LEBANON ECONOMIC MONITOR THE BIG SWAP: DOLLARS FOR TRUST Fall 2016 Global Practice for Macroeconomics & Fiscal Management, GMFDR MIDDLE EAST AND NORTH AFRICA REGION The World Bank LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST PREFACE The Lebanon Economic Monitor provides an update To be included on an email distribution list for on key economic developments and policies over this Lebanon Economic Monitor series and related the past six months. It also presents findings from publications, please contact Nada Abou Rizk recent World Bank work on Lebanon. It places them (nabourizk@worldbank.org). For questions and in a longer-term and global context, and assesses comments on the content of this publication, please the implications of these developments and other contact Wissam Harake (wharake@worldbank. changes in policy on the outlook for Lebanon. org) or Eric Le Borgne (eleborgne@worldbank.org). Its coverage ranges from the macro-economy to Questions from the media can be addressed to Zeina financial markets to indicators of human welfare El Khalil (zelkhalil@worldbank.org). 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), Samer Matta (Economic Analyst) and Zeina Hasna (Economic Analyst), under the general guidance of Eric Le Borgne (Lead Economist) and Auguste Kouame (Global Practice Manager). Ibrahim Jamali (Assistant Professor at the American University of Beirut) authored the Special Focus on central bank interventions. May Ibrahim (Senior Executive Assistant) provided Arabic translation, Nada Abou-Rizk (Program Assistant) provided French translation and Zeina El Khalil (Communications Officer) print-produced the report. 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 Preface | 1 THE WORLD BANK TABLE OF CONTENTS PREFACE........................................................................................................................................................ 1 EXECUTIVE SUMMARY ............................................................................................................................... 4 …ò«ØæàdG ¢üî∏ªdG .............................................................................................................................................. 7 SOMMAIRE EXÉCUTIF ................................................................................................................................ 8 RECENT ECONOMIC AND POLICY DEVELOPMENTS ......................................................................... 10 Output and Demand ..................................................................................................................................... 10 Poverty and Labor ......................................................................................................................................... 13 Fiscal Policy................................................................................................................................................... 14 External Sector .............................................................................................................................................. 15 Money and Banking ...................................................................................................................................... 17 Financial Markets .......................................................................................................................................... 19 PROSPECTS ................................................................................................................................................ 21 APPENDIX ................................................................................................................................................... 22 SPECIAL FOCUS......................................................................................................................................... 26 Central Bank Intervention in the Lebanese Economy ................................................................................ 26 Abstract ......................................................................................................................................................... 26 SMEs in Lebanon, the State of SME Financing and Obstacles to Firm Growth .............................................. 26 BdL’s Policy Interventions ............................................................................................................................. 28 The Impact: A Preliminary Look .................................................................................................................... 33 Conclusion and Preliminary Recommendations ............................................................................................ 37 References .................................................................................................................................................... 39 DATA APPENDIX ........................................................................................................................................ 42 SELECTED SPECIAL FOCUS FROM RECENT LEBANON ECONOMIC MONITORS.......................... 43 SELECTED RECENT WORLD BANK PUBLICATIONS ON LEBANON .................................................. 46 LIST OF FIGURES FIGURE 1. Frequent shocks result in volatile economic activity ................................................................. 11 FIGURE 2. A further deceleration in economic activity in 2015 ................................................................. 11 FIGURE 3. The real estate sector shows signs of recovery in H1-2016… ................................................... 11 FIGURE 4. … while an increase in expatriate visitors helps support tourism ............................................. 11 FIGURE 5. Consumer sentiment is volatile ................................................................................................ 13 FIGURE 6. Poverty rate highest in the Bekaa and North 2011/12 .............................................................. 13 FIGURE 7. Fiscal stance largely unchanged in 2016… ............................................................................... 15 FIGURE 8. … as price deflation drove debt- to-GDP higher ....................................................................... 15 FIGURE 9. Regression in capital inflows exacerbated in 2015… ................................................................ 16 FIGURE 10. Banks increase their exposure to foreign currency-denominated sovereign debt ... .................. 16 FIGURE 11. … inducing a decline in gross foreign reserves at BdL .............................................................. 17 FIGURE 12. Deflationary trend reversed in 2016, as provisional import deflation abates ............................ 17 FIGURE 13. A discerned slowdown in both resident and non-resident deposit growth .............................. 19 FIGURE 14. New deposits at commercial banks affected by regional crisis.................................................. 19 FIGURE 15. Access to bank accounts and bank loans .................................................................................. 27 FIGURE 16. Major obstacles to firm growth ................................................................................................. 28 FIGURE 17. Commercial banks’ exposure to sovereign debt ....................................................................... 29 FIGURE 18. Loan-to-deposit ratio of commercial banks ............................................................................... 29 FIGURE 19. Growth of lending to the private sector .................................................................................... 29 LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST FIGURE 20. Value of credit guarantees by Kafalat ....................................................................................... 32 FIGURE 21. Kafalat credit guarantees by sector for the period July to December 2015 .............................. 32 FIGURE 22. Loans which benefit from a reduction in reserve requirements, liabilities subject to reserve requirements or both (as a % of total loans).................................................................................................. 33 FIGURE 23. Total loans and loans benefitting from reductions in reserve requirements and in liabilities subject to reserve requirements ................................................................................................................... 33 FIGURE 24. Year-on-year growth in total lending deductible loans. ............................................................. 33 FIGURE 25. New deductible loans .............................................................................................................. .33 FIGURE 26. Loans which benefit from a reduction in reserve requirements, liabilities subject to reserve requirements or both (as a % of total loans).................................................................................................. 34 FIGURE 27. Total loans and loans benefitting from reductions in reserve requirements and in liabilities subject to reserve requirements (LBP Billion) ................................................................................................ 34 FIGURE 28. Subsidized-interest loans .......................................................................................................... 35 FIGURE 29. Sectoral distribution of medium- and long-term loans subsidized by BdL ................................ 35 FIGURE 30. Sectoral distribution of BdL subsidized loans that are guaranteed by Kafalat ........................... 35 LIST OF TABLES TABLE 1. Macroeconomic Indicators with and without Syrian Refugees .................................................. 12 TABLE 2. Initial Balance Sheet for the Three Institutions. ......................................................................... 22 TABLE 3. Changes in the Balance Sheets after the Swap between MoF and BdL ...................................... 23 TABLE 4. Changes in the Balance Sheets after the Swap between BdL and Commercial Banks. .............. 23 TABLE 5. A Chronology of BdL’s Policy Interventions. ............................................................................. 30 TABLE 6. Sectoral Distribution of Utilized Credit Benefiting from Deductions in Banks’ Reserve Requirements or in Banks’ Liabilities (in Percent).......................................................................................... 35 TABLE 7. Lebanon: Selected Economic Indicators, 2013-2018 ................................................................ 42 LIST OF BOXES BOX 1. Counting Syrian Refugees as Part of the Population Figures...................................................... 12 BOX 2. Types of Loans Benefitting from Reduction in Reserve Requirements Held at BdL .................... 30 BOX 3. Subsidized Loans Provided under BdL’s Stimulus Packages ...................................................... 31 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. As the political stalemate continues, reached 1.3 percent in 2015 and is projected to policy-making bodies of the country are mostly accelerate slightly to 1.8 percent, in 2016, partly on inoperative. This is manifested by a presidential account of a moderate first half of 2016. In H1-2016, vacancy for two and a half years, a parliament that the construction sector rebounded somewhat: seldom convenes and a cabinet that hardly finds construction permits and cement deliveries both a consensus to take decisions. These illustrate expanded by 6.5 percent and 9.9 percent yoy, how Lebanon’s system of governance is incapable respectively. Tourist arrivals grew by 7.7 percent of resolving the country’s acute predicaments, (yoy) in H1-2016. including endemic corruption and the collapse of public services (electricity, water supply and waste IV. The fiscal stance is expected to be largely treatment). All the while, Lebanon continues to face unchanged in 2016, maintaining a primary momentous challenges emanating from the war surplus. The overall fiscal deficit for the year until in Syria, including hosting the largest assembly of April grew by 10 percent (yoy), equivalent to 3.3 Syrian refugees (in proportion to the population). percent of GDP and compared to 3 percent of GDP during the same period in 2015. Both revenues and II. Amid fiscal policy paralysis, monetary expenditures rose during this period, with the latter policy under the proactive Banque du Liban outpacing the former, partially due to sizable transfers (BdL) continues to actively manage economic and to municipalities. For the year, we project that an financial challenges facing the country. The BdL increase in tax revenues, from a marginally improving has provided critical support to the real economy as economy, will offset slightly higher expenditures, well as acting as a backstop to the financial sector. leaving the overall fiscal deficit at around 8 percent To respond to the shock from the Syrian conflict on of GDP and a primary surplus of 1.8 percent of GDP. the Lebanese economy, BdL has introduced since With subdued GDP growth and high interest rates, 2013 successive packages of subsidized loans for the such a surplus remains insufficient to prevent the private sector, helping to support demand especially debt-to-GDP ratio from continuing its unsustainable to the real estate sector. In 2016, and faced with path; remaining elevated at a projected 149 percent weaker capital inflows—a main resource for an by end-2016. economy with sizable fiscal and current account deficits—BdL financially engineered a swap that V. A pick up in imports of merchandize goods was able to boost its foreign exchange reserves and combined with deteriorating exports is expected capitalization in local currency at commercial banks. to induce a widening in the already sizable Notwithstanding the short-term needs, given the current account deficit. H1-2016 witnessed a 5 current fundamentals and lack of structural reforms, percent growth (yoy) in merchandize imports, led such interventions can exacerbate macro-financial by minerals and metals, while exports continued risks. to be afflicted by the closure of the last remaining Syrian route, which occurred in May 2015 and III. Economic activity in 2016 is marginally through which exporters were able to access the picking up, thanks to the construction and GCC market. The widening trade-in-goods deficit travel sectors in the context of benign security is expected to induce a deterioration in the current conditions. Real GDP growth is estimated to have account balance in 2016, to a deficit of 19 percent of 4 | Executive Summary LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST GDP, among the largest in the world, which exposed the country to significant refinancing risks. VI. BdL policy interventions in the real economy has provided critical support to the real estate sector and, ultimately, to the banking sector (Special Focus). As Lebanon’s economic landscape came under duress following the eruption of the war in Syria, the BdL introduced successive subsidized lending packages targeting the real economy. The real estate sector has been the largest beneficiary of these packages. Nonetheless, preliminary evidence suggests that, given current economic fundamentals, the existing political paralysis, a volatile security environment and spillovers from the Syrian conflict, economic activity in Lebanon would have been more sluggish in the absence of BdL’s policy interventions. 