LEBANON ECONOMIC MONITOR ºµd ÉfDhGóf Spring 2017 Global Practice for Macroeconomics & Fiscal Management, GMFDR MIDDLE EAST AND NORTH AFRICA REGION The World Bank lebanon economic monitor | ‫ندا�ؤنا لكم‬ Preface The Lebanon Economic Monitor provides an update this Lebanon Economic Monitor series and related on key economic developments and policies over publications, please contact Nada Abou Rizk the past six months. It also presents findings from (nabourizk@worldbank.org). For questions and recent World Bank work on Lebanon. It places them comments on the content of this publication, please in a longer-term and global context, and assesses contact Wissam Harake (wharake@worldbank. the implications of these developments and other org) or Eric Le Borgne (eleborgne@worldbank.org). changes in policy on the outlook for Lebanon. Questions from the media can be addressed to Zeina Its coverage ranges from the macro-economy to El Khalil (zelkhalil@worldbank.org). financial markets to indicators of human welfare and development. It is intended for a wide audience, including policy makers, business leaders, financial market participants, and the community of analysts and professionals engaged in Lebanon. The Lebanon Economic Monitor is a product of the World Bank’s Lebanon Macro-Fiscal Management (MFM) team. It was prepared by Wissam Harake (Country Economist), and Naji Abou Hamde (Economic Analyst) under the general guidance of Eric Le Borgne (Lead Economist and acting Global Practice Manager). A cross-sector team led by Wissam Harake (Country Economist) authored the Special Focus on priority reforms for the Government of Lebanon. Zeina El Khalil (Communications Officer) led on media outreach and print production, Naji Abou Hamde (Economic Analyst) provided Arabic translation and Nada Abou-Rizk (Program Assistant) assisted with French translation. The findings, interpretations, and conclusions expressed in this Monitor are those of World Bank staff and do not necessarily reflect the views of the Executive Board of The World Bank or the governments they represent. For information about the World Bank and its activities in Lebanon, including e-copies of this publication, please visit www.worldbank.org.lb To be included on an email distribution list for Preface | 1 The World Bank Table of Contents Preface......................................................................................................................................................... 1 EXECUTIVE SUMMARY................................................................................................................................ 4 ‫الملخ�ص التنفيذي‬............................................................................................................................................... 7 Sommaire Exécutif................................................................................................................................. 8 Recent Economic and Policy Developments.......................................................................... 10 Output and Demand...................................................................................................................................... 11 Poverty and Labor.......................................................................................................................................... 14 Fiscal Policy.................................................................................................................................................... 14 External Sector............................................................................................................................................... 16 Monetary Sector............................................................................................................................................. 18 Financial Markets........................................................................................................................................... 19 Prospects................................................................................................................................................. 22 SPECIAL FOCUS.......................................................................................................................................... 24 Priority Reforms for the Government of Lebanon....................................................................................... 24 Abstract.......................................................................................................................................................... 24 I.The Exigency: Stating the Case..................................................................................................................... 24 II.Short-Term Priorities................................................................................................................................... 27 A. Passing a Credible Budget: the Litmus Test............................................................................................. 27 B. Building Trust.......................................................................................................................................... 27 C. Securing a Soft Landing........................................................................................................................... 28 D. Delivering the Essentials......................................................................................................................... 29 E. Empowering the Poor.............................................................................................................................. 31 F. Shaping a Breathing Space....................................................................................................................... 32 G. Working and Accessing Finance............................................................................................................. 32 III.Medium-Term Priorities............................................................................................................................. 33 A. Making Government Work..................................................................................................................... 33 B. Plugging the Information Gap................................................................................................................. 34 C. Breaking the Debt Chain......................................................................................................................... 34 D. The Dream of 24/7................................................................................................................................. 35 E. Toward a New Social Model.................................................................................................................... 36 F. … Growth for All..................................................................................................................................... 38 G. … And Jobs at Home.............................................................................................................................. 39 H. The Refugee Crisis: Creating Opportunities........................................................................................... 40 DATA APPENDIX......................................................................................................................................... 41 Selected Special Focus from Recent Lebanon Economic Monitors........................... 42 SELECTED RECENT WORLD BANK PUBLICATIONS ON LEBANON................................................... 45 List of Figures Figure 1. Frequent shocks result in volatile economic activity.................................................................. 11 Figure 2. A slight pick up in economic activity in 2016 ............................................................................ 11 Figure 3. Recovery in tourism persisted in 2016….................................................................................... 12 Figure 4. Slight pickup in real estate ........................................................................................................ 12 Figure 5. Consumer sentiment improving but volatile ............................................................................. 12 Figure 6. Poverty rate highest in the Bekaa and North 2011/12 ............................................................... 12 Figure 7. In 2016, debt-to-GDP ratio surges upward … ........................................................................... 15 lebanon economic monitor | ‫ندا�ؤنا لكم‬ Figure 8. … in response to a worsening fiscal position............................................................................. 15 Figure 9. Regression in capital inflows reversed in 2016… ...................................................................... 17 Figure 10. … inducing an increase in gross foreign reserves at BdL ........................................................... 17 Figure 11. Banks increase their exposure to foreign currency-denominated sovereign debt ...................... 19 Figure 12. Deflationary trend reversed in 2016, as provisional import deflation abates ............................. 19 Figure 13. Banks’ preferences for high return assets is sticky .................................................................... 20 Figure 14. Funding sourced from resident and non-resident deposits........................................................ 21 Figure 15. A discerned slowdown in both resident and non-resident deposit growth................................ 21 List of Tables Table 1. Lebanon Selected Economic Indicators, 2014-2019................................................................... 45 List of Boxes Box 1. Oil and Gas Decrees.................................................................................................................. 13 List of Key Abbreviations Used bps: Basis points H1, H2: First half of the year, second half of the year. 3mma: Three-months moving average pp: Percentage points Q1 (Q2, Q3, Q4): First (second, third, fourth) quarter of the year qoq: Quarter-on-quarter sa: Seasonally adjusted saar: Seasonally adjusted, annual rate yoy: Year-on-year lhs, rhs: Left hand side, right hand side (for axis of figures) Table of Contents | 3 The World Bank EXECUTIVE SUMMARY I. The election of President Michel Aoun in debt-to-GDP ratio to an estimated 157.5 percent by October 2016 after almost two and a half years end-2016, a rise of 8.1 pp from end-2015. of a presidential vacancy, and the subsequent formation of a national unity government have IV. A widening current account deficit along generated hope for the resuscitation of the with declining capital inflows motivated the BdL political process in Lebanon. Nonetheless, the financial swap. In 2016, a 3.5 percent growth in protracted Syrian conflict is markedly worsening the merchandize imports combined with a slowdown country’s vulnerabilities and remains an impediment in remittances. The latter began decelerating in to the return to potential growth. For the fifth year, 2016 following a couple of years of being largely Lebanon persists as the largest host (on a per capita unaffected by lower oil prices. This led to an increase basis) for displaced Syrians. in the already sizable current account deficit to an estimated 21 percent of GDP, from 17 percent of II. In 2016, real GDP growth underwent a GDP in 2015, which is among the largest in the world, slight acceleration to reach an estimated 1.8 exposing the country to significant refinancing risks. percent, compared to 1.3 percent in 2015. This Faced with weaker capital inflows—a main resource was driven by an improvement in the real estate for an economy with sizable fiscal and current sector, marking a low threshold-effect from a weak account deficits—BdL financially engineered a swap performance in 2015—cement deliveries expanded that was able to boost its gross foreign exchange by 4.4 percent in 2016 compared to a contraction reserves by 11.1 percent in 2016 to reach US$ 34 of 8.6 percent in 2015. Real GDP growth was billion after registering a decline of 5.4 percent in also boosted by tourist arrivals, an indicator 2015. Notwithstanding the short-term needs, given that registered an 11.2 percent growth in 2016. the current fundamentals and lack of structural Nonetheless, economic activity persists below reforms, such interventions can exacerbate macro- potential, inhibited by geopolitical and security financial risks. conditions, which remain decidedly volatile. V. Assuming the political process does not III. The fiscal position of Lebanon became revert back to a stalemate, improvements in the more tenuous as the overall fiscal deficit traditional economic drivers—tourism, real estate widened and the already elevated debt-to-GDP and construction—are likely to translate into a ratio surged. The overall fiscal deficit increased by pick-up in real GDP growth in 2017, which we an estimated 1.8 percentage points (pp) to reach project at 2.5 percent. We forecast growth over the 10 percent of GDP, hitting double digits for the medium term to remain around 2.5 percent annually first time since 2006. While both revenues and as potential growth is contingent on the resolution expenditures rose during 2016, the latter outpaced of the Syrian conflict. the former. Primary spending (excluding debt service) rose by 1.9 pp, cutting the primary surplus VI. Following the resumption of the political from 1.3 percent of GDP in 2015 to 0.1 percent process and in light of the urgent need for in 2016. This combined with a limited increase in reforms, we present a menu of reforms that nominal GDP (driven by slow real GDP growth and would enable the country to rapidly and a negative change in the GDP deflator) pushed the significantly turn the page of inaction and 4 | Executive Summary lebanon economic monitor | ‫ندا�ؤنا لكم‬ decline and return the country to a prosperous and inclusive development path (Special Focus). To that end, reforms are prioritized over two time horizons—the short and medium terms. The first set of reforms suggested aim at establishing a record of achievements and government credibility that is currently sorely absent; without such a clear statement, policymaking effectiveness will be limited. They will also set the platform for the medium term that are more systemic. Executive Summary | 5 ‫‪The World Bank‬‬ ‫| ‪6‬‬ ‫الملخ�ص التنفيذي‬ ‫| ‪lebanon economic monitor‬‬ ‫ندا�ؤنا لكم‬ ‫الملخ�ص التنفيذي‬ ‫التي كان �أثر انخفا�ض �أ�سعار النفط عليها محدود ًا لب�ضع �سنوات‪.‬‬ ‫�إن انتخاب الرئي�س مي�شال عون في ت�شرين الأول ‪/‬‬ ‫‪ I‬‬ ‫‪.‬‬ ‫ال في الح�ساب الجاري‬ ‫�أدى ذلك �إلى زيادة العجز المرتفع �أ�ص ً‬ ‫�أكتوبر ‪ 2016‬بعد نحو عامين ون�صف من ال�شغور الرئا�سي‪ ،‬وما‬ ‫المقدرة ن�سبته ب‪ 21‬في المئة من الناتج المحلي الإجمالي‪ ،‬بعد �أن‬ ‫تبع ذلك من ت�شكيل حكومة وحدة وطنية‪ ،‬قد ولد الأمل في‬ ‫كانت هذه الن�سبة تمثل ‪ 17‬في المئة من الناتج المحلي الإجمالي‬ ‫�إنعا�ش العملية ال�سيا�سية في لبنان‪ .‬ومع ذلك‪ ،‬ف�إن النزاع ال�سوري‬ ‫في العام ‪ ،2015‬وهي من �ضمن الأعلى في العالم مما يعر�ض البلد‬ ‫الذي طال �أمده يزيد ب�شكل ملحوظ من �ضعف البلد ويظل عائق ًا‬ ‫لمخاطر كبيرة في �إعادة التمويل‪ .‬لمواجهة �ضعف تدفقات ر�ؤو�س‬ ‫�أمام العودة �إلى النمو المحتمل‪ .‬هذا ويبقى لبنان لل�سنة الخام�سة‬ ‫الأموال الداخلة‪ ،‬والتي تعتبر مورد �أ�سا�سي القت�صاد يعاني من عجز‬ ‫�أكبر م�ضيف للنازحين ال�سوريين (ن�سب ً‬ ‫ة �إلى عدد ال�سكان)‪.‬‬ ‫بالغ في المالية العامة والح�ساب الجاري‪ ،‬قام الم�صرف المركزي‬ ‫بت�صميم هند�سة مالية ا�ستطاع بموجبها رفع احتياطاته من النقد‬ ‫�شهد العام ‪ 2016‬ارتفاعاً طفيفاً في نمو الناتج المحلي‬ ‫‪ .II‬‬ ‫الأجنبي بن�سبة ‪ 11.1‬في المئة في عام ‪ 2016‬لتبلغ ‪ 34‬مليار دوالر‬ ‫ً‬ ‫الإجمالي الحقيقي ليبلغ ‪ 1.8‬في المئة‪ ،‬مقارنة مع ‪ 1.3‬في المئة‬ ‫ضا بن�سبة ‪ 5.4‬في المئة في‬ ‫�أميركي وذلك بعدما �سجلت انخفا� ً‬ ‫في العام ‪ .2015‬يعود هذا النمو �إلى تح�سن في القطاع العقاري‪ ،‬مع‬ ‫عام ‪ .2015‬على الرغم من الإحتياجات على المدى الق�صير‪ ،‬نظر ًا‬ ‫�أخذ الأداء ال�ضعيف في عام ‪ 2015‬بعين الإعتبار‪ ،‬حيث ارتفعت‬ ‫للأ�سا�سيات الحالية ونق�ص الإ�صالحات الهيكلية‪ ،‬يمكن لتدخالت‬ ‫ت�سليمات الأ�سمنت بن�سبة ‪ 4.4‬في المئة في عام ‪ 2016‬مقارنة‬ ‫كهذه �أن ت�ؤدي �إلى تفاقم المخاطر المالية‪-‬الكلية‪.‬‬ ‫بانكما�ش بن�سبة ‪ 8.6‬في المئة في عام ‪ .2015‬كما تعزز نمو الناتج‬ ‫المحلي الإجمالي الحقيقي بارتفاع عدد ال�سياح القادمين �إلى‬ ‫على افترا�ض �أن العملية ال�سيا�سية لن تعود �إلى‬ ‫‪ .V‬‬ ‫لبنان وهو م�ؤ�شر �سجل نموا بن�سبة ‪ 11.2‬في المئة في عام ‪.2016‬‬ ‫حالة الجمود‪ ،‬ف�إن التح�سن في المحركات التقليدية للعجلة‬ ‫ومع ذلك‪ ،‬ف�إن الن�شاط االقت�صادي ما زال دون الإمكانات ب�سبب‬ ‫الإقت�صادية‪ ،‬المتمثلة بقطاعي ال�سياحة والعقارات والبناء‪ ،‬من‬ ‫المعوقات المتمثلة بالظروف الجيو�سيا�سية والأمنية التي ال تزال‬ ‫المرجح �أن يظهر �أثره بنمو في الناتج المحلي الإجمالي الحقيقي‬ ‫متقلبة‪.‬‬ ‫لعام ‪ ،2017‬والذي نتوقع �أن يكون ‪ 2.5‬في المئة‪� .‬إننا نتوقع �أن‬ ‫ي�ستمر النمو على المدى المتو�سط في حدود ‪ 2.5‬في المئة �سنويا‬ ‫‪� .III‬إزداد الو�ضع المالي للبنان ه�شا�شة مع ات�ساع العجز‬ ‫نظرا �إلى �أن �إدراك النمو المحتمل يتوقف على حل النزاع ال�سوري‪.‬‬ ‫المالي العام وتعاظم ن�سبة الدين �إلى الناتج المحلي الإجمالي‬ ‫المرتفعة �أ�صال‪ .‬ارتفع العجز المالي العام بنحو ‪ 1.8‬نقطة مئوية‬ ‫بعد ا�ستئناف العملية ال�سيا�سية‪ ،‬وفي �ضوء الحاجة‬ ‫‪ .VI‬‬ ‫لي�صل �إلى ‪ 10‬في المائة من الناتج المحلي الإجمالي‪ ،‬في �أعلى ن�سب ٍة‬ ‫الما�سة �إلى �إجراء �إ�صالحات‪ ،‬نقدم قائمة بالإ�صالحات التي من‬ ‫له منذ عام ‪ .2006‬وفي حين ارتفعت الإيرادات والنفقات خالل عام‬ ‫�ش�أنها �أن تمكن البلد من طي �صفحة التقاع�س والإنحدار ب�سرعة‬ ‫‪ ،2016‬فاق الإرتفاع في النفقات مثيله في الإيرادات‪ .‬وارتفع الإنفاق‬ ‫وب�شكل ملحوظ والعودة �إلى م�سار الإزدهار والتنمية ال�شاملة‬ ‫الأولي (با�ستثناء خدمة الدين) بمقدار ‪ 1.9‬نقطة مئوية‪ ،‬مما‬ ‫(التركيز الخا�ص)‪ .‬تجاه هذه الغاية تم تحديد الأولويات الإ�صالحية‬ ‫خف�ض الفائ�ض الأولي من ‪ 1.3‬في المئة من الناتج المحلي الإجمالي‬ ‫وفق اطارين زمنيين هما المدى الق�صير والمدى المتو�سط‪ .‬ال�سلة‬ ‫في عام ‪� 2015‬إلى ‪ 0.1‬في المئة منه في عام ‪ .2016‬وترافق هذا مع‬ ‫الأولى من الإ�صالحات المقترحة تهدف �إلى �إن�شاء �سجل للإنجازات‬ ‫زيادة محدودة في الناتج المحلي الإجمالي اال�سمي (مدفوعا ببطء‬ ‫وت�أ�سي�س م�صداقية الحكومة الغائبة حالي ًا �إذ �إن الفعالية في‬ ‫نمو الناتج المحلي الإجمالي الحقيقي وتغير �سلبي في مخف�ض الناتج‬ ‫ة دون بيان وا�ضح‪ .‬كما �أن هذه‬ ‫�صناعة ال�سيا�سات �ستم�سي محدود ً‬ ‫المحلي الإجمالي) دفع ن�سبة الدين �إلى الناتج المحلي الإجمالي‬ ‫الإ�صالحات �ستحدد البرنامج على المدى المتو�سط ب�شكل منهجي‪.‬‬ ‫�إلى ما يقدر بنحو ‪ 157.5‬في المئة بحلول نهاية عام ‪ ،2016‬بزيادة‬ ‫قدرها ‪ 8.1‬نقاط مئوية عن نهاية عام ‪.2015‬‬ ‫�شكلت زيادة العجز في الح�ساب الجاري والتي ترافقت‬ ‫‪ IV‬‬ ‫‪.‬‬ ‫ً‬ ‫مع انخفا�ض تدفقات ر�ؤو�س الأموال الداخلة حافزا لم�صرف لبنان‬ ‫للقيام بعمليات المبادلة المالية‪ .‬جاء ارتفاع الواردات لل�سلع بن�سبة‬ ‫‪ 3.5‬في المئة عام ‪ 2016‬م�صحوب ًا بانخفا�ض التحويالت المالية‬ ‫الملخ�ص التنفيذي‬ ‫‪| 7‬‬ The World Bank Sommaire Exécutif I. L’élection du Président Michel Aoun augmentation limitée du PIB nominal (motivée par en octobre 2016 après quasiment deux ans et une croissance lente du PIB réel et par un changement demi de vacance présidentielle et la formation négatif du déflateur du PIB), a poussé le ratio de la conséquente d’un gouvernement d’unité dette au PIB à un taux estimé de 157.5% à la fin de nationale ont revigoré l’espoir dans la reprise 2016, soit une augmentation de 8.1 pp à partir de la du processus politique au Liban. Toutefois, le fin de 2015. conflit syrien qui se prolonge aggrave d’une manière significative les vulnérabilités du pays et demeure un IV. Un déficit du compte courant combiné à obstacle au retour d’une éventuelle croissance. Pour un déclin des flux des capitaux a motivé le swap la cinquième année consécutive le Liban demeure le financier de la BdL. En 2016, une croissance de plus grand pays hôte (per capita) de déplacés syriens. 