Sources: WFP and WB (2020). Wages or salaries was the main source of income for 58 percent of reported households. The proportion of FIGURE 29 • Main Income Sources Over the Past households reporting assistance as their main source of 12 Months in July income was high at 23 percent (both for assistance provided by the government and by non-governmental organizations); Wages 58% 14 percent of households reported return on investments NGO assistance 23% as the main source of income, and 11 percent rely on Govt assistance 23% remittances from abroad (Figure 29). Non-farm business 19% Investments 14% Remittances from abroad 11% Farming 8% Pension 6% Remittances (domestic) 2% Sources: WFP and WB (2020). Over the medium term, Lebanon will have (NPTP); providing an education cash transfer for children to prioritize building better institutions, good from extreme poor households who are vulnerable to governance, and a better business environment dropping out of schooling; increasing access to quality alongside physical reconstruction. However, healthcare for poor Lebanese. Outlook and Risks 23 given Lebanon’s state of insolvency (sovereign, The Special Focus of the LEM presents one banking system) and its lack of adequate foreign approach to designing a comprehensive reform exchange reserves, international aid and private agenda aimed at addressing the root causes of the investment will be essential for comprehensive economic crisis. The purpose of the reform agenda recovery and reconstruction. The extent and is to help set the stage for a more equitable, more effi- speed to which aid and investments are mobilized cient and more resilient economy. It puts governance will depend on whether the authorities and the reforms at the fore, alongside macroeconomic stabili- Parliament can swiftly act on much needed fiscal, zation. The reform agenda presented is meant to feed financial, social, and governance reforms. Without into an open discussion among the citizens of Lebanon reforms, there can be no sustainable recovery and and between them and their government. Its aim is to reconstruction, and the social and economic situa- contribute to the debate that needs to take place on tion will continue to worsen. the path out of the ongoing crisis, the sequencing of reforms and the long-term development vision. 24 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION Selected Macroeconomic Indicators for Lebanon; 2015–2021 TABLE 2 •  2016 2017 2018 2019 2020 2021 Est. Proj. Real sector Real GDP 1.5 0.9 –1.9 –6.7 –19.2 –13.2 Real GDP per capitaa –1.2 –0.6 –2.5 –6.8 –19.6 –13.6 Agriculture (share of GDP) 4.0 4.5 4.4 5.0 4.7 4.7 Industry (share of GDP) 12.8 12.3 12.0 10.6 13.3 13.3 Services (share of GDP) 71.5 71.6 72.2 74.3 78.3 78.0 Net indirect taxes (share of GDP) 11.7 11.6 11.4 10.1 3.7 4.0 Money and prices CPI inflation (p.a) –0.8 4.5 6.1 2.9 75.0 40.0 Moneyb 7.3 4.2 3.0 –6.7 130.0 60.0 Investment & saving Gross capital formation 22.7 21.4 20.8 18.5 6.3 4.2 o/w private 21.3 19.9 19.1 17.2 5.2 2.4 Gross national savings 2.2 –1.5 –3.5 –2.7 –8.1 –3.7 o/w private –1.0 –4.8 –5.3 7.9 –3.4 –1.0 Central government finance Revenue (including grants) 19.4 21.9 21.0 20.6 11.5 13.5 o/w tax revenues 13.7 15.5 15.4 15.5 7.8 8.8 Total expenditure and net lending 28.6 28.6 32.0 31.2 17.3 18.1 Current 27.3 27.1 30.3 29.9 16.2 16.2 o/w interest payment 9.3 9.4 9.8 10.0 2.3 2.4 Capital & net lending (excluding foreign financed) 1.4 1.5 1.7 1.3 1.2 1.9 Overall balance (deficit (–)) –9.3 –6.7 –11.0 –10.5 –5.9 –4.6 Primary balance (deficit (–)) 0.0 2.7 –1.2 –0.5 –3.6 –2.2 External sector Current account balance –20.5 –22.9 –24.4 –21.2 –14.4 –8.0 Trade balance –23.6 –24.7 –24.8 –24.9 –4.4 2.7 o/w export (GNFS) 37.3 36.0 35.7 35.4 35.0 44.6 Exports of goods 7.7 7.6 7.0 9.3 13.9 17.5 Exports of services 29.6 28.4 28.7 26.1 21.1 27.1 o/w import (GNFS) 60.9 60.8 60.5 60.3 39.3 41.9 Imports of goods 35.0 34.7 34.4 35.0 22.7 24.2 Imports of services 25.9 26.1 26.1 25.2 16.6 17.7 Net private current transfers: 4.8 2.3 2.5 5.6 –10.4 –11.2 Net remittances 6.6 5.2 4.2 6.1 10.1 14.1 Net income reciepts –1.7 –0.5 –2.1 –1.9 0.4 0.5 Gross reserves (months of imports GNFS)c,d 15.2 15.6 14.3 14.3 23.8 12.5 Total public debt Total debt stock (in million US$) 74,900 79,530 85,139 88,900 62,276 55,464 Debt-to-GDP ratio (percent) 146.3 149.7 154.9 171.0 194.0 211.7 Memorandum items: GDP (in million US$) 51,205 53,141 54,961 51,992 32,103 26,200 Source: Government data, and World Bank staff estimates and projections. a Population figures, which include Syrian refugees registered with the UNHCR, are taken from the United Nations Population Division b Prior to 2020 this is M3, including non-resident deposits; 2020 and after, this is M0 (currency in circulation) c Gross Reserves (months of imports GNFS) = (Imports of Goods & Services / Gross Res. excl. Gold)*12 d Total Imports using the BOP data from the Quarterly Bulletin of BDL Outlook and Risks 25 SPECIAL FOCUS A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 30 L ebanon is in the midst of three mega-cri- between government and donors. Under a no-reform ses, each capable of extending the current scenario, Lebanon’s economy is forecast to contract trough into a long-term catastrophe. Leba- for the next two years; to mitigate this, decisive action non faces an economic crisis, the COVID-19 pandem- must be taken to save Lebanese citizens and refugees ic, and the aftermath of the Port of Beirut (PoB) explo- from an economic and humanitarian catastrophe. sion. The most disruptive of the three is the economic Citizens’ decisions. The reform agenda pre- crisis. It stems from longstanding structural fiscal and sented below is meant to fertilize an open discussion external account imbalances and an overvalued cur- among the citizens of Lebanon as well as between the rency, all sustained through sovereign debt issuance citizens and their government. The perspective of the and financed by expatriate deposits. The long dura- reform agenda is technical, based largely on principles tion of the imbalances contributed to oversized bank of efficiency, equity, and governance. The decisions balance sheets that had extensive exposure to Gov- will have social and economic consequences and ernment and BdL debt. The preceding section of the must therefore be ultimately political. Several good LEM explains how policy inaction is sowing the seeds proposals have been published in Lebanon, mostly of an economic and social catastrophe for Lebanon. at the beginning of the economic crisis. The current This Special Focus of the LEM presents a compre- proposal is different in that it is being published after hensive reform agenda that will address the nested a year of stalemate and policy inaction, and puts gov- causes of the economic crisis and deliver a more eq- ernance reforms at the fore. Its aim is to contribute to uitable, efficient, and resilient economy. The reform the debate that needs to take place regarding (i) the agenda puts governance improvements at the fore, path to exit the crisis; (ii) the sequencing of reforms; alongside macroeconomic stabilization. Before any financing for an economic recovery can take place, Lebanon must restore the trust between government 30 This Special Focus section is a product of the Lebanon and citizens, between government and investors, and country Team. 27 and (iii) the long-term development vision. The Special • The First Strategy (FS) carries the potential Focus begins with a grim reminder of the reasons for of a large development payoff, but, given the policy inaction, which were unfortunately visible as deep-rooted and symbiotic nature of the over- early as 2016 and need to be addressed. arching constraints, it will take time to bear fruit. Examples include implementing key out- standing elements of the Taef Accord, such as Governance Failure and Causes of adopting a decentralization law and creating Policy Inaction a lower chamber of parliament to be elected on a non-confessional basis, improving ac- Lebanon’s economic crisis has its roots in elite cess to (statistical) information, and promoting capture and regional conflict, both of which served political stability and institutional reform and to block reform and development when it did not development. benefit all confessional leaders. The World Bank’s • The Second Strategy (SS) is more suited to 2016 Systematic Country Diagnostic (SCD) placed delivering gains in the short term, but given the the root of Lebanon’s economic underdevelopment weight of the overarching constraints, these in the presence of two mutually reinforcing and gains are likely to be more limited in scope. Ex- overarching constraints: (1) elite capture behind the amples include conducting a political economy veil of confessionalism and confessional governance and conflict exposure analysis of nested sec- and (2) conflict and violence, stemming, in part, tors, devising a grand-bargain package of re- from the broader dynamics of conflict in the Middle forms, adopting an opportunistic approach (that East.31 These overarching constraints created a is, readiness to seize windows of opportunity fragile and dysfunctional political system, and a state when they arise), working around elite capture, that was unable to regulate political conflict and showing a willingness for “horizontal” social en- exercise sovereign authority. The SCD estimated the gagement, and managing the influx of Syrian cost of confessional governance at nine percent of refugees. GDP annually, at the time of its publication. Lack of political consensus on national priorities limited the This Special Focus of the LEM presents government’s ability to implement long-term and detailed elements of a Second Strategy of reform. visionary development policies. Inaction fueled several The purpose here is to identify the necessary policy additional constraints to development (these can also and institutional changes needed to put the economy be referred to as derivative or nested constraints) on a stable footing, start to root out corruption, and because they emerged due to the overarching constraints. In 2016, these constraints were identified to be macroeconomic instability, the weak business 31 Lebanon’s elite capture branches from its sectarian- environment, insufficient investment in infrastructure fueled fifteen-year civil war. The 1989/1990 Taef Accord (especially in lagging regions), skills mismatch ended the conflict and aimed to establish an equitable confessional system. However, its partial implementation with labor market needs, and weak institutions and enabled the wartime elite to solidify their power behind regulatory framework. All contributed to poor service the veil of confessionalism and resulted in a government delivery across the board and to poor development and state operating at the ‘lowest common denominator’ outcomes. In 2020, this list of constraints needs to in terms of efficiency and quality of services, a result of be extended to include defaulted public debt, an religious veto power. Syria facilitated decision making insolvent banking sector, high inflation, and multiple as an external power broker; its military withdrawal in 2005 created a new political dynamic, exposing exchange rates. Taef’s weaknesses represented in severe polarization Resolving elite capture is key for a sus- and consolidation of the sectarian state-within-a-state tained recovery. In 2016 the SCD recommended two phenomenon, resulting in persistent political deadlock strategies for reform, neither of which were followed: (World Bank, 2016). 28 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION FIGURE 30 • Reform Pillars Macroeconomic Stabilization Program Infrastructure Economic Human capital Recovery development opportunities development & growth Governance and accountability restore economic efficiency. These reforms address stabilization and better governance and accountability the secondary, derivative, and nested constraints. (Figure 30). Several of these reforms were presented during the Conférence économique pour le développement, par • A Macroeconomic Stabilization Program: les réformes et avec les entreprises (CEDRE) which Given that Lebanon’s macroeconomic conditions took place in Paris in April, 2018, were reviewed in the are rapidly and continuously deteriorating, this re- World Bank’s Assessment of the Capital Investment form agenda needs to start with a comprehensive Plan (CIP), 2018, were presented in the Government’s and credible macroeconomic stabilization plan. Financial Recovery Plan in April 2020, and were more Lebanon needs to arrest high inflation, rapid cur- recently included in the French Initiative. In order for the rency depreciation and the proliferation of mul- reforms to be launched, and to be effective and sustain- tiple exchange rates. It needs to put in place a able, they will need to be accompanied by foundational path to public debt sustainability based on debt agreements among Lebanon’s elite, which will require restructuring and a sustainable fiscal framework, the concurrent implementation of the First Strategy. and to include a strong social protection pack- age. The challenges of fiscal adjustment, and the necessary banking sector restructuring will A Reform Agenda for Stabilization, require full realization of resulting losses accord- Economic Efficiency, and Restoration ing to international accounting norms, which will of Trust need to be distributed according to the hierarchy of claims and in an equitable manner taking into At the heart of the proposed reform agenda are consideration past realized benefits. governance and accountability reforms that seek • A Governance and Accountability Reform to strengthen overall economic management Package: Internal failures resulting on the one in Lebanon in a way that is more inclusive and hand from corruption and inefficiencies in poli- more accountable; in doing so, the proposed cymaking and in public sector management and reform agenda seeks to rebuild trust. The agenda on the other hand from the implications of the is based on the strong assumption that the Lebanese broader conflict dynamics of the Middle East have policymakers want to rebuild a more productive, become mutually reinforcing and persistently limit equitable, and resilient economy. The reform agenda development. Lebanon needs to address the pri- compromises five pillars, which are anchored on macro mary sources of corruption and inefficiency in the SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 29 public sector in order to create budgetary sav- growth. The economic crisis will bring new ings, improve development impact, and begin to opportunities that primarily stem from domestic rebuild trust between government and citizens. price adjustments and the depreciated currency. Reforms under this package aim to rebuild trust Enterprises and finance must identify these by: (1) strengthening management of public funds opportunities and use them to create new jobs. through public finance, investment, and debt man- Lebanon will need to lighten the burden that it places agement reforms; (2) reforming public procure- on its enterprises by simplifying processes and ment, in part to increase fair private sector partici- procedures, reduce operating costs, and undertake pation; (3) improving transparency and inclusion fundamental reforms to level the playing field. through complying with and joining the Open Lebanon will also need to ensure that the banking Government Partnership (OGP); and (4) boosting sector has the ability to perform its intermediation accountability through anti-corruption and judi- function. These reforms can be supported by an cial reforms. These reforms can be viewed as the economic development plan that ensures markets building blocks of a public sector reform that is work efficiently and are unhindered by specific needed to rebuild the Lebanese state. sectoral constraints to growth. • An Infrastructure Development Reform • A Human Capital Development Reform Package: Lebanon’s dilapidated infrastructure Package: The deteriorating quality of Lebanon’s is a developmental constraint. Among the vital human capital will need to be arrested and basic services that are needed, Lebanon lags reversed. According to the World Bank’s behind in (1) electricity, (2) telecommunications, Human Capital Index (HCI) a worker of the next (3) port system, (4) transportation, and (5) water generation in Lebanon will be only 52 percent and sanitation. Lebanon needs urgent investment productive relative to her potential productivity in these sectors, which the state can ill afford, and with complete education and full health. This which the private sector is unwilling to undertake, figure is down from 56 percent in 2012 and is given opacity and weak regulatory governance. below the current averages for both upper- Immediate transparency initiatives and policy middle income and MENA countries, which and regulatory changes are required to attract stand at 56 and 57 percent respectively. As donor and private financing, which can trigger such, a key aspect of sustainability and growth initial investments and contribute to job creation for Lebanon’s economy is recapturing the and recovery. The 2018 Capital Investment Plan human capital potential. For Lebanon, part of the (CIP) can be an effective tool in preparing an challenge is the fiscal constraint of supporting Infrastructure Development Reform package. necessary public services. The other part of the A World Bank assessment in 2018 found that challenge is sector efficiency and management. the CIP choice of sectors was appropriate for A strategy for stabilization, economic efficiency, Lebanon, and that many of the listed projects and restoration of trust needs to include were relevant, and some critical, to help alleviate infrastructural bottlenecks. Given the depth of 32 The Capital Investment Plan (CIP) includes over 280 the current crises and financing constraints, infrastructure projects across the country divided investment priorities and phasing will need to be among energy, transport, water, wastewater, solid reviewed. Reforms to limit fiscal and quasi-fiscal waste treatment, telecommunications, special economic deficits of state-owned enterprises, strengthen zones and culture and tourism. Sectorally, the largest management, regulation and governance, and investment share is allotted to the transportation sector, amounting to 32 percent of the total CIP, of which 8 encourage private investment will need to be percent is allocated to land expropriation. Almost one prioritized.32 quarter of the investments are reserved for the energy • An Economic Opportunities Reform Package: sector, while water and wastewater amount to 22 percent Lebanon’s private sector needs to drive economic and 12 percent, respectively. 