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Comme l’impasse politique se poursuit, peuvent exacerber les risques macro-financiers. les organismes de prise de décision dans le pays restent, dans leur majorité, non fonctionnels. Cette III. L’activité économique en 2016 reprend situation s’illustre par une vacance présidentielle lentement du poil de la bête, grâce aux secteurs pour la troisième année consécutive, un parlement de la construction et du tourisme, à l’ombre de qui se réunit rarement et un conseil de ministres conditions sécuritaires clémentes. La croissance qui peine à parvenir à un consensus pour prendre réelle du PIB est estimée à 1.3 pour cent en 2015 des décisions. Le système de gouvernance au Liban et devrait s’accélérer légèrement pour atteindre 1.8 est désormais incapable de résoudre les problèmes pour cent en 2016, due en partie à une première graves auxquels le pays est confronté, notamment la moitié de 2016 considérée comme ayant été corruption endémique et l’écroulement des services modérée. Durant la première moitié de 2016, le publics (électricité, approvisionnement en eau et secteur de la construction a relativement rebondi: traitement des eaux usées). Dans le même temps, le les permis de construction et les livraisons de ciment Liban continue à être confronté à d’immenses défis ont augmenté de 6.5 pour cent et de 9.9 pour cent en raison de la guerre en Syrie, dont principalement respectivement, par rapport à l’année dernière. Le le fait d’accueillir le plus grand nombre de réfugiés nombre de touristes a augmenté de 7.7 pour cent syriens (par rapport à sa population). (par rapport à l’année dernière) durant la première moitié de H1-2016. II. Dans un contexte marqué par une paralysie de la politique financière, la politique IV. La position budgétaire devrait rester monétaire de la Banque du Liban (BdL), qui joue inchangée en 2016, maintenant un surplus un rôle proactif, permet de gérer activement primaire. Le déficit budgétaire général pour l’année les défis économiques et financiers auxquels le jusqu’en avril a augmenté de 10 pour cent (par pays fait face. La BdL a ainsi apporté un soutien rapport à l’année dernière), équivalentes à 3.3 pour primordial à l’économie réelle et a constitué un filet cent du PIB contre 3 pour cent du PIB durant la même de sécurité pour le secteur financier. Réagissant au période en 2015. Les revenus et les dépenses ont choc né du conflit en Syrie qui s’est répercuté sur augmenté durant cette période aussi, les dépenses l’économie libanaise, la BdL a introduit, depuis 2013, dépassant les revenus, ce qui est partiellement dû des prêts bonifiés destinés au secteur privé, aidant à des transferts de taille aux municipalités. Pour à soutenir la demande, particulièrement pour le cette année, une hausse des recettes fiscales et secteur foncier. En 2016 et face à un ralentissement une économie connaissant une légère amélioration des flux de capitaux—soit une ressource principale devraient compenser en quelque sorte des dépenses pour une économie souffrant d’un déficit significatif légèrement supérieures, laissant un déficit budgétaire des comptes budgétaires et courants—la BdL a mis général avoisinant 8 pour cent du PIB et un surplus en place une opération de swap qui a donné un élan primaire de 1.8 pour cent du PIB. Avec des taux à ses réserves en devises étrangères et a consolidé d’intérêt élevés et une faible croissance du PIB, un la capitalisation en monnaie locale dans les banques tel excédent demeure insuffisant pour empêcher le commerciales. En dépit des besoins à court terme ratio de la dette publique au PIB de poursuivre sur sa et au vu de la situation actuelle et de l’absence tendance non durable ; demeurant élevé et estimé à de réformes structurelles, de telles interventions 149 pour cent à la fin de 2016. 8 | Sommaire Exécutif LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST V. Une reprise des importations de biens associée à une régression des exportations devrait creuser davantage un déficit des comptes courants déjà important. La première moitié de 2016 a été marquée par une croissance de 5 pour cent (par rapport à l’année dernière) des importations de marchandises, essentiellement les minéraux et les métaux, alors que les exportations continuent à être affectées par la fermeture, en mai 2015, de la dernière route menant en Syrie, à travers laquelle les exportateurs étaient capables d’accéder au marché du CCG. Le déficit des échanges de biens qui se creuse de plus en plus, devrait provoquer une détérioration de la balance des comptes courants en 2016, pour accuser un déficit de 19 pour cent du PIB, parmi les plus grands du monde, ce qui expose le pays à des risques de refinancement significatifs. VI. La politique d’intervention de la BdL au niveau de l’économie réelle a apporté un soutien d’envergure au secteur foncier, et éventuellement au secteur bancaire (Intérêt particulier). Vu que la situation économique au Liban a été mise à rude épreuve depuis que la guerre a éclaté en Syrie, la BdL a introduit des séries successives de prêts bonifiés visant l’économie réelle. Le secteur foncier en a été le plus grand bénéficiaire. Toutefois, les preuves préliminaires montrent qu’au vu de la situation économique actuelle, la paralysie politique en place, un environnement sécuritaire qui peut être instable, et les répercussions du conflit en Syrie, l’activité économique au Liban aurait pu être encore plus faible, sans la politique d’intervention de la BdL. Sommaire Exécutif | 9 THE WORLD BANK RECENT ECONOMIC AND POLICY DEVELOPMENTS 1. Lebanon continues to be subject to limiting its predictive capacity for parliamentary regional tensions. Despite improved security elections outcome, the results do illustrate signs of conditions, violent incidents persist; on June 27, popular resentment toward the Lebanese political eight suicide bombers targeted the town of Al- class fueled by endemic corruption and failed public Qaa located only a few kilometers from the Syrian services. This was felt by all political parties, though border, killing five people and wounding dozens to varying degrees. more. Vulnerable Syrian refugees faced a backlash as the suicide bombers were Syrian nationals. In particular, several municipalities announced a curfew on Syrian refugees citing security concerns. Nevertheless, Lebanon remains the largest host (on Output and Demand a per capita basis) for Syrian refugees, and despite significant strain on already weak public finances, 4. Spillover from the regional turmoil, the government has received limited international in combination with a deteriorating domestic assistance in light of the needs. political process, has led to sluggish, below- potential real GDP growth since 2011.1 While the 2. Corruption scandals make headlines economy since the early nineties has traditionally with minimum accountability and an been susceptible to the frequent political and absence of a reliable legal due process. An security shocks resulting in volatile growth rates investigation launched by parliament’s Media and (Figure 1), the post-2011 period has witnessed a shift Telecommunications Committee reported that four in economic fundamentals. Traditional drivers—real internet networks in the Dinnieh highlands (north of estate, construction, finance and tourism—have Lebanon), Oyoun al-Siman, Faqra and Zaarour (all suffered greatly from the regional turmoil. Instead, three regions in Mount Lebanon) were unlicensed. support for the economy has originated from other Additionally, the Internal Security Forces (ISF) sources, including Syria-related economic activity in have launched a major inquiry into accusations of Lebanon2, in addition to periphery sectors such as embezzlement by security members for pocketing pharmaceuticals3 and the ICT sector; the percentage large amounts of money via the manipulation of of individuals using the internet jumped from 52 health care bills by ISF members. percent in 2011 to 74 percent in 2015, while fixed 1 National accounts data since 2011 are World Bank staff 3. Lebanese headed to the polls for first estimates, guided by our coincident economic indicator (for time in six years in May for municipal elections, details, see Matta, S. (2015) New Coincident and Leading Indexes for the Lebanese Economy, Review of Middle East marking a rare positive development amidst Economics and Finance, 11 (3), 277–303), pending updates on pervasive political dysfunctionality. These were GDP estimates from CAS for 2011 to 2015. the first elections since the last municipal polls in 2 Positive economic contribution of Syrian nationals in 2010, in a country that has not had a president for consequence of the war in Syria has been detailed in the Spring 2015 issue of the Lebanon Economic Monitor. over two years nor elected a new parliament since 3 According to Société Générale de Banque au Liban 2009, with the government running de minimis. in its EcoNews, No. 36, publication in September 2015, Whereas the nature of municipal elections amplifies pharmaceutical output and capacity have increased significantly local factors at the expense of national trends, thus over the past five years following a series of new investments in the industry geared mainly towards export markets. 10 | Recent Economic and Policy Developments LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST WB-CI Quarterly Growth (sa, yoy) Real Estate Sector Thousand of m2 Thousand of tons 2,000 700 Transfers of 1,800 Resignation of PM Fromation of PM Arrears to 600 Saad Harrir's Deteriorating Salam's government Muncipalities 12 government Start of Syrian 1,600 security conditions crisis 1,400 500 10 Government Formation of PM resignation Large drop in 1,200 Najib Mikati's oil prices 400 8 government 1,000 300 6 Garbage Crisis 800 Percent 600 4 200 400 2 100 200 0 0 0 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 May-11 Sep-11 May-12 Sep-12 May-13 Sep-13 May-14 Sep-14 May-15 Sep-15 May-16 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 -2 2010 2011 2012 2013 2014 2015 2016 -4 Construction permits (lhs) Cement deliveries (rhs) FIGURE 1. Frequent shocks result in volatile economic FIGURE 3. The real estate sector shows signs of recovery activity. in H1-2016…. Sources: Lebanese authorities and WB staff calculations. Sources: Banque du Liban Real GDP Growth (%) Tourism Sector (sa) 12 160 90 10.3 9.3 9.1 150 10 80 140 8.0 70 8 7.5 130 120 Thousand 60 Percent 6 110 100 50 3.9 4 3.4 90 2.7 40 1.7 2.0 2.2 1.8 80 2 1.6 1.3 30 1.1 0.9 70 Tourist arrivals (lhs) Hotel occupancy rate (rhs) 60 20 0 Oct-11 Oct-14 Jan-11 Apr-11 Jul-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Apr-13 01 02 03 04 05 06 07 08 09 00 10 11 e e e e 12 13 14 15 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 FIGURE 2. A further deceleration in economic activity in FIGURE 4. ... while an increase in expatriate visitors helps 2015. support tourism. Sources: Lebanese authorities and WB staff calculations. Source: Lebanese authorities and WB staff calculations. broadband subscriptions almost trebled to reach public expenditures, where total expenditures over 1.1 million persons, and mobile-cellular excluding debt service rose by 7.4 percent (yoy) for telephone subscriptions expanded by 127 percent the year through April. This was led by sizable, most over the same period.4 Nonetheless, this has been likely provisional, disbursements in the amount insufficient to regain pre-crisis growth rates or even of US$ 502.1 million in arrears to municipalities, reach potential. representing their share of telecom revenues from previous years. Excluding transfers to municipalities, 5. A pickup in economic activity was the WB-CI still grew by 2.5 percent (yoy) due to observed during the first half of 2016. Following a tempered rebound in the construction sector, a further deceleration in economic activity in reflecting a low-base effect; construction permits 2015 (Figure 2), and despite continued political and cement deliveries both underwent respective paralysis, the World Bank Coincident Index (WB- yoy expansions of 6.6 percent and 9.9 percent in CI), a monthly proxy for real GDP in Lebanon, grew H1-2016, compared to respective contractions of by 4.1 percent (yoy) during the first four months 18.9 percent expansion and 18.7 percent during of 2016, compared to 3.5 percent over the same the same period in 2015 (Figure 3). In this regard, period in 2015. A principal driver was increased BdL subsidized loan schemes continue to provide crucial support to the real estate and construction 4 Source: International Telecommunication Union (ITU). Recent Economic and Policy Developments | 11 THE WORLD BANK sectors. In addition, expatriate visitors to the country consumer sentiment caused by the deteriorating continue to provide a much needed boost to the political climate. While the two consumer confidence tourism sector, helping it recover from low levels; indices (CCIs) appear contradictory6 (Figure 5), both tourist arrivals increased by 7.7 percent (yoy) in H1- share a similar trend of deteriorating consumer 2016 (Figure 4). The hotel occupancy rate, however, sentiment from Q3-2015 to early 2016, followed by fell by 1.2 percentage points (pp), suggesting that a recovery. Private lending toward consumption and the additional tourist arrivals are for the most part real estate purchases continued to expand, in part Lebanese expatriates who refrained from visiting in thanks to another BdL stimulus package in 2015; earlier years due to security conditions. As a result commercial banks’ claims on residents grew by 6.5 of this mild pick up, we project real GDP growth for percent (yoy) by July 2016, largely unchanged from 2016 to accelerate slightly to 1.8 percent.5 July 2015. Anecdotal evidence suggests that private demand is also supported by Syrian investment 6. From the demand side, private and consumption, concentrated in the informal consumption continues to be a principal driver, sector; as the Syrian turmoil endures, Syrians in while the external sector has become a drag. Lebanon are gradually shifting their economic role Improved security conditions and low oil prices from being mainly consumers reliant on handouts helped partially offset the negative impact on to income earners, albeit for many, confined BOX 1. Counting Syrian Refugees as Part of the Population Figures. The World Bank now counts Syrian refugees in Lebanon’s population estimates.* The national accounts published by Central Administration of Statistics (CAS) do not differentiate between refugee and non-refugee contributions to output, meaning that, de facto, GDP figures include the contribution of Syrian refugees to the formal economy. On the other hand, the majority of refugees work in the informal economy, with unregistered enterprises or lacking a work permit. As such, refugees’ principal contribution would be unaccounted for by the national accounts. Per capita growth has been on a decline. Table 1 below compares main macroeconomic indicators per capita when the refugees are excluded (panel I) and which until recently has been our working assumption, with the same per capita indicators but including Syrian refugees** (panel II). The sluggish economic growth that has been in effect since 2011, combined with the larger denominator (population), generates an 8.3 percent drop in real GDP per capita for the 2012-2015 period, for a total loss of US$ 726 million. This compares to an increase of 4.1 percent if the refugees are not counted. While this suggests that the average standard of living has worsened in Lebanon, the caveat remains that the full contribution of Syrian refugees is not captured since the bulk of it is concentrated in the informal economy. Hence, the above-estimated contraction in real GDP is exaggerated. TABLE 1. Macroeconomic Indicators with and without Syrian Refugees. Panel I - Without Syrian refugees Panel II - With Syrian refugees 2012 2013 2014 2015 2012 2013 2014 2015 Population (Million) 4.44 4.49 4.55 4.65 4.92 5.29 5.61 5.85 GDP per Capita (US$) 9,729 9,870 10,058 10,130 8,774 8,389 8,149 8,048 GDP Growth per Capita (%) 1.0 -0.3 0.6 -0.9 -4.7 -6.0 -4.1 -2.8 * This is now consistant with UN Population Division, which has been using complete de-facto definition of the population, therefore they count everyone (including refugees) in the country. ** This is based on United Nations High Commissioner for Refugees (UNHCR) data, which could underestimate the number of Syrians in Lebanon since many Syrians are not registered for assistance. 6 The three-month-moving average for the Byblos/AUB index 5 Box 1 presents the key macroeconomic variables after contracted by 7.7 percent (yoy) in H1-2016, while the ARA counting Syrian refugees as part of the resident population in index increased by 5.7 percent (yoy) during the first 5 months Lebanon. of the year. 12 | Recent Economic and Policy Developments LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST Consumer Confidence Indices (nsa, yoy, %) Poverty Rates (% of head count) 40 60 35 50 Byblos/AUB (3mma) 30 40 ARA (3mma) 25 30 Percent 20 20 10 15 Percent 0 10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 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 -10 5 -20 -30 0 Nabatieh Bekaa Lebanon South Lebanon Lebanon Beirut Mount -40 North -50 -60 FIGURE 6. Poverty rate highest in the Bekaa and North FIGURE 5. Consumer sentiment is volatile. 