3.5% des importations de biens est venue s’ajouter à un ralentissement des remises de fonds. Ces II. En 2016, la croissance réelle du PIB a dernières ont commencé à se ralentir en 2016 après connu une légère accélération pour atteindre un des années pendant lesquelles elles demeuraient taux estimé de 1.8%, à comparer avec 1.3% en largement non affectées par des prix de pétrole plus 2015, motivée par une amélioration dans le secteur bas. Ceci a abouti à une augmentation du déficit du foncier et marquant un bas effet de seuil à partir compte courant déjà accru, estimé à environ 21% du d’une faible performance en 2015—les livraisons de PIB, à partir de 17% du PIB en 2015, soit l’un des ciment ont augmenté de 4.4% en 2016 à comparer PIB les plus élevés dans le monde, exposant ainsi avec une contraction de 8.6% en 2015. La croissance le pays à des risques significatifs de refinancement. réelle du PIB a été également encouragée par le Face à des flux plus faibles de capitaux, constituant retour des touristes, un indicateur qui a enregistré ainsi une principale ressource pour une économie une croissance de 11.2% en 2016. Toutefois, l’activité présentant un déficit du compte courant et un déficit économique demeure en-deçà de son potentiel. Elle fiscal de taille significative – la Banque du Liban reste, inhibée ainsi par les conditions sécuritaires a mis en place, sur le plan financier, un swap qui et géopolitiques, qui demeurent incontestablement était à même de promouvoir les réserves de change volatiles. brutes de 11.1% en 2016 pour atteindre 34 milliards $ après avoir enregistré une baisse de 5.4% en 2015. III. La position fiscale du Liban devient plus En dépit des besoins à court terme et vu les principes précaire avec l’élargissement du déficit fiscal fondamentaux actuels et le manque de réformes général et l’augmentation du ratio de la dette au structurelles, de telles interventions peuvent PIB déjà élevé. Le déficit fiscal général a augmenté exacerber les risques macro-financiers. de 1.8 point de pourcentage (pp) pour atteindre 10% du PIB, enregistrant un niveau à deux chiffres pour V. A supposer que le processus politique ne la première fois depuis 2006. Alors que les revenus se retrouvera pas de nouveau dans une impasse, et les dépenses ont augmenté en 2016, les dépenses les améliorations dans les moteurs économiques ont dépassé les revenus.  Les dépenses primaires traditionnels – le tourisme, le secteur foncier et (excluant le service de la dette) ont augmenté de la construction – seront éventuellement traduites 1.9 pp, réduisant le surplus primaire de 1.3% du par une reprise de la croissance réelle du PIB en PIB en 2015 à 0.1% en 2016. Cela, associé à une 2017, que nous estimons à 2.5%. Nous prévoyons 8 | Sommaire Exécutif lebanon economic monitor | ‫ندا�ؤنا لكم‬ que la croissance à moyen terme demeure autour de 2.5% par an alors que la croissance potentielle est tributaire de la résolution du conflit syrien. VI. Suite à la reprise du processus politique et à la lumière du besoin urgent de réformes, nous présentons un menu de réformes qui permettraient au pays de tourner, rapidement et radicalement, la page de l’inertie et du déclin et de s’orienter vers un développement prospère et inclusif (Centre d’intérêt spécial). A cette fin, les réformes sont proposées suivant un ordre de priorités qui sera exécuté en deux temps — à court et à moyen termes. Le premier ensemble des réformes en question vise à mettre en place un bilan des réalisations et à rétablir la crédibilité du gouvernement qui est actuellement particulièrement absent; sans un tel bilan clair, l’efficacité de l’élaboration de politiques sera limitée. Les réformes détermineront également la plateforme à moyen terme qui est plus systémique. Sommaire Exécutif | 9 The World Bank Recent Economic and Policy Developments 1. On 31 October 2016, Michel Aoun rates and fees intended to cover the additional cost. was elected President of the Republic putting The salary scale, as included in the draft budget, to an end the longest presidential vacancy is valued at LBP 1,200 billion (US$ 800 million), in Lebanon’s modern history, which ran 29 equivalent to 1.7 percent of 2017 GDP. months and 46 electoral sessions. This and the subsequent formation of a unity government under 3. The return of governing institutions after a Prime Minister Saad Hariri raised hopes that the long political stalemate offers Lebanon a unique political process in Lebanon would be resuscitated, window of opportunity to mitigate impending leading to a boost in confidence. However, the risks and tackle longstanding and, by now, fate of parliamentary elections, the only national pressing development challenges. Lebanon’s high plebiscite, which are due in May 2017, is unclear debt level, large twin deficits (fiscal and current as key political parties remain far apart on a new account) and a highly dollarized pegged economy parliamentary electoral law. This law is considered present significant macroeconomic vulnerabilities. crucial as it will help define the makeup of the new These macroeconomic risks have been compounded parliament, determining the extent of dominion by by the Syrian war, which has taken a toll on the traditional parties over confessional representation. economy. Furthermore, the influx of displaced Failure to reach an agreement may regress the persons from Syria (estimated at over one million political environment to the pre-presidential election by UNHCR as of December 2016) has placed added conditions of dysfunctionality and constitutional strain on Lebanon’s education, health, municipal and paralysis. A parliamentary vacuum is a notable risk. other sectors, while exacerbating already notable subnational inequalities. This sense of urgency is 2. Council of Ministers (CoM) makes early reinforced by a palpable deterioration in the quality headway with two essential achievements: passing of public services, institutions, governance and the two long-awaited decrees for the oil and gas sector business climate, to name a few. Critical reforms are and adopting the 2017 budget. In January 2017, needed to put the country on the right track. the CoM finally approved two oil decrees that have been pending due to the political stalemate, paving the way for the first licensing round of offshore gas exploration in Lebanon’s Exclusive Economic Zone (see Box 1). In March 2017, the government adopted the 2017 budget and sent it to parliament. If ratified by parliament, this would be the first formal budget for Lebanon since 2005. It remains unclear whether the previous discord between the political parties regarding accountability over previous fiscal accounts will re-emerge as a principal obstacle. Also unclear is the fate of the long-demanded salary scale adjustment, which has been included in the initial draft submitted to the CoM along with a set of associated fiscal measures consisting of hikes in tax 10 | Recent Economic and Policy Developments lebanon economic monitor | ‫ندا�ؤنا لكم‬ WB-CI Quarterly Growth (sa, yoy) Real GDP Growth (%) 12 10.3 Resignation of PM Sustained 10 9.3 9.1 Saad Harrir's Start of Syrian Deteriorating Formation of PM improvement in government crisis security conditions Salam's government security conditions 12 8.0 8 7.5 10 Formation of PM Government Large drop in Najib Mikati's government resignation oil prices 8 6 6 Garbage 3.9 Percent Crisis 4 3.4 4 2.7 2 1.7 2.0 2.2 1.8 1.8 2 1.6 1.3 1.1 0.9 0 Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3 0 -2 2010 2011 2012 2013 2014 2015 2016 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 -4 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 FIGURE 1. Frequent shocks result in volatile economic FIGURE 2. A Slight pick up in economic activity in 2016. activity. Sources: Lebanese authorities and WB staff calculations. Sources: Lebanese authorities and WB staff calculations. in population as well as local human capital; the Output and Demand percentage of individuals using the internet jumped from 52 percent in 2011 to 74 percent in 2015, while 4. Spillover from the regional turmoil, fixed broadband subscriptions more than trebled in combination with a deteriorating domestic to reach almost 1.3 million persons, and mobile- political process, have led to sluggish, below- cellular telephone subscriptions expanded by 35 potential real GDP growth since 2011.1 While the percent over the same period.3 Nonetheless, this economy since the early nineties has traditionally has been insufficient to regain pre-crisis real GDP been susceptible to the frequent political and growth rates or even reach potential. security shocks resulting in volatile growth rates (Figure 1), the post-2011 period has witnessed a shift 5. A marginal pickup in economic activity in economic fundamentals. Traditional drivers—real in 2016. Real GDP is estimated to have grown by estate, construction, finance and tourism—have 1.8 percent in 2016, compared to 1.3 percent in suffered greatly from the regional turmoil. Instead, 2015 (Figure 2). This was led by a continued, albeit support for the economy has originated from other modest, revival in the tourism sector; tourist arrivals sources, including Syria-related economic activity increased by 11.2 percent to reach 1.6 million in Lebanon.2 For example, and despite lagging arrivals in 2016, the most since the onset of the infrastructure due to deficiency by the government, regional turmoil, while hotel occupancy rate jumped information and communications technology 3 percentage points (pp) to an average of 59 percent, (ICT) is one sector that benefitted from the surge surpassing the 2011 rate (Figure 3). Furthermore, after a weak performance in 2015, the real-estate 1  National accounts data since 2011 are World Bank staff sector experienced a slight rebound, largely reflecting estimates, guided by our coincident economic indicator (for a low-base effect; cement deliveries underwent details, see Matta, S. (2015) New Coincident and Leading a 4.4 percent expansion in 2016, compared to a Indexes for the Lebanese Economy, Review of Middle East Economics and Finance, 11 (3), 277–303), pending updates on contraction of 8.6 percent in 2015 (Figure 4). In this GDP estimates from CAS for 2011 to 2015. regard, the subsidized loan schemes by the central 2  Positive economic contributions of Syrian nationals in bank, Banque du Liban (BdL), continue to provide consequence of the war in Syria has been discussed in the Spring crucial support to the real estate and construction 2015 issue of the Lebanon Economic Monitor. This contribution to overall economic activity from Syrian nationals living in sectors. Lebanon does not preclude negative impact on public finances (e.g. higher public spending on social services) or on overall economic activity due to the conflict in Syria. As the World 6. From the demand side, private Bank-United Nations Economic and Social Impact Assessment consumption continued to be a principal driver (ESIA) of the Syrian conflict details, both of these are large and negative for the country and its public finances. 3  Source: International Telecommunication Union (ITU). Recent Economic and Policy Developments | 11 The World Bank Tourism Sector (sa) Consumer Confidence Indices (nsa, yoy, %) 160 80 150 60 140 70 50 40 130 60 30 Thousand 120 Percent 20 110 50 10 Percent 100 0 Oct-11 Oct-12 Oct-14 Oct-15 Oct-13 Oct-16 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 90 40 -10 80 -20 30 -30 70 Tourist arrivals (lhs) Hotel occupancy rate (rhs) -40 60 20 -50 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 May-11 May-12 May-13 May-14 May-15 May-16 Mar-11 Mar-14 Mar-15 Mar-16 Mar-12 Mar-13 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 -60 Byblos Bank / AUB CCI (3mma) ARA (3mma) FIGURE 3. Recovery in tourism persisted in 2016. FIGURE 5. Consumer sentiment improving but volatile. Source: Lebanese authorities and WB staff calculations. Sources: Byblos Bank, ARA Marketing Research and Consultancy and BdL. Real Estate Sector Poverty Rates (% of head count) Thousand of m2 Thousand of tons 2000 700 40 1800 35 600 1600 30 1400 500 25 1200 Percent 400 1000 20 800 300 15 600 200 10 400 100 5 200 0 0 0 Oct-11 Oct-12 Oct-13 Oct-14 Oct-16 Oct-15 Nabatieh Bekaa Lebanon South Lebanon Lebanon Jan-12 Jan-13 Jan-14 Jan-15 Jan-11 Jan-16 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Jul-11 Jul-12 Jul-14 Jul-15 Jul-16 Jul-13 Beirut Mount North Construction permits (lhs) Cement deliveries (rhs) FIGURE 6. Poverty rate highest in the Bekaa and North FIGURE 4. Slight pickup in real estate.. 2011/12. Source: Banque du Liban. Sources: Lebanese authorities and WB staff calculations. in 2016, while the external sector was a drag. form of subsidized lending schemes; commercial Improved security conditions and low oil prices banks’ claims on resident private sector grew by helped partially offset the negative impact on 6.2 percent in 2016, compared to 5.9 percent in consumer sentiment caused by the deteriorating 2015. Anecdotal evidence suggests that private political climate last year. Both consumer demand is also supported by Syrian investment confidence indices (CCIs) improved in 2016, with and consumption, concentrated in the informal the Byblos/AUB CCI rising by 3.5 percent in 2016 sector. The external sector, on the other hand, has and the ARA index doing so by 3.8 percent for contributed negatively to real GDP growth during the year to September, year-on-year (yoy) (Figure 2016 as merchandize imports recovered from 2015 5). While this marks a slowdown compared to lows, when a sharp decline in oil prices combined 2015—where over corresponding periods, the with a euro depreciation provided temporary Byblos/AUB and ARA CCIs rose by 12.4 percent favorable conditions. Merchandize exports have and 12.9 percent, respectively—confidence has also suffered from road closures through Syria that clearly improved since early 2014 as agents have connected exporters to the lucrative GCC market. adjusted to the long-term prospects of the Syrian This led to a widening of the trade deficit in goods conflict. Private lending toward consumption and and services this year. Moreover, public investment real estate purchases continued to expand in 2016, continues to lag due to the political paralysis. in part thanks to continued BdL support in the 12 | Recent Economic and Policy Developments lebanon economic monitor | ‫ندا�ؤنا لكم‬ Box 1. Oil and Gas Decrees. In January 2017, the Cabinet of Ministers (CoM) passed two long-awaited oil decrees paving the way for the first licensing round of offshore gas exploration in Lebanon’s Exclusive Economic Zone (EEZ). The first decree divides the EEZ into 10 blocks, only some of which would be open for bidding during the first licensing round. It also establishes a buffer zone spanning the coastline with a width of 3 nautical miles, within which no petroleum activities would be allowed. The second decree includes (i) the tender protocol; (ii) the exploration and production agreement; and (iii) annexes that detail the accounting and financial procedures and the joint operating agreement. According to the exploration and production agreement, royalties paid to the State on gas production is set at 4 percent, while royalties on oil production are progressive ranging from 5 percent to 12 percent. Once royalties are paid out, Right Holders are able to recover capital expenditure (CAPEX) costs, Cost Petroleum, which is a biddable component starting from a set ceiling of 65 percent of Disposable Petroleum.* The remainder, Profit Petroleum, is then divided between the State and Right Holders according to the R-factor, defined as: ** such that the State’s share of Profit Petroleum, denoted by SP hereafter, is determined as follows: • For R≤1; SP=A percent, where A is a biddable component with the condition that A≥30 percent. That is, A is the minimum profit share for the State, which would be during the pre-breakeven point for the Right Holder. As cumulative cash inflow increases with time, R rises, leading to an increasing SP , such that: • For • For R≥RB ; SP=B percent where B and RB are biddable items that determine the maximum share of Profit Petroleum that the State would earn beyond RB under the condition that RB≥1 . To summarize A,B, and RB are to be determined via a bidding process, such that A≥30 percent, B>A percent and RB≥1, thus constituting the commercial proposal of the competitive process. The Right Holders’ portion will be RHP=100—SP, for every value of R. Finally, petroleum activities will be subject to Tax Payments, including corporate and individual tax, tax on dividends, import tariffs etc. This would be specified by a new tax law currently under discussion by an inter- ministerial committee that has been formed to discuss a draft taxation law governing the oil and gas sector. Once the tax law passes cabinet, it would then need parliament ratification. As such, Total State Income (TSI) from oil and gas activities will be: TSI = Royalties + SP + Tax Payments The commercial proposal, as summarized above, is given a 70 percent weight in the grading process, while the remaining 30 percent would be assigned to the technical proposal. In the technical proposal, the consortium bids for the minimum work commitment pertaining to the (i) geophysical survey given by the 3D seismic data carried out and processed, in square kilometers; (ii) other geological and geophysical activities given by line kilometers for airborne, gravity, aero-magnetics, and other means, and square kilometers for advanced technologies, such as electro-magnetics; (iii) the number and minimum depth of exploration wells. * “Disposable Petroleum” means the balance of petroleum extracted which is not reinjected and thus remaining and set aside to determine the Right Holders entitlements to Cost Petroleum and Profit Petroleum after deduction of (i) petroleum allocated to satisfying the Right Holders obligations to pay the royalty or deliver it in kind to the State; and (ii) that portion of petroleum that has been consumed, burned or in any way released or lost between the point of extraction and the point where aforesaid portion of Cost Petroleum or Profit Petroleum may be taken. ** Cumulative cash inflow is cumulative profit plus cumulative Cost Petroleum since the beginning of the production phase minus operating expenses. Cumulative CAPEX is all capital expenditures recorded. Recent Economic and Policy Developments | 13 The World Bank 9. Employment growth has been Poverty and Labor concentrated in low productivity activities as those involving higher productivity have not 7. About 27 percent of the population grown proportionally. Over the past decade, in Lebanon were poor according to the most trade accounted for about 47.3 percent of all new recent household budget survey in 2011/12. The employment, public and private services for 34.7 