On hard road to reform, Lebanon may need old friends

Heavily indebted Lebanon has passed a budget seen as a “first step” towards fixing its public finances but still has much to do to steer the country away from crisis. Investors are waiting to see if Gulf countries will offer a lifeline that may provide some breathing space. Lebanon has one of the world’s heaviest public debt burdens, after years of big budget deficits rooted in waste, corruption, and sectarian politics.
The government is now trying to put the public finances on a more sustainable footing with a budget to cut the deficit and a plan to fix the state-run power sector, which bleeds funds while inflicting daily power cuts on Lebanese.
After years of backsliding, the impetus to reform has grown due to economic stagnation and a virtual halt in the flow of dollars into Lebanon’s banks from abroad. Lebanon has depended on such flows from its diaspora to finance the current account and the state budget deficits. The government hopes the state budget approved by parliament last week will help confidence by slashing the deficit. An international support group for Lebanon, including donor states, welcomed it as “an urgently needed first step” and urged further reforms.
But many doubt the government can meet its goals. The IMF says this year’s deficit is likely to be well above a targeted 7.6 per cent of national output — and donors are still waiting to see important parts of the power plan implemented.
Foreign reserves, while still large relative to the size of the economy, have been falling. This has led banks to launch a new bid to attract dollars by offering 14 per cent a year to depositors willing to lock up large sums for three years — funds which the banks redeposit at the central bank for yet higher returns.
Lebanon’s risks are reflected in the cost of insuring its debt, which surged back to the highest of any government in the world after briefly easing in the wake of parliament approving the budget last Friday, signalling an elevated risk of default. “We believe investor malaise towards Lebanon is unlikely to dissipate soon,” said Yacov Arnopolin, senior portfolio manager at Pimco, one of the world’s biggest asset managers.
“While the significantly delayed budget passage is a step in the right direction, much remains to be done before the country is on a sustainable trajectory,” he said. “Foreign investors have been spooked by deposit flight.” Bank deposits, which have grown consistently on annual basis since the end of Lebanon’s 1975-90 civil war, have dipped by about 1.7 per cent in the first five months of 2019.
Such outflows are typically seen at times of major shocks, such as the 2005 assassination of former prime minister Rafik al Hariri, economists say.
The budget included some politically tricky measures, such as a three-year freeze on state hiring. More difficult ideas were torpedoed, such as a public sector pay cut, and critics say the government also avoided the main problem: corruption.
The major deficit reduction measures include hiking tax on the interest paid on bank deposits and government bonds, a new import duty, and a plan to cut debt servicing, though it is not yet clear how that will be achieved. “It is small steps for a big crisis. We have a very difficult situation that needs drastic steps, drastic measures, and none of them are being taken,” said Sami Gemayel, head of the Christian Kataeb Party, one of the few parties not represented in the unity government. — Reuters

Tom Perry and Tom Arnold