2011/12. Source: Byblos Bank, ARA Marketing Research and Consultancy and Sources: Lebanese authorities and WB staff calculations. BdL.. within the informal sector. This includes the highest poverty rates were in North Lebanon and establishment of micro and small businesses that Bekaa regions, while the largest poverty count was sell goods (including those originating in Syria) at observed in the most populous Mount Lebanon lower prices targeting the Syrian community (ILO, region (Figure 6). The unemployment rate was about 2014)7. However, Lebanese businesses, which are 9 percent, based on the same household survey, not able to compete at those prices are negatively which predates the impact of regional hostilities, impacted. The external sector, on the other hand, including the influx of refugees. Poverty rates were has contributed negatively to real GDP growth significantly higher for workers employed in the during H1-2016 as merchandize imports recovered agricultural and construction sectors who are paid from 2015 lows, when a sharp decline in oil prices on weekly or daily basis. combined with a euro depreciation provided temporary favorable conditions. Merchandize 8. In view of their protracted presence, exports have also suffered from road closures Syrian nationals have de facto become part of the through Syria that connected exporters to the labor market. With around half of the working age lucrative GCC market. We expect this to induce a Syrian refugees economically active (ILO, 2014),8 by widening of the trade deficit in goods and services end-2014 the labor supply in Lebanon was estimated this year. Moreover, public investment continues to have expanded by 50 percent (IMF, 20149). to lag due to the political paralysis, whereas private The majority of Syrian refugees are low- to semi- investment might improve marginally, driven by a skilled workers, engaged primarily in construction, better performing construction sector. agriculture, and personal and domestic services. The vast bulk of refugee employment, regardless of the level of education attained, focused on the informal sector (ILO, 2015).10 It is unclear to what extent low- Poverty and Labor 8 International Labor Organization (2014), Assessment of the Impact of Syrian Refugees in Lebanon and Their Employment Profile 2013. The study surveyed the employment profile of refugees and the impact of their economic participation on the 7. About 27 percent of the population host communities’ livelihoods. Data was collected from 400 in Lebanon were poor according to the most households, which included a total of 2,004 individuals. recent household budget survey in 2011/12. The 9 IMF (2014), Article IV Consultation and Selected Issues, July, Washington DC. 7 International Labor Organization, 2014, Assesment of the 10 International Labor Organization (2015), Towards Decent Impact of Syrian Refugees in Lebanon and Their Employment Work in Lebanon: Issues and Challenges in Light of the Syrian Profile. Refugee Crisis, Beirut, Lebanon. Recent Economic and Policy Developments | 13 THE WORLD BANK skilled refugees have been competing with Lebanese in tax revenues, from a marginally improving nationals since, even prior to the crisis, the low- economy, will offset slightly higher expenditures, skilled labor market was dominated by foreigners leaving the overall fiscal deficit at around 8 percent (e.g., Syrians, Bangladeshi, Ethiopians, Filipinos). As of GDP (Figure 7) and the primary deficit at a slightly such, it is more likely that low-skilled foreign labor in improved 1.8 percent of GDP. The slowdown in Lebanon, including other Syrians who were present economic activity since 2011 has induced a general before 2011, will bear the brunt of the competition softening in total revenues; in 2015 total revenues from refugees. This can explain the lack of significant amounted to 20.3 percent of GDP compared to the tensions between the refugees and host communities, 2002-2011 period average of 23.4 percent of GDP. considering the sheer number of refugees. On the other hand, primary spending (excluding interest payments) has remained close to the period 9. Employment growth has been average (21.2 percent of GDP in 2015, compared to concentrated in low productivity activities as a 2002-2011 period average of 21 percent of GDP). those involving higher productivity have not grown proportionally. Over the past decade, 11. Slower price deflation and the small trade accounted for about 47.3 percent of all new pickup in growth would help stabilize the debt- employment, public and private services for 34.7 to-GDP ratio in 2016. Gross public debt is forecast percent and construction for nearly 10 percent (ILO, to reach around 149 percent of GDP by end-2016, 2015). Thus, relatively low productivity activities largely unchanged from end-2015 (Figure 8). dominated employment growth, while growth While absolute gross debt is expected to continue in productive activities such as communications, growing at a comparable rate to 2015, nominal GDP financial services, agriculture and manufacturing is forecast to expand at an accelerated rate due to was marginal. Moreover, since foreign labor slower deflation and slightly higher real GDP growth. dominated low skilled (less productive) activities, high GDP growth rates have not translated into 12. Sizable Eurobond issues by the Ministry significant job creation for the Lebanese. In fact, the of Finance highlight large financing needs. The long-run employment-growth elasticity is estimated government continues to primarily finance the fiscal to be 0.2 (World Bank, 201211), much lower than an deficit by issuing Treasury bills and Eurobonds. In estimated MENA average of 0.5 (IMF, 2014). April 2016, Lebanon successfully issued $US 1 billion in Eurobonds to replace maturing debt. The Eurobond issue was divided into two tranches: the first was for $700 million, maturing in 2024 with a 6.65 percent interest rate, and the second was for Fiscal Policy $300 million that matures in 2031 with an interest of 7 percent. The ministry announced that the issue 10. The fiscal stance is expected to be largely was oversubscribed. The stock of debt outstanding unchanged in 2016, maintaining a primary remains mostly in local currency, albeit, decreasing surplus. The overall fiscal deficit for the year until in proportion; by June 2016, 60.3 percent of gross June grew by 9.9 percent (yoy) to be equivalent to public debt was denominated in LBP, compared to 3.8 percent of GDP, compared to 3.5 percent of GDP 61.4 percent in June 2015. during the same period in 2015. Both revenues and expenditures rose during this period, with the latter 13. Longstanding structural bottlenecks in outpacing the former partially due to sizable transfers public finance are important manifestations of to municipalities, which we expect to continue to the perceived endemic corruption12 and political be lumpy. For the year, we project that an increase 12 In the 2013 Global Corruption Barometer survey, 93 percent of Lebanese respondents reported that corruption 11 World Bank (2012), “Republic of Lebanon—Good Jobs is a (serious) problem in the public sector, while 77 percent Needed: The Role of Macro, Investment, Education, Labor and reported that the government is (very) ineffective in the fight Social Protection Policies”, December, Washington DC. against corruption. 14 | Recent Economic and Policy Developments LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST Central Government Finances (% of GDP) Gross Debt 35 3.5 80 190 30 3.0 70 180 25 2.5 60 170 20 2.0 50 US$ bln 160 Percent 15 1.5 40 150 Percent Percent 10 1.0 30 20 140 5 0.5 10 130 0 0.0 2009 2010 2011 2012 2013 2014 2015 2016p 0 120 -5 -0.5 2016p 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -10 -1.0 -15 Total Revenues (lhs) Total Expenditures (lhs) -1.5 Nominal GDP (lhs) Gross Public Debt (lhs) Budget Deficit (lhs) Primary Balance (rhs) Debt to GDP (rhs) FIGURE 8. ... as price deflation drove debt- to-GDP FIGURE 7. Fiscal stance largely unchanged in 2016… higher. Sources: MoF and WB staff calculations. Sources: BdL, CAS and WB staff calculations. malfunction, impeding the development of inflation continued to mitigate nominal merchandize the country. Since 2005, budgets have not been imports in 2016, they are expected to less than offset ratified by parliament due to discord regarding a pickup in volumes imported, reflecting the slightly accountability over previous fiscal accounts. improving economic activity; H1-2016 witnessed a Moreover, none of the post-war budgets were 20 percent growth (yoy) in volumes of merchandize voted within the constitutional period and the last imports, led by minerals and metals, whereas officially closed fiscal accounts are those of 2003, nominal imports rose by only 7 percent. Regarding although those from 1993 till 2003 need major exports, Lebanon continued to be afflicted by the adjustments. Spending has been conducted largely closure of the last remaining Syrian route, which through treasury advances and ad-hoc measures in occurred in May 2015, through which exporters times of pressures. This leaves fiscal policy without were able to access the GCC market.13 As a result, an anchor. Even prior to 2005, fiscal policy has in H1-2016, merchandize exports underwent yoy been missing a medium-term perspective. The lack volume and nominal contractions of 21.6 percent of proper oversight and extra-budgetary entities and 11 percent, respectively. The widening trade- that receive significant government funding help in-goods deficit will induce a deterioration in the entrench a perception of non-transparency and current account balance in 2016, which is projected might encourage corruption in fiscal affairs. to reach a deficit of about 19 percent of GDP, one of the largest in the world, exposing the country to significant refinancing risks. 15. World Bank staff’s expectations of External Sector resiliency of remittances over the short to medium term against low oil export prices in 14. A pick up in imports of merchandize goods the GCC area are confirmed. Recently released combined with deteriorating exports is expected balance of payments data by the central bank for to induce a widening in the already sizable current 2015 indicate that net remittances rose by 1.7 pp to account deficit. In 2015, the current account deficit reach 7.6 percent of GDP, helped by a 5.8 percent underwent an 8.6 pp contraction to reach 17.2 percent of GDP. This came as a result of a large 13 On August 10, 2015, the government agreed to subsidize retrenchment in the value of merchandise imports the cost of exporting goods to Arab countries through the sea over a period of 7 months. The total subsidy amount was set at driven by lower commodity prices, especially fuel US$14 million. Despite this, volumes exported showed a yoy products, and the depreciation of the euro. While decline of 23.6 percent during the period September-December favorable valuation effects due to low import 2015, compared to a yoy contraction of 10 percent for the period May-August 2015. Recent Economic and Policy Developments | 15 THE WORLD BANK Net Foreign Assets’ Position (NFAP) Types of Commercial Banks' Assets (% of total assets) Banks' deposits in BIS banks 20,000 4,000 Banks' FX sovereign debt exposure Banks' LBP sovereign debt exposure 15,000 3,000 50 Banks' FX lending to residents 45 10,000 2,000 40 5,000 1,000 35 US$ mln US$ mln Percent 0 0 30 2010 2011 2012 2013 2014 2015 2016 -5,000 -1,000 25 -10,000 -2,000 20 -15,000 -3,000 15 -20,000 -4,000 10 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Capital inflows (lhs) Trade balance (lhs) Change in NFA (rhs) FIGURE 9. Regression in capital inflows exacerbated in FIGURE 10. Banks increase their exposure to foreign 2015… currency-denominated sovereign debt. Source: BdL and WB staff calculations. Sources: BdL and WB staff calculations. increase and a 11.7 percent decrease in remittances 2015 grew by 1.7 percent to US$ 1.7 billion (3.7 inflows and outflows, respectively. As expounded on percent of GDP), this is primarily due to a sharp in earlier issues of the Lebanon Economic Monitor, fall in outbound FDI, which fell by 49 percent. This this resiliency stemmed from GCC fiscal buffers that compares poorly with the pre-crisis period, where mitigated the negative effects on remittances from between 2000 and 2010 net FDI averaged 9.5 the Gulf region in 2015. As for the fall in remittances percent of GDP. The presence of Syrian refugees outflows, that is partially due to (i) the slowdown in has partially compensated for the overall loss of economic activity in 2015, and (ii) the siphoning off inflows since 2010; international aid targeting of the refugee influx by end-2014. Syrian refugees provides additional support to the balance of payments.15 Support is also generated by 16. The widening trade-in-goods deficit the wide, albeit slightly narrowing, spread between drove the deterioration in Lebanon’s net foreign domestic and international interest rates; by June asset position. The country’s net foreign assets 2016, this spread registered 379 basis points (bps), (commercial banks plus central bank) have been on compared to 416 bps in June 2015.16 a decline every year since 2011. In 2015, it was a deceleration in capital inflows that more than offset 17. After falling in 2015, gross foreign reserves an improved trade balance, draining the economy of at the central bank started growing again. From around US$ 3.4 billion in foreign assets (Figure 9). 2012 to 2014, the loss of foreign assets (see Roles have reversed in 2016; for the year to July, an 8 paragraph above) did not reflect on gross foreign percent growth in the trade deficit more than offset exchange reserves at the central bank, which an 8 percent rise in capital inflows, leading to a loss continued rising. A principal reason has been that of US$ 1.4 billion in foreign assets. This registers commercial banks, faced with globally depressed the largest loss compared to those incurred during interest rates, repatriated foreign assets in search the corresponding periods for all years since 2011. of higher yields. Indeed, as illustrated in Figure The economy is structurally and heavily dependent on capital inflows to finance its current account 15 Inflows to Lebanon have also included international aid targeting Syrian refugees, albeit via various international deficit.14 Since 2012, leading sectors towards which organizations and not through the government, which continues the majority of foreign capital has traditionally to appeal for assistance. A United Nations Development Program gravitated have suffered a significant decline in (UNDP) study assesses the impact on the Lebanese economy of international humanitarian aid delivered via UN agencies to the activity, becoming a less attractive destination for Syrian refugees in Lebanon. It estimates that this aid, estimated FDI (e.g., real estate, tourism). While net FDI in at over a billion dollars between 2012 and 2014, has a multiplier effect that added 1.3 pp to 2014 GDP growth. 14 The current account deficit has averaged 17 percent of 16 This is the interest rate differential between the 3-month GDP during the past ten years. Lebanese T-bill and the 3-month LIBOR. 16 | Recent Economic and Policy Developments LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST Coverage Ratio Drivers of 12-Month Headline Inflation Food and non-alcoholic beverages Alcoholic beverages, tobacco 40 14 Clothin and footwear Actual rent Owner occupied Water, electricity and gas Furnishins, household equipment Health 35 12 Transportaion Communication Education Other 30 10 4 Headline Core 3 25 8 2 US$ bln Months 20 1 6 0 15 Percent -1 4 10 -2 5 2 -3 -4 0 0 -5 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016p -6 -7 Total Imports (lhs) Foreign reserves at BDL (excl Gold, lhs) May-15 May-16 Nov-15 Dec-14 Dec-15 Oct-15 Mar-15 Aug-15 Mar-16 Apr-15 Apr-16 Feb-15 Feb-16 Sep-15 Jun-15 Jun-16 Jan-15 Jan-16 Jul-15 Jul-16 Coverage Ratio (months of imported goods, rhs) FIGURE 11. … inducing a decline in gross foreign FIGURE 12. Deflationary trend reversed in 2016, as reserves at BdL. provisional import deflation abates. Source: BdL, Lebanese Customs and WB staff calculations. Sources: CAS WB staff calculations 10, since 2010, and except for a brief interruption reinforcing confidence in the exchange rate; (ii) to in 2012, commercial banks have increased their the extent that Eurobond purchases by commercial exposure to foreign currency-denominated banks have been funded from external resources, sovereign debt;17 simultaneously, they have sharply this scheme will boost capital inflows;18 (iii) the decreased the share of total assets held as balances MoF was able to exchange more expensive debt abroad, as proxied by balances held with Bank of (T-bonds) for cheaper debt (Eurobonds); and (iv) International Settlement (BIS) reporting banks. In commercial banks’ boosted their capital position. As 2015, portfolio preferences have weakened this a result, by July 2016, gross reserves at the central dynamic, and in combination with a growing need bank were back up to US$ 32.7 billion (Figure 11). for government foreign currency financing, led to On the other hand, a number of challenges arise a 5.4 percent decline in central bank reserves to including an increase in foreign exchange risk and reach US$ 30.6 billion. liquidity management issues. In addition, moving forward, and unless non-resident deposits regain 18. To re-incentivize commercial banks robust growth, commercial banks’ appetite for to hold domestic assets, Banque du Liban Eurobonds in the primary market can diminish. This (BdL), the Lebanese central bank, engineered a will reinforce BdL’s mediating role of government financial swap. This swap proceeded as follows: paper, whereby it participates heavily in the primary (a) in coordination with the ministry of finance, it market, and then pass it at a discount to commercial exchanged LBP-denominated debt with equivalent banks, carrying the cost on its balance sheets. amount in Eurobonds; (b) BdL proceeded to buy Lebanese Treasury bonds from commercial banks (probably at a premium), with the condition that (c) the banks buy government Eurobonds held by BdL, and/or BdL-issued, foreign currency-denominated, Money and Banking certificate of deposits (CDs) (For a more technical discussion, please refer to the Appendix on page 22). 