highest poverty rates were in North Lebanon and percent and construction for nearly 10 percent (ILO, Bekaa regions, while the largest poverty count was 2015). Thus, relatively low productivity activities observed in the most populous Mount Lebanon dominated employment growth, while growth region (Figure 6). The unemployment rate was about in productive activities such as communications, 9 percent, based on the same household survey, financial services, agriculture and manufacturing which predates the impact of regional hostilities, was marginal. Moreover, since foreign labor including the influx of refugees. Poverty rates were dominated low skilled (less productive) activities, significantly higher for workers employed in the high GDP growth rates have not translated into agricultural and construction sectors who are paid significant job creation for the Lebanese. In fact, the on weekly or daily basis. long-run employment-growth elasticity is estimated to be 0.2 (World Bank, 20127), much lower than an 8. In view of their protracted presence, estimated MENA average of 0.5 (IMF, 2014). Syrian nationals have de facto become part of the labor market. With around half of the working age Syrian refugees economically active (ILO, 2014),4 by end-2014 the labor supply in Lebanon was estimated to have expanded by 50 percent (IMF, 20145). Fiscal Sector The majority of Syrian refugees are low- to semi- skilled workers, engaged primarily in construction, 10. A surge in the already elevated debt-to- agriculture, and personal and domestic services. The GDP ratio heightens macro-fiscal risks. Gross vast bulk of refugee employment, regardless of the public debt is estimated to have reached 157.5 level of education attained, focused on the informal percent of GDP by end-2016, a rise of 8.1 pp from sector (ILO, 2015).6 It is unclear to what extent low- end-2015 (Figure 7). The sharp rise is attributable skilled refugees have been competing with Lebanese to deteriorating fiscal accounts as the overall fiscal nationals since, even prior to the crisis, the low- deficit widened and the primary surplus declined. skilled labor market was dominated by foreigners This dynamic was further exacerbated by slow real (e.g. Syrians, Bangladeshi, Ethiopians, Filipinos). As GDP growth combined with a negative change such, it is more likely that low-skilled foreign labor in in the GDP deflator, which together limited the Lebanon, including other Syrians who were present increase in nominal GDP, enacting a denominator- before 2011, will bear the brunt of the competition led push on the debt-to-GDP ratio. As a result, from refugees. This can explain the lack of significant almost half the progress achieved in the country’s tensions between the refugees and host communities, debt position over the latter half of last decade has considering the sheer number of refugees. been reversed; after peaking at 185 percent of GDP in 2006, robust real GDP growth drove the debt-to- 4  International Labor Organization (2014), Assessment of the Impact of Syrian Refugees in Lebanon and Their Employment GDP ratio down to 133.5 percent by 2012, at which Profile 2013. The study surveyed the employment profile of point it started rising again. This should highlight refugees and the impact of their economic participation on the host communities’ livelihoods. Data was collected from 400 the rising short-term risks associated with a lack of households, which included a total of 2,004 individuals. fiscal reforms in an environment where more brisk 5  IMF (2014), Article IV Consultation and Selected Issues, July, growth is contingent on either a resolution to the Washington DC. 6  International Labor Organization (2015), Towards Decent 7  World Bank (2012), “Republic of Lebanon—Good Jobs Work in Lebanon: Issues and Challenges in Light of the Syrian Needed: The Role of Macro, Investment, Education, Labor and Refugee Crisis, Beirut, Lebanon. Social Protection Policies”, December, Washington DC. 14 | Recent Economic and Policy Developments lebanon economic monitor | ‫ندا�ؤنا لكم‬ Gross Public Debt Central Government Finances (% of GDP) 35 3.5 30 3 80 200 25 2.5 70 180 160 20 2 60 140 15 1.5 US$ Billion 50 120 10 1 Percent Percent Percent 40 100 30 80 5 0.5 60 0 0 20 40 2009 2010 2011 2012 2013 2014 2015 2016e 10 20 -5 -0.5 0 0 -10 -1 19 19 19 20 20 20 20 20 20 20 20 20 -15 -1.5 94 96 98 00 02 04 06 08 10 12 14 16 Total Revenues (lhs) Total Expenditures (lhs) Gross public debt (US$ bln, lhs) Domestic public debt (US$ bln, lhs) Budget Deficit (lhs) Primary Balance (rhs) External public debt (US$ bln, lhs) Gross public debt as a percentage of GDP (rhs) FIGURE 7. In 2016, debt-to-GDP ratio surges upward … FIGURE 8. … in response to a worsening fiscal position. Sources: MoF and WB staff calculations. Sources: BdL, CAS and WB staff calculations. Syrian conflict or structural reforms that can payoff expenditures. During the 2012-2016 period, total but only over the medium and long terms. revenues averaged 21.8 percent of GDP, compared to 23.4 percent of GDP over the 2002-2011 period. 11. The fiscal position of Lebanon became On the other hand, primary spending has remained more tenuous as the overall fiscal deficit at the pre-crisis period average—21 percent of GDP widened and the primary fiscal surplus almost for both the 2002-2011 and the 2012-2016 periods. disappeared. The overall fiscal deficit increased by an estimated 1.8 pp to reach 10 percent of GDP, 13. Sizable Eurobond issues by the Ministry hitting double digits for the first time since 2006 of Finance highlight large financing needs. The (Figure 8). While both revenues and expenditures government continues to primarily finance the fiscal rose during 2016, the latter outpaced the former. deficit by issuing Treasury bills and Eurobonds. In A marginally improving economy in 2016 helped April 2016, Lebanon successfully issued US$ 1 push total revenues for government by an estimated billion in Eurobonds to replace maturing debt. The 0.7 pp to reach 21 percent of GDP, driven by tax, Eurobond issue was divided into two tranches: the non-tax and treasury revenues. However, this first was for $700 million, maturing in 2024 with a was more than offset by an estimated 2.5 pp rise 6.65 percent interest rate, and the second was for in total expenditures to 31.1 percent of GDP, $300 million that matures in 2031 with an interest of driven primarily by interest payments, payments 7 percent. This was followed by a sizable Eurobond of arrears and transfers to municipalities. Primary issue in March 2017, in the amount of US$ 3 billion spending (excluding debt service) rose by 1.9 pp, divided between US$ 1.25 billion, US$ 1 billion which caused the primary surplus to decline from and US$ 750 million tranches at, respectively, 6.85 1.3 percent of GDP in 2015 to 0.1 percent in 2016. percent, 7 percent and 7.25 percent interest rate Meanwhile, transfers to Électricité du Liban (EDL), with a maturity of 10 years, 15 years and 20 years, the state-owned electricity company, continued respectively. For both Eurobond issues, the ministry benefitting from the fall in oil prices, regressing announced that the bonds were oversubscribed. The by an estimated 0.5 pp in 2016 to be around 1.9 stock of debt outstanding remains mostly in local percent of GDP, compared to an average of 4.3 currency; by end-2016, 62.5 percent of gross public percent of GDP during the previous decade. debt was denominated in LBP, compared to 61.5 percent end-2015. 12. The slowdown in economic activity since the onset of the regional turmoil has induced a 14. The passage of the 2017 budget by cabinet general softening in total revenues, which has is a welcomed first step, which needs to be not been matched by a commensurate cut in ensued by parliament ratification. The last official Recent Economic and Policy Developments | 15 The World Bank budget for Lebanon was in 2005, at which point continued to be afflicted by the closure of the last discord regarding accountability over previous fiscal remaining Syrian route in May 2015, through which accounts have prevented subsequent budgets from exporters were able to access the GCC market, a being ratified by parliament. Spending has since been factor that kept merchandize exports weak at 8.6 conducted largely through treasury advances and ad- percent of GDP. Moreover, the increase in tourist hoc measures in times of pressures. This left fiscal arrivals signaling a mild revival in the tourism sector policy without an anchor. Even prior to 2005, fiscal was more than offset by price deflation in 2016, policy has been missing a medium-term perspective. leaving exports of services down by an estimated Moreover, none of the post-war budgets were voted 1.9 pp to 31.7 percent of GDP. The regional turmoil within the constitutional period and the last officially has significantly worsened the trade balance, whose closed fiscal accounts are those of 2003, although deficit in the pre-crisis period (2002-2010) averaged those from 1993 to 2003 need major adjustments. 19.9 percent of GDP, supported by stronger exports Such longstanding structural bottlenecks in public of goods and services that averaged 47.1 percent of finance are important manifestations of the perceived GDP and 13 percent of GDP, respectively. endemic corruption8 and political malfunction, impeding the development of the country. There is 16. Following short- to medium- term a lack of proper oversight and accountability over resiliency to low oil prices, remittances inflows public finance, including those over extra-budgetary show evidence of a slowdown. Indeed, with oil entities that receive significant government funding, prices declining sharply in 2014, balance of payments helping to entrench a perception of non-transparency (BoP) data published by the central bank illustrate and encouraging corruption in fiscal affairs. this resiliency as inflows of remittances actually rose by 0.4 pp to 14.1 percent of GDP in 2015, helping to push net remittances up by 1.5 pp to 7.6 percent of GDP. As expounded on in earlier issues of the Lebanon Economic Monitor, this resiliency stemmed External Sector from GCC fiscal buffers that mitigated the negative effects on remittances from the Gulf region in the 15. A pick up in imports of merchandize short to medium term. The latest available BoP goods combined with deteriorating exports data, however, indicate that remittances inflows induced a widening in the already sizable trade in H1 2016 are unvaried in levels (and lower as a deficit. After narrowing by 6.3 pp in 2015 to 23.2 ratio of GDP) compared to H1 2015, suggesting percent of GDP as a result of import deflation (lower that medium term negative implications of low oil commodity prices, especially fuel products, and prices are materializing. This, along with increased euro depreciation), the trade in goods and services outflows of remittances resulting from the slightly deficit in 2016 reversed this progress by almost improved economy, reduced net remittances by an half to reach an estimated 26.5 percent of GDP. estimated 0.8 pp to 6.8 percent of GDP in 2016. Despite continued favorable valuation effects due to low import inflation in 2016, a pickup in volumes 17. A widening trade in goods and services imported, reflecting the slightly improving economic deficit along with decelerating inflows of net activity, helped boost nominal imports. As a result, remittances effected a deterioration in the already merchandize imports increased by 1.8 pp to 38 sizable current account deficit. After narrowing percent of GDP, led by energy and pearls, precious by 8.4 pp in 2015 to 17 percent of GDP led by the stones and metal. Regarding exports, Lebanon improved trade balance, the current account deficit is estimated to have shot back up to 20.9 percent 8  World Economic Forum’s Global Competitiveness Index for of GDP in 2016, exposing the country to significant 2016-2017 ranks Lebanon very low in governance issues. For example, on the category of public trust in politicians, Lebanon refinancing risks. ranked 125 out of 144 countries, while on transparency of government policy making and wastefulness of government spending the country ranked 126 and 135, respectively. 16 | Recent Economic and Policy Developments lebanon economic monitor | ‫ندا�ؤنا لكم‬ Net Foreign Assets’ Position (NFAP) Coverage Ratio 40 14 20,000 4,000 35 12 15,000 3,000 30 10 10,000 2,000 25 8 US$ bln Months 5,000 1,000 20 6 US$ mln 0 0 15 2010 2011 2012 2013 2014 2015 2016 4 -5,000 -1,000 10 5 2 -10,000 -2,000 0 0 -15,000 -3,000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -20,000 -4,000 Total imports (US$ bln, lhs) Foreign reserves at BDL (excl Gold, US$ bln, lhs) Capital inflows (lhs) Trade balance (lhs) Change in NFA (rhs) Coverage ratio (months of imported goods, rhs) FIGURE 9. Regression in capital inflows reversed in FIGURE 10. … inducing an increase in gross foreign 2016… reserves at BdL. Source: BdL and WB staff calculations. Source: BdL, Lebanese Customs and WB staff calculations. 18. Financial engineering carried out by BdL in has partially compensated for the overall loss of 2016 reversed the negative trend in the country’s inflows since 2010; international aid targeting Syrian net foreign assets position (commercial banks refugees provides additional support to the balance plus central bank), which has been in effect every of payments.11 Support is also generated by the wide, year since 2011. The annual cumulative change albeit, slightly narrowing spread between domestic in net foreign assets (NFA) turns positive for the and international interest rates; by November first time since 2010, resulting in a US$ 1.2 billion 2016, this spread registered 353 basis points (bps), increase in NFA in 2016, compared to a decline of compared to 407 bps in November 2015.12 US$ 3.4 billion in 2015 (Figure 9). The BdL swap, whereby Eurobonds held on its balance sheet were 19. The BdL swap met a primary objective of exchanged for Treasury Bonds held by commercial replenishing central banks’ stock of gross foreign banks, attracted higher capital inflows reinforcing reserves, following a contraction in 2015. As a the economy’s NFA position.9 In fact, capital inflows result of the increase in capital inflows, the central increased by 44.2 percent in 2016, more than bank’s gross foreign reserves (excluding gold), offsetting the widening trade deficit. The economy reached US$ 34 billion by end-2016, equivalent to is structurally and heavily dependent on capital 12.9 months of imports of goods and services and inflows to finance its current account deficit.10 Since 11.1 percent higher than the end-2015 level (Figure 2012, leading sectors toward which the majority 10). This compares to a decline of 5.4 percent in of foreign capital has traditionally gravitated have 2015, until when gross foreign exchange reserves suffered a significant decline in activity, becoming seemed unaffected by the deteriorating balance a less attractive destination for FDI (e.g. real estate, of payments. In fact, from 2012 to 2014, the loss tourism). While net FDI in 2015 (latest available data of foreign assets (see paragraph above) did not for a complete year) grew by 2.4 percent to US$ 1.7 reflect on gross foreign exchange reserves at the billion (3.6 percent of GDP), this is primarily due central bank, which continued rising. A principal to a sharp 47 percent fall in outbound FDI. This compares poorly with the pre-crisis period, where 11  Inflows to Lebanon have also included international aid targeting Syrian refugees, albeit via various international between 2000 and 2010 net FDI averaged 9.5 organizations and not through the government, which continues percent of GDP. The presence of Syrian refugees to appeal for assistance. A United Nations Development Program (UNDP) study assesses the impact on the Lebanese economy of international humanitarian aid delivered via UN agencies to the 9  For a more in-depth analysis and presentation of the financial Syrian refugees in Lebanon. It estimates that this aid, estimated engineering mechanism, refer to the Lebanon Economic at over a billion dollars between 2012 and 2014, has a multiplier Monitor, Fall 2016 issue. effect that added 1.3 pp to 2014 GDP growth. 10  The current account deficit has averaged 18.5 percent of 12  This is the interest rate differential between the 3-month GDP during the past ten years. Lebanese T-bill and the 3-month LIBOR. Recent Economic and Policy Developments | 17 The World Bank reason has been that commercial banks, faced notwithstanding the persistent sluggish economic with globally depressed interest rates, repatriated activity. Indeed, items (i) and (ii) ceased to be foreign assets in search of higher yields. Indeed, deflationary drivers in 2016. as illustrated in Figure 11, since 2010, and except for a brief interruption in 2012, commercial banks 21. Exchange rate stability, a negative output have increased their exposure to foreign currency- gap and price deflation constituted motivations denominated sovereign debt;13 simultaneously, they for the central bank for continued expansionary have sharply decreased the share of total assets monetary policy in 2016. The dollarization rate—a held as balances abroad, as proxied by balances key gauge of confidence in Lebanon—has been held with Bank of International Settlements (BIS) largely unchanged since early 2015, registering reporting banks. In 2015, the combination of 65.8 percent in July 2016. Simultaneously, real slowing capital inflows since 2010 and a growing GDP growth continues to lag behind the 1993-2014 need for government foreign currency financing, led average rate of 4.4 percent, and well below potential, to a 5.4 percent decline in central bank reserves to generating a negative output gap.14 These, along reach US$ 30.6 billion. To re-incentivize commercial with price deflation, allowed BdL to extend its loan banks to hold domestic assets, BdL proceeded with subsidy program in 2015 for the third year running,15 the financial swap. with an additional injection of US$ one billion. The swap undertaken by BdL this year has also injected additional liquidity into the banking system. 