30 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION TABLE 3 • High Priority: 7-Actions, 5-Programs and 3-Reviews 7-Actions 5-Programs 3-Reviews 1. Adopt 2021 Budget, and 2021-2022 sustainable 1. Expand the Social Safety Net System (the 1. Review of new Competition Law macro-fiscal framework National Poverty Targeting Program) and reform exclusive agencies 2. Exchange rate unification and capital controls law and 2. Implement broad-coverage compensation regulations BdL audits scheme for Subsidy Reform 2. Review and assess role and 3. Adopt Electricity Regulatory Strengthening governance arrangements of CDR 3. Restructure public debt and other public institutions (incl. Package, launch EdL Audit and ensure 4. Adopt effective bank resolution framework transparency in the procurement processes SOEs/PCs) that carry out public 5. Remove bank secrecy law 4. Adopt and launch tax compliance and reform investments package 3. Launch Public Investment 6. Implement public procurement law Management reform program 5. Launch Citizens’ Groups that develop 7. Establish a High-level Justice Reform Committee, expertise on key issues or line ministry and prioritization review for an announce an Action Plan to Improve Justice and Rule of programs infrastructure investment plan Law and implement Anti-Corruption Strategy necessary strategic and efficiency reforms that address pubic spending, taxation, social safety nets, support the development of human capital, and electricity provision, rebuilding the Port of Beirut at the same time create fiscal space to inscribe better, etc.33 such expenditure to support such reforms in a While the rest of the Special Focus presents sustainable budget framework. However, the a detailed set of short and medium term reforms, first element of the human capital development the most critical immediate reforms needed to reform package needs to be a strong social jump start the economy and rebuild trust are pre- protection package that is an integral ingredient sented in Table 3. Several of these reforms would of the macroeconomic stabilization program. form part of a macroeconomic stabilization plan.34 Many reforms would need to be adapted to a new Implementation of the reform agenda will growth strategy and a new development model for require a new form of economic governance Lebanon. that is inclusive, transparent, and accountable. Decisions will need to be based on rigorous analysis, publicly available evidence, and con- 33 The RDNA adopted a “Whole of Lebanon” approach in which a multi-disciplined team closely engaged with sensus on the economic and social trade-offs. representatives and stakeholders from distinct spheres This approach could develop into a sixth reform and segments of Lebanese society. This approach pillar, to be developed in collaboration with civil has helped to inform RDNA findings, analyses, and society and with government. Challenges to policy recommendations on emerging needs and priorities of formulation and consensus building have been the affected population. the hallmark of policymaking in Lebanon. While 34 This list is adapted from Priority Reforms for the Government of Lebanon, World Bank Policy Paper, Lebanon struggles to reach consensus, governance 2017, given the deteriorated macroeconomic conditions models based on transparency and public dialogue in the country. That paper had identified the following aimed at building consensus on particular issues priority reforms: (1) ratification of the 2017 budget, should be piloted. Based on the “Whole of Lebanon” (2) ratification of the 2013 public procurement law approach introduced in the Beirut Rapid Damage (completed), (3) fiscal reforms to cap transfers to EdL, and Needs Assessment (RDNA) it is possible to (4) cabinet adoption of draft PPP Law (completed), (5) launch of tender for LNG, (6) increasing power envision fora that bring together government, civil generation, (7) prepare Beirut public transport project, society, the private sector, activist groups, youth (8) scale up of NPT, (9) parliamentary approval of solid groups, think tanks, academia and the international waste management law, and (10) improved business community. These fora can be issue focused, and environment. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 31 Pillar I: Macroeconomic Stabilization: • Lebanon’s policy response needs to A Necessary, but not Sufficient, comprise in the medium term strengthen BdL’s Condition to Growth balance sheet. High inflation, loss of foreign currency reserves Element 2: Public Debt Restructuring and a worsening fiscal deficit, all argue for urgent action and a comprehensive program to stabilize With public debt projected to reach 194 percent the economy. Delayed action maintains high inflation of GDP at end-2020 and interest costs at 10 and foreign reserve losses with enormous costs to percent of GDP, Lebanon needs to negotiate a households and enterprises. However, a program that medium-term debt plan with creditors to return to is not comprehensive and does not put public debt on fiscal sustainability. On March 9, 2020, Government a sustainable path, introduce a credible monetary and defaulted on its marketable foreign currency debt. exchange rate policy, and restore solvency in the banking Reducing debt to a sustainable level is necessary to sector will not succeed in stabilizing the economy. Partial regain prospects for market access and to address the solutions will signal that current challenges risk being economy’s financing limitations caused by a defaulted repeated and will likely not restore investor confidence credit rating. This requires negotiating with creditors or set foundations for a new growth model. (domestic and external) over a medium-term debt plan, based on a solid macroeconomic framework, in Element 1: Monetary Stabilization order to restore public debt sustainability. Over the past 12 months, fiscal, monetary, and • Lebanon’s policy response needs to comprise exchange rate policies fueled high inflation, in the short term (1) Macroeconomic and Debt the proliferation of multiple exchange rates, Sustainability Framework; (2) domestic debt - and a rapid depreciation of the Lebanese Lira. Medium Term Plan; and (3) temporary body to Stop-gap measures as well as new policies are handle debt restructuring. needed. The Lebanese Lira depreciated from the • Lebanon’s policy response needs to official rate of 1,507.5 per USD in August 2019 comprise in the medium term agree on before the crisis fully materialized to about LL 8,500 external and domestic debt restructuring plans in October 2020 on the dollar note market (that and on losses with creditors, subject to equitable market peaked at about LL 10,000 per USD). The burden sharing. depreciation resulted from the loss of confidence in the economy and the deterioration in the Element 3: Financial Sector Restructuring fundamentals (discussed earlier in the LEM). The and Resolution central bank’s efforts to ration foreign exchange and slow the loss of reserves led to multiple exchange Lebanon’s banking sector needs to address its rates and are unsustainable. Additional depreciation worsening portfolio before playing an active role pressures arise from the need to finance the fiscal in Lebanon’s economic recovery. The fundamental deficit (mainly salaries, transfers, and debt payments restructuring of the banking system (BdL and banks) notwithstanding the selective debt default) in light of is imperative to resolving the ongoing financial crisis the collapse in revenues. To reduce inefficiencies in and paving the way to recovery. Given the banking the foreign exchange market: sector’s large exposure to the sovereign (government and central bank), this implies recognition of banking • Lebanon’s policy response needs to comprise sector losses and requires restructuring of the in the short term 1) BdL independent audits; sector to attain solvency. The aforementioned debt (2) capital controls law; and (3) policy actions on restructuring will result in unprecedented losses exchange rate and monetary policy framework. to the local banking sector. The recognized losses 32 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION would form a key parameter in the financial sector purposes: first, to clarify depositor protection in the con- restructuring strategy, ensuring the recapitalization text of the resolution of the current crisis and second, of systemically important banks, equitable burden- to restore public confidence in the banking sector sharing, and the orderly exit of insolvent non-systemic going forward. Updating the framework would include banks. This strategy should be supported by the clarifying coverage, recapitalizing the deposit insur- legislative initiatives that are necessary to establish an ance fund, improving governance arrangements and effective bank resolution framework. The intertwining enhancing the role of deposit insurance in resolution, of balance sheets of government, commercial banks, such as options to finance asset and liability transfers, and the central bank suggests a similar restructuring under the “least cost” criterion, to support resolution. of BdL’s balance sheet will be required. • Lebanon’s policy response needs to • Lebanon’s policy response needs to comprise in the short term an update of the comprise, in the short term (1) update bank deposit insurance framework. resolution framework; (2) implement banking sector restructuring; and (3) restructuring of Lebanon’s insurance sector has also been BdL’s balance sheet. adversely affected by the crises. Given the insur- • Lebanon’s policy response needs to comprise ance sector’s large exposure to the sovereign, a in the medium term (1) improve supervisory restructuring and development strategy for the sector early intervention mechanisms; and (2) improve will be essential to strengthen the sector and close emergency liquidity assistance arrangements. the protection gap highlighted in the PoB explosion. The insurance sector also faces challenges as it has Another result of the ongoing crisis is seen the value of its assets deteriorate in light of the the drastic deterioration of the credit portfolio, deteriorating quality of government bonds and a which must be be resolved. NPL ratio (including surge in claims due to the PoB explosion. Beyond unearned interests) increased to 28.3 percent as of immediate priorities of supporting claim settlement June 2020, up from 13.3 percent at end-June 2019. in the aftermath of the PoB explosion, authorities NPL ratio for construction, wholesale and retail trade, should closely monitor and manage insurer solvency, and processing industries stood at 47 percent, 40 including establishing policies on solvency forbear- percent, and 42 percent, respectively. Improving the ance, industry consolidation and defining the scope frameworks for insolvency and out-of-court workout and modalities for potential direct assistance to poli- could help resolve both the widespread corporate dis- cyholders of failed insurers. To address these issues: tress and NPLs in the banking sector and facilitate the ultimate recovery of the economy. Authorities should • Lebanon’s policy response needs to comprise also consider imposing regulatory requirements to in the short term (1) develop insurance promote timely NPL recognition and provisioning, sector restructuring development strategy; and providing supervisory guidance for banks to develop (2) update and enact Insurance Law. a credible NPL management and recovery strategy. • Lebanon’s policy response needs to comprise in the medium term (1) initiate • Lebanon’s policy response needs to insurance sector restructuring; and (2) improve comprise in the short term (1) develop an regulatory governance. out-of-court workout framework; and (2) improve regulatory guidelines on NPL recognition and Element 4: Fiscal Deficit Reduction provisioning. Lebanon’s widening primary balance is An update of Lebanon’s deposit insurance driven by inefficient and unaffordable current framework is important. This would serve two expenditures (with subsidies and generous SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 33 pensions causing economic distortions) and (3) implementing the Macroeconomic and Debt weak and declining revenues. A credible and Sustainability Framework; (4) reducing transfers sustainable path to fiscal sustainability needs to EdL (phased);37 (5) VAT and Customs Reform to introduce efficiencies in public spending and (phased); (6) unified Income Tax Code and au- revenue collection, and to create fiscal space for tomatic income tax declaration; (7) subsidy re- an adequate social protection scheme. In the latest form; (8) address SOE revenue/dividend transfer ‘pre-crisis’ year, 2018, Lebanon’s non interest framework and cash management hurdles; and expenditures were 21.9 percent of GDP and were (9) civil service review by an independent inter- broken down as follows: public employment bill was national institution.38 11.4 percent of GDP,35 subsidies to EdL came to 3.1 • Lebanon’s policy response needs to percent of GDP, other current transfers came to 5.5 comprise, in the medium term (1) property percent of GDP, while capital expenditures were 1.5 taxation reform; (2) review move from a scheduler percent of GDP. Total revenues and grants came to a global income tax base; and (3) adjusting to 20.5 percent of GDP and the primary balance excises. was –1.4 percent of GDP. The 2018 figures mark a departure from the early part of the decade, when the primary balance was almost +1 percent (2000– 17). This departure highlights the burden of debt 35 Of the public employment bill, 34 percent went for retirees, pensions, and end of service compensations, on public coffers. Lebanon’s long-term challenge which cover about 10 percent of the labor force. was its inefficient and inequitable composition 36 Lebanon’s income tax structure has large disparities of public spending, and the lack of sustained across sources, distorting the flow of savings away incremental efforts to obtain a primary surplus, from productive investment. Bank deposits in Lebanon which were hindered by governance challenges have yielded relatively high returns, a policy intended to outlined earlier. In 2020, with a projected primary support public debt and the overvalued exchange rate. Meanwhile, tax rates on interest earned are 10 percent, balance of –3.6 percent of GDP, Lebanon’s debt far below the 17 and 15 percent rates on corporations is projected to increase if no action is taken. To and individuals, respectively. It is estimated that the reverse the trend, Lebanon needs to amend the largest 1 percent of depositors hold 50 percent of total 2020 budget and prepare a 2021 budget consistent deposits, while the largest 0.1 percent of accounts hold with a macroeconomic and debt sustainability 20 percent of total deposits (WB-IMF FSAP, 2017), framework negotiated with debt holders. With the skewing the lower financial income tax rate towards the very rich. framework, Lebanon will need set the building 37 Transfers to EDL can be reduced through (a) reducing blocks to achieving fiscal sustainability over the network and commercial losses on EDL’s system medium and long-term. To start, Government should and improving collections and to increase EDL’s introduce measures to boost direct and indirect tax revenue, (b) accelerating switching to natural gas compliance and revamping Lebanon’s tax structure, for power generation to reduce EDL’s generation including, but not limited to, income tax unification costs, (c) increasing electricity tariffs, targeting higher consumption blocks, and adopting an automatic and raising VAT.36 Several institutions have proven indexation mechanism to pass to targeted consumers useful in reaching fiscal targets; for Lebanon, a fiscal fuel cost and foreign exchange fluctuations. council can aid evaluation and adjustment in the 38 Maintaining a sound fiscal positioning is key for context of short to medium-term macroeconomic achieving macroeconomic stability. While voters and objectives. As such: financial markets punish fiscal mismanagement, they are often late. Independent scrutiny by a transparent fiscal council can contribute towards achieving fiscal • Lebanon’s policy response needs to discipline by incentivizing governments to allocate and comprise, in the short term (1) adjust- manage public resources in an efficient manner. The ing 2021’s budget and preparing 2022’s on council can consist of independent experts entrusted time; (2) fiscal council becomes operational; to provide information to push policymakers in the 34 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION Element 5: Social Protection and Pension • Lebanon’s policy response needs to Reform comprise, in the short term (1) initiate Public Pension Reform; (2) conduct audit of NSSF; and Lebanon’s economic crisis has led to a deepening (3) parliament to pass Pension Law for private of overall and extreme poverty with continued poor sector workers. prospects unless a reform program were to be • Lebanon’s policy response needs to adopted. The World Bank estimates that total poverty comprise, in the medium term (1) Public reached 45 percent of the population in 2019, up from Pension Reform; (2) initiate financial and about a third in 2018 and from 27.4 percent in 2011– governance reform of NSSF; and (3) implement 2012, while extreme poverty reached 22 percent in new Pension Law. 2019. A slow recovery of the economy and reduction in public spending (including pensions and subsidies) Element 6: Consensus on an Economic will place an additional burden on the poor and near Recovery and Growth Plan poor, which will have immediate effects on food consumption, but also more permanent effects from The lack of consensus on an alternative economic lower consumption of education and health services. vision for Lebanon is a contributing factor to the Currently, Lebanon spends only 0.35 percent of GDP current crisis. Lebanon’s economic performance on targeted social safety nets (compared to well over since 2011 is noteworthy in that it proved resilient to 3.5 percent of GDP on subsidies and untargeted regional crises and the absorption of 1.5 million Syrians SSNs). To mitigate the impact: (which amounted to about 30 percent of Lebanon’s population); economic growth averaged 1.8 percent • Lebanon’s policy response needs to com- per year between 2011 and 2017 (see Table 4). But prise, in the short term (1) COM approval of a the rate of growth and the quality of growth were National Social Protection Strategy;39 (2) expand unsatisfactory because unemployment remained high, National Poverty Targeting Program (NPTP) per the economy did not produce the quantity and types of the Emergency Social Safety Net (ESSN) pro- jobs needed to absorb the majority of the labor force, gram and provide financing in 2021 Budget; and and the economy did not innovate, except in the area (3) establish National Social Registry. of financial services and possibly construction. One reason was the large public debt and the overvalued Public pension expenditures amounted to exchange rate needed to support it and the currency 3.9 percent of GDP in 2018, while only benefiting peg, which provided contradictory incentives to 10 percent of the Labor force. The majority of diversification and large scale export development.40 pension costs are financed through the budget and Another reason was the lack of contestability in the the pensions deficit exceeds 3 percent of GDP. On domestic economy which did not create market the other hand, coverage among the private sector incentives for innovation or competitiveness. To chart an does not exceed 20 percent of the employed. In short, Lebanon’s current pension system serves few of the country’s citizens, crowds out other social programs, direction of implementing more responsible and efficient and adds to budget deficit. Current circumstances policies. (Cangiano, Curristine & Lazare, 2013). require a decisive set of measures that would bring 39 Including the design of a centralized and transparent both short term fiscal relief and address the long grievance redress mechanism and a corresponding run structural deficiencies in the design of the pen- online platform to capture information on the changing needs of those impacted, the accessibility and sion schemes. The outcome of the reform measures awareness of services, and perception of fairness in the would need to be a fiscally, economically, socially, provision of services. and actuarially fair national pension system serving 40 Final consumption expenditure averaged 104 percent of all citizens. GDP between 2011 and 2017. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 35 efficient course for macroeconomic stabilization and to Pillar II: A Governance and realign its macroeconomic fundamentals to support the Accountability Reform Package development of a more equitable, efficient and resilient economy: Early sequencing of governance and accountability reforms can reduce corruption, boost public sector • Lebanon’s policy response needs to com- efficiency and begin to restore trust between the prise in the short term, following the revision government and its three critical partners: citizens, of existing growth plans, agreement on an eco- investors and donors. According to Transparency nomic vision for Lebanon and action plan tai- International’s Corruption Perception Index, Lebanon lored for promoting sustainable and equitable ranks 137 out of 180 countries, indicating high economic growth and resilient financial inflows. corruption levels. A robust agenda on governance A comprehensive investment strategy (private, and accountability reforms can overturn some of public) review, reprioritization and operational- the principal sources of corruption and elite capture ization and export development strategy cou- in Lebanon. These reforms would form the building pled with a corresponding strategy tailored for blocks of state building and be critical contributors to the agricultural and industrial sectors, which the success of other reform pillars. The purpose of the can serve as a source of job creation and ex- governance and accountability reform package would port proceeds, is also required. The foundation be to boost efficiency in public financial management, for the strategy has to be a sustainable macro- provide for judicial independence, reduce corruption, economic framework, a competitive exchange and strengthen oversight bodies. rate reflective of Lebanon’s new economic fun- damentals, and as noted below, a level playing Element 1: Public Procurement Reform field for the private sector. These policies can set Lebanon in a direction of equitable growth Strengthening public procurement is a critical based on productivity gains. element of government reform. Public procurement Empirical Evidence behind Lebanon’s Pre-Crisis Economic Slowdown TABLE 4 •  Contribution to Total Real GDP Annual Growth (in percentage points) Expenditure Type 1992–2017 1992–2000 2001–2007 2008–2010 2011–2017 Annual GDP Growth 4.4 5.2 4.4 9.0 1.8 By Expenditure Consumption 4.5 3.4 2.3 9.7 3.9 Households/NPISHs Consumption 3.9 2.2 2.1 9.1 3.4 Government Consumption 0.6 1.2 0.2 0.6 0.4 Investment 1.0 0.7 1.0 2.8 0.2 Exports 1.7 2.7 2.8 3.4 –0.3 Imports –2.8 –1.5 –1.5 –6.9 –2.0 By Sector Agriculture 0.2 0.4 0.0 0.2 0.1 Industry 0.6 0.7 0.8 1.0 0.0 Services 3.7 4.1 3.6 7.8 1.7 a Data Sourced from World Development Indicators (1992–2017). b Growth rates are weighted by the average share of total Value Added in the beginning and end years. c Expenditure growth rates weighted by their average share in total expenditure (evaluated in the mid-point between beginning and end of the period). 36 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION is governed by the 1963 Public Accounting Law the budget and treasury functions. In parallel, public and is supplemented by several decrees. The main oversight institutions are also weak, as both internal areas of the law that require attention are: (1) a weak control and audit functions are almost absent in the control environment that cannot implement rules and public sector, which increases the risk of misuse of procedures; (2) lack of an independent regulatory body public funds in budget execution. These key PFM and independent mechanism for handling procurement challenges have negative effects on fiscal policy, complaints; (3) lack of procurement performance budget transparency, debt and cash management, information/data; (4) weak competition for contracts; public investment management, and public service and (5) weak implementing agencies. Resolving these delivery in Lebanon. As a result, PFM reforms are a issues demands reforming toward a well-governed high priority. In order to develop a well-functioning public procurement system that helps increase public PFM system that promotes trust and accountability: trust, enhance quality of services, build a prosperous, broader, and more equitable access to the procurement • Lebanon’s policy response needs to com- market for the private sector (including SMEs, women, prise in the short term (1) revamp and revital- and youth), facilitate access to information, and increase ize a national PFM steering committee; (2) up- inclusion of stakeholders including civil society. date cash safety buffer; (3) integrate cash and debt management and prepare analysis reports; • Lebanon’s policy response needs to com- (4) ratify a revised Court of Account Law and en- prise in the short term (1) development and large scope of audits; (5) complete assessment validation of a public procurement strategy; and recommendations for institution Internal (2) public procurement law enacted; (3) second- Audit (IA); (6) update macro fiscal models; (7) ary legislation drafting and adoption; (4) standard formalize data flow from/to Macro-Fiscal Depart- bidding documents developed (phased); (5) es- ment (MOUs); and (8) review of Budget System tablishment and operationalization of an inde- Law (BSL). pendent procurement regulatory body and Policy • Lebanon’s policy response needs to com- and Oversight and Complaints Handling Units; prise in the medium term of (1) develop and and (6) assessment of e-procurement initiatives. implement action plan for consolidating cash ac- • Lebanon’s policy response needs to comprise counts; (2) enact/ amend related treasury single in the medium term (1) capacity building and pro- account laws & decrees; (3) treasury single ac- fessionalization of the procurement function; (2) de- count operational; (4) strengthen the indepen- velopment of e-procurement strategy and functions; dence and capacity of the Central Inspection and and (3) deployment of the validated e-procurement Court of Accounts (including forensic audits); platform at decentralized level and training (phased). (5) finalize the audit of previous financial state- ments; (6) issue Ministerial decrees for establish- Element 2: Public Financial Management ment of IA; (7) develop IA Strategy, charter and (PFM) and Public Investment Management manuals, and carry out capacity building; carry (PIM) Reform out the IA function ; (8) introduce quarterly eco- nomic evaluation reports, including policy impact Strengthening the PFM system is a crucial assessments, public finance monitor (PFM) and strategic choice to improve transparency, fiscal risk reports; (9) implement new accounting accountability, and efficiency in managing public procedures; (10) transition to IPSAS; (11) update finances and investments. Lebanon’s PFM system BSL and/or regulations; and (12) implementation is based on the Constitution and the outdated and review of updated BSL and regulations. rigid 1963 Public Accounting Law (PAL). The control environment is weak, leading to a lack of enforcement Lebanon’s Public Investment Management of rules and guidelines and severe fragmentation in (PIM) is also weak. The development of public SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 37 infrastructure is hindered by low investment quality approved medium-term debt restructuring framework and inefficiency. Lebanon displays an efficiency and its underlying macroeconomic framework demands gap of 43 percent compared to the most efficient a revision of the public debt management law and prac- countries with similar capital stocks. The gap partly tices. Ensuring debt sustainability is vital to exit this cri- stems from weak procedures and practices governing sis and avoid a double dip. Between 1980 and 2012, public investment. Many of the country’s policies and out of the 44 countries that restructured their debt, 86 procedures, as well as practices governing public percent had more than one restructuring (Lebanon’s investment are either partially or not at all aligned 2020 restructuring is the first in the country’s history); with good practices. PIM faces significant challenges: improving public debt management is paramount for (i) fragmentation of public investment between several GoL to avoid a double dip. Moreover, improving debt institutions; (ii) absence of fiscal policy formulation; management aids in raising credit ratings and achiev- (iii) non-alignment of the strategic planning with avail- ing market access. This requires a medium term debt able resources; (iv) non-existence of a unified and management legal framework, and the establishment comprehensive approach for project appraisal and of new functions, and strategies (medium term debt selection; (v) weak project oversight and monitoring; management; communication and investor relations). (vi) outdated legal framework; and (vii) weak oversight of investment, including procurement. These chal- • Lebanon’s policy response needs to comprise lenges contribute to the efficiency gap in PIM. in the short term (1) implement a medium- term debt management strategy (MTDS); and • Lebanon’s policy response needs to com- (2) design a framework for issuing, monitoring prise in the short term (1) review functions of and managing risks related to contingent the Council for Development and Reconstruction liabilities and longer-term fiscal commitments (CDR), Council of the South, Higher Council of (Fiscal Commitment and Contingent Liabilities). Refugee’s, line ministries and other public insti- • Lebanon’s policy response needs to comprise tutions including SOEs and Public Corporations; in the medium term (1) revise/ ratify public debt (2) develop mechanisms for enhanced MoF over- management law; (2) establish independent debt sight over SOE and Public Corporations; (3) im- management body; (3) prepare communication plement WB-IMF PIMA 2018 recommendations and investor relations strategy; and (4) establish (phased); and (4) launch Forensic Audit of SOEs. a primary dealer group. • Lebanon’s policy response needs to com- prise in the medium term (1) adopt legislation Element 4: Open Government regarding management large projects; (2) launch PIM framework; (3) develop Public Sector Balance Citizens and government can also capitalize on Sheet; (4) enhance capacity of MoF to financial technology to rebuild trust. In 2020 according to the control SOEs; and (5) review establishment of a United Nation’s 2020 e-Government survey Lebanon SOE and Public Corporations management entity. ranked 127 out of 193 countries on e-government development. Restoring credibility demands a new Element 3: Reinforcing Public Debt era for governance—an era that can be ushered Management in by implementing an inclusive and accountable government process through membership in the Open In order to promote better debt management, gov- Government Partnership (OGP) and supported by ernment can strengthen debt management insti- a whole of government digital transformation. Upon tutions. Signs of debt unsustainability had preceded attaining the OGP membership, citizen groups would Lebanon’s Eurobond default by years. However, de- be able to collaborate with government to develop ficiencies in debt management practices hindered Open Government Action Plans and help to monitor a credible response. The sustainability of a creditor all aspects of public service, thus empowering public 38 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION accountability. Moreover, the use of digital technology • Lebanon’s policy response to strengthen the can increase transparency while reducing physical anti-corruption framework needs to comprise interactions to help to reduce opportunities for corruption. in the medium term (1) fully implement the National Anti-Corruption Strategy; (2) conclude • Lebanon’s policy response needs to com- UNCAC Assessment of Lebanon’s anticorruption prise in the short term (1) full transactional govt efforts; and (3) conduct and publish monitoring administrative e-services available on Internet, mo- report on implementation of first year of Anti- bile, etc. at central and municipal levels; (2) commit Corruption Strategy (to include UNCAC to join Open Government Partnership (OGP); and assessment recommendations). (3) publish executive budget and audit reports. • Lebanon’s policy response to strengthen the • Lebanon’s policy response needs to rule of law needs to comprise in the short comprise in the medium term (1) strengthen term (1) establish high-level Justice Reform institutional capacity and deploy digital Committee and announce Action Plan to Improve assurance and performance management Justice and Rule of Law; and (2) adopt Court of systems; (2) implement a Whole of Government Accounts Law. Digital Transformation Strategy; (3) promote • Lebanon’s policy response to strengthen the public access to asset disclosure forms and data; rule of law needs to comprise in the medium (4) apply for OGP membership; Co-create first term (1) judicial independence law submitted OGP National Action Plan, NGO stakeholders; to parliament and approved; (2) initiate justice and (5) implement first OGP National Action Plan. sector assessment, and roundtables with justice stakeholders and CSOs; (3) judiciary revises and Element 5: Anti-Corruption and Judicial implements court performance improvement Reform plans based on findings of justice sector assessment; (4) judiciary continues implementing Anti-corruption and judicial reforms strengthen court performance improvement plans; and the rule of law and the country’s ability to fight (5) High-level Justice Reform Committee submits corruption and limit elite capture. According to the annual progress report with roundtables. Arab Barometer (2019), 91 percent of Lebanese citizens • Lebanon’s policy response to strengthen report corruption as a problem within state institutions transparency needs to comprise in the short to a large or medium extent. Lebanon’s overarching term (1) fully implement the Access to Information governance crisis can be partially attributed to Law; (2) implement the whistleblower protection underdeveloped anti-corruption frameworks and wide- law; and (3) lift Banking Secrecy Law. spread judicial dependence on political parties. In the aftermath of the Port of Beirut explosion, strengthening With stronger anti-corruption measures and state institutions and making them more inclusive and the increased rule of law, the implementation of accountable are top priorities; these reforms feed into the whistleblower protection law (approved pre- providing constraint against elite capture, the country’s viously by parliament) creates a line of defense most prominent development roadblock. against statewide corruption, fueled by elite cap- ture, that is hindering Lebanon’s development. • Lebanon’s policy response to strengthen the anti-corruption framework needs to comprise Element 6: Reforming Municipalities in the short term (1) accede to the 1997 OECD treaty on combating corruption; (2) create an anti- The Government of Lebanon needs to enhance the corruption commission and fully staffing it; and role of municipalities as a provider of basic service (3) adopt and implement the Illicit Enrichment provider and empower them with adequate techni- Law and assets declaration law. cal and financial capacity for local development SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 39 in Lebanese cities. Municipalities are at the forefront worsened productivity, and put the country on of local development and service delivery in Lebanon. a lower growth trajectory. According to the World Municipalities also play a key role in disaster response Economic Forum’s (WEF) Competitiveness Index as was evident from their role following PoB explosion. Lebanon’s infrastructure is a major constraint to Historically, however, financial and capacity constraints growth; Lebanon ranks 89 out of 140 countries have limited the effectiveness of the municipal services for the quality of infrastructure. Lebanon lags in provided by Lebanese municipalities. Key challenges several basic areas: electricity, telecommunications, include, among others, decline in municipal invest- transportation, and water and sanitation. The PoB ments, weak own source revenues, unpredictable explosion added to Lebanon’s infrastructure needs. intergovernmental transfers, and a hiring freeze and Improving the quality of infrastructure demands retrenchment of municipal employees. These devel- sizable investments and governance and regulatory opments have eroded living standards, accelerated reforms. Challenges on the public sector financing environmental degradation, and undermined public side, and international experience in provision confidence in local governments. Also, a combination of quality infrastructure services suggest that a of a difficult macro-economic and fiscal situation, the much larger role in infrastructure provision can be large influx of Syrian refugees, an alarming outbreak of accorded to the private sector in Lebanon. With a the COVID-19 pandemic and the recent PoB explosion clear governance and regulatory reform agenda at have further contributed to the deterioration of both the the sectoral level, clear visions, judicious use of the level and quality of municipal services. public private partnerships (PPP) framework would allow Lebanon to create the right opportunities for • Lebanon’s policy response to strengthen private sector participation and financing. Out of the transparency needs to comprise in the box solutions can also be utilized to pool capital from short term (1) enhance role of municipalities investors in to diversified funds. In addition, given the in implementing integrated spatial planning uncertainty surrounding the policy environment in frameworks for local development; (2) public Lebanon, instruments for additional guarantees/risk disclosure of decisions and financial statements; mitigation could be developed. To this end: (3) improved capacity for financial management; (4) introduce transparency, accountability, • Lebanon’s policy response needs to predictability and reliability of intergovernmental comprise in the short term (1) Enable and fully fiscal transfers; and (5) establish a municipality staff the Higher Council for Privatization (HCP); One-Stop-Shop with sub-windows. and (2) conclude review of PPP regulatory • Lebanon’s policy response to strengthen framework, currently being undertaken by transparency needs to comprise in the me- EBRD. dium term (1) coordinate of responsibilities with • Lebanon’s policy response needs to stakeholders; (2) promote private investments; comprise in the medium term (1) include PPP (3) engage with citizens; (4) incentive mecha- commitments in the FCCL framework and MTDS; nisms for improved municipal performance; and (2) widen use of public-private partnerships; and (5) implement reforms for improved administra- (3) develop a comprehensive diagnostic and tion of intergovernmental fiscal transfer (IMunF). strategy for infrastructure planning and finance in Lebanon, covering public, PPP private sector investment. Pillar III: Infrastructure Development Reform Package Element 1: Electricity The under-provisioning of infrastructure in Lebanon’s power sector has undermined fiscal Lebanon has created gaps in service delivery, sustainability and economic growth objectives 40 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION for many years. Transfers to EdL between 1998 thermal power plants and advance on existing and 2019 accounted for 30 percent of GoL’s debt renewable energy initiatives; (7) agreement on at end-2019; reforming the sector is paramount concession model for the distribution sector; (8) for jumpstarting a recovery and achieving debt competitively select concessionaires; (9) reduce sustainability. Lebanon’s energy sector has been a distribution network system and commercial development bottleneck for many decades. The influx losses, consistent with targets established in of Syrian refugees further exacerbated the power the Sector Policy paper adopted in April 2019, sector’s challenges. Several attempts to reform it by modified to reflect developments since 2019 various governments and by development partners, (phased); (10) adjust tariffs to cost reflective including the World Bank, have been unsuccessful. levels while ensuring affordability for poor and Budget transfers to EdL averaged 3.54 percent of less advantaged consumers (phased); and GDP between 2011 and 2017. The sector’s deficit (11) prioritize capital investments needed to is the byproduct of non-cost-reflective tariffs and increase generation and transmission capacity high costs from operational inefficiencies—key to ensure adequacy and reliability of electricity among them is the utilization of highly polluting supplies (phased). and expensive diesel and heavy fuel oil rather • Lebanon’s policy response needs to comprise than cleaner and more economical natural gas or in the medium term42 (1) operationalize the renewables, which, in fact, would have a significant ERA; (2) start construction of new thermal and balance of payments benefit. In response, the World renewable energy plants; (3) launch process Bank outlined solutions in a paper entitled “Lebanon to privatize publicly owned generation plants; Power Sector Emergency Action Plan – 2020”. The (4) install and operate private-sector floating gas plan aims at implementing the core requirements import terminals; (5) complete negotiation of of Law 462 with subsequent amendments,41 which concession agreements and mobilization/transfer was promulgated in 2002 but not implemented. The of control of the distribution system; (6) start law called for restructuring the sector by limiting construction of requisite transmission upgrades; EdL’s role to transmission system operations while and (7) revise building codes and facilitate migrating the distribution and generation assets concessional financing to incentivize energy to private sector ownership and operation, with efficiency and renewable energy upgrades. oversight from an independent and autonomous regulator. The plan also targets modernizing Element 2: Telecommunications operations, governance, and transparency according to international standards, and promotes adopting Lebanon’s telecom sector is heavily set back a utility-scale renewable energy program to comply by opacity, high cost to consumers, and low with announced 2030 renewable energy targets. In service quality, and it has fallen behind other order to implement the plan: middle-income countries along most metrics.43 The sector suffers from high costs and low quality; • Lebanon’s policy response needs to comprise in the short term adoption of 41 Given the reform agenda’s wide scope, Law 462 an Electricity Regulatory Strengthening requires amendments to facilitate the establishment of Package: (1) update sector policy note to reflect concessions, rebuilding the destroyed EdL building (due the country’s current conditions; (2) implement to the PoB explosion) and boarder restructuring of the Law 462 with subsequent amendments; (3) staff sector. 