19. The deflationary trend in prices has A number of confidence boosting factors resulted: (i) reversed in 2016. In 2015, headline CPI inflation with the sale of Eurobonds, the central bank was able contracted by 3.7 percent, with the deflationary trend to increase its foreign exchange reserves, ultimately cutting across most categories (Figure 12), reflecting 17 This includes Eurobonds and World Bank staff estimates of 18 In fact, in August alone, the country’s net foreign asset commercial banks’ foreign currency reserves held at the central position (commercial banks and BdL) rose by almost US$ 1.8 bank (which we are assuming to include outstanding foreign- billion, helping net inflows to regain positive territory for the currency denominated Certificate of Deposits (CDs) issued by year to August, compared to a loss of US$ 1.6 billion during the the central bank). same period in 2015. Recent Economic and Policy Developments | 17 THE WORLD BANK the decline in the global prices for energy, food and gross financing needs are met. For the former, BdL commodities as well as an appreciating effective introduced various subsidized refinancing schemes exchange rate given the country’s peg to the dollar, as well as new certificate of deposits for the 15- and subdued economic activity (below potential year, 20-year and 30-year tenors, lengthening the output). Due to the provisional nature of this import maturity structure. As to public finance, BdL bids deflation, we have been expecting this trend to be on the TBs primary market and acts as a buyer on temporary, notwithstanding the persistent sluggish the secondary sovereign debt market. In absence of economic activity. In fact, after reaching a trough in government, the central bank has aimed at sustaining Q3-2015, the trend in headline inflation reversed or even boosting private demand (e.g., the stimulus and turned positive as deflation abated in (i) water, packages) as well as the financial sector’s stabilizer electricity, gas and other fuel, (ii) transportation and of last resort, multiplying the financial burdens on (iii) communication, with the former two reflecting BdL. The resulting banking-sovereign feedback loop, the steady, albeit low, energy prices since Q4-2015. however, is a source of significant macroeconomic By April 2016, core inflation turned positive for the risk (Le Borgne and Jacobs, 201621). first time since August 2015 and has since remained positive. 22. Lending to the resident private sector continues to expand in 2016. The stock of 20. Exchange rate stability, a negative output commercial banks’ credit to the private sector gap and price deflation constitute the motivations increased by a sluggish 4.3 percent (yoy) in July for the central bank for expansionary monetary 2016, albeit an improvement from 2015 when it policy in 2016. The dollarization rate—a key registered 2.6 percent (yoy) in July 2015. However, gauge of confidence in Lebanon—has been largely this comes with a couple of caveats. First, with a unchanged since early 2015, registering 65 percent deflationary environment, the change in real private in July 2016. Simultaneously, real GDP growth lending was larger; second, this conceals diverging continues to lag behind the 1993-2014 average rate dynamics; while claims on non-residents contracted of 4.4 percent, and well below potential, generating by 1.3 percent (yoy) over the same period, those on a negative output gap.19 These, along with price residents grew by 7 percent (yoy). Part of the growth deflation, allowed BdL to extend its loan subsidy in credit to residents, which nonetheless signaled a program in 2015 for the third year running,20 with deceleration from 10.4 percent (yoy) growth in July an additional injection of US$ one billion. The swap 2015, was related to the BdL’s stimulus packages. undertaken by BdL (see Appendix) this year has also The deceleration possibly reflects declining marginal injected additional liquidity into the banking system. returns to the stimulus package as the pool of viable borrowers shrinks. Going forward, authorities need 21. To maintain the peg, BdL ensures banks to exert scrutiny and caution to risks associated with offer attractive dollar spreads to finance the the over-leveraging of households. In precaution current account. Under sustained and large fiscal of such risks, BdL introduced in 2014 a number of needs and a banking sector balance sheet that is macro prudential measures.22 over three times GDP, BdL ensures that banks keep attracting foreign deposits and that the public sector 19 For a more in-depth analysis on the output gap, please refer to Box 1 in the Fall 2015 issue of the Lebanon Economic Monitor. 21 Lebanon: Promoting Poverty Reduction and Shared Prosperity, Systematic Country Diagnostic, World Bank, 20 This program was launched by the BdL in 2013 and Washington DC. continued in 2014 in the amounts of US$1.46 billion and US$800 million, respectively. The real estate sector has been the 22 To limit leverage risks on the consumer side and the fallout principal beneficiary, boosting domestic demand after demand impact on banks, in 2014, BdL instructed banks to require a from Lebanese expatriates and foreign buyers dropped sharply. minimum down-payment of 25 percent for any car or housing To a lesser extent, BdL’s subsidized loans also targeted start- loan and to limit the value of the loan such that the monthly ups and venture capital (relatively nascent in Lebanon), with yet installment does not exceeding 45 percent of family income (35 undetermined effect. percent for a housing loan). 18 | Recent Economic and Policy Developments LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST Deposits at Commercial Banks (nsa, yoy %) New Deposits (% of GDP) Resident deposits (lhs) Non-resident deposits (lhs) Total new deposits New non-resident deposits 70 25 25 Total deposits (rhs) 60 Total real deposits (rhs) 20 20 50 15 40 10 15 Percent Percent Percent 30 5 10 20 0 5 10 -5 0 -10 0 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 May-10 May-11 May-12 May-13 May-14 May-15 May-16 Jan-10 Jan-16 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 199 200 201 4-2 3-2 1-2 002 010 015 FIGURE 13. A discerned slowdown in both resident and FIGURE 14. New deposits at commercial banks affected non-resident deposit growth. by regional crisis. Source: BdL and WB staff calculations. Source: BdL and WB staff calculations. 6 percent in July 2015. Deposits constitute the Financial Markets principal funding source for commercial banks, with the deposit-to-total liabilities ratio27 at 82.9 23. Lebanon’s banking sector is liquid, percent by July 2016. However, over the past few profitable and well regulated, but highly exposed years, there has been a discerned slowdown in to the public sector. Banks are well capitalized deposit growth, with total private sector deposits and resilient owing to prudent investments and at commercial banks increasing by 4.5 percent conservative regulation by BdL and the Banking (yoy) by July 2016, compared to 5 percent a year Control Commission. The liquid asset-to-total earlier; resident and non-resident private deposits deposit ratio23, an indicator of short-term liquidity, increased by 4.7 percent (yoy) and 3.7 percent stood at 71.4 by July 2016, compared to 70.3 in (yoy) (Figure 13). January 2016. Nonetheless, commercial banks are highly exposed to sovereign credit risk as they are 25. Non-resident deposits, a principal source a large investor in public debt.24 In fact, Lebanese of inflows to the country, have been on a sharp banks’ sovereign debt exposure25 increased slightly decline. Non-resident deposits have been a vital from 58.4 percent end-January 2016 to 59.2 percent factor in the stability of the banking sector, and in end-July. In an attempt toward diversification, banks fact the whole economy, constituting 21 percent expanded regionally, an effort that has been severely of total private deposits (end-July 2016). Attracted compromised by the recent regional upheaval.26 by interest rate spreads28, new private deposits at commercial banks29 have averaged a significant 24. Deposit growth decelerates. Commercial 7.8 percent of GDP annually since 1994. In fact, banks’ balance sheets continued to grow, rising between 2003 and 2010 total new private deposits by 6.1 percent (yoy) by July 2016, compared to (TD) averaged 19.4 percent of GDP, while non- 27 This is the ratio of total private and public sector deposits at 23 Liquid assets consist of commercial banks’ deposits with commercial banks to commercial banks’ balance sheet. central bank, Treasury Bills in LBP held by commercial banks and Eurobonds held by commercial banks. 28 The main interest rates that matter in this arrangement are the international dollar rate, a local rate on dollar deposits 24 Interest income, as obtained from BilanBanques, amounted and a local rate on LBP deposits. A spread between the local to 66.15 percent and 66.31 percent of total consolidated banks’ and international dollar rates attracts deposits in dollar, while a income in 2013 and 2014, respectively. spread between LBP and local dollar rates encourages deposits 25 The sovereign debt exposure is computed as a ratio of in local currency. Nonetheless, like much of the country, commercial banks’ aggregate investment in Treasury bills, Lebanon’s banking system is highly dollarized (65 percent Eurobonds and deposits at BdL relative to total assets. dollarization rate). 26 Expansion of Lebanese commercial banks in Turkey 29 New deposits are calculated as deposits minus interest continues, however, helping to increase profitability. paid on the previous year’s deposits. Recent Economic and Policy Developments | 19 THE WORLD BANK resident new private deposits (NRD) averaged 15 percent (Figure 14). These ratios have declined sharply since, due primarily to the regional turmoil and secondarily to the unsustainability of such high levels. During the crisis period of 2011-2015, however, TD and NRD shares of GDP fell to 5 percent and 4.3 percent, respectively. Despite this deterioration, Lebanon’s financial sector retains key advantages. To begin with, exceptionally low global interest rates warrant a reduction in Lebanon’s rates. Furthermore, non-resident deposits, which are largely sourced from Lebanese expatriates, are resilient to shocks due to the diaspora’s familiarity with the country’s political and security volatilities. Additionally, the BdL has demonstrated its readiness to be the ultimate guarantor of the financial sector via its large foreign exchange reserves and good crisis management overall. 20 | Recent Economic and Policy Developments LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST PROSPECTS 26. The regional turmoil, especially the war in exacerbate macro-financial risks other than the Syria, poses serious security threats in Lebanon liquidity and balance-sheet challenges discussed and the recent relative calm is not a guarantee of above. First, expected normalization of global interest stability. A key assumption underlying projections rates will make it harder to attract hard currency for the Lebanese economy regards the Syrian conflict unless domestic interest rates rise in commensurate, and its spillovers. World Bank staff projections which is inconsistent with the objectives of BdL’s assume that current conditions hold, i.e., spillovers interventions. Second, the enthusiastic response continue to be contained without precluding the to BdL initiatives (subsidized loans) has helped occurrence of occasional serious security events. boost economic activity but after several years of Real GDP growth for 2016 is projected to be a such lending, more attention will need to be paid sluggish 1.8 percent, albeit slightly improved from to the issue of household leveraging and repayment an estimated 1.3 percent in 2015. Over the medium capacity. Third, the swap just undertaken, if not term, we expect real GDP growth to be around made clear that it is an exceptional instrument for 2.5 percent. The return to potential output growth exceptional times, can further erode the role of critically hinges on a resolution of the conflict in Syria commercial banks in favor of BdL in the primary as well as a marked improvement in the security and market for public debt. Banks will instead expect a political situations in Lebanon. premium on government paper paid for by BdL. 27. Absent significant structural reforms on either revenue or spending, Lebanon’s public finances are projected to remain structurally weak. The overall fiscal deficit is expected to continue widening over the medium term. Current spending is projected to grow as a result of increased debt servicing due to pass through from higher global interest rates and higher oil prices that will reflect on transfers to EdL. Moreover, assuming political paralysis eases by 2017, we expect some limited public sector wage increases. In addition, and despite the expected return of positive inflation in 2017, the trend for debt-to-GDP ratio based on current policies and real GDP growth rates remains unsustainable and is expected to notably worsen once global dollar interest rates start normalizing (a pace which is expected to start with a tightening of policy rates by the U.S. Federal Reserve Board). 28. Structural reforms are supplanted by an increasingly active central bank. Notwithstanding the short-term need, such interventions can Prospects | 21 THE WORLD BANK APPENDIX 29. The details of the swap are not fully a, b and c were equivalent at the present exchange disclosed, but the main provisions include the rate, plus the incentivizing premium, p, for step b. following steps: 31. To analyze the central bank’s swap scheme a. Banque du Liban (BdL) exchanged with the we apply a balance sheet approach focusing on Ministry of Finance (MoF) LBP-denominated the three relevant institutions—MoF, BdL and debt for Eurobonds; commercial banks. Initial balance sheets for the b. BdL proceeded to buy Lebanese Treasury bonds three institutions are presented in Table 2, whereby (T-bonds) from commercial banks, with the all components are denominated in LBP including condition that: foreign assets and liabilities. We now list the assets c. Commercial banks buy either (i) government and liabilities for each institution: Eurobonds held by BdL, or (ii) BdL-issued, foreign currency-denominated, certificate of deposits MoF (CDs), or (iii) an equivalent combination of both. • Assets: (i) MoF balances in LBP with the 30. Assuming that banks’ initial portfolio central bank, LPfc; (ii) MoF balances in LBP with reflected risk-return preferences, for banks to be commercial banks, LPfb; (iii) MoF balances in incentivized to hold additional Eurobonds (and US dollar with the central bank, $fc; (iv) Mof fewer T-bonds), as illustrated by the conditioning balances in US dollar with commercial banks, of step b on step c, necessitated a financial gain $fb; and (v) other. for the banks. Let us assume that this gain comes in the form of a premium, p, paid on top of the market price of the T-bonds30. For simplicity, let us also assume that the transaction values of each of steps TABLE 2. Initial Balance Sheet for the Three Institutions. MoF BdL Banks Assets Liabilities Assets Liabilities Assets Liabilities LPf +LPf c b Tb +Tb c b Tbc LP +LPb f c c Tb +CDL b LPfb $fc+$fb €bc+€bb €bc $fc+$bc €bb+CD$ $fb Other Other Fx CDL+CD$ LPbc DPL Other Other $b c DP$ FCb Other Other 30 For example, news outlets have reported thet BdL, after buying the T-bonds from banks, would split the coupon rate with them. The premiuk in such a case would be banks’ portion of the coupon payment, present-valued for a one-time payment 22 | Appendix LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST TABLE 3. Changes in the Balance Sheets after the Swap between MoF and BdL. MoF BdL Banks Assets Liabilities Assets Liabilities Assets Liabilities LP +LP f c f b Tb +Tb -X c b Tb -X c LP +LPb f c c Tb +CDL b LPfb $fc+$fb €bc+€bb+X €bc+X $fc+ $bc €bb+CD$ $fb Other Other Fx CDL+CD$ LPbc DPL Other Other $ b c DP$ FCb Other Other TABLE 4. Changes in the Balance Sheets after the Swap between BdL and Commercial Banks. MoF BdL Banks Assets Liabilities Assets Liabilities Assets Liabilities LPfc+ LPfb Tbc+Tbb-X Tbc-X+X LPfc+LPbc+X+p Tbb+CDL-X LPfb $fc+ $fb €bc+€bb+X €bc+X-X1 $fc+ $bc €bb+CD$+X $fb Other Other Fx+X CDL+CD$+X2 LPbc+X+p DPL Other Other $ b c DP$ FCb-X Other Other • Liabilities: (i) T-bonds held by BdL, Tbc; (ii) Commercial banks T-bonds held by banks, Tbb; (iii) Eurobonds held by BdL, €bc; (iv) Eurobonds held by banks, €bb; • Assets: (i) T-bonds, Tbb; (ii) BdL-issued certificate (v) other. of deposits in LBP, CDL; (iii) Eurobonds, €bb; (iv) BdL-issued certificate of deposits in US$, CD$; BdL (v) banks’ balances in LBP held at BdL, LPbc; (vi) banks’ balances in US$ held at BdL, $bc; (vii) • Assets: (i) T-bonds, Tbc; (ii) Eurobonds, €bc; (iii) foreign placed US$, FCb; and (viii) other. foreign exchange reserves, Fx; and (iv) other. • Liabilities: (i) MoF balances in LBP with • Liabilities: (i) MoF balances in LBP held at BdL, commercial banks, LPfb; (ii) Mof balances in US$ LPfc; (ii) banks’ balances in LBP held at BdL, with commercial banks, $fb; (iii) private sector LPbc; (iii) MoF balances in US$ held at BdL, $fc; deposits in LBP, DPL; (iv) private sector deposits (iv) banks’ balances in US$ held at BdL, $bc; (v) in US$, DP$; and (vi) other. BdL-issued certificate of deposits in LBP, CDL; (vi) BdL-issued certificate of deposits in US$, 32. The first transaction BdL undertook was CD$; and (vii) other. that it exchanged with the MoF LBP-denominated debt with an equivalent amount in Eurobonds. Assuming this amount to be X, the balance sheets become as illustrated in Table 3 (with the changes in red font): Appendix | 23 THE WORLD BANK 33. In this case, the MoF redeemed an X 37. Let us now list the advantages and amount of T-bonds and issued new Eurobonds in disadvantages of this scheme for each institution: the same amount, with both changes occurring on the liability side of its balance sheet. On the other MoF hand, changes to BdL balance sheet were on the assets side, as an X amount of T-bonds were swapped • Advantage: it substituted dearer debt for Eurobonds. Both institutions maintained the total (Eurobonds) for cheaper debt (T-bonds), on balance sheet value. which it pays a lower interest. • Disadvantage: it increased sovereign exposure 34. BdL proceeded to buy Lebanese Treasury- to exchange rate risk. bonds from commercial banks at face value, • Net impact: a continuation of the authority’s paying a premium, p, over the market price X. recent strategy that favors borrowing in foreign This was with the condition that the banks buy X currency over local currency. amount of (i) government Eurobonds held by BdL, or (ii) BdL-issued CD$, or (iii) a combination thereof. BdL Table 4 presents the new balance sheets. Here we assume that X=X1+X2, such that X1 and X2 are the • Advantage: it boosted its stock of foreign exchange values for Eurobonds and CD$, respectively, that reserves by X, re-enforcing confidence in the banks bought from BdL as a condition for being exchange rate and the financial system at large. part of the scheme. Moreover, and since a principal • Disadvantage: BdL raised its exposure to objective of this exercise is to improve the stock of sovereign foreign-denominated debt by holding foreign exchange in the economy, we assume that X2 more Eurobonds on its asset side. commercial banks used their foreign-placed, foreign • Disadvantage: BdL expanded its liabilities in currency-denominated liquid assets to fund the foreign currency by issuing X2 CD$. purchase of the Eurobonds and CD$.31 • Disadvantage: BdL expanded its liabilities in local currency by holding X+p more in balances 35. In the final standing, BdL holds the initial for commercial banks. amount of T-bonds it started with, Tbc, but is • Net impact: a boost to foreign exchange now liable by an additional X+p amount in LBP reserves comes at the expense of a weakened balances, as it credits banks’ balances for the balance sheet, with capital declining by p. purchase. BdL also holds X2=X-X1 more Eurobonds and has issued X2 additional CD$. Crucially, central Commercial Banks bank foreign exchange reserves have risen by X. BdL’s total balance sheet has increased by X+X2, • Advantage: a fall in banks’ sovereign exposure whereas its capital (assets minus liabilities), has in local currency by X. declined by p. • Advantage: an increase banks’ liquidity in local currency by X+p. 36. Commercial banks on the other hand, hold • Advantage: an increase in banks’ capital position X amount less (more) in T-bonds (€bb+ CD$), and by p. have used up X amount form their foreign-placed • Disadvantage: an increase in banks’ sovereign foreign assets. Their balances with the central bank exposure in foreign currency by X. have increased by X+p. Both, commercial banks’ • Disadvantage: a decrease in banks’ foreign- total balance sheet and capital have been enlarged placed liquid foreign assets by X. by p. • Net impact: an increase in banks’ liquidity in local currency and banks’ capital position, 31 As an alternative, commercial banks can issue foreign further strengthening their balance sheet. This, currency bonds and/or raise deposits in their foreign branches. however, is achieved at the expense of lower A small capital market precludes the former while raising foreign liquidity in foreign exchange, which can be deposits is more involved and requires time and strategy. 24 | Appendix LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST deployed globally, compared to LBP liquidity that can only be utilized locally. Macroeconomy: • Advantage: to the extent that there is sufficient demand for the additional liquidity in local currency, this should have a positive impact on private lending and, thus, economic growth. • Disadvantage: to the extent that there is insufficient demand for the additional liquidity, and in an attempt to keep the interest rate margin sufficiently attractive for exchange rate stability, there would be liquidity management challenges. • Disadvantage: moving forward, and unless non-resident deposits regain robust growth, commercial banks’ appetite for Eurobonds in the primary market can diminish. This will reinforce BdL’s mediating role of government paper, whereby it participates heavily in the primary market, and then passes it at a discount to commercial banks, carrying the cost on its balance sheets. • Disadvantage: an increase in foreign exchange risk. • Disadvantage: rent is transferred from the public to the banking sector. Appendix | 25 THE WORLD BANK SPECIAL FOCUS CENTRAL BANK SMEs in Lebanon, the INTERVENTION IN THE State of SME Financing 32 LEBANESE ECONOMY and Obstacles to Firm Growth 38. Existing studies confirm that SMEs are an Abstract integral component of the Lebanese economic landscape and that younger firms are the main Small and Medium Enterprises (SMEs) occupy a engine of job creation in the country. A survey central role in the Lebanese economic landscape undertaken by Hamdan (2003) on behalf of the and are primary engines for job growth. To ensure Economic Research Forum summarizes SMEs’ adequate SME access to finance and stimulate importance to the Lebanese economy by noting economic activity, the Banque du Liban (BdL) has that “Lebanon’s economy is dominated by SMEs” established a number of schemes. The Special and that “small enterprises employing less than Focus reviews SMEs’ role in Lebanon’s activities five employees make up the bulk of operational and outlines the various BdL policy interventions enterprises, constituting 88 percent of the total, in the real economy. The preliminary findings while those employing less than 50 individuals make suggest that the real estate sector was the largest up 96 percent of the total”.33 The importance of SMEs recipient of subsidized lending by BdL and that as an engine for growth and job creation was echoed the proportion of subsidized funds channeled by the Ministry of Economy and Trade (MoET)’s SME to SMEs continues to be modest. Nonetheless, strategy (MoET, 2014).34 Furthermore, the World the preliminary evidence suggests that, with the Bank (2014a) finds that young firms (young startups existing political paralysis, a volatile security and microenterprises and SMEs) are the main engine environment and spillovers from the Syrian of job creation in the country. conflict, economic activity in Lebanon would have been more sluggish in the absence of BdL’s policy interventions. These interventions, however, come at a cost borne by BdL, which are difficult to quantify but have possible implications on long- term monetary policy. 33 The study clearly points to a preponderance of micro enterprises, defined as having a maximum of five employees, in Lebanon. 34 The MoET (2014) defines micro enterprises as companies with an annual turnover of less than LBP 500 million and less than 10 employees, small enterprises as firms with an annual turnover of less than LBP 5 billion and less than 50 employees 32 The author is Ibrahim Jamali, Assistant Professor at the and medium enterprises as companies with an annual turnover American University of Beirut. of less than LBP 25 billion and less than 150 employees. 26 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST 39. While Lebanon compares favorably to MENA in terms of the development of the banking sector and SME access to finance, SMEs did report Access to bank loan facing some challenges in accessing finance. According to the World Bank and the Union of Arab Banks (2010), SMEs’ share of total bank loans in Access to Lebanon is around 16 percent. This firmly places the bank account country as second in MENA in terms of an overall measure of SMEs’ access to finance.35 Claessens 0 20 40 60 80 100 and Tzioumis (2006) rank Lebanon’s highly liquid Lebanon MENA All Countries banking sector as 50th (out of 95 countries) in terms of development. While Lebanese banks seem FIGURE 15. Access to bank accounts and bank loans. to have a preference to lend the Sovereign, banks Source: World Bank Enterprise Survey. have increased their engagement with Lebanese SMEs, including via the Circular 331 initiative of the BdL which put in place a facility through which world and MENA averages (Figure 15). Nonetheless, commercial banks – most often through investment gaps in SME access to finance persist. The 2013/14 fund intermediaries – could provide equity for enterprise survey results show that 41.5 percent of knowledge sector start-ups. Nevertheless, Lebanese Lebanese micro and SMEs (MSMEs) cite access to SMEs remain highly dependent on bank lending and finance as an obstacle. This proportion is higher than places banks at the center of financial intermediation both the 35.7 percent of MENA-region firms and the in the country. global average of 27 percent of firms citing access to finance as a constraint to growth. Firms in Lebanon 40. SMEs do not identify the lack of access to rarely resort to supplier credit in contrast, for finance as the most important constraint to firm example, to Tunisia and, at approximately 10 percent, growth but existing studies suggest that financing more Lebanese firms report being credit-constrained gaps are present. The most recent 2016 report36, than other Magreb countries, but slightly less than is drawing on 2013/14 enterprise survey data identified the case in Jordan. Moreover, access to finance is a Lebanon as one of the foremost countries in the greater constraint the smaller the business is. This region with a share of bank finance at 20 percent was evident in the 2008 survey undertaken by IFC which is above that of peer economies in the lower which looked at 539 micro and small enterprises in middle income bracket (12 percent). The results four areas in Lebanon (IFC, 2008). A more recent from the enterprise survey in Lebanon indicate that study by IFC (2014) finds that entrepreneurs and SMEs’ access to checking or savings accounts and small businesses face difficulties in applying to (or to bank loans/lines of credit compare favorably to obtaining) loans due to high collateral requirements, lack of an established relationship with the financial 35 The overall measure is composed of the following intermediary or due to a limited track record.37 World indicators, as used by the OECD scorecards to assess the state Bank (2015a) acknowledges Lebanese MSMEs’ of SME financing: (1) share of SME loans in total business financing constraints and discusses the potential for loans; (2) share of SME short-term loans in total SME loans; (3) total SME loan and credit guarantees; (4) total SME direct NBFIs to offer leasing, factoring, microfinance and government loans; (5) the ratio of SME loans used to SME loans other capital markets solutions to ease access to authorized; (6) the ratio of SME non-performing loans to SME loans; (7) interest rate charged on SME loans; (8) interest rate finance. spread between large and small company loans; (9) percent of SMEs required to provide capital; (10) venture capital and 41. SMEs overwhelmingly identify political growth capital; (11) payment delays; and (12) bankruptcies. instability as the most important constraint to 36 “What’s Holding Back the Private Sector in MENA – Lessons from the Enterprise Survey”, a joint World Bank-European Investment Bank and European Bank for Reconstruction and 37 The same study also finds that female entrepreneurs and Development report, 2016. This included enterprise surveys small companies run by women face significant difficulties in conducted in eight MENA countries. accessing finance. Special Focus | 27 THE WORLD BANK Political 58 instability 56 54 Electricity Percent 52 Corruption 50 48 Access to 46 finance Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 May-07 Sep-07 May-08 Sep-08 May-09 Sep-09 May-10 Sep-10 May-11 Sep-11 May-12 Sep-12 May-13 0 20 40 60 80 Lebanon MENA All Countries FIGURE 17. Commercial banks’ rxposure to sovereign FIGURE 16. Major obstacles to firm growth. debt. Source: World Bank Enterprise Survey. Source: BdL and WB staff calculations. business growth. The 2013/14 enterprise survey In fact, Lebanon’s fiscal imbalances have created results showing that 58 percent of Lebanese SMEs a dynamic, dubbed the “fiscal dominance” by the identify political instability as a major obstacle to World Bank (2015b), in which the well-capitalized growth (Figure 16). This proportion is significantly domestic banking sector40 finances the fiscal deficits larger than the 30.1 percent (11.4 percent) of SMEs at the expense of the private sector and SMEs (World in MENA (globally) identifying political instability Bank, 2015a). In fact, Lebanon’s central bank, the as a constraint to growth.38 The second and third Banque du Liban (BdL), acts as residual buyer of most important obstacles to SME growth in Lebanon sovereign debt, resulting in a high and increasing are, respectively, electricity and corruption.39 While exposure of the banking sector to sovereign debt access to finance compares favorably to global and (Figure 17) compared to smaller loan portfolios MENA averages, it continues to be the fourth most (Figure 18). The high exposure to the Sovereign can important obstacle to Lebanese SMEs’ growth (with potentially become a source of systemic risk and 6.6 percent of firms identifying it as an obstacle to serves as an indicator of potential crowding-out of growth). private borrowing. In fact, Ali Abbas and Christensen (2007) note that the availability of high-yielding government debt can act as a disincentive for banks to increase private sector lending.41 BdL’s Policy Interventions 43. Since 2011, the growth rate of lending to the private sector exhibited a remarkable 42. Recurrent and sizable fiscal deficits and slowdown (Figure 19). The year-on-year (yoy) a high debt-to-GDP ratio characterize Lebanon’s growth rate in lending to the private sector averaged fiscal stance. Lebanon’s fiscal imbalances are an a remarkable 15.4 percent over the January 2008 important constraint to growth (Berthélemy, Dessus to December 2010 period. However, the post- and Nahas, 2007) and have deprived the private 2011 sluggish economic growth, combined with sector and SMEs from adequate access to finance. an increasing exposure by banks to the Sovereign, resulted in a significant slowdown in the growth rate 38 Given that the events of the Arab Spring (or its of lending to private sector to 7.8 percent (yoy) over reverberations) were continuing to unfold in some MENA region countries in 2013, the much higher proportion of Lebanese firms identifying political instability as the most severe constraint to 40 By end of 2015, balance sheets of commercial banks growth (relative to MENA) is very noteworthy. amounted to 395 percent of GDP. 39 World Bank, 2015a discusses the problems with the 41 The authors note, however, that evidence of crowding out Lebanese electricity sector as well as the costs of the inadequate at the macroeconomic level is mixed. For further details, see provision of electric power. Abbas and Christensen (2007). 