22. To maintain the peg, BdL ensures banks Monetary Sector offer attractive dollar spreads to finance the current account. Under sustained and large fiscal 20. The deflationary trend in prices has needs and a banking sector balance sheet that is reversed in 2016. After reaching a trough in Q3- over four times GDP, BdL ensures that banks keep 2015, the 12-month headline inflation rate finally attracting foreign deposits and that the public sector turned positive in September 2016, pushing the gross financing needs are met. For the former, BdL average for the year to -0.8 percent, compared to introduced various subsidized refinancing schemes -3.7 percent in 2015. Higher inflation has been led as well as new certificate of deposits for the 15-year, by (i) real estate (rent and owner occupied), (ii) 20-year and 30-year tenors, lengthening the maturity clothing and footwear and (iii) education (Figure structure. As to public finance, BdL bids on the 12). The contribution of the latter two categories Treasury Bills and Bonds primary market and acts has become increasingly palpable, reflecting the as a buyer on the secondary sovereign debt market. yoy change in rising energy prices since Q4-2015. In the absence of a government, the central bank Core inflation (excluding energy and food) turned has aimed at sustaining or even boosting private positive earlier in April 2016 for the first time since demand (e.g., the stimulus packages) as well as the August 2015. The deflationary trend over the past financial sector’s stabilizer of last resort, multiplying couple of years reflected (i) the decline in global the financial burdens on BdL. The resulting banking- prices for commodities, especially energy and food; sovereign feedback loop, however, is a source of (ii) an appreciating effective exchange rate given the country’s peg to the dollar; and (iii) subdued 14  For a more in-depth analysis on the output gap, please refer to Box 1 in the Fall 2015 issue of the Lebanon Economic economic activity (below potential output). Due to Monitor. the provisional nature of this import deflation, we 15  This program was launched by the BdL in 2013 and have been expecting this trend to be temporary, continued in 2014 in the amounts of US$1.46 billion and US$800 million, respectively. The real estate sector has been the 13  This includes Eurobonds and World Bank staff estimates of principal beneficiary, boosting domestic demand after demand commercial banks’ foreign currency reserves held at the central from Lebanese expatriates and foreign buyers dropped sharply. bank (which we are assuming to include outstanding foreign- To a lesser extent, BdL’s subsidized loans also targeted start- currency denominated Certificate of Deposits (CDs) issued by ups and venture capital (relatively nascent in Lebanon), with yet the central bank). undetermined effect. 18 | Recent Economic and Policy Developments lebanon economic monitor | ‫ندا�ؤنا لكم‬ Commercial Banks Assets (% of total assets) Drivers of 12-Month Headline Inflation Banks' deposits in BIS banks Food and non-alcoholic beverages Clothin and footwear Alcoholic beverages, tobacco Actual rent Banks' FX sovereign debt exposure Owner occupied Furnishins, household equipment Water, electricity and gas Health 50 Banks' LBP sovereign debt exposure Transportaion Education Communication Other Headline Inflation growth Core Inflation 12-M Growth Banks' FX lending to residents 6 45 5 40 4 35 3 2 30 Percent Percent 1 25 0 20 -1 -2 15 -3 10 -4 5 -5 -6 0 -7 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 FIGURE 11. Banks increase their exposure to foreign FIGURE 12. Deflationary trend reversed in 2016, as currency-denominated sovereign debt. provisional import deflation abates. Sources: BdL and WB staff calculations. Sources: CAS and WB staff calculations significant macroeconomic risk (Le Borgne and Jacobs, 201616). Financial Markets 23. Lending to the resident private sector 24. The substantial size of the BdL swap19, continued to expand in 2016. Commercial banks’ both in scale and scope20, has imposed short- claims on resident private sector grew by 6.2 percent term dynamics on the banking sector. Examining in 2016, compared to 5.9 percent in 2015. With the evolution of commercial banks’ balance sheet a deflationary environment in 2016, the change over the relevant time period can be illuminating. By in real private lending was larger. To a significant end-January 2017, commercial banks’ total balance extent, this is supported by BdL’s numerous sheet expanded by 9.8 percent (yoy), compared subsidized lending schemes.17 Nonetheless, it is to an average of 6 percent over the previous 5 also a notable deceleration from an average growth corresponding periods starting in January 2011. The of 9.4 percent and 9.7 percent in 2014 and 2013, scale becomes even more glaring if total balance respectively, possibly reflecting declining marginal sheet is considered as a percentage of GDP, rising returns to the lending schemes as the pool of viable from an already elevated 395 percent in January borrowers shrinks. Going forward, authorities need 2016 to 430 percent in January 2017. The monthly to exert scrutiny and caution to risks associated yoy growth in the total balance sheet began with the over-leveraging of households, via possibly accelerating in spring 2016, picking up speed in Q3 enhanced macro prudential measures such as those 2016 and then slowing down in Q4 2016 (Figure introduced by the BdL in 2014.18 13). The swap, which involved an exchange of LBP- denominated Treasury Bonds (TBs) held by banks with Eurobonds and foreign currency-denominated Certificate of Deposits (CDs) held by BdL, translated into increases and decreases in banks’ holdings of 16  Lebanon: Promoting Poverty Reduction and Shared Eurobonds and TBs, respectively, from spring until Prosperity, Systematic Country Diagnostic, World Bank, Washington DC. the summer. Interestingly, soon after, these trends 17  For an in-depth discussion of BdL-subsidized lending were sharply reversed as banks’ preferences to hold schemes, refer to the Special Focus in the Lebanon Economic Monitor, Fall 2016 issue. 19  For a more in-depth analysis on the implications of the financial engineering mechanism, refer to the Lebanon Economic 18  To limit leverage risks on the consumer side and the fallout Monitor, Fall 2016 issue. impact on banks, in 2014, BdL instructed banks to require a minimum down-payment of 25 percent for any car or housing 20  IMF staff estimate BdL’s sale of Eurobonds and other loan and to limit the value of the loan such that the monthly foreign exchange-denominated securities to commercial banks installment does not exceed 45 percent of family income (35 at US$ 13 billion (Article IV, January 2017), equivalent to around percent for a housing loan). 27 percent of 2016 GDP. Recent Economic and Policy Developments | 19 The World Bank Bank's Assets (% yoy change) fact the whole economy, constituting 21 percent of Balance sheet total private deposits (end-January 2017). Attracted 30 Eurobonds TBs by interest rate spreads, new private deposits at 25 Banks’ deposits with Bdl. commercial banks have averaged a significant 13.4 20 15 percent of GDP annually since 1994, of which new Percent 10 non-resident deposits averaged 3.5 percent of GDP 5 annually. These deposits are a principal resource 0 -5 for the economy, including crucial inflows used to -10 meet external balances generated from a sizable -15 and persistent current account deficit. In fact, -20 between 2003 and 2010, total new private deposits FIGURE 13. Banks’ preferences for high return assets is (TD) averaged 19.4 percent of GDP, while new sticky. non-resident private deposits (NRD) averaged 4.4 Source: BdL and WB staff calculations. percent. These ratios have declined sharply since, due primarily to the regional turmoil and secondarily higher yielding instruments became evident with to the unsustainability of such high levels. During the surge of banks’ deposits with BdL and even a re- the crisis period of 2011-2016, TD and NRD accumulation of TBs. shares of GDP fell to 9.4 percent and 3.9 percent, respectively. Increasing deposit growth has been a 25. The swap resulted in a surge in LBP liquidity main objective of the BdL swap. presenting liquidity-management challenges. Broad money measures, M3 and M421, rose by 7.8 27. Raising foreign exchange (FX) for the percent (yoy) and 7.1 percent (yoy), respectively, purpose of engaging in the swap operation has in January 2017, compared to 5.2 percent for both been a primary focus for banks in 2016. Figure in January 2016, with M3 experiencing the fastest 14 suggests three such sources of FX funding for growth since June 2011. The liquid asset-to-total banks, with non-resident deposits being an early deposit ratio22, an indicator of short-term liquidity, source as the pickup in the trend is evident from stood at 74.5 percent by January 2017, compared to the spring, while resident deposits growth began 70.4 percent end-2015. This increase in liquidity has accelerating in Q3 2016. Resident and non-resident translated into increased LBP lending to the private private sector deposits increased by 7.7 percent sector (Figure 14), as banks’ LBP claims on resident (yoy) and 6.2 percent (yoy), respectively, by January private sector grew by 14.9 percent (yoy), its fastest 2017, compared to a respective 5 percent and 5.3 pace since May 2014. percent in January 2016. Additionally, banks cut down FX lending to resident private sector allowing 26. Over the past few years, there has been a for savings. discernable slowdown in deposit growth, which has constituted the principal funding source for 28. The swap operation has also imposed commercial banks. The deposit-to-total liabilities short-term dynamics on the proportional ratio23 stood at 81.5 percent by January 2017. Non- allocations within the portfolio. As a percentage resident deposits, in particular, have been a vital of total assets, Eurobond and TB bank holdings, factor in the stability of the banking sector, and in once again increased and decreased, respectively, at the beginning, only to reverse trend later, with 21  M3 includes demand deposits at BdL, currency in circulation, deposits in LBP, deposits in foreign exchange and the former ending up at a lower ratio compared to bonds, while M4 is M3 plus non-resident deposits. the start of the operation (Figure 15). The proportion 22  Liquid assets consist of commercial banks’ deposits with being deposited at BdL also increased, while that central bank, Treasury Bills and Bonds in LBP held by commercial lent out to the resident private sector in FX declined. banks and Eurobonds held by commercial banks. 23  This is the ratio of total private and public sector deposits at commercial banks to commercial banks’ balance sheet. 20 | Recent Economic and Policy Developments lebanon economic monitor | ‫ندا�ؤنا لكم‬ Bank's Assets (% yoy change) Bank's Assets (% of total assets) TBs Resident private sector deposits in FX Eurobonds Non resident private sector deposits in FX LBP credit outstanding to resident private sector 16 LBP credit outstanding to resident private sector FX credit outstanding to resident private sector 320 Banks' deposits at BdL 14 FX credit outstanding to resident private sector 50 Balance sheet (rhs) 310 12 LBP trillions 300 40 10 Percent Percent 290 8 30 280 6 20 270 4 260 2 10 250 0 0 240 FIGURE 14. Funding sourced from resident and non- FIGURE 15. A discerned slowdown in both resident and resident deposits. non-resident deposit growth. Source: BdL and WB staff calculations. Source: BdL and WB staff calculations. 29. Commercial banks’ already high exposure to sovereign credit risk, as they have long been large investors in public debt24, has been further intensified, especially that denominated in FX. Hence, while Lebanese banks’ sovereign debt exposure (FX plus LBP)25 increased by only 2.2 pp (yoy) to 60.7 percent by January 2017, that denominated in FX rose by a much more substantial 15.5 pp over the same period, to reach 45.6 percent. The mild (substantial) increase in the former (latter) is due to the nature of the swap operation, where the face value of aggregate debt is minimally impacted, while that of the currency compositions are strongly affected. However, this renders banks highly exposed to FX sovereign debt. 24  Interest income, as obtained from BilanBanques, amounted to 66.15 percent and 66.31 percent of total consolidated banks’ income in 2013 and 2014, respectively. 25  The sovereign debt exposure is computed as a ratio of commercial banks’ aggregate investment in Treasury Bills and Bonds, Eurobonds and deposits at BdL relative to total assets. Recent Economic and Policy Developments | 21 The World Bank Prospects 30. The regional turmoil, especially the war in that which is denominated in hard currency. Syria, continues to pose serious security threats in Lebanon and the recent relative calm is not a 32. Absent significant structural reforms on guarantee of stability. A key assumption underlying either revenue or spending, Lebanon’s public projections for the Lebanese economy regards the finances are projected to remain structurally Syrian conflict and its spillovers. World Bank staff weak. Debt servicing is expected to continue rising projections assume that current conditions hold, due to pass through from higher global interest rates, i.e., spillovers continue to be contained without while rising oil prices will reflect on transfers to EdL. precluding the occurrence of occasional serious Meanwhile, government revenues are unlikely to security events. On those basis, real GDP growth for improve significantly. As a result, and despite the 2017 is projected to pick up somewhat to 2.5 percent, return of positive inflation in 2017, the trend for as a result of progress made in the domestic political the debt-to-GDP ratio based on current policies and process, continued revival of the tourism sector and real GDP growth rates remains unsustainable and a slight improvement in real estate and construction. is expected to notably worsen once global dollar This, however, is contingent on the political scene interest rates start normalizing (a pace which is not reverting back to stalemate conditions. Removing expected to pick up in 2017 due to a tightening of the drag effected by the political stalemate will policy rates by the U.S. Federal Reserve Board). nonetheless not be sufficient for growth to return to potential as that critically hinges on a resolution of 33. Structural reforms are supplanted by an the conflict in Syria or on the introduction of a strong increasingly active central bank. Notwithstanding and credible reform program (see Special Focus). As the short-term need, such interventions can such, we expect real GDP growth to continue to be exacerbate macro-financial risks other than the around 2.5 percent over the medium term. liquidity and balance-sheet challenges discussed above. First, the expected normalization of global 31. Large financing needs stemming from interest rates will make it harder to attract hard unsustainable debt ratios and persistent and currency deposits unless domestic interest rates sizable twin (fiscal and current account) deficits rise in commensurate, which is inconsistent with render the country exposed to significant the objectives of BdL’s interventions. Second, the refinancing risks. The overall fiscal deficit is enthusiastic response to BdL initiatives (subsidized projected to stay elevated over the medium term, loans) has helped boost economic activity but after remaining at around 10 percent of GDP in 2017 several years of such lending, more attention will and 2018, and driving the debt-to-GDP ratio to a need to be paid to the issue of household leveraging projected 166 percent of GDP and 170 percent of and repayment capacity. Third, it remains unclear GDP, respectively. Similarly, a large trade-in-goods the extent or duration of the swap operation, deficit will keep pressure on the current account which reaped banks exceptional rates of return in balance, keeping it an expected deficit of 19 a very unconventional way, and in their turn, banks percent of GDP over the same period, a sizable and extended seductive offerings to investors to transfer alarming level. As such, and in light of decelerating US$ from abroad. These operations are disruptive to deposit inflows, pressure will be maintained on the the market, creating massive liquidity that has a high authorities to identify refinancing sources, especially long-term cost. 22 | Prospects lebanon economic monitor | ‫ندا�ؤنا لكم‬ 34. Lebanon is confronting a multitude of protracted shocks each of which can have the potential to alter the country in fundamental ways in the short to medium term. These include: security spillovers and economic challenges of the war in Syria; prolonged domestic political impasses and institutional paralysis; hosting the largest per capita refugee population in the world, most of whom made an influx over a period of only 2-3 years. The sense of urgency is reinforced by a palpable deterioration in the quality of public services, institutions, governance and the business climate. Moreover, a frail macro-fiscal framework, underpinned by unsustainable debt ratios and persistent and sizable fiscal and current account deficits, exposes the country to significant refinancing risks. As a result of these compounding risks, Lebanon can ill afford not to proceed with deep and expansive structural reforms (see Special Focus). Prospects | 23 The World Bank Special Focus Priority Reforms for the Government of Lebanon26 I. The Exigency: Abstract Stating the Case The end to the long political stalemate offers Lebanon a unique window of opportunity to 35. Today Lebanon is confronting a multitude mitigate impending risks and tackle longstanding of protracted shocks each of which can have the and, by now, pressing development challenges. potential to alter the country in fundamental The sense of urgency is reinforced by rising ways in the short to medium term. These include macroeconomic risks and a palpable deterioration significant internal and external security threats, in the quality of public services and institutional extensive and systemic macroeconomic risks, and performances. This has been compounded by the the arrival of an unprecedented number of refugees Syrian war and the massive influx of refugees, making Lebanon the largest per capita host of taking a toll on the economy and placing added refugees in the world. Moreover, the protracted strain on Lebanon’s education, health, municipal nature of these shocks is of particular concern as it and other sectors. This Special Focus presents a is testing the limits of the country’s well-renowned menu of reforms that would enable the country resiliency. to rapidly and significantly turn the page of inaction and decline and return the country to a 36. After a long political stalemate, reforms prosperous and inclusive development path. To are urgently needed to return Lebanon to a sound that end, reforms are prioritized over two time development path. The election of President horizons—the short term, allowing for initiative Michel Aoun in October 2016 after almost two by the present government to establish a record and a half years of a presidential vacancy, and the of achievements and government credibility that subsequent formation of a unity government under is currently sorely absent, and the medium term Prime Minister Saad Hariri, have generated hope for for more comprehensive and systemic reforms, the resuscitation of the political process in Lebanon. which can alter Lebanon’s fundamentals toward This constitutes a unique window of opportunity to sustainable and inclusive development. mitigate impending risks and tackle longstanding and, by now, pressing development challenges. The country has been on a path of structural decline since the early 21st century—the quality of public services, institutions, governance and the business climate, to name a few, have all shrunk to poor levels, unbefitting the country’s history of excellence (as detailed in the World Bank’s 2016 Systematic Country Diagnostic on Lebanon). This new opening provides a renewed opportunity to address these challenges. 26  This Special Focus was authored by a cross-sector team led by Wissam Harake (Country Economist). 