42 Reforms can be supported by updating the 2010 and empower the Electricity Regulatory Authority electricity sector policy note. (ERA); (4) adopt a least-cost generation expansion 43 Telecommunications Sector Reform: Fiscal Impact plan; (5) prepare EDL audited financial statements Assessment of Different Liberalization Scenarios, World for previous years; (6) launch tenders for new Bank analysis, June 2020. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 41 as a result, it has fallen behind other middle-income and define the role of port communities in the man- countries. Lebanon ranked 95 out of 141 countries agement of the sector and the monitoring of its per- in ICT adoption in 2019, according to the World formance. Other needed reforms target customs and Economic Forum, and 195 out of 221 countries in trade facilitation as well as cost accounting and tariffs. broadband speed in 2020 according to Cable’s To enhance the overall resilience of the port sector, Worldwide Broadband Speed League; moreover optimize operations throughout the national coastline, mobile data and voice prices are about 2–3 times and balance public and private investments, there is its regional peers (Morocco and Egypt) according to also a need to prioritize development of a national GoL’s 2018 economic vison. Crucial reforms include strategy for maritime clusters, ports, logistics, and the adoption of a unified vision for the sector that corridors, taking into consideration potential comple- highlights: (1) the direction of reform policy; (2) a mentarities between the Lebanese ports. liberalization roadmap; (3) potential legal framework changes; and (4) an implementation timeline. Current • Lebanon’s policy response needs to telecom Law No. 431 of 2002 merits a fresh look to comprise in the short term (1) enact corridor- ensure it is still suited to the fast-evolving sector, and based strategic planning vision; (2) adopt port to guarantee citizens access to high-speed, reliable, sector reform principles; (3) pass new port sector and affordable broadband. Any potential revision law; (4) establish a port management authority; should address the sector’s regulatory framework (5) approve a Customs & Special Economic and the emergence of new services and business Zones Modernization program; (6) update models. To this end: the PoB master plan; and (7) establish port communities. • Lebanon’s policy response needs to • Lebanon’s policy response needs to comprise in the short term44 (1) appoint comprise in the medium term (1) build Telecom Regulatory Authority (TRA) Board; capacity at the ministerial and port authority (2) review telecom Law No. 431 for potential levels; (2) digitalize processes: port community revision; and (3) create a standard license for system, maritime single window and national Data Service Providers. single window; (3) enact port tariff reform; • Lebanon’s policy response needs to (4) implement cost accounting in POB and POT; comprise in the medium term (1) develop a (5) identify potential public-private partnerships unified Telecom Sector Vision; and (2) create a (PPPs) and ensure competitive bidding. reference offer for access to MoT’s ducts. Element 4: Transportation Element 3: Port System Endemic traffic congestion was estimated to cost The Lebanon port sector mixes different institu- Lebanon 8 percent of GDP annually (World Bank, tional models that do not promote efficiency nor 2017). Road transport holds the lion’s share of pas- transparency. Reforming the Lebanese port sector senger, freight, and commerce transport in Lebanon; it requires addressing these two criteria, and would be accounts for 25 percent of all energy consumption. De- best achieved, according to international best prac- spite its relevance, Lebanon’s road network ranks 127 tices, by adopting a three tiered structure: (i) a na- tional port administration setting policies and national strategies; (ii) port-level port authorities structured on 44 Developing the telecommunications sector can benefit from adopting of a unified vision for the sector the landlord port model (in the form of a corporatized through stakeholder engagement (technical and legal public entity); and (iii) operations delegated to the experts) that highlights: (i) reform policy direction; (ii) a private sector through PPP, concession, or licensing liberalization roadmap; (iii) changes in legal frameworks; agreements. The new framework shall also recognize and (iv) implementation of the roadmap. 42 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION out of 140 countries in terms of quality45 (WEF 2019), Element 5: Water driving up congestion. The problem is further amplified by the lack of a well-functioning public transportation Lebanon needs to accelerate water sources system, thereby requiring that residents move closer to diversification and implement demand the capital. While the transport sector generates signifi- management measures to cope with natural and cant fiscal resources to the government (ports, airport, human-made shocks. Today, Lebanon stores only taxes on vehicles and gasoline) its revenues lack trans- 6 percent of its total water resources, considerably parency; moreover, expenditures and financing into the lower than the MENA average of 85 percent. Despite sector lack planning and have been low and inefficient. relatively high network coverage (79 percent on A National Transport Strategy is essential to assess the average), water service delivery quality is sub-standard complementarity of the transport sub-sectors, institu- with intermittent supply shortages and limited tions, and projects to improve the synergies among wastewater treatment. This situation notably impacts them and therefore the efficiency of the whole transport the poor who spend up to 15 percent of total household sector. To this end:46 income on alternative water supply sources, often at high environmental and public health costs. The • Lebanon’s policy response to improve road influx of Syrian refugees, the socio-economic crisis, transport needs to comprise in the medium the COVID-19 pandemic, and the explosion of PoB term (1) adopt the transport sector strategy further exacerbated the water sector’s challenges and master plan; and (2) adopt a Road Asset and jeopardized the Water Establishments’ (WEs) Management System and a road safety strategy. ability to collect fees and ensure the continuity of • Lebanon’s policy response to improve public water and wastewater services. The four regional transport needs to comprise in the short term WEs have witnessed a substantial drop in revenues, (1) develop a national transport sector strategy caused by: (1) a significant decrease in collection master plan; and (2) adjust policies on parking, rates since the onset of the crisis; (2) suspensions of public transport and other related regulation. invoicing water bills during part of the COVID crisis; • Lebanon’s policy response to improve and (3) suspension of invoicing water bills in the areas public transport needs to comprise in the impacted by the explosion at the PoB. As a result, medium term introduce private sector financing the water sector’s proposed readjustments could modalities. entail a three-pronged approach towards preserving • Lebanon’s policy response to improve civil the sector, pursuing reforms/transparency and aviation needs to comprise in the short infrastructure maintenance and development. term (1) review the 2002 Civil Aviation Law and associated 2004 decree; and (2) improve • Lebanon’s policy response for better sector institutional and regulatory framework of the Civil management needs to comprise in the short Aviation Sector. term (1) ratify the Water Code and the related • Lebanon’s policy response to improve civil decrees; (2) approve an updated National Water aviation needs to comprise in the medium Sector Strategy 2020; (3) establish the Water term transition to the new regulatory framework for the aviation sector. 45 The economic cost of road traffic fatalities and injuries • Lebanon’s policy response to improve in Lebanon is equivalent to 6 percent of national GDP. railway transportation needs to comprise 46 Improving Lebanon’s public transportation system in the short term47 (1) reviewing Railway and can benefit from the development and adoption of a National transport sector strategy, master plan, and a Public Transport Authority (RPTA) organizational corresponding budgeted medium-term expenditure chart and functions, and strengthen its capacity framework. to manage the sector; and (2) developing a 47 Developing a railway rehabilitation plan is necessary for railway rehabilitation plan. reinvigorating public transport. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 43 Executive Committee; and (4) cost recovery sector and provide wider access to financial services. action plan for Water Establishments. In addition, Lebanon’s regulatory frameworks will • Lebanon’s policy response for better SOE need to evolve, by becoming more efficient, by being management needs to comprise in the applied evenly and fairly, and by ensuring that the medium term (1) promote private sector economy is more contestable, which will help drive participation in operations and management; productivity improvements. These changes will take (2) design and implement a mechanism/platform time as Lebanon’s economy goes through a period of a stakeholder oversight; (3) start publishing reorganization and discovery. annual financial statements; and (4) adopt an operations and management HR plan. Element 1: Setting Financial Sector Foundations Pillar IV: An Economic Opportunities Promoting the development of Lebanon’s Reform Package financial sector to support businesses and individuals necessitates adopting a sector-wide Lebanon’s future trajectory will depend on its digital transformation strategy. Despite playing a economy’s ability to attract investment and to pivotal role in Lebanon’s post-war development, the create good jobs. Relative to 2018, the economy financial sector has been slow in adopting digital will need to raise its productivity and find new transformation. Regulatory and market barriers sources of growth. Lebanon will need a new growth prevent digital financial services from taking off model, and its business environment and institutions and reaching a large untapped market. According will need to be open and flexible to allow this new to the Global Findex 2017 data only 33.1 percent economic model to emerge. According to the World of Lebanese adults have made or received digital Bank Groups’ Doing Business report, Lebanon ranks payments in 2017. Account ownership is below 143 out of 191 economies in the ease of doing global income averages, reflecting strong urban- business, highlighting the multiple challenges and rural disparities (45 percent headline transaction high regulatory burden faced by businesses from account; 25 percent for women; 58 percent of entry to exit. Also, widespread monopolistic activities nationals according to BDL’s survey). Digital finance have limited business entry and resulted in economic can promote financial inclusion and reduce the cost deadweight losses. The combination of a hostile of financial transactions and makes businesses more business environment and an overvalued currency efficient and productive. A set of policy and regulatory have contributed to the poor productivity, the prerequisites can enable broader use of digital decline of the tradable sectors and the worsening of financial services in the medium-term: Lebanon’s trade deficit. The process can be reversed, driven by the depreciated exchange rate, which can • Lebanon’s policy response needs to incentivize domestic production. Lebanon can expect comprise in the short term (1) pass fundamental a boost in agriculture, and possibly regional trade; regulatory enablers for digital financial services; according to the World Bank 2019, 62.5 percent of (2) improve interoperable digital payments firms in Lebanon used inputs of foreign origin, in line infrastructure; and (3) update regulations related with regional and income peers, while 19.4 percent of to (i) data privacy and protection laws and firms export goods directly, exceeding both regional (ii) cybersecurity and cybercrime prevention. and income peers. Lebanon can also expect a • Lebanon’s policy response needs to resurgence and growth in services (including exports), comprise in the medium term (1) agree on given the prevalence of highly skilled and well trained a vision for the financial sector; and (2) develop Lebanese. However, Lebanon’s financial sector will open and transparent pathways for financial also need to respond to financing needs of the private innovation including technology firms (fintech). 44 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION Element 2: Enabling a Nation of demands for the short and medium and longer term: Entrepreneurs (1) incentivizing formality; (2) improving investment policy and promotion legislation; (3) supporting inte- Though Lebanon is perceived as economically gration with global value chains; and (4) amending liberal, monopolistic behaviors are widespread. positioning to benefit from multilateral and bilateral Lebanon’s Legislative Decree No. 34 of 1967 grants trade agreements (requiring a sector by sector analysis exclusive agencies and sole distribution rights to to pinpoint Lebanon’s trade advantages): importers of all products, excepting foodstuffs and washing products. This undermines competition • Lebanon’s policy response needs to through reinforcing dominance and limiting entry, comprise48 (1) improving investment policy undermines efficiency and facilitates collusive behavior. and promotion; (2) developing a Business Tamping down the exclusive agencies’ regulations Environment Action Plan; (3) updating the Code will likely reduce economic deadweight losses and of Commerce; (4) streamlining process and encourage market entry. Lebanon can also benefit reducing time and costs to starting a business; from a competition law. Adopting and implementing (5) streamlining licenses and permits; (6) such a law would establish an antitrust enforcement introducing secured lending; (7) streamlining framework prohibiting anticompetitive arrangements, tax payment and inspection process; (8) abuse of market power, and anticompetitive merger streamlining, automating and reducing costs and acquisition activities. To this end: of trading across borders; (9) modernizing insolvency framework; (10) implementing the • Lebanon’s policy response needs to Judicial Mediation Law; (11) improving labor comprise in the short term (1) enact new regulation; and (12) modernizing Intellectual competition law; and (2) establish and empower Property Framework and improving enforcement. a competition commission. • Lebanon’s policy response needs to Lebanon’s businesses are also in need comprise in the medium term building of financial support as a result of the economic capacity on market competition and antitrust crisis, the pandemic, and the PoB explosion. Firms matters. have an urgent need for immediate and short term support to replenish working capital and establish Businesses in the commerce and industry foreign exchange credit lines. sectors have been hard hit by the economic crisis post October 2019. Surveys estimates that 12 per- • Lebanon’s immediate policy response cent of firms already ceased their operations between needs to comprise (1) working capital; and October 2019 and January 2020, and one-third (2) foreign exchange lines of credit. reduced their workforce by 60 percent on average. The World Bank/EBRD/EIB Enterprise Surveys show Element 3: Promoting Agriculture that real sales dropped by 11.1 percent year-on-year Resilience during 2019, 7.9 percent of firms introduced new prod- ucts/services, compared to the upper middle income The ongoing crisis has amplified existing problems country (UMIC) average of 34.2 percent, and 1 percent in Lebanon’s agricultural sector; supporting its of firms introduced a process innovation, compared to resilience is vital for food security. According to the UMIC average of 25.6 percent. These figures are IDAL, the agricultural sector made up 3.2 percent of likely to further deteriorate in light of the policy inaction Lebanon’s GDP in 2018 despite directly employing and the PoB explosion. In addition, fast-tracking busi- ness environment reforms will be critical to accelerate the recovery process. Other non-financial development 48 Detailed in the matrix below. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 45 6 percent of the population; the sector averaged 6.8 framework and system for risk management in percent of GDP between 1994 and 2007; however, the sector. shifting consumer preferences and currency appreciation have resulted in its decline. The sector’s potential is hampered by a number of structural issues, Pillar V: A Human Capital including the extremely high share (up 90 percent) of Development Reform Package small farms and agri-food enterprises, lack of public investment which would encourage much-needed As a result of the ongoing economic crisis, and af- private investment, a poor food safety system, as well ter decades of disregard for human capital devel- as its unmitigated exposure to an array of production opment, Lebanon is suffering from a human capital and price risks. On a policy level, the lack of planning, crisis. Prior to the economic crisis : (1) relatively low lack of strategic alignment of state support with the public spending on human capital coupled with high sectoral priorities, and administrative clogs created inefficiencies and high private spending needs had a bottleneck that hampers effective state support. placed a burden on poor and middle-class households; Furthermore, Lebanon’s ongoing crisis has disrupted (2) despite an increase in enrollment, drop out among supply chains and created adverse effects further the poorest families is increasing in secondary edu- downstream. As a result, Lebanon has also not been cation further exacerbating the high inequality in the able to benefit from the opportunities presented sector; (3) hospitalization resources have been dispro- by its various trade agreements. At the same time, portionately allocated and formal health insurance cov- the currency depreciation caused a mismatch erage has been low in the best of cases; (5) little spend- between revenues and production costs. The high ing on safety nets had resulted in low coverage for poor dependency (up to 80 percent) on food imports and vulnerable households to shocks; and (6) high presents fiscal challenges especially given the local youth unemployment and inactivity (40 percent of youth currency depreciation and limited foreign exchange neither in employment nor in education or training) had earnings. Adjustment costs and the sector’s potential led to loss of human capital through migration, mostly for job creation and export income generation warrant of the educated youth. The economic crisis has ex- further reliance on domestic agro-food production. posed these vulnerabilities, leading to unprecedented rise in poverty. A human capital development package • Lebanon’s policy response needs to is a must. At this stage it should encompass reforms re- comprise in the short term (1) enact a lated to education, healthcare, environment, and social Food Safety Law; (2) assess effectiveness of sustainability and inclusion. agricultural support schemes; (3) provide short- term input support to farmers; (4) introduce a risk Element 1: Education sharing mechanism for private financing; and (5) develop comprehensive export development Human Capital outcomes are worryingly low in strategy for the sector. Lebanon, risking the future for generations of • Lebanon’s policy response needs to children.49 The World Bank’s Human Capital Index comprise in the medium term (1) improve (HCI) indicates that a child born in Lebanon today food safety and quality system; (2) adopt a legal will reach, on average, only 52 percent of his/her framework for agriculture zoning; (3) adopt potential productivity when s/he grows up. This is a private land consolidation and exchange lower than the average estimates for the Middle East program; (4) introduce support instruments for and North Africa (MENA) region and Upper middle- promoting sustainable solutions; (5) support income countries. Lebanon’s poor performance private investment mobilization; (6) implement on the HCI is largely attributed to the education PPP program for investment in marketing infrastructure; and (7) establish the institutional 49 see Lange, Wodon, and Carey 2018. 46 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION outcomes calculated for the index. If actual years of operated by non-governmental organizations (NGOs). schooling, which are around 10.2 years on average More than 90 percent of drugs and 100 percent of in Lebanon, are adjusted for actual learning, the medical equipment and supplies are imported. Health effective years of schooling are 40 percent less—on insurance coverage is low, with around 49 percent of average, only 6.3 years of actual learning (World Lebanese citizens being uninsured, resulting in high Bank 2020). Behind Lebanon’s educational system’s out-of-pocket spending on health. This problem is ex- underperformance are: (1) ineffective utilization of pected to exacerbate poverty which is already deepen- teachers; (2) infrastructure deficiencies; (3) persisting ing from the ever-compounding crisis. Even before the and increasing school dropouts; (4) weak alignment explosion, Lebanon’s health system was suffering from between skills supply and labor market demand the consequences of a crippling economic crisis start- leading to high unemployment; (5) inequitable and ing in October 2019. Multiple economic and financial inefficient public spending; and (6) inadequate sector problems greatly constrained the health sector’s ability coordination. A comprehensive reform agenda, to provide accessible and affordable services. These in- that focuses on learning for all, and re-centers the clude: (i) protracted delays in government payments of education sector on the learner, is urgently needed. its arrears to hospitals; (ii) a dollar shortage along with unregulated restrictions on depositors’ access to their • Lebanon’s policy response needs to funds, hindering the import of essential medical equip- comprise in the short term50 (1) localize the ment, medicine, and supplies; and (iii) an increase in un- back to school plans; (2) enhance coordination employment rates leading to an increase in the number and synergies in the Ministry of Education; of uninsured citizens requiring government assistance, (3) support remote learning; (4) address and especially among middle-income groups. The CO- support the lowest performing schools; and VID-19 pandemic further exacerbated financial strains (5) integrate psychosocial wellbeing into on the health sector; as such the following is warranted: scholastic programming and beyond. • Lebanon’s policy response needs to • Lebanon’s short-term policy response comprise in the medium term (1) prepare needs to comprise (1) prepare and publish a a new 5-year plan for the education sector; National COVID-19 Response Strategy and Plan (2) commit to a new national curriculum framework and allocate resources as needed, including and set ambitious learning and reading targets; private sector participation; (2) introduce and (3) improve the efficiency of public education deploy a national COVID-19 vaccine strategy and financing; (4) sanction bullying and violence operational plan including e-health; (3) identify in schools; (5) address and support the lowest those in need of healthcare subsidies and performing schools; (6) improve the relevance of provide emergency funding; (4) allocate financial higher education ; (7) regulate the private sector resources for healthcare subsidies; (5) establish for quality delivery of services; and (8) reform financing instruments for pharmaceutical and repetition policy and assessment frameworks. medical imports; and (6) clear government hospital arrears and inject emergency resources. Element 2: Health • Lebanon’s medium to long-term policy response needs to comprise (1) extend Lebanon’s residents face grave health security health insurance coverage under the NSSF after risks; policies and reforms are urgently needed to prevent a catastrophe in the short term and later 50 Reforming education can be aided by (1) adoption on providing healthcare services to all those in of a new vision for the educational sector based on need. Lebanon’s health sector is predominately pri- stakeholder engagement; and (2) adoption of a 5-year vate, accounting for 85 percent of hospital beds, with plan that focuses on immediate, medium, and long-term 80 percent of primary health care centers (PHCCs) needs for better learning. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 47 unemployment; (2) develop and implement a UHC Element 4: Environment strategy; and (3) redistribute efficiently public primary healthcare and prevention spending. Environmental pollution and degradation of natu- ral resources in Lebanon pose significant risks to Element 3: Housing economic development and threaten its citizens’ health and well-being. In 2011 the World Bank es- The three mega crises have aggravated Lebanon’s timated the cost of environmental degradation at 3.4 hostile market housing conditions; resolving those percent of GDP; according to the UNDP, that figure conditions is paramount for social safety. Renters rose to 4.4 percent in 2018. Environmental degrada- make up 55 percent of the housing market in Beirut. tion in Lebanon is a result of mismanagement across Over time, poverty, disinvestment, and real estate spec- all sectors and has been exacerbated by the influx ulation have created a bifurcated housing market book- of Syrian refugees. Despite alarming environmental ended by high-rise residences. Many of these were held degradation, the environment has remained a sec- aside for short-term tourist rentals, while migrants, refu- ondary priority at the political level; domestic political gees and low-income Lebanese occupy overcrowded interests have weighed heavily against establishing informal rental units and rooms. A slow transition to a strong basis for environmental governance and market-oriented regulation of the rental market has led slowed down needed legal and institutional reforms. to the deterioration of many buildings, often those hous- For example, the CIP has only addressed solid waste ing the lowest-income households. The multiple crises management, and GoL’s reform plan fails to address that have affected Lebanon since 2011 have negatively the urgent need to shift towards a “Green Economy.” affected the housing sector, including the influx of Syr- ian refugees, the economic collapse, the impairment of • Lebanon’s policy response to resolve waste the banking sector, and the PoB explosion. The sheer management needs to comprise in the number of repair and reconstruction projects result- short term (1) develop and implement priority ing from the explosion is expected to strain the entire regulations under ISWM Law; and (2) implement housing value chain, from materials supply to engineer- the Strategic Environmental Assessment for the ing, finance, permitting, and inspections. Developing a draft ISWM strategy and adopt the ISWM strategy. housing strategy is essential to safeguard Lebanon’s • Lebanon’s policy response to resolve waste population from a housing crisis. Institutional reforms management needs to comprise in the and arrangements for housing strategy should focus medium term (1) strengthen the monitoring and on: (1) planning and monitoring; (2) building standards; enforcement of regulations under ISWM Law and (3) preserving historic properties; (4) stakeholder sup- under the legal framework for the management port; and (5) housing market reforms. of chemicals and hazardous material, including environmental health and safety regulations; and • Lebanon’s policy response needs to (2) develop an ISWM plan for the city of Beirut. comprise in the short term (1) expand building • Lebanon’s policy response to promote envi- permitting and inspection capacity; (2) guidelines ronmental conversation needs to comprise on tenure security for renters; and (3) develop in the short term (1) establish modalities for a national housing policy with emphasizing enhancing private sector engagement in environ- affordable housing. mental investments; (2) establish a collaborative • Lebanon’s policy response needs to comprise platform with civil society; and (3) develop a par- in the medium term (1) develop a rehabilitation ticipatory strategic framework for greening the and reconstruction strategy for historic buildings; reconstruction agenda including climate action. (2) update of the building regulatory system (on- • Lebanon’s policy response to promote envi- line permitting, energy efficiency, green building, ronmental conversation needs to comprise in etc.); and (3) taxation of vacant housing. the medium term (1) identify financing and user 48 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION charges for the sustainability of environmental in- will be crucial to develop a systematic, inclusive, and vestments and management systems; (2) estab- responsive approach to collaborate with a broad range lish a sustainable financing mechanism for pollu- of stakeholders to promote large scale participation, tion prevention, including fiscal instruments; and including civil society, communities, private sector, (3) mainstream the strategic guidelines for green- and academia. This will be essential to rebuild trust, ing the reconstruction agenda (including climate inform the selection and implementation of reforms, action) across all sectors. and improve the transparency of rulemaking, budgets, and public participation through greater transparency, Element 5: Social Sustainability and accountability, and inclusion. If not addressed, the lack Inclusion of transparency could exacerbate the existing mistrust and social tensions, so it is essential to ensure the The economic crisis, the pandemic and the reforms are informed by a participatory process and explosion at the PoB will significantly exacerbate equitable distribution of aid assistance. vulnerabilities and needs among poor and vulnerable populations. Even before these shocks, • Lebanon’s policy response needs to vulnerabilities were on the rise, with overall poverty comprise in the short term (1) initiate a having increased, which was compounded by the ‘People’s Platform’ and linkages with other NGO- influx of an estimated 1.5 million displaced Syrians, UN-donor-led initiatives; and (2) launch training themselves affected by high poverty. In addition to its program for procurement and budget monitoring impact on livelihoods, shelter, and other basic needs, and social audits for CSOs and volunteers. the explosion will further aggravate vulnerable citizens’ • Lebanon’s policy response needs to comprise situation in the Greater Beirut area, especially among in the medium term51 (1) consolidate advisory the children, women, persons with disabilities, the services offered by People’s Platform for a range elderly, the displaced, and migrant workers. Expanding of sectors (e.g. VSEs); (2) consolidate advisory cash transfer programs, as indicated in the first pillar of services offered by People’s Platform for a range this reform agenda, is necessary to mitigate the effects of sectors (e.g. VSEs); (3) enact a law on regula- Lebanon’s compounded crisis on those in need, tory governance emphasizing transparency and however more measures are needed. public participation; (4) develop a National Social Inclusion and Engagement Strategy and a 3-year • Lebanon’s policy response needs to implementation strategy; (5) pilot training program comprise in the short term support the on transparency and public engagement for ex- provision of social services through SDCs, NGOs, ecutive branch and oversight institutions (national and UN agencies. and local); (6) fine tune pilot training program on • Lebanon’s policy response needs to transparency and public engagement for execu- comprise in the medium term reinforce the tive branch and oversight institutions (national and role of MOSA and the social development centers local level); and (7) join the international CSO and to provide sustainable social services. government-led transparency and public participa- tion initiatives (GIFT, OGP). Support proactive, credible, and system- atic stakeholder engagement by establishing a “people’s platform”—as this will likely be key to 51 A key pillar for promoting social inclusion is the a successful recovery. The October 2019 protests development of a National Social Inclusion and were followed by widespread popular demands for Engagement Strategy and 3-year Implementation Plan more transparent and inclusive citizen engagement. It with an indicative budget outlay. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 49 TABLE 5 • Summary of Reform Matrix, by Pillar Reform Area 2021 2022 2023 2024–2025 Pillar I: Macroeconomic Stabilization Monetary Stabilization BdL independent audits Strengthen BdL’s balance sheet Capital controls law Policy actions on exchange rate and monetary policy framework Public Debt Restructuring Macroeconomic and Debt Sustainability Framework Domestic debt - Medium Term Plan Temporary body to handle debt Agree on external and domestic restructuring debt restructuring plans and on losses with creditors, subject to equitable burden sharing Financial Sector Update bank resolution framework Improve supervisory early Restructuring and Resolution intervention mechanisms Implement banking sector restructuring Improve emergency liquidity assistance arrangements Restructuring of BdL’s balance sheet Develop an out-of-court workout framework Improve regulatory guidelines on NPL recognition and provisioning Update deposit insurance framework Develop insurance sector Initiate insurance sector restructuring and development restructuring strategy Improve regulatory governance Update and enact Insurance Law Fiscal Framework Adjusting 2021’s budget and Formulation preparing 2022’s on time Fiscal council becomes operational Implementing the Macroeconomic and Debt Sustainability Framework Reducing transfers to EdL Reducing transfers to EdL Reducing transfers Reducing transfers to to EdL EdL VAT and Customs Reform VAT and Customs Reform VAT and Customs Reform Unified Income Tax Code and Property taxation reform automatic income tax declaration Review move from a scheduler to a global income tax base Subsidy reform Adjusting excises Address SOE revenue/dividend transfer framework and cash management hurdles Civil service review by an independent international institution (continued on next page) 50 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Social Protection COM approval of a National Social Protection Strategy Expand National Poverty Targeting Program (NPTP) per the Emergency Social Safety Net (ESSN) program and provide financing in 2021 Budget. Establish National Social Registry Initiate Public Pension Reform Public Pension Reform Conduct audit of NSSF Initiate financial and governance reform of NSSF Parliament to pass Pension Law for private sector workers Implement new Pension Law Review of growth plans Revision of existing growth plans Agreement on an economic growth vision for Lebanon Comprehensive investment strategy (private, public) review, reprioritization and operationalization Comprehensive export development strategy Pillar II: A Governance and Accountability Reform Package Public procurement reform Development and validation of a Capacity building and public procurement strategy professionalization of the procurement function Public procurement law enacted Secondary legislation drafting and adoption Standard bidding documents developed Establishment and operationalization of an independent procurement regulatory body and Policy and Oversight and Complaints Handling Units Assessment of e-procurement Development of e-procurement Deployment of the validated e-procurement initiatives strategy and functions platform at decentralized level and training PFM Revamp and revitalizing a national PFM steering committee PFM - Treasury Single Update cash safety buffer Develop and implement action Enact/ amend related Treasury single account Account (TSA) plan for consolidating cash treasury single operational Integrate cash and debt accounts account laws & management and prepare analysis decrees reports PFM - External Auditing Ratify a revised Court of Account Strengthen the independence Finalize the audit of Law and enlarge scope of audits and capacity of the Central previous financial Inspection and Court of Accounts statements (including forensic audits) PFM - Internal Auditing Complete assessment and Issue Ministerial decrees for recommendations for institution establishment of IA Internal Audit (IA) Develop IA Strategy, charter and manuals, and carry out capacity building; carry out the IA function (continued on next page) SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 51 TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 PFM - Macro- fiscal Analysis Update macro fiscal models Introduce quarterly economic evaluation reports, including Formalize data flow from/to Macro- policy impact assessments, public Fiscal Department (MOUs) finance monitor (PFM) and fiscal risk reports PFM - Accounting and Implement new accounting Transition to IPSAS Reporting procedures PFM - Budgeting Review of Budget System Law (BSL) Update BSL and/or regulations Implementation review of updated BSL and regulations PFM - Public investment Review functions of the Council for Develop PIM legal and regulatory Launch PIM management Development and Reconstruction framework framework (CDR), Council of the South, Higher Adopt legislation regarding Council of Refugee’s, line ministries management large projects and other public institutions including SOEs and Public Corporations Implement WB-IMF PIMA 2018 recommendations PFM - SOE management Develop mechanisms for enhanced Develop Public Sector Balance MoF oversight over SOE and Public Sheet Corporations Enhance capacity of MoF to financial control SOEs. Launch Forensic Audit of SOEs Review establishment of a SOE and Public Corporations management entity Reinforcing Public Debt Implement a Medium-term debt Revise/ratify public debt Establish Management management strategy (MTDS) management law independent debt management body Design a Financial Commitments and Contingent Liabilities (FCCL) framework Prepare communication and Establish a primary investor relations strategy dealer group Open Government Full transactional government Strengthen institutional capacity Implement a Whole administrative e-services available and deploy digital assurance of Government Digital online and performance management Transformation systems Strategy Commit to join the Open Government Promote public access to asset Apply for OGP Implement first OGP Partnership (OGP) disclosure forms and data membership; National Action Plan Co-create first OGP National Action Plan, NGO stakeholders Publish executive budget and audit reports (continued on next page) 52 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Anti-corruption and Judicial Accede to the 1997 OECD treaty on Fully implement the National Anti- Conduct and publish Reform combating corruption Corruption Strategy monitoring report on implementation Create an anti-corruption Conclude UNCAC Assessment of of first year of commission and fully staffing it Lebanon’s anticorruption efforts Anti-Corruption Adopt and implement the Illicit Strategy (to include Enrichment Law and assets UNCAC assessment declaration law recommendations) Establish high-level Justice Reform Judicial independence law Judiciary revises Judiciary continues Committee and announce Action submitted to parliament and and implements implementing Plan to Improve Justice and Rule approved court performance court performance of Law improvement plans improvement plans Initiate justice sector assessment, based on findings Adopt Court of Accounts Law and roundtables with justice High-level Justice Reform of justice sector stakeholders and CSOs Committee submits assessment annual progress report with roundtables Fully implement the Access to Information Law Implement the whistleblower protection law Lift Banking Secrecy Law Reforming Municipalities Enhance role of municipalities in Coordinate of responsibilities with implementing integrated spatial stakeholders planning frameworks for local Promote private investments development Public disclosure of decisions and Engage with citizens financial statements Improved capacity for financial Incentive mechanisms for management improved municipal performance Introduce transparency, Implement reforms for accountability, predictability and improved administration of reliability of intergovernmental fiscal intergovernmental fiscal transfer transfers Establish a municipality One-Stop- Shop with sub-windows Pillar III: Infrastructure Development Reform Package Public Private Partnership Enable and fully staff the Higher Include PPP commitments in the Widen use of public- Legislation Council for Privatization (HCP) FCCL framework and MTDS private partnerships Conclude review of PPP regulatory Develop a comprehensive framework, currently being diagnostic and strategy for undertaken by EBRD infrastructure planning and finance in Lebanon, covering public, PPP private sector investment (continued on next page) SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 53 TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Electricity Update sector policy note to reflect the country’s current conditions Implement Law 462 with subsequent amendmentsa Staff and empower the Electricity Operationalize the ERA Regulatory Authority (ERA) Adopt a least-cost generation expansion plan Prepare EDL audited financial statements for previous years Launch tenders for new thermal Start construction of new thermal Launch process to power plants and advance on and renewable energy plants privatize publicly existing renewable energy initiatives owned generation plants Install and operate private-sector floating gas import terminals Agreement on concession model for Complete negotiation of the distribution sector concession agreements and mobilization/transfer of control of Competitively select concessionaires the distribution system Start construction of requisite transmission upgrades Revise building codes and facilitate concessional financing to incentivize energy efficiency and renewable energy upgrades Reduce distribution network system and commercial losses, consistent with targets established in the Sector Policy paper adopted in April 2019, modified to reflect developments since 2019 Adjust tariffs to cost reflective levels while ensuring affordability for poor and less advantaged consumers Prioritize capital investments needed to increase generation and transmission capacity to ensure adequacy and reliability of electricity supplies Telecommunications Appoint Telecom Regulatory Develop a Unified Telecom Sector Authority (TRA) Board Vision Review telecom Law No. 431 for potential revision Create a standard license for Data Create a reference offer for Service Providers access to MoT’s ducts (continued on next page) 54 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Port Enact corridor-based strategic planning vision Adopt port sector reform principles Pass new port sector law Establish a Build capacity at the ministerial port management authority and port authority levels Approve a Customs & Special Digitalize processes: port Economic Zones Modernization community system, maritime program single window and national single window Enact port tariff reform Implement cost accounting in POB and POT Update the PoB master plan Identify potential public-private partnerships (PPPs) and ensure competitive bidding Establish port communities Transport Adopt the transport sector Adopt a Road Asset strategy and master plan Management System and a road safety strategy Develop a national transport sector Introduce private sector financing strategy master plan modalities Adjust policies on parking, public transport and other related regulation Review of the 2002 Civil Aviation Transition to the new regulatory Law and associated 2004 decree framework for the aviation sector Improve institutional and regulatory framework of the Civil Aviation Sector Review Railways and Public Private sector financing for mass Transport Authority (RPTA) transit and public transport operations. Develop a railway rehabilitation plan Water Ratify the Water Code and the Promote private sector related decrees participation in operations and management Approve an updated National Water Design and implement a Sector Strategy 2020 mechanism/platform of a stakeholder oversight Establish the Water Executive Committee Start publishing annual financial statements Cost recovery action plan for Water Adopt an operations and Establishments management HR plan (continued on next page) SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 55 TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Pillar IV: Economic Opportunities Reform Package Emergency Financing Introduce working capital and foreign exchange lines of credit Facilitating financial sector Pass fundamental regulatory Agree on a vision for the financial development enablers for digital financial services sector Improve interoperable digital Develop open and transparent payments infrastructure pathways for financial innovation including technology firms Update/strengthen regulations (fintech) related to (i) data privacy and protection laws and (ii) cybersecurity and cybercrime prevention Building an effective Enact draft competition law Building capacity on market competition framework and Reform Exclusive Agencies competition and antitrust matters Regulations Establish and empower a competition commission Improving investment policy Develop and adopt an investment Develop a proactive investor and promotion strategy for retaining and attracting outreach program FDI or Non-Equity Modes of financing Establish a one-stop shop for investors at IDAL Review and update the investment law and decrees to strengthen Investment Development Authority of Lebanon (IDAL) and include investor protection guarantees Prepare and discuss proposals for improving functioning of SEZ and their expansion Developing a Business Develop and approve a Environment Action Plan comprehensive Business Environment Action Plan Establish governance structure for business environment reforms Updating the Code of Update the Code of Commerce Commerce Streamlining process and Abolish the paid in capital Establish an integrated, online reducing time and costs to requirement one stop shop to register a starting a business business Waive mandatory use of intermediaries (notaries, lawyers) Streamlining licenses and Undertake and assessment of Streamline key operating licenses permits operating licenses and permits and permits Introducing secured lending Enact secured transactions draft law Operationalize electronic movable assets registry Draft and approve secured transactions executive regulations Raise awareness and develop the capacity of public and private Launch the procurement process for stakeholders the registry provider (continued on next page) 56 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Streamlining Tax payment Publish online all tax compliance Simplify VAT collection and and inspection process requirements expediting refunds Set up hotline/grievance Digitize tax filings and payment mechanisms during tax inspections Mandate tax inspectors to provide timely inspection reports Streamlining, automating Approve customs strategy Develop Adopt Effective Risk Management Implement the and reducing costs of trading an inventory of all administrative fee (RM) and Post Clearance Audits national e-Single across borders schedules (PCA) systems Window Conduct a Time Release Study Develop a national e-Single Window Modernizing insolvency Enact the draft Insolvency and Build the capacity of judges on framework Insolvency Practitioner (IP) laws the new insolvency regime Draft and approve executive Raise awareness on the new regulations for both laws insolvency regime with main stakeholders Develop a training curriculum for IPs and for judges training Train and license the first cohort of the new generation of IPs Implementing the Judicial Draft and approve the Judicial Mediation Law Mediation executive regulations Build judges capacities on the new mediation mechanism Improving labor regulations Update the Labor Law Introduce special visas and work permits for high-skilled foreign experts Modernizing Intellectual Modernize IP laws Establish specialized court to Property Framework and hear IPR claims Enhance IPPO’s financial and human improving enforcement resources Agriculture Enact a Food Safety Law Improve food safety and quality system Assess effectiveness of agricultural Adopt a legal framework for Adopt a private land support schemes agriculture zoning consolidation and exchange program Provide short-term input support to Introduce support instruments for Implement farmers promoting sustainable solutions PPP program for investment Introduce a risk sharing mechanism Support private investment in marketing for private financing mobilization infrastructure Develop comprehensive export Establish the institutional development strategy for the sector framework for risk management in the sector (continued on next page) SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 57 TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Pillar V: Human Capital Development Reform Package Education Localize the back to school plans Prepare a new 5-year plan for the Commit to a new education sector national curriculum framework and set ambitious learning and reading targets Enhance coordination and synergies Improve the efficiency of public Sanction bullying and in the Ministry of Education education financing violence in schools Support remote learning Improve the Regulate the private relevance of higher sector for quality delivery Address and support the lowest education of services performing schools Integrate psychosocial wellbeing into Reform repetition scholastic programming and beyond policy and assessment frameworks Health Prepare and publish a National COVID-19 Response Strategy and Plan and allocate resources as needed, including private sector participation Introduce and deploy a national COVID-19 vaccine strategy and operational plan including e-health Identify those in need of healthcare Extend health insurance Develop and subsidies and provide emergency coverage under the NSSF after implement a UHC funding unemployment strategy Allocate financial resources for healthcare subsidies Establish financing instruments for Redistribute pharmaceutical and medical imports efficiently public primary healthcare Clear government hospital arrears and prevention and inject emergency resources spending Housing Expand building permitting and Develop rehabilitation and Update of the inspection capacity reconstruction strategy for building regulatory historic buildings; system Guidelines on tenure security for Tax vacant housing renters Develop a national housing policy with emphasizing affordable housing (continued on next page) 58 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION TABLE 5 • Summary of Reform Matrix, by Pillar (continued) Reform Area 2021 2022 2023 2024–2025 Environment Develop and implement priority Strengthen the monitoring and regulations under ISWM Law and enforcement of regulations under Resolve waste management implement regulatory improvements ISWM Law and under the legal for the chemicals and hazardous framework for the management material management framework of chemicals and hazardous material, including environmental Implement the Strategic health and safety regulations Environmental Assessment for the draft ISWM strategy and adopt the Develop an ISWM plan for the city ISWM strategy of Beirut Promote environmental Establish modalities for enhancing Identify financing and user Establish a conversation private sector engagement in charges for the sustainability of sustainable financing environmental investments environmental investments and mechanism for management systems pollution prevention, including fiscal instruments Establish a collaborative platform Mainstream the strategic with civil society guidelines for greening the reconstruction agenda (including Develop a participatory strategic climate action) across all sectors framework for greening the reconstruction agenda including climate action Social Sustainability and Support the provision of social Reinforce the role of MOSA and Inclusion services through SDCs, NGOs, and the social development centers UN agencies to provide sustainable social services Initiate a ‘People’s Platform’ and Consolidate advisory services Enact a law Develop a National linkages with other NGO-UN-donor- offered by People’s Platform for a on regulatory Social Inclusion led initiatives range of sectors (e.g. VSEs) governance and Engagement emphasizing Strategy and a 3-year transparency and implementation strategy public participation Launch training program for Pilot training program on Fine tune pilot Join the international procurement and budget monitoring transparency and public training program on CSO and government-led and social audits for CSOs and engagement for executive transparency and transparency and public volunteers branch and oversight institutions public engagement participation initiatives (national and local) for executive branch (GIFT, OGP) and oversight institutions (national and local level) a Given the reform agenda’s wide scope, Law 462 requires subsequent amendments to facilitate the establishment of concessions, rebuilding the destroyed EdL building (due to the PoB explosion) and boarder restructuring of the sector. SPECIAL FOCUS – A REFORM AGENDA TO TURN THE COUNTRY AROUND: PROPOSAL FOR DISCUSSION 59 ANNEX Key BdL Circulars since October 2019 • In regard to the interest earned on banks’ holdings of dollar-denominated CDs and dollar BdL has issued a series of circulars that reflect time deposits at BdL, the central bank would pay policy initiatives under three main categories: half in LL and the other half in dollars; (i) monetary and exchange rate policies; • Banks to pay half of the interest earned on (ii) socio-economic support; and (iii) financial customers’ foreign currency deposits with it in LL sector regulations. These policies have laid a clear and the other half in dollars. distinction between deposits that existed prior to the closure of the banking sector (October 2019) and the Circular 149 new (or fresh) deposits that came in later. In circular 149 (April 3, 2020), BdL established Monetary and Exchange Rate Policies a special unit that exchanges foreign currencies compromising BdL, banks and exchange Circular 536 bureaus. An electronic board is launched that publishes exchange rates, including those in dollars. Circular 536 (December 4, 2019) stipulated: We henceforth refer to this exchange rate as the • An interest rate ceiling on new and renewed e-board rate, mostly recently set at LL 3,900 per US$. LL and US$ deposits set at 8.5 percent and 5 percent, respectively; Circular 148, 151, 549, 565 • The lower deposits rates to reflect on lending rates through a lower Beirut Reference Rate These circulars allowed the withdrawal of pre- (BRR) to which private loans are benchmark; crisis deposits at exchange rates that are higher 61 than the official rate, but lower than the black- mandated that transfers would once again be dis- market rate. For example, the first such circular (148, bursed in US dollars. April 3, 2020) allowed account holders of deposits up to LL 5 million in total in a bank, to request withdrawal Circular 568 of their deposits, such that: Circular 568 (August 26) instructs banks to i. Bank would convert LL account to dollars at the accept repayments by resident clients of their official exchange rate; dollar retail loans—with limits of $US 800,000 for ii. Bank then converts dollars from step 1 back to LL housing loans and $US 100,000 for retail loans— at market rate (which was first set at LL 2,600 per in LL at the official exchange rate. US$ and later changed to the e-board rate) and pays out to customer, thus closing the account. Socio-Economic Support Circular 148 also allowed account holders Circular 535, 556, 557, 561, 564 of (pre-crisis) deposits up to $3000 in total in a bank, to request withdrawal of deposits, such that: In circular 535 (November 26, 2019) and 561 (July 8 2020), BdL formalized its backup of i. Bank converts dollars in deposit to LL at market critical imports; specifically, BdL’s provision of rate (which was first set at LL 2,600 per US$ and foreign currency at the official exchange rate later changed to the e-board rate) and pays out to for 90 percent of the import bill for fuel products customer, thus closing the account. and 85 percent for wheat, medicine, medical equipment and baby milk imports. Circular 151 (April 21), then removed the In circular 556 (May 27, 2020), banks were limits on accounts, allowing all holders of pre- allowed to solicit foreign currency from BdL for crisis deposits to benefit, subject to individual 90 percent of the value of raw materials imported bank limits on amount withdrawn. by the industrial sector, up to $US 100 million in total for each bank and $US 300 thousand for Circular 150 each client. Circular 557 (May 27) further targeted this scheme to agribusinesses, removing the limits. Circular 150 (April 9) removed reserve Circular 564 (July 8, 2020) allowed for requirements on new (fresh) dollar deposits. foreign currency back up at the e-board rate for another list of essential goods imports identified Circular 551, 566 by the Ministry of Economy and Trade (MoET). On April 22, BdL issued circular 551 compelling Circular 547, 552 non-bank money transfer institutions (NbMT) to pay transfer recipients in LL and not in dollars, These circulars (23 March and April 22, 2020) having reversed policy on this a number of times permitted the rollover of private sector loans in in a couple of months. Expatriates were increasing LL and dollars that were coming due between using NbMTs in response to banking sector March–June 2020, at zero interest rate and constraints. BdL assigned a special exchange rate 5-year maturity. It also allowed business over the at which NbMTs would convert transfers (starting at same period to borrow at the same terms in order to LL 2,600/US$). pay wages and necessary expenses. In return, and This policy was once again reversed by as an incentive to banks, BdL would extend loans in circular 566 on August 6, in the aftermath of dollars to banks at zero interest rates at the value of the explosion at the Port of Beirut. Circular 556 the LL or dollar loans to banks’ customers. 