28 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST 30 27 26 25 25 20 Percent 24 Percent 15 23 10 22 21 5 20 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Growth in claims on resident private sector (yoy) FIGURE 18. Loan-to-deposit ratio of commercial banks. FIGURE 19. Growth of lending to the private sector. Source: BdL and WB staff calculations. Source: BdL and WB staff calculations. the January 2011 to December 2013 period. This sectors42. The success of these incentive schemes led noticeable deceleration might imply that SMEs and BdL to increase the deduction ceiling to 90 percent other firms faced significant difficulties in accessing in January 2011. finance. The ratio of loans to private sector to total commercial banking assets over the January 2008 to 46. Since early 2013, BdL introduced three October 2015 did not exceed 26.17 percent again sizeable stimulus packages to fuel the tepid indicating the preference of banks to lend to the economic activity (Box 3). According to BdL (2015), Sovereign. the principal goal from launching the stimulus packages is “to create new job opportunities for 44. Since 1997, BdL has embarked on several the Lebanese youth and stimulate the Lebanese interventions which aim to entice banks to increase economy through ensuring the necessary financing private sector lending in Lebanese Pounds. The for small and medium enterprises”. In detailing the earliest among such interventions consisted of an stimulus packages launched, BdL (2015) makes interest rate subsidy scheme for medium and long- an explicit link between the growth in lending to term loans which BdL initiated in 1997. In 2001, the the private sector and economic growth by noting central bank allowed for reductions in the reserve that “The economic slowdown that Lebanon has requirements of banks which lend to firms in the witnessed, mainly due to the unstable political industrial, information technology (IT), agriculture and security situations in the region, stirred and tourism sectors (Box 2). Banque du Liban to launch a new initiative, with the aim to motivate private lending, and hence 45. Faced with a slowdown in lending to the economic growth”. A first stimulus package of private sector, BdL initiated an incentive scheme LBP 2,210 billion (US$ 1.46 billion), launched in in 2009 to entice banks to lend to specific sectors. January 2013, was designed to spur lending to The 2007-2009 period witnessed a surge in banks’ investments in high-yielding BdL certificates of 42 The IMF (2012) notes that “Additional reserve requirement exemptions introduced in 2009 allowed banks to deduct 60-100 deposits and Treasury papers leading to insufficient percent of a qualifying loan in LL (depending on type of loan) lending in Lebanese Pounds to the private sector from required reserves on customer deposits, up to a ceiling of 75 percent of the reserve requirement for all qualifying (IMF, 2012). In June 2009, BdL scaled up the 2001 loans.” IMF (2012) continues, “During June 2009-August 2011, incentive scheme by allowing for a larger reduction there were about US$ 1.1 billion in housing loans and US$ 59 in the effective reserve requirements of commercial million in new education loans; in addition, there were loans to environmental friendly projects and small and medium banks which extend loans to the industrial, enterprises. Real estate development and consumption-related Information Technology (IT), agriculture and tourism lending do not qualify. Education loans qualify for a 100 percent reduction, housing for 65 percent and housing loans to military for 60 percent.” Special Focus | 29 THE WORLD BANK BOX 2. Types of Loans Benefitting from Reduction in Reserve Requirements Held at BdL. The subsidized loans department of the Banking Control Commission identifies the following loans as eligible for direct reductions in reserve requirements: • Subsidized loans guaranteed by Kafalat S.A.L. • Housing loans granted by banks based on a protocol signed with the Public Housing institution. • Housing loans granted by banks based on a protocol signed with the Military Volunteers Housing Unit. • Long term housing loans that banks grant to their clients, and which are subject to the exemptions that long term and investment banks are subject to. • Private and public sector bonds denominated in foreign currency and purchased without recourse. • Direct loans that the banks grant to the Public Housing institution to construct buildings for rent for the benefit of limited income groups. • Loans granted to the Housing Bank S.A.L. that are used to finance the loans granted by the bank. • Micro credits granted with the approval of Micro – Credits institutions. • Housing loans granted by banks based on a protocol signed with the Mutual Fund of the Magistrates. • Housing loans granted by banks based on a protocol signed with the Directorate General of the ISF. • Housing loans granted by banks based on a protocol signed with the Directorate General of the SG. • Housing loans granted by banks based on a protocol signed with the Ministry of Displaced. • Loans granted by banks to finance environmental loans in both energy and non-energy. • Loans granted by banks for high school education. • Loans granted by banks based on a protocol signed with the Ministry of Agriculture. • Loans granted by banks to students to buy tablets. Source: http://www.bccl.gov.lb/committee/subsidized-loans-department/ TABLE 5. A Chronology of BdL’s Policy Interventions. Year Policy Intervention 1997 Introduction of a Subsidy Scheme for Medium and Long-Term Loans 2001 Initiation of Reductions in Reserve Requirements 2009 Additional Reductions in Reserve Requirements up to 75 Percent for all Qualifying Loans 2011 Increase in the Allowable Ceiling of Reductions in Reserve Requirements to 90 Percent 2013 Launch of the First Stimulus Package totaling US$ 1.46 Billion 2014 Increase in the Size of the First Stimulus Package by 0.92 US$ Billion industry, IT, agriculture, environment, housing, to commercial banks who on-lend the funds at education and tourism sectors. According to the a subsidized rate of interest. A timeline of BdL’s World Bank (2013b), 56 percent of the funds in policy interventions is provided in Table 5. the first stimulus package were earmarked to the housing sector. In view of the success of the first 47. Operationally, the financing unit at BdL package, BdL increased it by an additional LBP oversees the administration of subsidized interest 1,400 billion (US$ 0.92 billion) in 201443. In 2015, rate loans and facilities in reserve requirements. a third stimulus package of LBP 1,500 billion (US$ The financing unit assesses the applications 0.99 billion) was launched to stimulate lending submitted by banks and leasing companies for to the aforementioned sectors. The funds from subsidized loans and grants exemptions for required the stimulus packages are provided as soft loans reserve requirements. Subsidized interest rate loans 43 Stimulus package funds which are not lent during a given year are rolled over to the following year. 30 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST BOX 3. Subsidized Loans Provided under BdL’s Stimulus Packages. The following is a summary of some of the subsidized loans provided under BdL’s 2015 package (BdL, 2015): 1. Financing of projects in the tourism, agriculture, industry and handicrafts sectors. Target Beneficiaries: Manufacturing firms information technology equipment, design programs and specialized technologies. Loan Specifics: i. The loans guaranteed by Kafalat s.a.l. are excluded. ii. The funds must be fully invested in Lebanon to finance a new project (with a minimum value of LBP 50 million). iii. The loan’s duration ranges between five and seven years. iv. The loan can be made in LBP, Euro or US$. v. Total funds received by any one institution should not exceed LBP 15 billion. 2. Subsidized SME loans in LBP. Target Beneficiaries: Firms in the industrial, agricultural, tourism and handicrafts industries as well as technologically- intensive sectors. Loan Specifics: i. The loans are guaranteed by Kafalat s.a.l. ii. The interest rate charged on the loan should not exceed 40 percent of the yield on the one-year T-bill plus 3.3 percent. 3. Subsidized loans, subject to the approval of a microcredit institution, to small enterprises and individuals in LBP. Target Beneficiaries: Individuals or small enterprises, defined as having no more than four employees, embarking on new projects in the production, services, tourism or commercial fields. Loan Specifics: i. The principal value of the loan should not exceed LBP 20 million. ii. The loan’s tenure should not exceed five years. 4. Subsidized loans in LBP for expanding existing projects or starting new projects. Target Beneficiaries: Firms not operating in the real estate or land purchasing sectors. The funds should also not be used to finance working capital, refinance existing projects or to reimburse previous loans. Loan Specifics: i. The loan’s principal value should not exceed LBP 22.5 billion. ii. The loan’s duration is not to exceed ten years. iii. The interest rate and commissions on the loan should not exceed 40 percent of the one-year Treasury bill yield plus 3.3 percent. 5. Loans in LBP to entrepreneurs. Target Beneficiaries: Entrepreneurs undertaking new projects in the fields of knowledge and education. Loan Specifics: i. The principal value of the loan is not to exceed LBP 300 million. ii. The reimbursement period of the loan should not exceed seven years. iii. All interest and commissions should not exceed 0.75 percent. 6. Educational loan in LBP. Target Beneficiaries: Higher education student pursuing academic, vocational or technical studies. Loan Specifics: i. The loan’s maximum reimbursement period is ten years. ii. Interest and commissions on the loan should not exceed 3.5 percent. In an earlier document, BdL (2011a) describes the types of loan that would benefit from an interest rate subsidy or other incentives. These loans comprise: housing loans, loans to microcredit organizations, educational loans and medium and long-term loans to selected sectors. In a separate document, BdL (2011b) specifies the support it provides to environmentally- friendly projects. More specifically, the central bank would provide incentives for organizations whose projects involve (i) green buildings, (ii) recycling, (iii) ecotourism and (iv) roofing. BdL would also provide incentives for loans falling under the National Energy and Renewable Energy Action (NEEREA). Examples of loans falling under the latter initiative include (i) energy saving and (ii) renewable energy projects. Special Focus | 31 THE WORLD BANK 3.6% 11.1% 45.9% 90 80 3.6% 70 Agriculture 60 US$ Million 50 Industry 40 Advanced Technologies 30 20 Tourism 10 0 Craft Industries 11 11 12 12 13 13 14 14 15 15 20 20 20 20 20 20 20 20 20 20 1- 2- 1- 2- 1- 2- 1- 2- 1- 2- H H H H H H H H H H 35.8% FIGURE 21. Kafalat credit guarantees by sector for the FIGURE 20. Value of credit guarantees by Kafalat. period July to December 2015. Source: Kafalat and WB staff calculations. Source: Kafalat and WB staff calculations. are governed by basic circular 8044 while facilities in the reserve requirements are governed by basic The Impact: A Preliminary circular 84. Look 48. Kafalat plays an instrumental role in providing credit guarantees on some of the 49. BdL circular 84 and intermediate subsidized loans. Kafalat, a credit guarantee circular 185 define banks’ reserve requirements institution established by the government in 2000, exemptions. According to circular 84 dated June plays a key role in facilitating MSMEs’ access to 2001, commercial banks’ LBP reserve requirements subsidized BdL lending. Figure 20 provides the are 25 percent of demand deposits and 15 percent value (in US$ millions) of credit guarantees granted of time deposits. BdL’s credit support schemes by Kafalat over the 2011-2015 period. The observed include (i) interest subsidies, (ii) deductions of decline in the value of the credit guarantees new loans from bank liabilities subject to reserve extended in 2014 and 2015 (relative to 2011 and requirements and (iii) outright reductions in banks’ 2012) is likely attributable to a volatile security reserve requirements. For the first type of supported and political environment as well as lukewarm lending schemes, an interest rate subsidy, ranging economic activity. The agricultural and industrial between 5 to 7 percent, is paid directly to the sectors have consistently been the largest recipients borrowers by the Ministry of Finance (IMF, 2015b).45 of credit guarantees (Figure 21). According to Nasr According to the IMF (2015b), the “direct reductions and Pearce (2012), the Kafalat credit guarantee in reserve requirements have a larger effect on schemes have achieved the broadest coverage in banks’ effective reserve requirement, as 60 to 100 all of MENA. Kafalat also provides innovative partial percent of qualifying loans can be deducted from equity guarantee schemes for selected start-up SMEs banks’ required reserves on customer deposits”. which exhibit an ability to create value added (Nasr The difference between the two reserve requirement and Pearce, 2012). reductions is, according to the IMF (2015b), that the deductions of new loans from bank liabilities subject to reserve requirements only have the effect of reducing the basis over which the reserve requirements is computed. Reductions in reserve requirements and deductions from liabilities apply 45 Both foreign currency and LBP loans are eligible for the 44 Other circulars relating to subsidized interest rate lending subsidy. Subsidized-interest lending started as early as 1997 include intermediary circulars 286, 195, 187, 135, 121 and 57. while deductible loans were scaled up after 2009 (IMF, 2015b). 32 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST 25 100 20 80 15 60 Percent Percent 10 40 5 20 0 0 2008Q2 2008Q4 2009Q2 2009Q4 2010Q4 2011Q4 2012Q2 2012Q4 2013Q2 2007Q4 2010Q2 2011Q2 2013Q4 2014Q2 2014Q4 2015Q2 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 -20 Liabilities & Reserves Reserves Liabilities Total Loans Liabilities Reseve Requirements FIGURE 22. Loans which benefit from a reduction in FIGURE 24. Year-on-year growth in total lending reserve requirements, liabilities subject to reserve deductible loans. requirements or both (as a % of total loans). Source: BdL Quarterly Bulletins and WB staff calculations. Source: BdL Quarterly Bulletins and WB staff calculations. 1200 80,000 70,000 1000 60,000 800 50,000 LBP Billion 40,000 600 Percent 30,000 400 20,000 10,000 200 0 0 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2012Q2 2015Q1 2015Q2 2015Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 -200 Total Loans Loans Benefitting From Deductions Liabilities Reserves FIGURE 23. Total loans and loans benefitting from reductions in reserve requirements and in liabilities FIGURE 25. New deductible loans. subject to reserve requirements. Source: BdL Quarterly Bulletins and WB staff calculations. Source: BdL Quarterly Bulletins and WB staff calculations. to both LBP and foreign currency loans. Reserve in total lending over the 2008 to 2013 period (Figure requirements exemptions also apply to all subsidized 24). However, this trend reversed in 2014 and 2015 interest loans. as reflected by the lower volumes of new deductible loans (Figure 24 and Figure 25). In contrast to the 50. Loans benefitting from reductions in pre-2011 period, the share of loans benefiting from reserve requirements and liabilities (subject to direct reductions in reserve requirements exceeded reserve requirements) exhibited a sharp increase the share of loans benefitting from deductions in after 2011. After BdL increased the deductions’ liabilities over the 2011 to 2015 period (Figure 22). ceilings in 2011, the share of loans benefitting from deductions in liabilities and reserve requirements saw 51. The share of loans benefitting from direct a marked increase. The deductible loans outstanding reductions in reserve requirements (as a percent reached a peak at the end of 2012 and the positive of total loans) was larger than the share of loans trend slowly reversed between 2012 and 2015 which benefitted from reductions in liabilities (Figure 22 and Figure 23). The year-on-year growth subject to reserve requirements. The share of in loans benefitting from reductions in reserve total loans benefitting from deductions in reserve requirements or liabilities was larger than the growth requirements averaged 15.41 percent over the Special Focus | 33 THE WORLD BANK 25 80,000 70,000 20 60,000 15 50,000 Percent 40,000 10 30,000 20,000 5 10,000 0 0 2007Q4 2008Q4 2009Q2 2009Q4 2010Q2 2011Q2 2011Q4 2012Q2 2012Q4 2013Q4 2014Q2 2014Q4 2008Q2 2010Q4 2013Q2 2015Q2 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 Total Loans Liabilities & Reserves Liabilities & Reserves Reserves Liabilites FIGURE 26. Loans which benefit from a reduction in FIGURE 27. Total loans and loans benefitting from reserve requirements, liabilities subject to reserve reductions in reserve requirements and in liabilities requirements or both (as a % of total loans). subject to reserve requirements (LBP Billion). Source: BdL Quarterly Bulletins and WB staff calculations. Source: BdL Quarterly Bulletins and WB staff calculations. period Q2-2012 to Q3-2015, compared to only March 2012 to March 2015 period (Table 6)46. In 6.3 percent for loans benefiting from deductions in contrast, loans to productive sectors, microcredit labilities. Nonetheless, the average share of loans institutions (and microcredit to corporations), benefiting from either of the two credit incentive education and environmentally-friendly projects schemes exhibited a downward trend over the (benefiting from reserve requirement deductions) same period (Figure 26). While the value of total accounted for, respectively, around only 3.5 loans benefitting from the two deductions remained percent, 0.4 percent, 1.6 percent and 0.5 percent broadly stable over the Q2-2012 to Q2-2015 period of total utilized credit over the same period. While (Figure 27), the downward trend observed in the the share of housing loans exhibited a moderate share of deductible loans is attributable to a larger increase between March 2012 and March 2015, growth rate in total lending over the same periods. the percent of credit allocated to the productive and microcredit sectors did not exceed 4 percent and 1 52. The housing sector was the largest percent, respectively. recipient of BdL loans which benefit from deductions in reserve requirements. Housing 53. The share of housing loans benefiting loans account for the largest share of utilized from deductions in banks’ liabilities is credit which benefits from deductions in reserve smaller. In June 2013, the share of housing requirements. In fact, housing loans accounted for loans benefiting from deductions in bank over 76 percent of total utilized credit benefiting from deductions in reserve requirements over the 46 This proportion is computed from Table 3.4.8 of BDL’s Quarterly Bulletin (2015Q1). The share is obtained by adding utilized credit under “Housing loans in LBP benefiting from incentives 2009”, “Loans in LBP to military volunteers”, “Loans in LBP granted by the military housing unit”, “Housing loans in LBP under the Protocol between banks and the Ministry of Displaced”, “Housing loans in LBP under the Protocol between banks and Mutual Fund of the Magistrate”, “Housing loans in LBP granted from credits to the Banque de l’Habitat upon decision 2010/26/16”, “Housing loans in LBP under the Protocol between banks and the Directorate General of the ISF”, “Housing loans in LBP under the Protocol between banks and the Directorate General of the SG”, “Housing loans in LBP granted from credits to the Banque de l’Habitat”, “Housing loans in LBP under the Protocol between banks and the Public Corporation for Housing” and “Housing loans in LBP granted from credits to the Housing Bank benefiting from incentives 2009”. 