24 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ 37. A frail macro-fiscal framework, particularly for the youth, and a (further) deterioration underpinned by unsustainable debt ratios and in core public services. The latter are under pressure persistent and sizable fiscal and current account given the sudden and large increase in demand deficits, exposes the country to significant arising from the Syrian refugee influx, which has refinancing risks. Attracting sufficient capital, and incurred a sizable fiscal cost. Across all core public in particular deposits, to finance significantly larger services, the surge in demand is currently being budgetary and current account deficits could prove partly met through a decline in public service access challenging based on recent deposit growth data. and quality. This is especially so in light of rising U.S. interest rates and the persistence of sluggish growth 39. The following section identifies priority prospects in oil-producing Gulf countries, knowing reforms that policymakers can adopt and the strong correlation between inflows of capital implement on an urgent basis in order to mitigate to Lebanon and the dynamics of the economies of sizable and impending risks and unlock principal Gulf countries. Meanwhile, a near-complete void of constraints for Lebanon’s development. These Government initiative to address macroeconomic critical reforms are needed to put the country on imbalances is best exemplified by an absence of an the right track. Specifically, the Government can official budget since 2005. Instead, progressively announce immediately a set of very specific reforms potent interventions by the central bank, the Banque it intends to undertake with communication around du Liban (BdL), to actively manage economic the reforms the central message of the Government. and financial challenges facing the country, even Achieving a good mass of these reforms will bestow when successful, offer only temporary reprieve, on the Government much needed credibility and and are not without additional macro-financial generate essential momentum to launch and risks. Macroeconomic vulnerabilities are also a implement further key reforms over the medium consequence of an unbalanced growth model that term. Accordingly, the Special Focus is divided into is heavily reliant on specific non-productive, non- short-term reforms, which are critically needed and tradable and rent-seeking sectors that benefit the are readily achievable, and medium term reforms. select few and fail to deliver quality job opportunities Below we summarize the top 10 priority measures to a large share of the population. Structural reforms that the new Government and the President, in emanating from a cohesive and integrated overall collaboration with Parliament, can adopt and economic vision is the prerogative of the political implement over the short term so as to send a strong authority, with the dual responsibility of the signal to all stakeholders that the country is being legislative and the executive branch. governed again and that growth and development will resume. 38. The Syrian crisis has exacerbated already existing challenges and pressures compounding the need for reforms. The conflict in Syria is having a large and negative impact on Lebanon’s economy and its social and infrastructure sectors.27 Lebanon’s macroeconomic framework has deteriorated markedly since the onset of the Syrian conflict; while the country is known for its resiliency and for seemingly defying gravity, its buffers now urgently need replenishing. Social cohesion has also been adversely affected partly due to the combination of rising poverty, unemployment and joblessness 27  Lebanon - Economic and Social Impact Assessment of the Syrian Conflict, World Bank (2013), Report No. 81098-LB, September. Special Focus | 25 The World Bank Priority Reform 1: RATIFICATION OF BUDGET 2017 Following the Council of Ministers (CoM) submission of a draft budget to Parliament, Parliament to pass a budget for 2017 in a manner that upholds constitutional edict and procedure, such that the budget generates a primary surplus. Priority Reform 2: RATIFICATION OF PUBLIC PROCUREMENT LAW 2013 Parliament to ratify the revised Public Procuremewnt Law of 2013. Priority Reform 3: FISCAL REFORMS CoM to pass a Decree stating that any increase in power supply from new power generation output would be matched by an automatic and commensurate rise in the average tariff leaving government transfers to EdL unaffected by the rise in output. Priority Reform 4: PUBLIC PRIVATE PARTNERSHIP CoM to pass an updated version of the existing draft PPP law. Priority Reform 5: GAS-RUN POWER GENERATION CoM to issue a tender package for a liquefied natural gas (LNG) terminal to supply fuel for power generation. Priority Reform 6: INCREASING POWER GENERATION CoM to support ongoing plans for development of power generation capacity through (a) resolving and providing the necessary public financing to complete ongoing generation projects; and (b) hiring a transaction advisor to initiate implementation of a program to develop new generation capacity by independent power projects (IPPs). Priority Reform 7: ESTABLISHING PUBLIC TRANSPORT CoM to authorize and mandate Council of Development and Reconstruction (CDR) as executing agency to prepare and negotiate the Greater Beirut Urban Transport Project. Priority Reform 8: SOCIAL SAFETY NETS CoM to scale up the National Poverty Targeting Program (NPTP) by approving the expansion of the electronic-card food voucher, and the necessary budgetary allocation, from the current 10,000 extreme poor households to 15- 20,000 extreme poor households; and the Ministry of Social Affairs (MoSA) and the Presidency of the Council of Ministers (PCM) to finalize the updating and renewal of the NPTP database of poor households via a recertification of all beneficiaries currently in the database (110,000 households) and an assessment of new applicants based on the new targeting formula and agreed protocols of assessments and supervision. Priority Reform 9: SOLID WASTE TREATMENT Parliament to approve the Integrated Solid Waste Management Law. Priority Reform 10: IMPROVED BUSINESS ENVIRONMENT CoM to announce the launch of an accelerated program of business environment reforms through (i) the passage of a Secured Transaction and Collateral Registries law in close coordination with the central bank given its vital role over the banking sector; (ii) reform of the commercial registry and licensing procedures, in particular in the tourism sector; (iii) the passage of the e-signature law to enable dematerialization of regulatory processes; and (iv) the launch of a matching grant program designed to support job creating investments by Micro, Small and Medium Enterprises (MSMEs). 26 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ Development and Reconstruction, the Council for II. Short-Term the South, and the Central Fund for the Displaced). This helps entrench a culture of non-transparency Priorities and capture of fiscal policy for geo-confessional and political purposes, creating room for fiscal leakages, inefficiencies and corruption. A. Passing a Credible Priority Reform 1: Ratification of Budget 2017 Budget: the Litmus Test Following the Council of Ministers (CoM) submission of a draft budget to Parliament, Parliament to pass a budget for 2017 in a manner 40. Lebanon is unique in the world in that it that upholds constitutional edict and procedure, such that the budget generates a primary surplus. has not had an official budget since 2005, leaving The primary surplus will send a strong signal that fiscal policy without an anchor, and development the incoming government appreciates the gravity without a vision. This has prevented necessary imposed by the macroeconomic risks. Passing a reforms that address the country’s structurally weak budget and institutionalizing best budgetary practices offer a high return-to-effort ratio, imparting a much- public finances with sizable and growing overall fiscal needed positive shock and allowing the Government deficits. Moreover, current spending is projected to signal to its people and the world its resurrection to grow as a result of increased debt servicing and larger transfers to Electricité du Liban due to pass through effects from rising global interest rates and oil prices, respectively. As a result, the trend for the already sharply elevated debt-to-GDP ratio based on current policies and real GDP growth rates remains B. Building Trust unsustainable and is expected to notably worsen. A budget is needed for fiscal policy decisions to be 42. Poor governance and weak institutions taken (on taxes, public spending, etc.) to restore are significant constraints that impede the the sustainability of public finances, to improve economic and social development of Lebanon. the progressivity of the tax system and to increase Institutions are extremely weak, characterized the efficiency of spending. A budget is also needed by both inefficiency and corruption. The country to enshrine fundamental development policy suffers from a governance trap, whereby political choices and charter a vision and a project through stability is maintained through subordination of a well thought through medium term expenditures national prerogatives to consensus among sectarian framework. leaders, at the cost of strong institutions focused on the common good. As a result, Lebanon scores 41. The budget process has been in disarray. poorly on many aggregate governance indicators. Since 2005, budgets have not been ratified by For instance, out of 144 countries, Lebanon ranks parliament, while fiscal accounts have not been 118 in irregular payments and bribes, 125 in public officially closed since 2003. Spending has been trust in politicians and 135 in wasteful government conducted largely through treasury advances and spending.28 Strengthening governance, institution- ad-hoc measures. Even prior to 2005, fiscal policy building, accountability procurement, and the rule has been missing a medium-term perspective. of law can present key ingredients in achieving Furthermore, there is a striking lack of adequate Lebanon’s strategic objectives, from improved oversight and accountability, including over state- service delivery to growth and poverty reduction. owned enterprises or extra-budgetary entities Public procurement has received considerable that receive significant government funding (most notably, the Electricity Company, the Council for 28  Source: World Economic Forum, Global Competitiveness Index 2016-2017. Special Focus | 27 The World Bank public attention recently, with controversies 44. One potential risk with such a feedback centered on large tenders related to main sectors loop can be a sudden stop scenario, whereby an (waste treatment, electricity). Moreover, weak abrupt confidence shock would lead to a short- public procurement procedures have enabled fall in foreign capital inflows that would become elite capture and prevented effective competition insufficient to meet the country’s sizable gross between bidders over a certain class of projects financing needs. Given Lebanon’s large balance tendered out by the state. sheet vulnerabilities—starting with a banking system with a heavy balance sheet, primarily exposed to the Priority Reform 2: Ratification of Public Procurement law Lebanese sovereign (directly or indirectly through the 2013 Central Bank)—said scenario will ripple extremely Parliament to ratify the Public Procurement Law rapidly through the economy. First, through of 2013. The law of 1963, which constitutes the systemic banking sector bankruptcies (as all banks legal foundation of Lebanon’s current institutional have broadly the same business model of holding framework for procurement, is excessively large sovereign paper) and a currency collapse; and centralized, resulting in procurement and execution delays. A revised procurement law originally drafted second, via a deep and prolonged recession in the in 1990, with the latest revisions introduced as real economy. People’s deposits would likely be recently as 2013, was submitted by the CoM to partially lost (given the limited assets of the deposit the Parliament. It was only put on the agenda of a insurance fund), the exchange rate peg would break “Combined Committee” for discussion on February 24, 2015. Due to lack of time, the review has been and economic activity would collapse. The banking- postponed, and the law remains unratified. sovereign feedback loop should be gradually diluted; for that to occur, the fiscal deficit needs to shrink sufficiently. While this is a structural, medium-term effort, immediate signaling, in the form of balanced and effective fiscal measures on the revenue and expenditure sides, is critical. C. Securing a Soft 45. Electricité du Liban (EdL), the national Landing utility company, imparts a staggering burden on Lebanon’s public finances. Prior to the Syrian 43. Lebanon’s high and rapidly growing conflict, transfers to EdL amounted to an average of debt level, large twin deficits (fiscal and current 55 percent of Lebanon’s fiscal deficit. At their peak in account) and a highly dollarized pegged 2012 and 2013, the government transferred around economy present significant macroeconomic US$2 billion per year to EdL. As the overall fiscal vulnerabilities. The country’s substantial financing balance has been in deficit since 1992, EdL transfers needs are primarily funded by a banking sector have been effectively paid through borrowing. whose balance sheet is over four times GDP. Based on annual budget documents, World Bank Banque du Liban (BdL) ensures that banks keep staff estimate that cumulative government transfers attracting foreign deposits and that the public and to EdL from 1992 to 2013 account for a staggering private sectors gross financing needs are met, 55.4 percent of 2013 GDP, and almost 40 percent of thereby financing the sizable current and fiscal Lebanon’s total public debt. That is to say: Lebanon’s account deficits. To attract foreign deposits, BdL debt-to-GDP ratio would have been 87.8 percent has introduced certificate of deposits and various instead of 143.1 percent (in 2013) if EdL had not subsidized refinancing schemes. To meet the been loss making. needs of government, BdL is the residual buyer of government debt in the primary and secondary markets. The result is a banking-sovereign feedback loop with an amplification effect on systematic macro-financial risks. 28 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ Priority Reform 3: Fiscal Reforms increased competitiveness, economic growth and job creation. Toward that end, the enactment of CoM to pass a Decree stating that any increase Public-Private Partnership (PPP) legislation is critical, in power supply from new power generation helping to introduce best practices in the selection, output would be matched by an automatic and preparation, negotiation, implementation and commensurate rise in the average tariff leaving government transfers to EdL unaffected by the fiscal management of private participation for the rise in output. This will mitigate the impact of the delivery of public infrastructure and social services. increase in capacity on government transfers to Currently, PPP initiatives in Lebanon are undertaken EdL, and importantly, establish a link between tariff on an ad hoc basis with mixed outcomes. A more increases and an expansion in power generation capacity. More than half of respondents to a World coordinated approach will send an important signal Bank’s Social and Impact Assessment Survey said to domestic and international investors to renew that they would be willing to pay double their current their engagement with the country and improve budget on EdL electricity in return for 24-hour Value for Money outcomes. service. The cost of EdL-supplied electricity would remain far lower than that of privately supplied generators. At the same time, the Government can Priority Reform 4: Public Private Partnership protect the poor segments of the population from tariff increases through direct transfers via the National Poverty Targeting Program (NPTP – see CoM to pass an updated version of the existing below). draft PPP law. A proper PPP platform, with an effective and enforceable regulatory and accountability mechanism, and one that accounts for fiscal implications can re-invigorate and improve the investment climate and streamline Government- to-Business interactions. Hence, the positive externalities would extend to both the private and D. Delivering the public sectors, with job creation and economic activity for the former and expanded and more efficient service delivery for the latter. Essentials 46. One of the most flagrant signs of failing 48. Despite EdL’s large and subsidized budget, governance and the weakening of the social power supply remains inconsistent for 92 percent contract between the state and its citizens is the of households, who need to be linked to private breakdown in the delivery of basic public services. generators. EdL’s production is both inefficient and The key basic services that Lebanon lags behind in are insufficient, with a generating capacity of 2,019 electricity, safe water, sanitation, telecommunication MW, compared to a peak demand of 3,195 MW. and transportation. These services are not only This results in systematic and long daily blackouts, essential for growth in productivity and aggregate causing the extensive use of back-up private income, but also for ensuring a basic level of living generators at a cost that is three times the level of standard for people. When effectively provided, EdL tariffs. Moreover, whereas only about half of they can have a positive impact on income equality, total electricity production costs are recoverable, allowing low income groups access to better and electricity tariffs have remained unchanged since more productive opportunities. Their provision also 1996 (when the price of oil was US$23 per barrel). enhances health and education outcomes, thus improving human capital—a critical driver of growth 49. The poor quality of electricity supply in high middle-income economies such as Lebanon. is a primary impediment to economic activity. Development and cost-efficient investment in 47. In view of limited capacity and fiscal space energy systems is correlated with GDP growth. for the Government, private sector participation When electricity supply is frequently interrupted is imperative in key infrastructure development or prohibitively expensive, economic growth slows and public service delivery, also helping to foster down or even contracts. Electricity ranks as a key Special Focus | 29 The World Bank binding constraint to doing business in Lebanon about 1.2 million vehicles in a country of only 4.5 as the country ranks second worst in the quality million people. Its footprint is apparent on national of electricity supply in the world (2014–15 World energy consumption: road transport accounts for 25 Economic Forum’s Global Competitiveness Index). percent of all energy consumption in the country. Compared to other countries, Lebanon’s supply 50. The failures of the electricity sector also of vehicles, defined as the number of vehicles per widen inequality in the country. Inequality is 1,000 people, is extraordinarily high. A primary and exacerbated as (a) consumers who are not billed are immediate step toward tackling Lebanon’s