62 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION Circular 152, 569 distributing profits if these ratios drop below 7 percent for common equity tier 1 ratio, 10 These circulars (August 6, August 26, 2020) percent for tier 1 ratio, and 12 percent for total allowed banks to extend loans at zero interest capital ratio. rates and 5-year maturity to those affected by • Banks must also constitute a capital conservation the PoB explosion. In return, and as an incentive to buffer on common equity of 2.5 percent of risk banks, BdL would extend loans in dollars to banks at weighted assets. zero interest rates at the value of the LL or dollar loans • Every bank must prepare a comprehensive plan to banks’ customers. to conform to the minimum capital requirements set forth by the regulator. Circular 153 • Banks can also take the following exceptional measures: This circular (August 19) permitted the transfer • During the years 2020 and 2021: Add to of up to US$ 10,000 of pre-crisis deposits to common equity tier 1 capital 100 percent of students abroad. However, in practice, this remained the provisions taken on Stage 1 and Stage subject to banks’ liquidity constraints. 2 on balance sheet financial assets and off balance sheet financial commitments. The Banking Sector Regulations previously mentioned provisions do not include those taken in local and foreign Circular 567 currency sovereign placements including those with BDL. Key stipulations for circular 567 (August 26) • Starting 2022 till the end of year 2024: The include:52 aforementioned provisions taken as part of • Banks and financial institutions operating in common equity tier 1 capital will be gradually Lebanon must apply a statutory Expected amortized to 75 percent in 2022, 50 percent Credit Loss (ECL) of 1.89 percent on foreign in 2023 and 25 percent in 2024. currency placements with the Central Bank • A supporting factor of 0.1 is applied on (including certificate of deposits) and 45 the provided exceptional loans’ capital percent on foreign currency placements with requirements over a period of five years the Government. The provisions of the circular, starting June 30, 2020. however, do not require the constitution of • Banks are prohibited from distributing profits any statutory ECL on LBP placements with the generated from the sale of real estate and Government and with the Central Bank. These real estate acquired in settlement of debt. provisions will be constituted progressively over a period of five years. Circular 154 • Banks and financial institutions must not downgrade delinquent loans (between February Key stipulations for circular 15 (September 1, 2020 and December 31, 2020) for borrowers 14) include:53 affected by the COVID-19 pandemic. • The Central Bank required banks to complete • Banks are required to refrain from distributing a fair value assessment of their assets and profits to shareholders for the years 2019 and 2020, and increase by December 31, 2020 their common equity tier one capital by 20 percent 52 Source: Credit Libanais, Weekly Market Watch, August from the 2018 level. 29–September 4, 2020. • Banks must apply the minimum capital adequacy 53 Source: Credit Libanais, Economic Insights, August 31, ratios, noting that banks are forbidden from 2020. Annex 63 liabilities and set a plan that helps in complying Averaging Lebanon’s Multiple with all applicable regulations, notably those Exchange Rates related to liquidity and capital adequacy, while also demanding banks to increase the level We use consumption-based weights to estimate of services provided to their clients to the pre- the average exchange rate in Lebanon. To October 2019 level. proceed, we adopt the following nomenclature: • Banks must boost their liquidity with their foreign • Cg denotes share of goods in the consumption correspondent banks by incentivizing clients basket; who have transferred more than $0.5 million • Cs denotes share of services in the consumption (or its equivalent in foreign currencies) of their basket; deposits abroad since July 1, 2017 to channel • Cgm denotes ratio of imported goods to total back 15 percent of said amount to Lebanon, goods in the consumption basket; 30 percent for banks’ Chairmen, members of • Csm denotes ratio of imported services to total Board of Directors, large shareholders and top services in the consumption basket; management, and 30 percent for Politically • Mgc1 denotes ratio of highly critical goods Exposed Persons (PEPs). Always in the same imported (at LL 1,507.5 per US$) to total imports vein, the circular stipulates that funds that are of merchandise goods in value; retransferred to Lebanon will be deposited in • Mgc2 denotes ratio of critical goods imported (at “special” saving accounts having a term of 5 LL 3,900 per US$) to total imports of merchandise years, bearing in mind that said account will not goods in value; be subject to reserve requirements. • Mgo denotes ratio of all other goods imported (at • Banks must encourage importers to transfer black market rate) to total imports of merchandise from outside Lebanon an amount equivalent to goods in value; 15 percent of the value of documentary credits • Eo denotes the official exchange rate LL 1507.5 opened in any of the years 2017, 2018 or per US$; 2019, with the transferred amounts also being • Ec1 denotes the exchange rate used for the deposited in “special” saving accounts. importation of highly critical goods, which we • Banks to constitute by end of February 2021, an refer to as critical 1 (C1); external account at their correspondent banks • Ec2 denotes the exchange rate used for the equivalent to 3 percent of the size of foreign importation of critical goods (LL 3,900 per US$), currency deposits as of July 31, 2020. which we refer to as critical 2 (C2); • Banks must also, and according to the previously • Eb denotes the black-market exchange rate. mentioned plan, submit a request to the Central Council at BDL to reconstitute/raise their capital Cg and Cs are derived from the weights to the required levels by the end of the first for different components in the Consumer Price quarter of the year 2021. Index (CPI). Specifically, Cs is calculated by summing • In this vein, banks must offer their depositors the up the weights of CPI components that are assumed option to convert their deposits into shares or into to be focused on the consumption of services.54 redeemable, tradable and convertible bonds that can grant priority to subscribe in any future capital increase, subject to the following conditions: • Listing all of the bank’s shares on the Beirut 54 Components assumed focused on the consumption of services and their associated weights are: Housing, Bourse; rent (weight = 3.4%); Housing, owner occupied (13.2%); • Separating the Chairman of the Board Health (7.8%); Transportation (13.1%); Communication of Directors function from the bank’s (4.6%); Recreation, amusement and culture (2.3%); management. Education (5.9%); and Restaurant & hotels (2.6%). 64 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION Remaining components in the CPI are assumed to be basket are imported; we now also assume that focused on the consumption of goods. Hence, the remaining 15 percent of goods are linked to Cs = 53% the official exchange rate. This stems from the fact Cg = 1 – Cs = 47%55 that Lebanon is a highly dollarized economy and that We assume Cs and Cg remain unchanged even LL-denominated transactions are either psycho- throughout our projection period. logically or contractually linked to the exchange rate. We assume that 85 percent of goods in the In fact, key contracted prices, such as wages, real consumption basket are imported, whereas only estate rent, university and school tuition etc. continue 40 percent of services in the consumption basket to be linked to the official exchange rate, which partly are imported. Hence, explains why inflation has so far lagged the depre- ciation of the black-market rate (inflation expectations Cgm = 85% will, however, adjust over time to the new hyperinfla- Csm = 40% tion reality and might become a key driver of it). The consumer exchange rate for goods, Eg, is thus We assume Cgm and Csm remain unchanged throughout our projection period. Eg = Cgm * Egm + (1 – Cgm) * Eo We can calculate the value ratios of highly critical, critical and other goods imported to total Earlier we made the assumption that 40 merchandise imports from actual data. percent of services in the consumption basket are • BdL guarantees 85% to 90% of highly critical imported; we now also assume that the remaining imports, C1, in value at the official exchange rate, 60 percent of services are linked to the official while importers have to revert to the black market exchange rate. Hence, the consumer exchange rate for the remaining 15% to 10%; services, Es, is as follows • Since July 2020, BdL has guaranteed 100% of the critical imports, C2, in value at LL 3,900/US$; Es = Csm * Eb + (1 – Csm) * Eo • All other imports are traded at the black-market rate. The consumption-based average exchange • Hence, for C1 goods, rate (AER) can thus be calculated as, Ec1 = 0.85*Eo + 0.15* Eb AER = Cg * Eg + Cs * Es • while for C2 goods, VAR Estimations of Impact of E = E from October 2019 through July 2020 c2 b Currency Devaluations on Economic Activity. and Exchange rate stability was at the heart of E = 3,900 since August 2020. c2 Lebanon’s post-civil war growth model, and thus, its instability over the crisis period is a Based on the above, the exchange rate for merchandise imports, Egm becomes 55 While the above components that are assumed focused Egm = Mgc1 * Ec1 + Mgc2 * Ec2 + Mgo * Eb on the consumption of services also include goods (i.e. communication), we can assume that this is offset Earlier we made the strong assumption by components that are assumed focused on the that 85 percent of goods in the consumption consumption of goods but that also include services. Annex 65 TABLE 6 • VAR Results on the Impact of Currency Devaluations on Main Economic Variables. Currency Devaluation = 100% Currency Devaluation = 129% Currency Devaluation = 49% Estimate 95% confid. interv. Estimate 95% confid. interv. Estimate 95% confid. interv. Growth rate in   Min Max   Min Max   Min Max CPI (inflation) 11.1% 5.0% 17.2% 14.3% 6.4% 22.1% 5.4% 2.4% 8.4% CI –16.3% –22.1% –10.6% –21.1% –28.5% –13.6% –8.0% –10.8% –5.2% Imports services 22.1% 18.1% 26.0% 28.5% 23.3% 33.6% 10.8% 8.8% 12.7% Imports goods –26.7% –31.4% –22.0% –34.5% –40.5% –28.4% –13.1% –15.3% –10.8% Exports services 14.3% 9.0% 19.7% 18.5% 11.6% 25.4% 7.0% 4.4% 9.6% Exports goods 11.6% 5.3% 17.9% 14.9% 6.8% 23.0% 5.7% 2.6% 8.7% main drag on economic activity. We generate constraints and panic conditions that are currently unconditional and conditional forecasts from a prevailing, we limit our conclusions to the impact on Vector Autoregressive (VAR) model to quantify the the CI. impact of the AER devaluations estimated above on VAR results suggest large contractions main macroeconomic variables, including the World in the CI in 2020 and 2021 as a result of the Bank’s coincident indicator.56 devaluation in the AER. Specifically, based on an The VAR includes the following variables: assumption of a 129 percent depreciation in the the logarithm of the Nominal Effective Exchange AER in 2020, CI is estimated to grow between Rate (NEER, from IFS database), the logarithm –13.6 and –28.5 percent (within a 95 percent of the World Bank Coincident Indicator (CI),57 the confidence interval). In 2021, the assumed 49 per- logarithms of exports of goods (from BdL), exports cent depreciation in the AER can cause an estimated of services(from BdL), imports of goods(from BdL), growth of between –5.2 and –10.8 percent (within a imports of services (from BdL) as well as the loga- 95 percent confidence interval). rithm of the consumer price index (CPI; from Central Administration of Statistics—CAS; 2007 base year). The sample period employed in the analysis extends Global Financial Crises Episodes from January 2008 to December 2019. Conditional and unconditional forecasts The Asian Financial Crisis of 1997–98 from a VAR model are generated under the assumption of a 100 percent depreciation in the In July 1997, Thailand devalued the Thai baht NEER, as well as the AER depreciations that we under intense speculation, with the Government have identified in 2020 and 2021, namely, 129 subsequently requesting technical assistance and 49 percent, respectively. Table 2 presents the from the International Monetary Fund (IMF). A results. regional contagion effect ensued such that by October We note the following caveats: (i) the sample period used to estimate the VARs, and upon which the forecasts are based, reflect for 56 Matta, S. (2015), New Coincident and Leading Indexes the most part non-crisis conditions, and hence for the Lebanese Economy, Review of Middle East do not factor into panic dynamics; and (ii) the Economics and Finance, 11 (3), 277–303). sample period also precludes COVID-19 and PoB 57 We use the CI as a general gauge of growth as opposed explosion effects. Considering foreign exchange to a one to one indicator of growth. 66 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION 1997, Malaysia, Indonesia, the Philippines, Hong Kong fiscal measures. The Philippines adapted its policies, and South Korea were subsequently targeted by heavy including through the floating of the peso, tightening speculation. The contagion effect also traversed the of monetary policy and strengthening of the banking region to reach Russia and Brazil. Only Hong Kong system. It eventually relaxed its fiscal and monetary was able to successfully defend the currency board policies as stabilization took hold in mid-1998 (IMF, that had been in effect since the parity was set at 7.8 2000). Hong Kong vigorously defended its currency Hong Kong dollars to 1 US$ in October 1983. board with punitive interest rates. It also intervened While macroeconomic imbalances did heavily in the stock markets to counter speculative plague the region on the eve of the crisis—namely, attacks that aimed to cause exchange market pres- large current account deficits, real exchange rate sures through the collapse of stocks.62 appreciations and the concentration of invest- ment in the non-tradable sector—it is generally The Argentinian Financial Crisis of 2001–02 accepted that Asian macroeconomic fundamen- tals warranted neither the scale nor the scope of The Argentine Currency Board—via the so-called the Asian Financial Crisis.58 Instead, causes were Convertibility Law—pegged the Argentine peso concentrated on financial excesses in the private sector, and not the public sector (Katz, 99).59 Furman et al. (1998)60 specifically identifies principal culprits 58 The Asian crisis countries generally enjoyed fiscal surpluses, low inflation and positive real interest rates. to be rapid financial liberalization and capital account 59 S. Stanley Katz (1999), The Asian Crisis, the IMF and convertibility. Domestically, the former did not allow the Critics, Eastern Economic Journal, Vol. 25, No. 4, time for the proper development of credit assessment Symposium: Liberalization and Crisis in Developing and and risk-monitoring skills, placing complex financial Transitional Economies, Fall, 1999: pp. 421–439. instruments beyond the expertise of bankers and 60 Furman, Jason, Joseph E. Stiglitz, Barry P. Bosworth, supervisors. Internationally, the latter shifted foreign and Steven Radalet (1998), Economic Crises: Evidence and Insights from East Asia, Technical Report, The capital flows toward short-term investments in a pri- Brookings Institute. marily private-to-private affair. 61 IMF (2000), Recovery from the Asian Crisis and the Role Thailand, South Korea and Indonesia of the IMF, Issues Brief, June 23, 2000. entered into IMF programs, which totaled around 62 “In August 1998, market speculation against the HK US$35 billion. Another US$85 billion was com- dollar took a distinct form whereby the currency and mitted from other multilateral and bilateral sources, the stock markets were attacked simultaneously. The modus operandi of this ‘double-market play’ involved although not all of this financing actually materialized selling short the HK dollar on the spot and forward (IMF, 2000).61 The IMF called for monetary policy markets, while simultaneously shorting Hong Kong tightening in defense of the exchange rate and to stocks on the cash and futures markets. The shorting of counter inflationary-depreciation effects. Fiscal policy HK dollars was expected to squeeze interbank liquidity stressed surpluses within overly optimistic growth by pushing up the HIBOR and in turn inducing a sharp projections, which in effect rendered them contrac- fall in the stock and futures markets. In the event that this occurred, speculators could reap high rewards even tionary. As the depth of the crisis was realized, some if the exchange-rate peg were maintained. Facing this of the fiscal measures were subsequently relaxed. On prospect, Hong Kong authorities launched a ‘double- the structural side, financial and corporate restructur- counter play’, intervening in both the foreign exchange ings were expansive further exacerbating liquidity and stock markets. Over a period of ten working days constraints. from August 14 to August 28, the Hong Kong Monetary Malaysia opted out of an IMF program and Authority (HKMA) spent a total of HK$118 billion (US$15 billion) to buy stocks directly.” (Harake and Meade, 2014). instead adopted what was at time considered Harake, Wissam and Ellen Meade (2014), Hong heterodox macroeconomic policies that included Kong’s Currency Crisis: A Test of the 1990s ‘Washington targeted and temporary capital controls, a fixed Consensus’ View, International Finance, Volume17, exchange rate and a loosening of monetary and Issue 3, 2014: pp. 1–24. Annex 67 to the U.S. dollar at a parity from March 1991, The Iceland Financial Crisis of 2008 until its failure in January 2002 (Spiegel, 2002).63 Argentina adopted the hard peg in an attempt to While Iceland was not a member country of the eliminate hyperinflation and stimulate economic growth European Monetary Union, it was part of the following an tumultuous economic performance in European Economic Area (EEA), which facilitated the 1980s. While successful initially, it became a financial European integration via the so-called main constraint on the economy’s competitiveness Single Passport.66 In the early 2000s, the Central Bank in general, and on countercyclical macroeconomic of Iceland (CBI) increased interest rates to temper a management in particular. Moreover, there was a large heated economy. This raised the interest rate differential degree of financial dollarization in the economy with between the Icelandic Krona and international the banking system functioning mainly in US dollars. currencies, generating large capital inflows. Insufficient The banking system’s dollar-denominated, short-term macro- and micro-prudential oversight allowed the liabilities exceeded its stock of dollar assets—namely Icelandic banking system to grow at a blistering pace in liquidity held by banks and international reserves. As the years leading up to the crisis (Baudino et al., 2020).67 the system lacked a lender of last resort in dollars, the This resulted in an outsized banking sector as it allowed financial system was inherently unstable, subject to Icelandic banks to amass assets reaching 900 percent bank runs (Kiguel, 2016).64 of GDP by end-2007 (IMF, 2008a).68 In the period just prior to the abandonment According to Baudino et al. (2020), total of the currency board (1998–2001), the economy assets of the three largest Icelandic banks— witnessed a deep contraction, exposing mounting Kaupthing, Glitnir and Landsbanki—more than vulnerabilities in the economy. The hard peg and a doubled in 2004 and again in 2005. The authors lack of fiscal space precluded countercyclical macro- describe how the three banks accessed international economic measures. In response, in January 2001, finance using wholesale, retail and official instruments, the IMF approved an augmentation of financing, namely: (i) wholesale financing via Medium-Term boosting an existing Stand-By Arrangement (SBA) Notes issued in both European and US markets;69 program, to an equivalent of US$ 14 billion, centered on fiscal adjustment and accelerated structural reforms (IMF, 2003).65 However, this failed to achieve 63 Spiegel, Mark (2002), Argentina’s currency crisis: stability. So did various attempts by the Government lessons for Asia, Federal Reserve Bank of San Francisco, for voluntary debt arrangements. The IMF approved December 2002. 