34 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST TABLE 6. Sectoral Distribution of Utilized Credit Benefiting from Deductions in Banks’ Reserve Requirements or in Banks’ Liabilities (in Percent). Deductions in Reserve Requirements Mar-12 Mar-13 Mar-14 Mar-15 Housing Sector 76.60 77.11 77.94 79.59 Productive Sectors 3.89 3.65 3.91 3.89 Microcredits and Microcredit Institutions 0.06 0.43 0.37 0.24 Educational Sector 1.34 1.54 1.72 1.87 Environmentally-Friendly Projects 0.40 0.46 0.57 0.50 Deductions in Liabilities Mar-12 Mar-13 Mar-14 Mar-15 Housing Sector 12.67 16.70 19.64 22.87 Productive Sectors 4.10 4.12 2.70 1.79 Subsidized Loans Guaranteed by Kafalat 1.96 2.31 2.17 1.96 Source: BdL Quarterly Bulletin (2015 Q1) Table 3.4.7 (for utilized credit benefiting from deductions in banks’ liabilities subject to reserve requirements) and Table 3.4.8 (for utilized credit benefiting from deductions in banks’ reserve requirements). The figures provided in the Table account for utilized credit in both LBP and/or foreign currencies. liabilities stood at around 17.6 percent47. the CAS’s 2013 real GDP).48 Banks are estimated However, the share of housing loans to total utilized to have generated, on average, around US$ 0.49 credit benefiting from deductions in banks’ liabilities million in revenues per quarter as a result of BdL’s increased significantly over the March 2012 to deductions in reserves and liabilities over the Q2- March 2015 period (Table 6) whereas the share of 2012 to Q3-2015 period. Assuming that US$ 0.49 loans to the productive sector exhibited a decrease million of revenues per quarter accrue to banks as a from an already low base of around 4 percent over result of the use of deductible loans, revenues from the same period. the use of deductible funds account for 18 percent of total banking sector revenues in 2014.49 In contrast, 54. The effective reserve requirements after subsidized-interest loans account for a negligible taking into account the reductions on required source of additional revenues for the banks. reserves which banks receive under the credit support schemes is significantly lower than 25 56. The industrial, tourism and agricultural percent. According to the IMF (2015b), the effective sectors were the largest recipients of BdL interest rate once reductions in banks’ reserve subsidized-interest rate loans over the 2008 requirements are taken into account averaged 5.4 to 2014 period (Figure 29 and Figure 30). The percent at the end of 2014. sectoral distribution of the subsidized medium- and long-term loans and the subsidized interest 55. Subsidized-interest loans account for a loans guaranteed by Kafalat demonstrates that the more modest share of total lending (Figure 28) industry, tourism and agricultural sectors were spiking in 2011 as BdL scaled up of its public the largest recipients of BdL subsidized loans. support programs. According to BdL, the cumulative Although the industrial sector accounts for a smaller subsidized-interest loans over the Q1-1997 to Q3- proportion of Lebanon’s Gross Domestic Product 2015 period amounted to 9,694.4 Billion LBP. Assuming an average subsidy of 4 percent, the 48 The last official (CAS) national accounts figure dates back to 2013. The IMF (2015b) estimates the cost of the interest interest rate subsidy’s cumulative cost (for the period rate subsidy to be 0.3 percent of GDP. It is unclear, however, Q1-1997 to Q3-2015) is 0.62 percent of GDP (using whether the IMF (2015b) refers to the cumulative cost of the subsidy. 49 According to the Association of Banks in Lebanon (2014), 47 These percentages are computed from Table 3.4.7 of BDL’s the consolidated revenues of the banking sector were LBP Quarterly Bulletin (Q1-2015). 16,317 billion. Special Focus | 35 THE WORLD BANK 1400 3 100 1300 90 1200 2.5 80 1100 70 1000 2 LBP Billion 60 Percent Percent 900 50 800 1.5 40 700 30 600 1 20 500 10 400 0.5 0 2008 2009 2010 2011 2012 2013 2014 08 09 10 11 12 13 14 1 5Q 20 20 20 20 20 20 20 01 Share of subsidized loans (total value, lhs) -2 97 Industry Tourism Agriculture 19 Share of subsidized loans (as a % of total loans, rhs) FIGURE 30. Sectoral distribution of BdL subsidized loans FIGURE 28. Subsidized-interest loans. that are guaranteed by Kafalat. Source: BdL Quarterly Bulletins and WB staff calculations. Source: BdL Quarterly Bulletins and WB staff calculations. companies. According to the World Bank (2015a), 100 the initiative makes “US$ 400 million of non- 90 80 bank financial products including the provision of 70 start-up equity available”. In addition to start-up 60 companies, beneficiaries from the package include Percent 50 40 30 business incubators/accelerators and venture capital 20 companies (BdL, 2013). Eligibility criteria exclude 10 0 offshore and financial companies and require that the beneficiary from the loan to use the funds for 08 09 10 11 12 13 14 1 5Q 20 20 20 20 20 20 20 01 projects supporting “creative intellectual skills -2 97 Industry Tourism Agriculture 19 and intellectual capital”. In tandem with efforts to FIGURE 29. Sectoral distribution of medium- and long- increase early equity finance, BdL organized two term loans subsidized by BdL. highly successful international conferences, known Source: BdL Quarterly Bulletins and WB staff calculations. as “BdL accelerate”51, on startup financing with the aim of establishing Lebanon as an international hub (GDP) than the tourism sector50, it was the largest for startup financing. The importance of the prior recipient of both medium- and long-term loans as initiatives is threefold: (i) they limit the extent of well as subsidized loans that are guaranteed by Lebanese start-ups and MSMEs’ dependence on Kafalat. In contrast, and despite their eligibility, the bank financing52; (ii) they attempt to fill a significant specialized technologies and handicraft sectors did equity financing void resulting from the absence of not receive any subsidized medium- and long-term early stage venture capital, angel financing networks loans or any subsidized loans guaranteed by Kafalat. This is likely to be attributable to a lack of demand. 51 The website for the 2015 conference is: http://2015.bdlaccelerate.com/ 57. BdL has also introduced specific vehicles 52 As noted earlier, Lebanon’s banks are at the center of financial intermediation in the country and are highly liquid and targeting SMEs and microenterprises. In an effort well-capitalized. This increases SMEs, micro enterprises and to promote a knowledge economy, BdL (2013)’s start-ups dependence on bank financing. The over-reliance of Lebanese SMEs on bank financing is evinced by the results of intermediate circular 331 encourages banks to the 2013/14 enterprise survey for Lebanon which show that invest in equity financing solutions for startup 40.2 percent of firms use banks to finance working capital and that 32.9 percent of firms investments are supplied by banks. 50 Agriculture, industry and services account for, respectively, Both of the latter numbers are higher than the world and MENA 4.5 percent, 20.1 percent and 75.4 percent of Lebanon’s averages. In addition, the 2013 WBES shows that only 2.9 GDP (World Bank, 2013b). The contribution of each sector percent of Lebanese firms’ investments are financed by equity to economic output did not (or is not expected to) exhibit sales. This is lower than the world average of 4.7 percent and fluctuations over the 2011 to 2015 period. the MENA average of 3.3 percent. 36 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST or an SME stock exchange in Lebanon and in MENA are showing potential for some success but limited (Nasr and Pearce, 2012); and (iii) they boost the track records, large collateral requirements, and supply of capital for early stage companies with the lack of an established relationship with the financial best potential to create jobs. intermediary hinder particularly start-up firms. As a result of the recent 331 Circular initiated by BdL, Lebanon currently has had a catalytic effect on venture capital; this bodes well for the future of early-stage equity investments though the sector is Conclusion and still in its infancy.” Preliminary 59. On a broader macroeconomic level, the existing evidence suggests that BdL’s stimulus Recommendations packages succeeded in closing existing economy- wide financing gaps. The propensity of commercial 58. BdL’s stimulus packages and other banks to lend the Sovereign occasionally resulted initiatives, in conjunction with the instrumental in economy-wide financing gaps. The IMF (2012)’s role played by Kafalat, have provided significant econometric analysis of the supply and demand support to the real sector, especially since 2011. for credit suggests that BdL’s early interventions BdL’s policy interventions’ positive effects are (through reserve requirement and liability threefold: (i) they entice banks to increase their deductions for commercial banks) allowed banks to MSME portfolio shares; (ii) they esbalish viable increase lending capacity in the Lebanese Pound and alternative sources of start-up and MSME financing; succeeded in closing economy-wide financing gaps and (iii) they provide avenues which allow MSMEs that manifested prior to 2000 and in the 2005-2009 to access low-cost financing. While the subsidized period. No existing studies examine the effects of the funds which directly reach SMEs do not appear to be recent rounds of subsidized lending on the overall sizeable, BdL’s (and Kafalat’s) actions and initiatives financing environment (or on SMEs’ access finance). induced commercial banks to increase the share of From a macroeconomic stability perspective, the IMF SME investments in their portfolios as evinced by (2015a) notes, however, that BdL’s stimulus packages a high reliance of SMEs on bank funding to finance do not imperil financial stability in the country53. working capital and investments. According to Nonetheless, the IMF (2014) expresses concern the World Bank (2015b), the more pronounced that the stimulus packages can weaken the central engagement by banks in SME financing is due “to bank’s balance sheet. various incentive and support programs to SME lending provided by the GOL and BdL since 2000, 60. However, little evidence exists regarding for example subsidizing interest payments of SME the effects of the BdL stimulus packages on borrowers, extending special guarantees to SMEs, economic growth or job creation. Despite the and granting exemptions on compulsory reserves of central bank Governor’s repeated reference to the creditors. It is unclear how much of this business importance of the subsidized lending programs would appeal to the commercial banks in the for the economy, no elaborate studies, besides absence of these incentive programs”. BdL’s efforts newspaper articles questioning the usefulness of in fostering viable alternatives to bank financing BdL’s subsidized lending programs in stimulating for startups and establishing Lebanon as a hub for startup financing is likely to lead to higher job growth. This latter observation is also reflected in World Bank’s (2015a): “Ongoing efforts initiated by the Central Bank and other governmental and 53 Using the deviation of credit-to-GDP ratio from its long- quasi-governmental agencies (such as Kafalat) to run trend as a measure of the “financing gap”, the IMF (2015a) promote SMEs and improve their access to finance concludes that “risks to financial stability are not currently out of line” as a result of the US$ 3.4 billion stimulus packages of BdL. Special Focus | 37 THE WORLD BANK economic growth and job creation54, of the effects 62. Costs born by BdL for such interventions of BdL’s subsidized lending programs on economic are not specified. BdL does not publish income growth or job creation exist. Such studies are statements, while its balance sheet offers limited complicated by two factors: (i) the unavailability information. As a result, the costs associated with of contemporaneous and high frequency official these subsidies, which are denominated in local GDP figures55 and (ii) the fact that the central currency and carried by the central bank, are bank’s subsidized lending programs (akin to other difficult to quantify precisely, but have possible accommodative monetary or fiscal policy measures) implications on long-term monetary policy (inflation are likely to affect the real economy with a lag. This, and exchange rate). in turn, complicates the measurement of the effect of BdL’s subsidized lending programs’ on economic 63. The enthusiastic response to BdL initiatives activity. A widely shared view suggests that, amidst (subsidized loans) has helped boost economic security and political turmoil, Lebanon’s economic activity but, after several years of such lending, growth would have been lower without BdL’s more attention will need to be paid to the issue stimulus packages. For example, the World Bank of leveraging and repayment capacity. This is (2013a)’s Lebanon Economic Monitor provides the especially relevant in an environment of prolonged following assessment of BdL’s first stimulus package: low economic growth as has been the case since “Given the current weak consumer, investor, and 2011. Toward that end, and to limit leverage risks on banker sentiment, the multiplier impact of this the consumer side and the fallout impact on banks, stimulus package is expected to be limited. The in 2014, BdL instructed banks to require a minimum primary benefit of the package will, therefore, be the down-payment of 25 percent for any car or housing lower cost of financing on US$1.46 billion. Under loan and to limit the value of the loan such that the such a scenario, BdL’s stimulus package could boost monthly installment does not exceeding 45 percent GDP growth by 0.2 to 0.3 percentage points”. of family income (35 percent for a housing loan). Hence, while monetary policy has been one of the 61. While BdL’s supported credit schemes few effective countercyclical policy tools during appear to have improved Lebanese households’ the ongoing period of sluggish growth, it will likely access to real estate finance (as well as their become a less potent economic stimulant going borrowing terms), they also encourage rent- forward. seeking behavior by banks and developers. Lebanese households’ ability to afford housing that is consistent with their demand patterns and size References preferences is estimated to have increased by around 10 percent as a result of BdL’s stimulus packages. Acemoglu, D., and Johnson, S., (2005), “Unbundling However, the supported credit schemes might have Institutions”, Journal of Political Economy 113, 949- allowed banks and real estate developers to extract 95. rent. Acemoglu. D, Johnson. S. and Robinson. J, (2001), 54 An article in the Executive magazine argues that the “The Colonial Origins of Comparative Development: stimulus packages benefit the wealthy homeowners by not the public: http://www.executive-magazine.com/business-finance/ An Empirical Investigation”, American Economic real-estate/lending-homeowners-a-hand.This sentiment is Review 91, 1369-1401. shared by another article in the Executive Magazine dubbing Lebanon’s stimulus package “futile” in spurring growth: http:// www.executive-magazine.com/economics-policy/central-bank- Acemoglu, D., Johnson, S. and Robinson, J., (2002), injection-economy-lebanon. An article in the newspaper Al- “Reversal of fortune: geography and institutions in the Akhbar also expresses strong skepticism regarding the stimulus packages’ success in generating growth and employment: http:// making of the modern world income distribution”, english.al-akhbar.com/node/14504. Quarterly Journal of Economics 117, 1231–1294. 55 As of September 2016, Lebanon’s national accounts data only cover the 2004-2013 period. The frequency of the existing Ali Abbas, S. M. and Christensen, J. E., (2007), national accounts data is annual. 