chaotic cross-subsidized by taxpayers and EdL customers traffic is with the enforcement of already existing who pay their bills; (b) consumers who suffer laws. This would have an instantaneously tangible from electricity blackouts must use higher-cost positive effect on the citizen, reinforcing the role of alternatives (private generators for the rich, candles the state in what is a very observable, low cost (in for the poor); and (c) electricity rationing favors fact, revenue generating) measure. the rich at the expense of the poor—poor regions go without public electricity for 12–13 hours every 52. Tackling Lebanon’s traffic logjam problem day, while richer ones such as Beirut are subject to 3 efficiently and structurally can only be with the hours of daily blackouts. introduction of a reliable, affordable and efficient public transport network. Traffic congestion and Priority Reform 5: Gas-Run Power Generation high transport costs are having huge detrimental effects on the development of lagging regions CoM to issue a tender package for a liquefied and are forcing the population to move closer to natural gas (LNG) terminal to supply fuel for employment and services in Beirut. This dynamic power generation. Currently, most of the power has the dual effect of exacerbating congestion in generation capacity in Lebanon depends on expensive liquid fuels, whereas LNG imports provide Beirut and increasing poverty in the regions. While a less expensive, more efficient and less polluting some highway expansions at key bottlenecks is alternative. Moreover, gas infrastructure, which is needed, the past policies to continue highway and currently completely lacking has strong implications bridge expansions are financially and economically on offshore gas extraction. unsustainable, and will only provide temporary solutions at select areas since most of the road Priority Reform 6: Increasing Power Generation network is already saturated. CoM to support ongoing plans for development of 53. Given a near-complete absence of public power generation capacity through (a) resolving transportation in Lebanon and the lack of fiscal and providing the necessary public financing space, an economically feasible starting point to complete ongoing generation projects; would be a public-private sector scheme for a Bus and (b) hiring a transaction advisor to initiate implementation of a program to develop new Rapid Transit (BRT) network. The concept involves generation capacity by independent power allocating exclusive lanes on roads and highways for projects (IPPs). It is imperative for EdL to increase its public buses bypassing typical traffic bottlenecks. generation capacity to reduce rolling blackouts and These would be gradually rolled out from one region increase energy supplies for residential, commercial and industrial customers, and with that it can justify to another as additional resources materialize and tariff increases. as benefits become more tangibly perceived by the public. It would also heavily involve the private sector, especially in financing, construction and 51. Lebanon’s endemic traffic congestion operation phases, helping to generate jobs. problem is estimated to cost the economy an estimated 8 percent of GDP annually. Road transport is by far the most dominant form of transport in Lebanon for passengers, freight and commerce, with 30 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ Priority Reform 7: Establishing Public Transport 56. The National Poverty Targeting Program (NPTP), launched in October 2011, is Lebanon’s CoM to authorize and mandate Council of first poverty-targeted social assistance program. Development and Reconstruction (CDR) as Its objective is to reach extreme poor households, executing agency to prepare and negotiate the defined as the 8 percent poorest segment of Greater Beirut Urban Transport Project. This would establish a BRT within Beirut as well as between the population, which is approximately 42,000 Beirut and Tabarja, with extension of services to Lebanese households. With significant progress and Byblos and Tripoli. The operation of the BRT and achievements accomplished since its establishment, feeder bus networks will involve the private sector the NPTP today nevertheless has reached a point boosting job creation. The project will also institute a feeder bus network in Greater Beirut. where important reforms need to take place. These include: (i) a review of the social assistance provided with a view to transfer the hospitalization and basic education benefits to the Ministries of Public Health (MPH) and Ministry of Education and Higher Education (MEHE), respectively, and focus E. Empowering the Poor NPTP resources on expanding and enhancing the electronic-card food voucher program (and possibly 54. Even prior to the onset of the Syrian a conditional education benefit for secondary and conflict and the inflow of large numbers of Syrian vocational education); (ii) renewal of the NPTP refugees, poverty in Lebanon was significant. The targeting database to reduce the leakages (i.e. most recently completed Household Budget Survey number of in-eligible households from current (HBS 2011-12) shows that poverty in Lebanon was 110,000 to 42,000); (iii) reduce inefficient program 27 percent (pre-Syrian crisis), which implies that expenditure and adequately resource the program to about one million people had levels of consumption finance the expanded e-card food voucher; and (iv) below the annual poverty line set at LBP4.7 million introduce a “graduation from poverty” component per capita per year (US$3,150), the equivalent for beneficiaries via linkages to employment and of approximately US$8.5 per day. Similarly, it is skills upgrading opportunities. 29 estimated that extreme poor (i.e. below the food poverty line) Lebanese individuals live on LBP3.1 Priority Reform 8: Social Safety Nets million per year (US$2,078), the equivalent of approximately US$5.7 per day. The Syrian conflict CoM to scale up the NPTP by approving the is estimated to have increased poverty among the expansion of the electronic-card food voucher, Lebanese population. and the necessary budgetary allocation, from the current 10,000 extreme poor households to 15- 20,000 extreme poor households; and the Ministry 55. Social safety nets (SSNs) can help reduce of Social Affairs (MoSA) and the Presidency of poverty when they are effectively targeted and the Council of Ministers (PCM) to finalize the adequately resourced. Currently, poor households updating and renewal of the NPTP database rely primarily on assistance from private sources— of poor households via a recertification of all beneficiaries currently in the database (110,000 welfare institutions, NGOs, remittances etc. The households) and an assessment of new applicants Government spending on non-subsidy SSNs does not based on the new targeting formula and agreed exceed 1 percent of GDP and fails to target the poor protocols of assessments and supervision. effectively. If electricity subsidies and, in particular, transfers to EdL, are included as part of Lebanon’s SSN for the Lebanese poor, then spending on SSNs 29  Budgetary constraints limit the reach of the e-card food increases dramatically to above 5.6 percent of GDP. voucher today to only 10,000 households. Meanwhile, education and health benefits reach many more, a significant portion of However, EdL transfers are not targeted and subject whom are ineligible. We propose to recertify all beneficiaries to high leakages, and hence are not an efficient use aiming for at least 15,000-20,000 households, in the process of public funds. reducing the number of education and health beneficiaries, but scaling up those for the e-card food voucher. Special Focus | 31 The World Bank labor force participants have a formal sector job. F. Shaping a Breathing Moreover, since foreign labor dominated low skilled (less productive) activities, high GDP growth rates Space have not translated into significant job creation for the Lebanese. In fact, the long-run employment-growth 57. Environmental degradation incurs high elasticity is estimated to be 0.2, much lower than economic and social costs in Lebanon as well an estimated MENA average of 0.5. Thus, relatively as immeasurable health effects. The three most low productivity activities dominated employment pressing issues are water pollution, inappropriate waste growth, while growth in productive activities such management and the destruction of natural resources. as communications, financial services, agriculture Water pollution threatens public health and agricultural and manufacturing was marginal. Without more and productivity, while inappropriate management of better earning opportunities, households in Lebanon waste impacts public health and damages the quality have difficulty in achieving substantial welfare of life. Meanwhile, the progressive destruction of improvements. Lebanon’s natural resources (its mountains, coastline, lakes, rivers and forests) poses irreversible damages. 59. The business climate offers little support In fact, the World Bank estimates the environmental to private investment growth and competitiveness damage related to only five quarries at over $90 million. improvements. Both the Global Competitiveness There are more than 700 quarries scattered with little (GC) and the Doing Business (DB) reports place consideration to the environment. Lebanon at low rankings—101 out of 138 countries in the former and 126 out of 190 economies in Priority Reform 9: Solid Waste Treatment the latter. In the GC report, only Egypt (115) and Yemen (138) ranked lower from the MENA region, Parliament to approve the Integrated Solid Waste with Lebanon’s performance particularly weak in Management Law. In April 2012, the Council of core components: institutions (including legal and Ministers approved Decree 8003 on Integrated Municipal Solid Waste Management, which has administrative framework within which government been awaiting parliamentary approval since. The and the private sector interact), infrastructure, Draft Law promotes an integrated and proper macroeconomic environment and labor market management of municipal waste by encouraging efficiency. As for the DB report, the only MENA waste minimization, source separation, recycling, energy recovery, effective treatment facilities, countries with a lower ranking than that of Lebanon etc. An immediate approval by Parliament of the are Algeria, Iraq, Libya, Syria and Yemen. Draft Law is a first and essential step in setting the overall legal framework governing municipal waste management. Priority Reform 10: Improved Business Environment CoM to announce the launch of an accelerated program of business environment reforms through (i) the passage of a Secured Transaction and Collateral Registries law in close coordination with the central bank given its vital role over the G. Working and banking sector; (ii) reform of the commercial registry and licensing procedures, in particular Accessing Finance in the tourism sector; (iii) the passage of the e-signature law to enable dematerialization of regulatory processes; and (iv) the launch of a 58. In Lebanon, job creation has trailed labor matching grant program designed to support job creating investments by Micro, Small and force growth with employment opportunities Medium Enterprises (MSMEs). These reforms aim concentrated in low productivity activities. Data to reduce the regulatory burden on businesses as analysis suggests that most job creation has been well as improve access to credit for MSMEs, which in low productivity sectors, especially trade, real dominate in the Lebanese economic landscape and are primary engines for job creation. estate and tourism, while only about one in three 32 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ 61. CoM to complete public consultations III. Medium-Term over the draft 2014 Decentralization Law and Parliament to pass it. Decentralization reform is Priorities essential to strengthen the delivery of sustainable services at the local level and encourage economic growth. In 2014, a Draft Decentralization Law was presented for public consultation, however, due to the political stalemate there has been no A. Making Government progress on its passage. The current unpredictable character of intergovernmental transfers makes it Work very difficult for municipalities to plan infrastructure and service improvements that encourage local 60. Governance is at the root of Lebanon’s economic development. Crucially, decentralization failure to deliver basic services and generate reform should include a restructuring of the fiscal inclusive growth and jobs. Internal failures transfer system, which will provide localities with stemming from corrupt and inefficient practices sufficient resources and a clear delineation of conflate with external security and political shocks roles between the central and local governments. to become mutually reinforcing and pervasive As a result, investments will be more efficient and constraints on development, imposing a heavy could be targeted towards promoting the healthy burden on the economy. For example, the cost growth of businesses and increasing employment of confessional governance is estimated at 9 opportunities for communities. percent of GDP annually.30 Influence of economic stakeholders and personal connections are likely 62. The Government to see the to impact policy execution and enforcement of the implementation of the Public Procurement Law rule of law. Thus, elite capture and corruption is of 2013. Three interventions would be needed endemic and undermine development objectives.31 to implement the public procurement reform Similarly, the cost of the conflict and violence is efficiently: (i) empowering the Central Tender Board large and recurrent. These include the (i) 1975- (CTB) as an independent regulatory body; (ii) public 1990 civil war that halved the country’s economy; procurement capacity building by the Institute of (ii) the 2006 conflict with Israel which resulted in Finance; and (iii) moving towards e-procurement at estimated direct damages of US$2.8 billion, and CTB. US$700 million in indirect damages, and (iii) more recently the Syrian conflict which is estimated to 63. The Government to boost Public Financial have cost the Lebanese economy US$7.5 billion in Management (PFM) capacity in budget planning, foregone output and widened the fiscal deficit by preparation and execution to ensure efficient US$2.6 billion through 2014. As such, a structural allocation of resources and improved service improvement in governance will not only provide delivery. The PFM system suffers from several typical returns reaped by other countries, but for the constraints that hinder its proper functioning, Lebanon-specific case, it will also reinforce resiliency weaken its transparency and result in an inefficient to external shocks to which the country is frequently use of public resources. As a result, unproductive exposed. Toward that end, the following medium- spending and fiscal leakages are significant and term reforms are emphasized. widespread, and crowd out effective social safety net programs and improvements in living conditions for the population. Specific measures include: 30  Chaaban, Jad (2014), The Costs of the Lebanese Sectarian System, mimeo, American University of Beirut. • CoM to submit a credible, universal budget that 31  Le Borgne, Eric and Thomas J. Jacobs (2016) Lebanon: incorporates extra budgetary entities (i.e. the Promoting Poverty Reduction and Shared Prosperity, Systematic Council for Development and Reconstruction, Country Diagnostic, World Bank Group, Washington DC. Special Focus | 33 The World Bank Council for the South, and the Central Fund for sector institutions and tax administration, in the Displaced) to Parliament in a timely manner coordination with the Lebanese Association of to ensure its approval before the end of the fiscal Certified Public Accountants. year; • Ministry of Finance (MoF) to finalize 65. Major deficiencies exist in Lebanon’s the production and reconciliation of the micro and macro data. The weakness of the government’s financial statements for the years statistical system is widespread and impedes since the end of the war and submit them to the economic analysis at the macroeconomic and Court of Accounts for audit; sectoral levels. These deficiencies include: (i) the • Revamp and revitalize a national PFM steering lack of regular information on the development of committee to include MoF, BdL, line ministries labor markets and living conditions of households— and key oversight entities. The PFM steering the latest household budget survey was conducted committee would update the authorities’ before the Syrian crisis and suffered from a large medium-term PFM reform strategy, endorse the non-response rate; (ii) weak balance of payments output and oversee its implementation; (BoP) statistics issued with a long lag and subject • Develop appropriate coordination mechanisms to sizable revisions—for an economy that is heavily between the PFM steering committee and dependent on the external sector in general and development partners; capital inflows in particular, timely and accurate • MoF to set up and empower critical functional BoP data is essential for macroeconomic risk PFM teams and units in the MoF (e.g. pilot mitigation; (iii) weak inflation statistics; and (iv) long internal audit, macro-fiscal department, public delays (up to three years) in the release of annual debt department, etc.). national accounts. Meanwhile, Lebanon frequently faces significant shocks, especially since 2011, and adequate policy measures require regular and high quality data. B. Plugging the 66. The Government to enhance capacity of both the Central Administration of Statistics (CAS) Information Gap and the Balance of Payments (BoP) unit at BdL to collect and disseminate regular high quality data 64. Adopting proactive disclosure measures by providing sufficient resources and securing can help mitigate corrupt practices by limiting their mandates. discretionary opportunities for public officials and increasing accountability. In Lebanon, data availability and access to information appear as a cross-cutting constraint that impacts evidence-based policy making and impedes an informed population. C. Breaking the Debt Specific measures include: Chain • Make publicly available records on private and public land holdings through the MoF General 67. Fiscal reforms need to be undertaken Directorate on Land Registry and Cadastre. MoF to reduce public debt ratios from being of the could issue a communication announcing this highest in the world to sustainable levels, thus policy; generating widespread positive macroeconomic • Publication of judicial decisions on the website externalities. In such a case, the afore-mentioned of the Ministry of Justice; risk-amplifying feedback loop (see paragraph 10) • Create a single consolidated database of audited would be supplanted with a confidence-reinforcing financial statements, to be accessed by financial one; as the country’s risk premium decreases, 34 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ reflecting a reduced likelihood of default, the debt this would improve sector financial conditions service would fall, which in turn further lowers without increasing the fiscal burden on public sovereign risk. In addition, reduced financing needs finances, while also generating public support or at in foreign currency will help boost confidence in the least minimizing public resentment. peg. Toward that end, tax reforms can be an effective tool. Currently, Lebanon’s revenue generation is 70. CoM to approve the corporatization of regressive in nature,32 while tax collection relative to EdL and create an inter-Ministerial committee GDP has been receding lately.33 to develop and implement a time-bound corporatization plan. Reforms of EdL’s operation 68. BdL to gradually streamline lending to are a key aspect that have been outstanding for a long real economy focusing more on monetary and time, and the government has already completed financial stability. This would be in tandem with a multiple studies that form the basis of the identified gradual improvement in the country’s fiscal position, corporatization plan. EdL’s corporatization is allowing the government more responsibility over expected to increase efficiency of sector operations real economy issues. The process should also include and reduce its running costs. The governance a more market-based interest rate determination, by framework should be designed carefully in order to making commercial bank’s bidding over central bank maximize transparency and accountability avoiding and government instruments a more competitive, the all too often Lebanese elite capture scenarios. more transparent process. 