64 Kiguel, Miguel (2016), Argentina’s 2001 Economic and a new program, disbursing US$ 5 billion immediately Financial Crisis: Lessons for Europe, Brookings, June 2016. and pledging another US$ 3 billion in support of 65 IMF (2003), Lessons from Argentina, Washington DC, prospective debt restructuring. October 2003. The crisis broke with a run on private 66 The so-called Single Passport allowed a bank deposits, which fell by more than US$ 3.6 billion headquartered in the EEA to open a branch in any other (6 percent of the deposit base) over November EEA county without the need to apply for a license from the host EEA supervisory authority, as banking regulations at 28–30, 2001. The authorities responded with a wide the national level are derived from common EU rules. range of controls on banking and foreign exchange 67 Baudino, Patrizia, Jon Thor Sturluson and Jean-Philippe transactions. As the economy faltered, social and Svoronos (2020), The banking crisis in Iceland, Bank political unrest ensued, forcing the resignation of for International Settlements, Financial Stability Institute, President de La Rua on December 20, followed by Crisis Management Series No. 1, March 2020. 4 other (Congress-appointed) Presidents within 3 68 IMF (2008a), Iceland: Request for Stand-By Arrangement, IMF Country Report No. 08/362, Washington DC. weeks. On December 23, President Sáa declared 69 According to Baudino et al. (2020), from 2004 to a default on Government debt; on January 3, 2002, 2008, issuance by Icelandic banks totaled €45 billion, President Duhalde announced the end of the convert- accounting for a large share of their combined balance ibility regime (IMF, 2003). sheet in 2008. 68 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION (ii) retail financing via deposits from foreign European reduced capital requirements and eased the rules on jurisdictions using the internet, with Landsbanki and the eligibility of collateral (IMF, 2008a). After two years Kaupthing being particularly aggressive in the United of negative real GDP growth (–6.8 and –3.4 percent in Kingdom and Landsbanki in the Netherlands;70 and 2009 and 2010, respectively), real GDP growth turned (iii) collateralized borrowing from central banks, in par- positive in 2011 (1.9 percent). Iceland’s economic ticular the CBI and the European Central Bank (ECB). recovery continued, imbalances in the balance sheets The eruption of the Global Financial Crisis were reduced and the country embarked on phased exposed the currency and maturity mismatches fiscal consolidation. Capital controls were eventually of Iceland’s three largest banks. The sovereign lifted on March 14, 2017. risk premium as well as the perceived riskiness of Icelandic banks, as measured by CDS spreads, Crises in the European Monetary Union increased markedly. A rapid loss of confidence in the 2008–13 Icelandic banking system ensued. By end-September, 2008, the three banks were resorting to the Icelandic Countries of the EMU, namely, Greece, Portugal, Government for backing, which could not be attained Ireland, Spain, Italy and Cyprus, were all subject due to the large volumes of foreign currency needed. to systemic crises over the period 2008–2013. Lacking a lender of last resort, the three banks essen- Important financial and economic linkages as well tially became insolvent and collapsed in October as common fundamentals warrant a collective look 2008. The Krona depreciated by more than 70 per- at this group. Nonetheless, each episode retains cent in the offshore market, equity prices fell by more important idiosyncratic factors, which translated into than 80 percent and the crisis severely stressed bal- differentiated remedies and recovery paths. Greece, ance sheets in the corporate, household and banking Portugal, Ireland, Spain and Cyprus all required direct sectors (IMF, 2009).71 assistance in the form of bailout packages provided Faced with the unfolding crisis, the by The Troika of the IMF, the European Commission Icelandic government acted rapidly to stem the and the European Central Bank (ECB). exchange rate depreciation and safeguard the Naturally, as part of the EMU, member stability of the banking sector. The authorities states surrender exchange rate and monetary enacted capital controls in 2008 and adopted a “new policies. On the other hand, until the EMU crises, bank/old bank system” approach for the three col- each exercised considerable prudential and regula- lapsed banks. Under this approach, new banks would tory authority over its own financial sector.73 Common service domestic needs while foreign liabilities were to all is a form of perceived economic security allocated to the old banks. That is, the three banks were placed under receivership and the remaining banks were recapitalized. 70 According to Baudino et al. (2020), by mid-2008, foreign On November 19, 2008, the authorities deposits had increased to €16 billion, or 15 percent of also sought and secured, a US$ 2.1 billion SBA Landsbanki’s and Kaupthing’s combined balance sheet. 71 IMF (2009), Iceland: Staff Report for First Review Under from the IMF (IMF, 2008b)72 and the central bank Stand-By Arrangement and Requests for Extension entered into swap agreements with other Nordic of the Arrangement, Waivers of Nonobservance of central banks in May 2008 (IMF, 2008a). The Performance Criteria, and Rephasing of Access, IMF SBA was predicated on three tenets: (i) stabilizing the Country Report No. 09/306, Washington DC. exchange rate and restoring confidence in the banking 72 International Monetary Fund (2008b), Press Release: sector, (ii) limiting the collapse of the banking sector IMF Executive Board Approves US$2.1 Billion Stand-By Arrangement for Iceland, Washington DC. and (iii) implementing a comprehensive and sound 73 As part of financial reform measures introduced to address banking system strategy (IMF, 2008a). In tandem, the causes of the Euro area crises, prudential and regulatory government borrowed €300 million to boost reserves supervision of large and systemic European banks came and the central bank increased liquidity provision, under the jurisdiction of European Central Bank. Annex 69 afforded by being part of the EMU that encouraged banks (IMF, 2015).77 This was followed by the nation- excesses, either public of private. In this section, we alization of Ireland’s third largest bank, a €7 billion shall focus on Ireland, Greece and Cyprus. recapitalization of its two other large banks and the creation of a “bad bank” (National Asset Management The Irish Financial Crisis of 2008 Agency) to manage the billions of nonperforming or toxic loans in the banking system (O’Sullivan and Ireland enjoyed a rare economic boom in the two Kennedy, 2010). decades prior to the crisis, transforming itself into In November 2010, the Irish government one of the most vibrant economies in Europe to enlisted the help of The Troika, who offered be aptly described as the “Celtic Tiger” economy a package in the amount of €85 billion (IMF, (O’Sullivan and Kennedy, 2010).74 GDP increased 2015). The IMF Extended Fund Facility arrangement by an average of 7 percent annually, the highest of €22.5 billion was predicated on restoring the health among EU-15 at the time; in terms of GDP per capita, of the financial system and establishing a smaller and Ireland went from the 22nd richest country in 1997 more robust banking sector. Strong Irish ownership to the 5th richest by 2007 (O’Sullivan and Kennedy, of the program and prompt action by the authori- 2010). Ireland’s growth model was bolstered by large ties resulted in rebuilding banks’ lending capacity, Foreign Direct Investments (FDI) owing to a favorable resolving high nonperforming loan (NPLs) ratios tax regime and the business-friendly environment. and improving business sentiment and consumer Ireland’s entry into the EMU on 1 January confidence (IMF, 2014).78 As a consequence, after 2002 offered opportunities and challenges common contracting in 2008 and 2009 by 4.5 percent and 5.1 with its peers; a boost of confidence, easier access percent, respectively, real GDP resumed growth in to international finance and a rise in factor prices. 2010 at 1.8 percent. Excesses converged on the real estate market, as the property market demonstrated signs of an asset price The Greece Financial Crisis of 2009 bubble; demand for housing soared, with loan approvals rising from €4.4 billion in 1997 to over €31.4 billion in Greece’s accession to the EMU in 2001 did not 2006. Supply of housing surged to meet demand as correct structural imbalances that included large the total stock of house completions increased by over internal and external deficits coupled with a low 430,000 units in six years (2001–2007) (O’Sullivan and growth environment. Public sector net borrowing Kennedy, 2010). Meanwhile, net indebtedness of Irish averaged around 7 percent of GDP annually in banks to the rest of the world rose from 10 percent the Euro-but-pre-crisis period (2002–2008), of GDP at end-2003 to over 60 percent by early 2008 compared to 6.7 percent in the pre-Euro period (Honohan, 2009).75 As a result, on the eve of the crisis, (1994–2000). Public debt remained relatively stable the Celtic Tiger had developed a “heavy reliance on building investment, sharp increases in house prices, and rapid credit growth, especially to property-related 74 O’Sullivan, K.P.V and Tom Kennedy (2010), What Caused the Irish Banking Crisis? Journal of Financial sectors” (IMF, 2006).76 Regulation and Compliance 18 (July): 224–242. In the wake of the Global Financial Crisis 75 Honohan, Patrick (2009), Policy paper: Resolving of 2008, international finance dried up and the Ireland’s Banking Crisis, The Economic and social extent of spillovers on the Irish banking sector review 40(2): 207–231. quickly materialized. This came in the form of 76 IMF (2006), Ireland, Staff Report for the 2006 crashing stock prices of banks’ and inability (of one Article IV Consultation, International Monetary Fund, Washington DC. particular bank) to roll-over wholesale foreign debt. In 77 IMF (2015), Ireland: Ex Post Evaluation of Exceptional response, on September 30, 2008, the Government Access under the 2010 Extended Arrangement. announced an unprecedented blanket guarantee 78 IMF (2014), Ireland: First Post-Program Monitoring scheme to depositors and creditors of six domestic Discussions. 70 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION over the former period fluctuating between 100 and in May 2010, complemented with a cooperative 110 percent of GDP. Externally, the current account package of financing from the European Union deficit rose from a pre-Euro average of 3.3 percent amounting to €110 billion (IMF, 2012b).84 The of GDP to Euro-pre-crisis average of 10.5 percent. SBA was underpinned by a stringent fiscal consoli- Moreover, external debt also rose decidedly from dation program that aimed at putting Greek debt on about 100 percent of GDP end-2003, to 133 percent sustainable footing. However, key SBA macro-fiscal by end-2008. Clearly, the EMU facilitated easier targets, namely, fiscal and current account indicators, access to foreign financing for both the public as failed to be met. The SBA was subsequently can- well as the private sectors; by 2009, private sector celled in 2012 and was replaced with an Extended external debt stood at 175 percent of GDP (IMF, Fund Facility (EFF) arrangement on March 15, 2012, 2017a).79 The adoption of the Euro also adversely also under the Troika. The EFF arrangement included affected the Greek economy’s competitiveness financing of about €173 billion over four years. relative to its trading partners, given that wages in Critically, and as a prior action for the EFF, the European periphery countries rose relative to the a Private Sector Initiative (PSI) was announced core countries (Hale, 2013).80 Hence, on the eve of the on June 2011 for a voluntary debt swap of Greek crisis, Greece was gripped with deep twin structural sovereign bonds involving a haircut on private deficits, lack of competitiveness as wage growth creditors who were represented by the Institute of outpaced productivity growth and a real exchange International Finance. This haircut, which was subse- rate overvaluation (IMF, 2012a).81 quently implemented on March 2012, was equivalent The onset of the global financial crisis to a 53.5 percent cut in the face value (principal) of exacerbated the mounting imbalances of the the bonds, corresponding to an approximately €107 Greek economy. After the failure of Lehman brothers billion reduction in Greece’s debt stock.85 in September 2008, the spread between the Greek The internal adjustment proved harsh Government bonds and the German bunds soared to and counter-productive, as macro-fiscal tar- 100 basis points (IMF, 2013)82 and led to downgrades gets remained elusive due to unaccounted for by Standard and Poor’s. A main trigger to the Greek episode was data revision by the authorities in October 2009, which entailed a sizeable increase in the pro- 79 IMF (2017a), Greece: Ex-Post Evaluation of Exceptional jected fiscal deficit from 4 to 12.5 percent of GDP.83 Access Under the 2012 Extended Arrangement, This roiled markets further, weakened confidence in Washington DC. 80 Hale, G. (2013), Balance of Payments in the European the Greek economy and prompted a downgrade by Periphery, Federal Reserve Bank of San Francisco Fitch (IMF, 2013). The loss of confidence in the Greek Economic Letter. economy prompted capital outflows from the banking 81 IMF (2012a), Greece: Request for Extended Arrangement sector estimated at 30 percent of the deposit base. It Under the Extended Fund Facility, Washington DC. also suspended Greece’s access to financial markets 82 IMF (2013), Greece: Ex-Post Evaluation of Exceptional by significantly widening yields on Greek bonds to Access Under the 2010 Stand-By Arrangement, Washington DC. unaffordable rates. 83 The data revision came amidst concerns raised Given that Greece is an EMU member, a by Eurostat—the statistical office of the European nominal currency devaluation that corrects the Commission—regarding the quality of Greece’s fiscal built-up imbalances was not possible. Instead, data on five occasions over the period 2005–2009. under the Troika, Greece underwent a very sharp 84 IMF (2012b), Press Release: IMF Executive Board internal devaluation, including a reduction in the wage Approves €30 Billion Stand-By Arrangement for Greece. 85 The European Stability Mechanism: https://www. bill and pension benefits. A deep recession ensued esm.europa.eu/content/what-was-private-sector-debt- over the next decade. restructuring-march-2012#:~:text=Also%20known%20 In return, the Greek authorities secured a as%20the%20PSI,lighten%20Greece’s%20overall%20 €30 billion Stand-By Arrangement from the IMF debt%20burden. Annex 71 economic contractions and an unsustainable Cypriot banks, which were subsequently deprived public debt that persisted despite the PSI. This of access to international financial markets translated into social pain and political instability. A (Orphanides 2016).89 Specifically, two major banks banking sector crisis ensued in 2015, which required with sizeable operations in Greece came under the introduction of capital controls. Once again, the intense pressure in early 2012, and a full-blown EFF program faltered and was eventually cancelled in banking crisis ensued following the restructuring of January 2016 (IMF, 2017a). The prolonged economic Greek debt. IMF (2013) notes that the banking sector contraction helped drive the debt-to-GDP ratio to a lost 10 percent of its domestically raised deposits peak of 180 percent of GDP in 2016. In July 2017, while Cyprus’ second largest bank lost one-third of its the IMF approved a precautionary €1.6 billion SBA deposits. for Greece (IMF, 2017b).86 This time the program In response to the crisis, Cypriot authorities explicitly notes that, without debt relief, Greece’s debt instituted capital controls, resolved and restruc- will continue to be unsustainable. tured two insolvent banks, and recapitalized the banking sector. The authorities also embarked on The Cyprus Financial Crisis of 2011–13 a fiscal consolidation plan that aimed at a primary budget surplus of 4 percent of GDP. This was Cyprus has been part of the EMU since January underpinned by a three-year extended fund facility 2008. In the lead to the crisis, especially over arrangement from the IMF of about 1 billion euros and 2009–2010, Cyprus increased its reliance on an additional support of 9 billion from the European foreign sources for sovereign debt financing, Stability Mechanism (IMF, 2013). as the lure of lower foreign interest rates was The Cyprus case stands out as the first too great a temptation to resist in the face of to implement a Bail In resolution framework for falling tax revenues and higher government the banking sector, where uninsured depositors expenditures (Mikaelides, 2016).87 Additionally, would be called upon to recapitalize their banks, the banking sector attracted sizeable non-resident and a hierarchy of losses implied the wipeout of inflows due to Cyprus’s tax regime, accumulating bank shares. assets that stood at more than eight times GDP. The non-resident deposit flows financed the country’s current account deficits, contributed to a worsening of 86 IMF (2017b), Greece: Request for Stand-By Arrangement, Washington DC. Cyprus’ international investment position and spurred 87 Mikaelides, Alexander (2016), Cyprus: From Boom a domestic credit boom (IMF 2013).88 The Cypriot to Bail-In: Policy Lessons from the Cyprus Economic banking sector was also heavily exposed to Greece; Crisis, 59th Economic Policy Conference, April 2016. Cypriot banks’ loans to Greek residents stood at 130 88 IMF (2013), Cyprus: Request for an Arrangement Under percent of GDP, while holdings of Greek sovereign the Extended Fund Facility, Country Report No. 13/125, debt amounted to 30 percent of GDP (IMF, 2013). Washington DC. 89 Orphanides, Athanasios (2016), What Happened in By Fall 2011, losses on Cypriot sovereign Cyprus? The Economic Consequences of the Last debt as well as losses on holdings of Greek debt— Communist Government in Europe, The Cyprus Bail-in, due to the EU negotiated Private Sector Initiative The Policy Lessons from The Cyprus Economic Crisis, for Greece—induced significant pressures on pg. 163. 72 LEBANON ECONOMIC MONITOR: THE DELIBERATE DEPRESSION 1818 H Street, NW Washington, DC 20433