38 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST “The Role of Domestic Debt Markets in Economic Beck, T., Demirguc-Kunt, A., (2004), “SMEs, Growth Growth: An Empirical Investigation for Low-Income and Poverty: Do Pro-SME Policies Work?”, View Countries and Emerging Markets”, IMF Working Point, Private Sector Development Vice Presidency, Paper WP/07/127, Washington DC. World Bank, Washington DC. Association of Banks of Lebanon, (2014), “The Beck, T., Demirguc-Kunt, A. and Levine, R., (2005), Lebanese Banking Sector in 2014”, Beirut, Lebanon “SMEs, Growth and Poverty: Cross- Country Evidence”, Journal of Economic Growth 10, 199- Ayyagari, M., Beck, T. and Demirguc-Kunt, A., 229. (2007), “Small and Medium Size Enterprises across the Globe”, Small Business Economics 29, 415-434. Beck, T., Demirguc-Kunt, A. and Martinez Peria, M., (2008), “Bank Financing for SMEs around the World: Ayyagari, M., Beck, T. and Demirguc-Kunt, A., Drivers, Obstacles, Business Models and Lending (2008), “How Important are Financing Constraints? Practices”, World Bank Policy Research Working The Role of Finance in the Business Environment, Paper 4785, Washington DC. World Bank Economic Review 22, 483-516. Bekaert, G., Harvey, C.R. and Lundblad, C., Ayyagari, M., Demirguc-Kunt, A. and Maksimovic, (2001), “Emerging equity markets and economic V., (2011), “Small vs. Young Firms across the development”, Journal of Development Economics World: Contribution to Employment Job Creation” 66, 465–504. World Bank Policy Research Working Paper 5631, Washington DC. Bekaert, G., Harvey, C. R. and Lundblad, C., (2005), “Does Financial Liberalization Spur Growth?”, Ayyagari, M., Demirguc-Kunt, A. and Maksimovic, Journal of Financial Economics 77, 3-55. V., (2012), “Financing Firms in Developing Countries: Lessons from Research”, World Bank Berthélemy, J. C., Dessus, S. and Nahas, C., (2007), Policy Research Working Paper 6036, Washington “Exploring Lebanon’s Growth Prospects”, World DC. Bank Policy Research Paper 4332, The World Bank, Washington DC. Ayyagari, M., Demirguc-Kunt, A. and Maksimovic, V. (2014), “Who Creates Jobs in Developing Cadoux, A. and Geffroy, J., (2015), “Financing Countries?”, Small Business Economics 43, 75-99. Solutions to Sustain the Growth of SMEs and MTEs and Lay the Foundation for Future Competitiveness”, Bank Audi, (2015), “Lebanon’s Real Estate Sector: Banque de France, Financial Stability Review A Weakening Demand in a Buyer’s Market”, Real (Financing the Economy: New Avenues for Growth) Estate Sector Research, Beirut, Lebanon. 19, 37- 49. Banque du Liban, (2011a), “Incentives…for your Claessens, S., and Tzioumis, K., (2006), “Measuring projects” [In Arabic], Beirut, Lebanon. firms’ access to finance”, Paper prepared for Conference: Access to Finance: Building Inclusive Banque du Liban, (2011b), “Incentives…for your Financial Systems, organized by the Brookings environment” [In Arabic], Beirut, Lebanon. Institution and the World Bank in Washington, D.C., May 30-31, 2006. Banque du Liban (2013), “Banking outside the Box: Equity Finance”, BdL Intermediate Circular Dated De Bolle, M., (2015), “Do Public Development August22, 2013, Beirut, Lebanon Banque du Liban, Banks Hurt Growth? Evidence from Brazil”, Policy (2015), “Banque du Liban Stimulus Package”, Beirut, Brief Number PB15-16, Petersen Institute for Lebanon. International Economics, 1-15, Washington DC. Special Focus | 39 THE WORLD BANK Demirguc-Kunt, A. and Levine, R., (2001), “Bank- King, R.G. and Levine, R., (1993a), “Finance, based and market-based financial systems: a cross- entrepreneurship, and growth”, Journal of Monetary country comparison”, In: Demirguc-Kunt, A. and Economics 32, 513–542. Levine, R. (Eds.), Financial Structure and Economic Growth: Cross-Country Comparisons of Banks, King, R.G. and Levine, R., (1993b), “Finance and Markets and Development. MIT Press, Cambridge, Growth: Schumpeter Might Be Right.”, Quarterly Massachusetts. Journal of Economics 153, 717-738. . Glaeser. E, La Porta. R, Lopez-De-Silanes. F., and Laporta R., Lopez-de-Silanes, F., Shleifer, A. and Shleifer, A, (2004). “Do institutions cause growth?” Vishny, R., (1998), “Law and Finance”, Journal of Journal of Economic Growth 9, 271-303. Political Economy 106, 1113-1155. Hamdan, K., (2003), “Micro and Small Enterprises Laporta R., Lopez-de-Silanes, F., Shleifer, A. and in Lebanon”, Economic Research Forum Research Vishny, R., (1999), “The Quality of Government ”, Report No. 0417, Cairo, Egypt. Journal of Law, Economics and Organization 15, 222-279. International Finance Corporation, (2008), “Lebanon: A Diagnostic Study of the Demand for Mackinzie, G. A. and Stella, P., (1996), “Quasi- Financial Services by Micro and Small Enterprises”, Fiscal Operations of Public Financial Institutions”, Final Report, July 2008, The World Bank Group, International Monetary Fund, Washington DC. Washington DC. Organization for Economic Co-operation and International Finance Corporation (2014), “IFC and Development (OECD) (2013), “Financing SMEs and Fransabank Supporting Job Creation in Lebanon” Entrepreneurs 2013: an OECD Scoreboard”, OECD Case Study. February, The World Bank, Washington Publishing, Paris. DC. Organization for Economic Co-operation and International Monetary Fund, (2012), “Lebanon: Development (OECD) (2015), “Financing SMEs Selected Issues”, IMF Country Report No. 12/40, and Entrepreuneurs 2015: An OECD Scoreboard”, Washington DC. OECD Publishing, Paris. International Monetary Fund, (2014), “Lebanon: Rajan, R. and Zingales, L., (1998), “Financial 2014 Article IV Consultation”, IMF Country Report Dependence and Growth”, American Economic No. 14/237, Washington DC. Review 88, 559-586. International Monetary Fund, (2015a), “Lebanon: Markiewicz, M., (2001), “Quasi-Fiscal Operations 2015 Article IV Consultation”, IMF Country Report of Central Banks in Transition Economies”, Bank No. 15/190, Washington DC. of Finland, Institute for Economies in Transition, Helsinki, Finland. International Monetary Fund, (2015b), “Background Notes for the 2015 Article IV Consultation”, Matta, S., (2014), “New Coincident and Leading Washington DC. Indicators for the Lebanese Economy” , Policy Research Working Paper WPS6950, World Bank, Jamali, I. and Le Borgne, E., (2014), “A Washington DC. Lebanon Sovereign Wealth Fund: Preliminary Recommendations,” Assadissa: A Journal of Public Ministry of Economic and Trade, (2014), “Lebanon Finance & State Modernization 5, 68-88. SME Strategy: A Roadmap to 2020”, Ministry of Economy and Trade, Beirut, Lebanon. 40 | Special Focus LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST Munoz, S., (2007), “Central Bank Quasi-fiscal Diagnostic, The World Bank, Washington DC. Losses and High Inflation in Zimbabwe: A Note”, IMF Working Paper WP/07/98, African Department, World Bank, (2015b), “Lebanon Economic Monitor: International Monetary Fund, Washington DC. The Great Capture”, Fall 2015, The World Bank, Washington DC. Nasr, S., and Pearce, D., (2012), “SMEs for Job Creation in the Arab World: SME Access to Financial World Bank and Union of Arab Banks, (2010), “The Services”, The World Bank, Washington, DC. Status of Bank Lending to SMEs in the Middle East and North Africa Region: The Results of a Joint Wennekers, S., Van Stel, A., Thurik, A. R., Reynolds, Survey of the Union of Arab Banks and The World P., (2005), “Nascent Entrepreneurship and the Bank,” Financial Flagship. World Wide Fund. Level of Economic Development”, Small Business Economics 24, 293-309. Van Stel, A., Storey, D. J., and Thurik, A. R., (2007), “The Effects of Business Regulations on Nascent and Young Business Entrepreneurship”, Small Business Economics 28, 171-186. World Bank, (2008), “Finance for All? Policies and Pitfalls in Expanding Access”, World Bank Policy Research Report, The World Bank, Washington DC. World Bank, (2013a), “Lebanon Economic Monitor: Growing Tensions in a Resilient Economy”, Spring 2013, The World Bank, Washington DC. World Bank, (2013b), “Lebanon Economic Monitor: The Brunt of the Syrian Conflict”, Fall 2013, The World Bank, Washington DC. World Bank, (2013c), “Lebanon - Economic and social impact assessment of the Syrian conflict,” Report No. 81098-LB, September, The World Bank, Washington DC. World Bank, (2014a), “Jobs or Privileges—Unleashing the Employment Potential of the Middle East and North Africa,” Macro and Fiscal Management Global Practice, Middle East and North Africa Region, the World Bank, Washington DC. World Bank, (2014b), “Lebanon Economic Monitor: A Sluggish Economy in a Highly Volatile Environment”, Spring 2014, The World Bank, Washington DC World Bank, (2015a), “Lebanon: Promoting Poverty Reduction and Shared Prosperity”, Strategic Country Special Focus | 41 THE WORLD BANK DATA APPENDIX TABLE 7. Lebanon: Selected Economic Indicators, 2013-2018. 2013 2014 2015 2016 2017 2018 Est. Est. Est. Proj. (annual percentage change, unless otherwise specified) Real sector Real GDP 0.9 1.8 1.3 1.8 2.2 2.3 Real GDP per Capita/1 -6.0 -4.1 -2.8 -0.6 1.4 2.6 Agriculture (share of GDP) 4.4 4.5 4.5 4.7 4.7 4.6 Industry (share of GDP) 14.2 15.5 15.4 14.0 14.3 14.3 Services (share of GDP) 81.4 80.0 80.1 81.3 81.0 81.1 Money and prices CPI Inflation (p.a) 2.7 1.2 -3.7 -1.5 2.0 3.0 Money (M3, including non-resident deposits) 9.0 6.0 5.1 3.0 4.5 6.0 (percent of GDP, unless otherwise specified) Investment & saving Gross Capital Formation 30.4 31.2 27.6 30.4 31.0 31.3 o/w private 28.5 29.6 26.1 28.8 29.5 29.8 Gross National Savings 4.5 5.4 10.3 11.3 11.3 11.8 o/w private 16.4 16.5 22.1 17.6 18.4 19.3 Central Government Finance Revenue (including grants) 21.2 23.8 20.3 20.9 21.6 21.6 o/w. tax revenues 15.1 15.1 14.6 15.2 15.7 15.7 Total expenditure and net lending 30.7 30.4 28.5 28.8 30.1 30.6 Current 28.8 28.8 27.1 27.3 28.6 29.1 o/w Interest Payment 8.5 9.2 9.5 9.7 10.0 10.5 Capital & Net Lending (excl. foreign financed) 1.9 1.6 1.5 1.5 1.5 1.5 Overall balance (deficit (-)) -9.5 -6.6 -8.2 -7.9 -8.6 -9.0 Primary Balance (deficit (-)) -0.9 2.6 1.3 1.8 1.4 1.5 External sector Current Account Balance -26.0 -25.7 -17.2 -19.1 -19.7 -19.5 Trade Balance -28.3 -29.4 -23.2 -26.3 -26.8 -26.4 o/w Export (GNFS) 47.1 42.1 41.9 41.1 42.4 42.7 Exports of Goods 11.7 10.0 8.5 7.4 8.3 8.4 Exports of Services 35.4 32.2 33.4 33.7 34.1 34.3 o/w Import (GNFS) 75.4 71.5 65.1 67.5 69.2 69.1 Imports of Goods 46.2 42.8 36.3 38.7 39.2 39.1 Imports of Goods 29.2 28.7 28.8 28.8 30.0 30.1 Net Private Current transfers 3.1 5.0 7.2 6.3 5.9 5.4 Remittances 4.7 5.9 7.6 6.8 6.4 5.8 Net Income reciepts -0.7 -1.3 -1.2 0.9 1.2 1.5 Gross Reserves (months of imports GNFS) /2 /3 11.4 11.9 12.0 11.2 11.2 11.3 Total Public Debt Total Debt Stock (in million US$) 63,490 66,564 70,322 74,249 78,582 83,327 Debt-to-GDP ratio (percent) 143.1 145.6 149.4 148.7 155.5 158.4 Memorandum Items: Nominal GDP (in billion LBP) 66,861 68,939 70,980 75,256 76,172 79,318 GDP (in million US$) 44,352 45,731 47,085 49,921 50,528 52,616 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 42 | Data Appendix LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST SELECTED SPECIAL FOCUS FROM RECENT LEBANON ECONOMIC MONITORS 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 Lebanon (Special Focus 1): Lebanon’s industrial startups generate also helps make the tech sector sector in Lebanon has lagged, both on a regional and more dynamic and sustainable. Lebanon’s tech global comparative basis. Lebanon’s macroeconomic scene is becoming increasingly attractive driven by structure, being heavily dependent on tourism and the example of successful startups that have tapped real estate at the expense of industry and agriculture, regional and global markets and the innovative renders the economy vulnerable to political and initiative by the country’s central bank in facilitating economic shocks. In this context, Lebanon needs venture capital financing. The nation now needs to to focus on its industrial potential and provide leverage these developments by finding solutions solutions to the numerous constraints hindering to constraints hindering the blossoming of its tech its industrial establishments from functioning at startup ecosystem. their full capacity. One possibility to strengthen the industrial sector is via spatial industrial policies, most notably, industrial parks and special economic zones (SEZs), which support increased investment and competitiveness in the industrial sector. FALL 2015 LEM: THE Special care should be allotted to fiscal incentives which evidence suggest are ineffective and might GREAT CAPTURE instead lead distortions such as the relocation of existing businesses to the zones rather than the Elite Capture and the Hollowing of the State: an establishment of new business. Under suitable Overarching Constraint to Lebanon’s Development conditions, industrial zones have proven successful (Special Focus 1): Lebanon’s post-war governance in various locations and industries across the world endures systemic failures. Institutionalized which make them an attractive tool in Lebanon. confessionalism intended as protection for the mosaic of communities in a country that lacks a Tech Startup Ecosystem: The Case of Lebanon demographic majority has developed into pervasive (Special Focus 2): A new wave of entrepreneurship elite capture and patronage system. This elite driven by small digital businesses is sweeping both commands the main economic resources, generating developed and emerging economies. Information large rents and dividing the spoils of a dysfunctional and Communications Technology (ICT) has state. In the process, the public sector has become dramatically reduced the cost of innovation and increasingly governed by bribery and nepotism market access, allowing small tech entrepreneurs practices, failing to deliver basic public services and to compete with established businesses. Today, a incapable of resolving the most urgent needs. This Selected Special Focus from Recent Lebanon Economic Monitors | 43 THE WORLD BANK has culminated in the comprehensive breakdown in the political process, with the three branches of SPRING 2015 LEM: THE government either vacant or effectively idle, and the only national plebiscite abrogated. This has triggered ECONOMY OF NEW a series of protests and civil disobedience measures targeting the ruling political class with emphasis on DRIVERS AND OLD corruption and incompetence. Current conditions are unsustainable, and without significant political DRAGS and economic reforms, a widening and worsening of socio-economic unrest is not unfathomable. The Trade Impact of the Syrian conflict on Lebanon (Special Focus 1): We explore the trade effect of the Lebanon’s Health Sector: Modest Reforms despite Syrian war on Lebanon up until the second half of the Challenges (Special Focus 2): This special focus 2014. A dissection of the data reveals that, so far, the provides an overview of the health sector in Lebanon war seems to have affected neither merchandise nor and highlights both successes and challenges facing services exports at the aggregate level. At the same the system. Lebanon’s trends in health outcomes, time the relative stability of merchandise imports is inputs and spending are analyzed over time and likely a result of increased demand due to refugee compared to a number of countries with similar inflow being offset by higher transit costs through levels of income and health spending, as well as to Syria as well as depressed Syrian production. A the averages for the Middle East and North Africa gravity-type trade model confirms these findings, (MENA) region. Global comparisons are presented for suggesting also that Lebanese trade seems to have each of these measures based on the latest available been less negatively affected by the Syrian war than year of data (generally 2011). Key challenges are other Syria’s neighbors. An empirical analysis using highlighted; (i) low public spending on health which micro level exporter data substantiates this finding. hinders the Ministry of Public Health’s (MoPH) While Lebanese exporters to Syria have suffered from ability to adequately respond to the health needs a drop in demand in the Syrian market (but less so of low income groups; (ii) high household out-of- than their Jordanian counterparts), other Lebanese pocket spending on health subjecting low income exporters have started to export to Syria to fill the gap groups to financial hardship; (iii) disproportionate in Syrian production. Further econometric analysis allocation of resources on expensive curative care; suggests that Syrian refugees in Lebanon provide and (iv) emerging epidemiologic and population important impetus to Lebanese services exports. trends associated with unprecedented influx of refugees having significant implications on the Challenges in the Lebanese energy sector (Special delivery and financing of the health sector. Despite Focus 2): The Lebanese electricity sector has the challenges and prolonged periods of instability, been underperforming and in crisis for several the MoPH embarked on several successful reforms decades, requiring urgent action to avoid further that contributed to the resilience of the system in the deterioration of the quality of electricity delivery. The face of the crisis. 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. 44 | Selected Special Focus from Recent Lebanon Economic Monitors LEBANON ECONOMIC MONITOR | THE BIG SWAP: DOLLARS FOR TRUST 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- agency coordination and weak central government oversight. Moving forward, the Government must urgently address priorities within the sector. Selected Special Focus from Recent Lebanon Economic Monitors | 45 THE WORLD BANK SELECTED RECENT WORLD BANK PUBLICATIONS ON LEBANON (for an exhaustive list, please go to: http://go.worldbank.org/8700A29QW0http://go.worldbank.org/5N4AMNJXV0) 46 | Selected Recent World Bank Publications on Lebanon 0.9375 cm The World Bank www.worldbank.org/lb