71. The Ministry of Energy to complete implementation of approved development plan for natural gas supply by developing new liquefied natural gas (LNG) supply D. The Dream of 24/7 and infrastructure facilities, LNG importing infrastructure and plan to explore and exploit 69. CoM to approve and implement a multi- off-shore domestic gas resources. year electricity tariff cost-recovery plan for EdL over a 3-year transition period. EdL’s tariff has 72. The Government to aim towards meeting not been revised since 1996 and is thus far below and expanding the target in the 2010 energy plan cost-recovery levels, exacerbating the fiscal burden for renewable energies and green growth. Evidence on government which covers the utility’s revenue suggests that Lebanon is especially exposed to large gap. Any tariff increases, however, need to be vulnerabilities from climate change with the poor phased in to coincide with increases in hours of disproportionately affected. The estimated impact electricity supplied by EdL to show its customers of climate change on Lebanon is encompassing and tangible results commensurate with the larger bill. costly (estimated at US$ 1.9 billion by 2020 in a first Importantly, tariff increases should also include an of its kind analysis for Lebanon released this year effective lifeline block helping to protect low income by Ministry of Environment/UNDP). A green growth consumers and/or cash transfers. Taken together, and low carbon emissions development strategy for Lebanon could also be an opportunity for job 32  On average, since the start of the millennium, over half creation. of budget revenues were generated from taxes on goods and services (largely consisting of the Value Added Tax) taxes on international trade (customs, as well as excises on gasoline, car 73. Water storage capacity should expand and tobacco) and administrative fees and charges applied on in order to boost resilience to natural (i.e. various governmental services offered to the public. Meanwhile, drought) and man-made (i.e. refugees) shocks. direct taxation, property taxes and revenues from public institutions and government properties accounted for a bit over Despite Lebanon’s relatively high per capita water 40 percent of budget revenues. endowment,34 inadequate management of and 33  In 2015, tax revenues amounted to only 14.7 percent of GDP, compared to an average over the previous decade of 16 34  Lebanon is the fourth best-endowed country in water percent. resources in the MENA region. Special Focus | 35 The World Bank investment in the sector are leading to chronic supply to quality private and public schools; large amounts shortages. There is a seasonal mismatch between of money are spent on relatively low returns water supply (at its peak in the rainy winter) and particularly in the public sector. Finally, the education demand (peaking in the hot, dry summer months). information system is neither institutionalized nor One of the principal factors that is exacerbating integrated. This causes a lag in the collection of data this seasonal water imbalance is the very low water from schools, resulting in a decreased ability to plan, storage capacity (6 percent of total resources, specifically, to make data-based decisions and to compared to the MENA average of 85 percent). measure the impact of policy initiatives. As a result, water supply services are below the levels expected in a middle income country. If no 76. A new teacher law is needed to end the action is taken, including in water governance to two-tiered public teacher workforce and make improve efficiency and manage demand, the country the teaching profession more attractive to high- will continue to depend in the long-run on mined skilled individuals. There is need to create a groundwater. smaller, higher-quality teacher workforce, including selecting among the most qualified of the contractual teachers. To advance the quality of public education, improving teacher quality through reforms in teacher recruitment and professional development is at the E. Toward a New Social core. This can be done in part through reforming teacher recruitment processes and requirements Model… and through continuous professional development and performance-based incentives for teachers. 74. A new social model needs to be developed The law would also likely need to address teacher and implemented between the Government and salary scale and working hours for civil servants at Lebanese citizens, particularly for the poor and the same time. This could include the requirement low-middle income segments of the population. to re-certify teacher accreditation every five years in The main elements of such a model need to include: order to remain in the system, as well as incentives (i) a higher quality of public education; (ii) universal for teaching high-need subjects or in high-need health coverage; (iii) a pension system for private geographic areas. Furthermore, in order to reduce workers (in lieu of current end-of-service indemnity inefficiencies in teacher allocation, the Ministry of system); (iv) an affordable, equitable and predictable Education and Higher Education (MEHE) needs to re- public pension system; and (v) an effective and allocate teachers away from low-student-population institutionalized social safety net system. schools and toward higher-density schools in order to increase the efficiency of the teacher workforce. 75. Education. Inefficiency and inequality characterize the education sector in Lebanon. 77. There is a need for a new law to establish Education is an investment with good returns an internal audit department at MEHE to increase in Lebanon as higher educational attainment transparency and accountability for spending. corresponds to higher earnings in the labor Improving execution, efficiency and transparency market. Private spending on education is high and of budget implementation in MEHE, as well as significantly exceeds public spending, which means data collection and publication is imperative. This that households carry the largest financial burden assumes a particular significance since MEHE has of education. In the public sector, teacher salaries one of the largest budget allocations compared represent 82 percent of the total public expenditure to other ministries and is the recipient of large on education. Actual teacher workloads are low, amounts of donor funds to implement its Reaching resulting in additional spending and reduced All Children with Education (RACE) strategy. The law productivity. In addition to these inefficiencies, could be coupled with the publication of detailed there is inequality of opportunity in terms of access budgets on MEHE’s website and a revision of the 36 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ accounting department function and structure to health services. However, additional resources are create a properly staffed budget preparation unit. needed to expand this program to cover all poor Lebanese identified as extreme poor through the 78. Cabinet of Ministers to issue a decree National Poverty Targeting project (NPTP) and to requiring (i) that essential data on student expand the PHC Network beyond the 208 centers. enrollment be made publically available by The expansion of this program should also entail March 1 of each school year; and (ii) that data expanding the package of care to cover additional on student pass rates and achievement be made services for the treatment of other priority non- publically available by August 31 for the school communicable diseases, as well as services that year ending in June. This will help improve access are targeting the health needs of the elderly. This to reliable information for decision-making. requires an increase in budget allocation towards PHC services within an overall increase in the 79. Health. Over reliance on direct payment Government’s budgetary allocation for the health for health services, at a time when people need sector, and a fast track plan to build the capacity of care, is pushing many into poverty. Lebanese services providers. households share the burden of out-of-pocket expenditures disproportionately with some 81. CoM to appoint a new Board of Directors households being pushed into poverty as a result of the National Social Security Fund (NSSF). of paying for care. The obligation to pay directly The original mandate for the NSSF board has long for services is subjecting a large proportion of the expired and is instead being extended on a periodic Lebanese population to financial hardship, even basis. Simultaneously, the fund is facing significant impoverishment, especially among the poor. As budget deficits and has been accumulating large such, financial protection is quite low, and there arrears with hospitals and individual subscribers. are inequities in the use of health services. Only Ensuring adequate health provisions for retired 47 percent of Lebanese citizens are insured under workers and their families is vital and hence reform three main insurance schemes: about 23 percent of the Sickness and Maternity Branch of the NSSF is are covered by the National Social Security Fund needed. Sustainable health protection coverage can (NSSF), 9 percent by military schemes, 7 percent be achieved through the creation of broad risk pools. by private insurance, 4 percent by the Civil Servants For this reason, the inclusion of retired workers into Cooperative (CSC) and 4 percent by other schemes. social health insurance for employees would be The remaining 53 percent lack any formal coverage, superior to creating a separate health insurance fund and are covered by the Ministry of Public Health for retirees. (MoPH), which serves as an ‘insurer of last resort”. At the same time, Lebanon’s public expenditures 82. Private Sector Worker’s Pensions. A on health have been decreasing as a share of GDP, fresh review of already submitted proposals for falling from 3 percent in 1995 to 1.7 percent in the design of a new scheme for private sector 2011 (putting it well below the global and MENA employees is urgently needed followed by averages). Meanwhile, private health spending, agreement and implementation of the most while regressing from 7.7 percent to 4.9 percent, is adequate proposal. Several reform suggestions nonetheless significantly above the global average. have been prepared over the past 10 years and draft legislation is in Parliament. Currently, private sector 80. CoM to expand the current Universal employees are not covered by a pension scheme, but Health Care (UHC) program to cover more can only receive, if covered, a lump-sum payment Lebanese living under the poverty line. Currently, (end-of-service-indemnity) which is not adequate the MoPH is building the capacity of 75 out of the and leaves them vulnerable at old age (especially that 208 Primary Health Centers (PHCs) and subsidizing their health insurance also terminates at retirement). the care for 150,000 Lebanese living below the extreme poverty line with a well-defined package of Special Focus | 37 The World Bank 83. Public Sector Worker’s Pensions. providing a more sustainable solution to eliminating Lebanon’s public-service pension arrangements extreme poverty in Lebanon. are a very large and growing financial burden on the national finances and on the country’s taxpayers. Their cost amounted to LBP1.9 trillion in 2013, equivalent to 2.7 percent of GDP or 8 percent of total government expenditure, but reached only 9 F. …Growth for All… percent of the labor force (military and civil servants). Yet, all workers pay into this mechanism through 86. Lebanon’s growth model has been heavily taxes on their incomes and consumption.  The dependent on non-productive, rent-seeking opportunity cost of this expenditure is readily sectors that have exacerbated external imbalances apparent when compared to public spending on without generating enough jobs. As highlighted health and SSNs, which amount to only 1.7 percent earlier, a particular concern is macroeconomic of GDP and negligible, respectively. risk emanating from the country’s dependency on inflows to finance persistent and sizable twin (fiscal 84. A commission on pension reform to and current account) deficits. Lebanon possesses be constituted to review alternative scenarios untapped possibilities using local resources of putting the public pension scheme on a and talents that will go some way in mitigating sustainable path, considering 3 options: this dependency. Industry and Information and Communication Technology (ICT) are two sectors • Smaller, slower reform: Gradual move from final that have been long neglected and that can be to lifetime-average earnings measure to calculate important sources of job creation for skilled labor, pensions (year-by-year); phased reduction in an outcome that has evaded post-war Lebanese benefit accruals from 1/40ths to 1/50ths of growth. They would also be a step toward sustainable salary (2.1 percent to 1.7 percent); and gradual growth since such sectors are less prone to external elimination of multiplier for military. shocks compared to Lebanon’s traditional drivers— • Middle scenario: Reduction in lump-sum tourism and real estate. Furthermore, human and payments for more than 40 years of contributions financial capital can be tapped locally, while the (cutting spending from 14 percent to 9 percent export market is a realizable potential, enfeebling the of total); and reduction in allowances for military dependence on capital inflows, attracting green field pensioners (from 40 percent to 20 percent of FDI and lessening balance of payments risks. Such a total pensions for new retirees). vision is necessary for Lebanon to exit a socially and • Larger, faster reform: Price indexation of pensions economically unsustainable model, whereby human in payment; tighter conditions for survivors’ capital is exported in return for inflows that finance benefits (single or divorced daughters); and rent-seeking activities that aggravate imbalances. In reduction in survivors’ payments from 100 this context, Lebanon needs to focus on its industrial percent to 80 percent of the deceased’s benefits. and high-tech potential, providing solutions to the numerous constraints that are hindering the 85. Social Safety Nets. Parliament to functioning of these sectors at their full capacity. institutionalize the NPTP program as a permanent feature of Lebanon’s social safety net system by 87. Spatial industrial policies, most notably, passing the “Extreme Poverty Law - Afaal”, which industrial parks and special economic zones was presented to Parliament by MP Robert Fadel (SEZs), can support increased investment and in February 2015. This would establish a program to competitiveness in the industrial sector. Special provide conditional cash transfers to poor Lebanese care should be allotted to fiscal incentives which building on and incorporating the NPTP. More evidence suggest are ineffective as a source of broadly, it would constitute a significant step in the differentiation, with the end result merely an development of Lebanon’s social safety net system, increasing ‘race to the bottom’ and transfer of 38 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ rents from governments to private investors. Under separation between policy making and operation/ suitable conditions, industrial zones have proven ownership within the Ministry, thus enhancing the successful in various locations and industries across performance of the operation of the fixed network. the world, which make them an attractive tool in Currently, while fiber optic infrastructure is available, Lebanon. it remains inoperative due to internal disputes and ad- hoc governance arrangements depriving the country 88. Two such projects are being undertaken of faster and more reliable services. Additionally, in Lebanon: the Tripoli Special Economic Zone the development of the sector is hindered by a lack (TSEZ) and a pilot project by the Ministry of of functional separation involving ownership of Industry (MoI) for three locations (Baalbek and infrastructure, regulations and policies, and decision Terbol in Bekaa, and Jleileye in Shouf). The former making on investment and network planning. The is at a more advanced stage, while the MoI project separation between these functions would encourage is still at the feasibility stage. The TSEZ, however, private sector investment in the sector and provide includes an extremely generous set of fiscal more transparency and objectivity in policy-making. incentives35 in addition to labor regulatory incentives that can distort incentives toward the geographical relocation of business, rather than promoting the expansion or generation of new operations. G. …And Jobs at Home 89. CoM to revise and update the Telecommunications law and the regulatory 91. Job creation will be aided by reforms framework. The current law was passed in 2002 that improve the business climate. While there and is based on the 1995 European regulatory have been no substantial reforms across any of the framework. Since then, market and technological key component measures that make up the Doing developments incited most developed countries to Business (DB) score since 2007, reform initiatives revise, more than once, the telecom legislation. The have been in the pipeline in key areas such as government can initiate the revision of the Law, along business regulation streamlining, extending credit with the related regulatory framework to account to SMEs and insolvency resolution. These are for convergence in infrastructure and services, the reforms that can be implemented promptly given emergence of new services and business models and their current readiness which could, in turn, have a the overall changes in the global telecommunications significant impact on SME start-up and growth and market. job creation. Limitations in these areas constrain the potential in areas where Lebanon does much better 90. Restructuring of the Ministry of such as in business sophistication and innovation. Telecommunications and Liban Telecom is Toward that end, the following have been identified essential toward a more dynamic ICT sector. A as key reforms: primary objection would be to achieve functional • CoM to pass the Insolvency and Insolvency 35  This includes (i) 100 percent customs exemption on Practitioners draft law that is currently pending. imported raw material; (ii) duty free export of finished goods; (iii) duty free import of construction material, equipment, office • The Government to reduce the burden of machinery and spare parts; (iv) 100 percent exemption on VAT customs procedures. Both, the GC and DB and excise tax for goods and services destined for exports; (v) 100 percent exemption on corporate profit tax (provided that not reports rank customs procedures in Lebanon less than 50 percent of the workforce is Lebanese and the value below the country’s aggregate score. of fixed assets or capital is greater than USD 300,000); (vi) 100 • CoM to pass the Judiciary Mediation Law percent exemption on withheld tax on salaries for employees of tenants and on social security contributions; (vii) 10 percent currently pending. This would reduce the exemption on building permit fees and built property tax; and heavy burden on the court system, providing (viii) 100 percent exemptions on shares and bonds issued by companies within TSEZ. an alternate global best practice to resolving commercial disputes. Special Focus | 39 The World Bank • Parliament to pass a high quality competition • The Government to employ a two-pronged law. The law should establish competent approach to increase job-creating investments competition authorities; review the legal which will create jobs for Lebanese as a priority framework for public land allocation, customs and refugees from Syria in the sectors where operation and public procurement to increase labor regulations allow. The first prong to transparency and reduce discretion; review the consist of a national level labor-intensive public legal framework regarding conflict of interest. infrastructure program that creates jobs for A draft competition law has been in existence the large unskilled and semi-skilled labor force since 2008. in Lebanon. The second prong is job creation • Extending the Prime Minister’s decree through the private sector that can include #246 related to the establishment of the matching grant programs conditional on job Commercial Registry committee to oversee the creation. It is also key to implement adequate implementation of the commercial registry one active labor market policies to ensure vulnerable stop shop for the coming two years. This will groups access those jobs. accelerate the process of the commercial registry • Taking advantage of concessional financing to one stop shop implementation and ensure that effectively implement programs that address the reform is implemented in accordance with Lebanon’s long-standing development needs, best international practices and addresses private while at the same time, help mitigate the impact sector needs by providing efficient government on the refugees. to business services. H. The Refugee Crisis: Creating Opportunities 92. The Syrian conflict and the ensuing influx of an unprecedented number of displaced persons into Lebanon since 2011 has created tremendous pressure on the Lebanese economy, social sectors and infrastructure. In its sixth year, and with little short term prospects of an end to the conflict in Syria, the strain on Lebanon is clear. The international community’s response has been significant but is not sufficient to match either the needs of the refugees nor those of the hosting communities. Going forward, the following suggestions are provided: • The Government to continue to implement plans to provide access to schools, primary health care centers and hospitals, social development centers and other public services to refugees, while seeking and insisting on more international financing assistance to finance this increased demand. 40 | Special Focus lebanon economic monitor | ‫ندا�ؤنا لكم‬ Data Appendix TABLE 1. Lebanon Selected Economic Indicators, 2014-2019   2014 2015 2016 2017 2018 2019   Est. Est. Est. Proj. (annual percentage change, unless otherwise specified) Real sector Real GDP 1.8 1.3 1.8 2.5 2.6 2.6 Real GDP per Capita/1 -4.1 -2.8 -1.2 -0.5 -0.4 -0.3   Agriculture (share of GDP) 4.5 4.5 4.1 4.1 4.0 3.9 Industry (share of GDP) 15.5 15.4 14.5 14.6 14.6 14.6 Services (share of GDP) 80.0 80.1 81.4 81.3 81.4 81.5   Money and prices CPI Inflation (p.a) 1.2 -3.7 -0.8 3.8 2.7 2.0 Money (M3, including non-resident deposits) 6.0 5.1 7.0 7.0 8.0 8.0             (percent of GDP, unless otherwise specified) Investment & saving Gross Capital Formation 31.2 27.6 27.9 28.3 28.3 28.4 o/w private 29.6 26.1 26.2 26.8 26.8 26.8 Gross National Savings 5.8 10.5 6.9 8.1 9.1 9.2 o/w private 16.9 2.3 15.3 16.2 17.4 17.4   Central Government Finance Revenue (including grants) 23.8 20.3 21.0 21.5 21.6 21.5 o/w. tax revenues 15.1 14.6 14.9 15.0 15.0 15.0 Total expenditure and net lending 30.4 28.5 31.1 31.0 31.4 30.9 Current 28.8 27.1 29.4 29.5 29.9 29.3 o/w Interest Payment 9.2 9.5 10.1 10.5 11.0 10.8 Capital & Net Lending (excl. foreign financed) 1.6 1.5 1.7 1.5 1.5 1.6 Overall balance (deficit (-)) -6.6 -8.2 -10.0 -9.5 -9.8 -9.4 Primary Balance (deficit (-)) 2.6 1.3 0.1 0.9 1.2 1.5   External sector Current Account Balance -25.4 -17.0 -20.9 -20.2 -19.2 -19.2 Trade Balance -29.4 -23.2 -26.5 -26.1 -25.6 -26.5 o/w Export (GNFS) 42.1 42.1 40.3 41.7 42.3 43.1 Exports of Goods 10.0 8.5 8.6 8.6 8.6 8.7 Exports of Services 32.2 33.6 31.7 33.2 33.8 34.4 o/w Import (GNFS) 71.5 65.3 66.8 67.8 67.9 69.6 Imports of Goods 42.8 36.3 38.0 38.9 38.7 40.3 Imports of Goods 28.7 29.0 28.7 28.9 29.2 29.3 Net Private Current transfers 5.2 7.2 6.6 5.9 5.4 5.5 Remittances 6.1 7.6 6.8 6.0 5.5 5.6 Net Income reciepts -1.1 -1.0 -1.0 0.0 0.9 1.8 Gross Reserves (months of imports GNFS) /2 /3 11.9 12.0 12.9 12.1 12.0 11.4   Total Public Debt Total Debt Stock (in million US$) 66,564 70,325 74,886 79,650 84,529 89,371 Debt-to-GDP ratio (percent) 145.6 149.4 157.5 165.7 169.9 173.1   Memorandum Items: Nominal GDP (in billion LBP) 68,939 70,980 71,662 72,454 74,991 77,831 GDP (in million US$) 45,731 47,085 47,537 48,063 49,745 51,629 Source: Government data, and World Bank staff estimates and projections /1 Population figures, which include Syrian refugees registered with the UNHCR, are taken from the United Nations Population Division /2 Gross Reserves (months of imports GNFS) = (Gross Res. excl. Gold / imports of goods & services) *12 /3 Total Imports using the BOP data from the Quarterly Bulletin of BDL Data Appendix | 41 The World Bank Selected Special Focus from Recent Lebanon Economic Monitors Lebanon (Special Focus 1): Lebanon’s industrial Fall 2016 LEM: The Big sector in Lebanon has lagged, both on a regional and global comparative basis. Lebanon’s macroeconomic Swap: Dollars for structure, being heavily dependent on tourism and real estate at the expense of industry and agriculture, Trust renders the economy vulnerable to political and economic shocks. In this context, Lebanon needs Central Bank Intervention in the Lebanese Economy to focus on its industrial potential and provide (Special Focus): Small and Medium Enterprises solutions to the numerous constraints hindering (SMEs) occupy a central role in the Lebanese its industrial establishments from functioning at economic landscape and are primary engines for job their full capacity. One possibility to strengthen growth. To ensure adequate SME access to finance the industrial sector is via spatial industrial policies, and stimulate economic activity, the Banque du most notably, industrial parks and special economic Liban (BdL) has established a number of schemes. zones (SEZs), which support increased investment The Special Focus reviews SMEs’ role in Lebanon’s and competitiveness in the industrial sector. activities and outlines the various BdL policy Special care should be allotted to fiscal incentives interventions in the real economy. The preliminary which evidence suggest are ineffective and might findings suggest that the real estate sector was the instead lead distortions such as the relocation of largest recipient of subsidized lending by BdL and existing businesses to the zones rather than the that the proportion of subsidized funds channeled establishment of new business. Under suitable to SMEs continues to be modest. Nonetheless, the conditions, industrial zones have proven successful preliminary evidence suggests that, with the existing in various locations and industries across the world political paralysis, a volatile security environment which make them an attractive tool in Lebanon. and spillovers from the Syrian conflict, economic activity in Lebanon would have been more sluggish Tech Startup Ecosystem: The Case of Lebanon in the absence of BdL’s policy interventions. These (Special Focus 2): A new wave of entrepreneurship interventions, however, come at a cost born by BdL, driven by small digital businesses is sweeping both which are difficult to quantify but have possible developed and emerging economies. Information implications on long-term monetary policy. and Communications Technology (ICT) has dramatically reduced the cost of innovation and market access, allowing small tech entrepreneurs to compete with established businesses. Today, a startup can be created with just a laptop and Internet Spring 2016 LEM: A connection. This has led to the surge of tech startup ecosystems worldwide, where communities of Geo-Economy of entrepreneurs interact. Lebanon in particular can benefit from this phenomenon, particularly for job Risks and Reward creation. Tech startup founders are predominantly young and have a college degree, generating Industrial Parks and Special Economic Zones in employment for educated youth. The innovation that 42 | Selected Special Focus from Recent Lebanon Economic Monitors lebanon economic monitor | ‫ندا�ؤنا لكم‬ startups generate also helps make the tech sector inputs and spending are analyzed over time and more dynamic and sustainable. Lebanon’s tech compared to a number of countries with similar scene is becoming increasingly attractive driven by levels of income and health spending, as well as to the example of successful startups that have tapped the averages for the Middle East and North Africa regional and global markets and the innovative (MENA) region. Global comparisons are presented for initiative by the country’s central bank in facilitating each of these measures based on the latest available venture capital financing. The nation now needs to year of data (generally 2011). Key challenges are leverage these developments by finding solutions highlighted; (i) low public spending on health which to constraints hindering the blossoming of its tech hinders the Ministry of Public Health’s (MoPH) startup ecosystem. ability to adequately respond to the health needs of low income groups; (ii) high household out-of- pocket spending on health subjecting low income groups to financial hardship; (iii) disproportionate allocation of resources on expensive curative care; Fall 2015 LEM: The and (iv) emerging epidemiologic and population trends associated with unprecedented influx of Great Capture refugees having significant implications on the delivery and financing of the health sector. Despite Elite Capture and the Hollowing of the State: an the challenges and prolonged periods of instability, Overarching Constraint to Lebanon’s Development the MoPH embarked on several successful reforms (Special Focus 1): Lebanon’s post-war governance that contributed to the resilience of the system in the endures systemic failures. Institutionalized face of the crisis. confessionalism intended as protection for the mosaic of communities in a country that lacks a demographic majority has developed into pervasive elite capture and patronage system. This elite commands the main economic resources, generating Spring 2015 LEM: The large rents and dividing the spoils of a dysfunctional state. In the process, the public sector has become Economy of New increasingly governed by bribery and nepotism practices, failing to deliver basic public services and Drivers and Old incapable of resolving the most urgent needs. This has culminated in the comprehensive breakdown Drags in the political process, with the three branches of government either vacant or effectively idle, and the The Trade Impact of the Syrian conflict on Lebanon only national plebiscite abrogated. This has triggered (Special Focus 1): We explore the trade effect of the a series of protests and civil disobedience measures Syrian war on Lebanon up until the second half of targeting the ruling political class with emphasis on 2014. A dissection of the data reveals that, so far, the corruption and incompetence. Current conditions war seems to have affected neither merchandise nor are unsustainable, and without significant political services exports at the aggregate level. At the same and economic reforms, a widening and worsening time the relative stability of merchandise imports is of socio-economic unrest is not unfathomable. likely a result of increased demand due to refugee inflow being offset by higher transit costs through Lebanon’s Health Sector: Modest Reforms despite Syria as well as depressed Syrian production. A the Challenges (Special Focus 2): This special focus gravity-type trade model confirms these findings, provides an overview of the health sector in Lebanon suggesting also that Lebanese trade seems to have and highlights both successes and challenges facing been less negatively affected by the Syrian war than the system. Lebanon’s trends in health outcomes, other Syria’s neighbors. An empirical analysis using Selected Special Focus from Recent Lebanon Economic Monitors | 43 The World Bank micro level exporter data substantiates this finding. agency coordination and weak central government While Lebanese exporters to Syria have suffered from oversight. Moving forward, the Government must a drop in demand in the Syrian market (but less so urgently address priorities within the sector. than their Jordanian counterparts), other Lebanese exporters have started to export to Syria to fill the gap in Syrian production. Further econometric analysis suggests that Syrian refugees in Lebanon provide important impetus to Lebanese services exports. Challenges in the Lebanese energy sector (Special Focus 2): The Lebanese electricity sector has been underperforming and in crisis for several decades, requiring urgent action to avoid further deterioration of the quality of electricity delivery. The macroeconomic impact has been massive; accruing debt on investments in and transfers to Electricité du Liban’s (EdL) amounts to 40 percent of Lebanon’s gross public debt and is escalating rapidly as transfers now account for over half of the fiscal deficit. Some of the measures needed to improve EdL’s financial situation are well known, such as increased investment, tariff reforms and corporatization of EdL. Political and confessional obstacles, however, have so far hindered any progress. Water in Lebanon – Coupling Infrastructure with Institutional Reform (Special Focus 3): Despite the relative availability of water resources, the Lebanese water sector has not achieved suitable levels of service provision and is not in line with the level of economic development reached by the country. The cost of inaction in the water sector is estimated at about 1.8 percent of GDP, or 2.8 percent of GDP if the cost of environmental degradation is included. Several factors have led to this situation and require sustained attention. These include: (i) low continuity of water supply due to small storage capacity, large amount of water lost to the sea, growing demand for water and deficiency of the existing water networks; (ii) unfinished reform agenda that contributed to institutional uncertainty and fragmentation of functions particularly relating to wastewater and irrigation; (iii) an irrigation sector that is characterized by inadequate water storage capacity, lack of proper maintenance and a heavy reliance on subsidies; and (iv) regional water establishments (RWE) that severely lack management and financial autonomy and are impeded by limited inter- 44 | Selected Special Focus from Recent Lebanon Economic Monitors lebanon economic monitor | ‫ندا�ؤنا لكم‬ SELECTED RECENT WORLD BANK PUBLICATIONS ON LEBANON (for an exhaustive list, please go to: http://go.worldbank.org/8700A29QW0http://go.worldbank.org/5N4AMNJXV0 Title Publication Date Document Type Lebanon Economic Monitor, Fall 2016: The Big Swap: Dollars for trust 2016/11/08 Working Paper Lebanon - Lake Qaraoun Pollution Prevention Project (English) 2016/06/22 Project Lebanon Economic Monitor, Spring 2016: A geo-economy of risks and 2016/06/02 Working Paper reward Lebanon - Promoting poverty reduction and shared prosperity: systematic 2016/01/01 Publication country diagnostic (English) The welfare of Syrian refugees: evidence from Jordan and Lebanon (English) 2015/12/22 Publication Snapshot of poverty and labor market outcomes in Lebanon household 2015/12/08 Working Paper budget survey 2011-2012: central administration for statistics and World Bank Lebanon economic monitor, April 2015: the economy of new drivers and old 2015/04/27 Working Paper drags MENA Quarterly Economic Brief, January 2015: Plunging Oil Prices 2015/01/29 Brief Economic effects of the Syrian war and the spread of the Islamic state on the 2014/12/01 Policy Research Working Paper Levant Lebanon Economic Monitor: Fall 2014 (English) 2014/10/31 Brief New coincident and leading indicators for the Lebanese economy (English) 2014/06/01 Policy Research Working Paper Lebanon Economic Monitor: Spring 2014 (English) 2014/04/30 Brief Lebanon Economic Monitor: Fall 2013 (English) 2013/10/31 Brief Lebanon - Economic and social impact assessment of the Syrian conflict 2013/09/20 Board paper (English) Lebanon Economic Monitor: Spring 2013 (English) 2013/06/25 Brief Lebanon - Economic and labor force impact of the change in the wage 2013/06/01 Policy Note structure of the public sector (English) Supporting innovation in SMEs in Lebanon through a public/private equity 2013/02/01 Brief fund : the iSME fund (English) Doing business 2013: Lebanon - smarter regulations for small and medium- 2012/10/23 Working Paper size enterprises: comparing business regulations for domestic firms in 185 economies (English) Lebanon - Economic monitoring note (English) 2012/09/01 Brief Doing business in a more transparent world 2012 – economic profile: 2012/01/01 Working Paper Lebanon - comparing regulation for domestic firms in 183 economies (English) PPIAF assistance in Lebanon (English) 2011/07/01 Brief Lebanon - Large scale solar water heater market development program in 2011/06/01 Working Paper Lebanon (English) Lebanon - Thermal standards for buildings: Review and implementation plan 2011/06/01 Working Paper (English) Selected Recent World Bank Publications on Lebanon | 45 0.9375 cm The World Bank www.worldbank.org/lb