Lebanon · minister, Rafiq al-Hariri, has strengthened prospects for an improvement in the...

COUNTRY REPORT

Lebanon

April 2001

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

f At a glance: 2001-02OVERVIEWThe decision of the president, Emile Lahoud, and the parliamentary speaker,Nabih Birri, to endorse the economic reform programme of the primeminister, Rafiq al-Hariri, has strengthened prospects for an improvement inthe political process. Agreement between the leaders is likely to come undergreat strain, however, when the prime minister begins to implement pro-posed job cuts. Mounting debate over Syria’s role in Lebanon will also chal-lenge domestic order. Growth is expected to resume this year, after two yearsof recession, but chronic and escalating budget deficits will pose a growingthreat to economic stability, particularly if the economic reform programmeslows. Mounting import spending will drive the current-account deficitupwards, leaving Lebanon dependent on further strong capital and in-visibles inflows to hold its balance of payments in check.

Key changes from last monthPolitical outlook• Agreement between the prime minister, president and parliamentary

speaker on the direction of economic reform has improved prospects foreffective co-operation among the elite.

Economic policy outlook• There has been a shift of emphasis in the prime minister’s economic

strategy towards implementing public-sector cost-cutting measures, in abid to slow the pace at which the fiscal deficit is growing.

Economic forecast• Full-year data have prompted a downward revision to the EIU’s estimate

for GDP growth in 2000 to –0.5%, representing a second consecutive yearof recession. Official figures claim that inflation fell by 2.2% in 2000.

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Lebanon 1

EIU Country Report April 2001 © The Economist Intelligence Unit Limited 2001

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2000-017 Political outlook8 Economic policy outlook9 Economic forecast

13 The political scene

18 Economic policy

26 The domestic economy26 Economic trends

29 Foreign trade and payments

List of tables

10 International assumptions summary11 Forecast summary21 Currency indicators22 Treasury-bill holdings27 Real economic indicators30 External accounts

List of figures

6 External trade6 Interest rate

12 Gross domestic product12 Lebanese pound exchange rate28 Passenger numbers at Beirut International Airport

Lebanon 3


Summary

April 2001

The decision of the president, Emile Lahoud, and the parliamentary speaker,Nabih Birri, to endorse the economic reform programme of the prime minister,Rafiq al-Hariri, has strengthened prospects for an improvement in the politicalprocess. Agreement between the leaders is likely to come under great strain,however, when the prime minister begins to implement planned job cuts.Mounting debate over Syria’s role in Lebanon will also challenge domesticorder. Growth is expected to resume this year after two years of recession, butchronic and escalating budget deficits will pose a growing threat to economicstability, particularly if the economic reform programme slows. Mounting im-port spending will drive the current-account deficit upwards, leaving Lebanondependent on further strong capital and invisibles inflows to hold its balanceof payments in check.

The situation on Lebanon’s border with Israel has remained tense following theelection of the hardliner Ariel Sharon as Israel’s new prime minister and afurther Hizbullah attack against Israeli forces. Christian-led anti-Syrian protestshave continued, and the government has struggled to find an adequate res-ponse to demands for the withdrawal of Syrian forces from Lebanon.

Lebanon recorded the world’s second highest fiscal deficit as a percentage ofGDP in 2000, placing the Lebanese pound under mounting pressure andprompting commercial banks to reduce their holdings of domestic-currencydebt. In response, Mr Hariri has negotiated political support for a range of cost-cutting measures designed to slow the growth of the budget deficit, althoughthese have yet to be included in the 2001 budget. The government has alsooverseen the closure of a loss-making state television company and draftednew privatisation legislation.

Full-year data suggest that the economy remained in recession in 2000, butthere have been early signs of a recovery in 2001 and the tourism sector hascontinued to perform well. Prices are reported to have fallen last year by 2.2%.

Imports and exports showed little growth in 2000, but the trade deficit hasbegun to widen following the introduction of tariff cuts. Net service and cap-ital flows fell sharply in the fourth quarter of 2000, pushing the balance ofpayments into deficit.

Editors: Simon Williams (editor); Merli Baroudi (consulting editor)Editorial closing date: April 2nd 2001

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2001-02

The political scene

Economic policy

The domestic economy

Foreign trade andpayments

4 Lebanon


Political structure

Republic of Lebanon

Parliamentary republic

Based on the 1926 constitution (with amendments incorporated in 1990) and theCivil Procedure Code, the Criminal Procedure Code and the Penal Code

Under the electoral law of July 16th 1992, the unicameral National Assembly has128 seats equally divided between Muslims and Christians

Universal direct suffrage over the age of 21

August-September 2000 (legislative); next elections due by 2003 (presidential) and 2004(legislative)

The president, currently Emile Lahoud, who was elected in November 1998 for a six-yearterm by the National Assembly. Under an unwritten agreement, the president must be aMaronite Christian

The prime minister is chosen by the president after consultation with parliamentarydeputies; the government is then chosen by the designated prime minister and thepresident. Ministers need not be members of the National Assembly, but are responsibleto it. The prime minister must be a Sunni Muslim. The current government wasappointed in November 2000

Hizbullah (Shia), Amal (Shia), National Liberal Party (Christian), National Bloc(Christian), Kataeb Party (largest Christian party), Progressive Socialist Party (mainlyDruze), Syria Social Nationalist Party

Prime minister Rafiq al-Hariri (Sunni)

Deputy prime minister Issam Fares (Greek Orthodox)

Agriculture Ali Abdallah (Shia)Defence Khalil Hrawi (Maronite)Economy & trade Bassil Fleihan (Protestant)Education Abdel-Rahim Mrad (Sunni)Electricity & water resources Mohammed Abdel-Hamid

Beydoun (Shia)Environment Michel Musa (Greek Catholic)Finance Fouad Siniora (Sunni)Foreign affairs Mahmoud Hammoud (Shia)Health Suleiman Franjiyeh (Maronite)Industry Georges Frem (Maronite)Information Ghazi Arida (Druze)Interior & municipal affairs Elias Murr (Greek Orthodox)Internal refugees Marwan Hamadeh (Druze)Justice Samir Jisr (Sunni)Labour Ali Kanso (Shia)Telecommunications & post Jean-Louise Cordahi (Maronite)Transport & public works Najib Miqati (Sunni)

Nabih Birri (Shia)

Riyadh Salameh (Maronite)

Official name

Form of state

Legal system

National legislature

Electoral system

National elections

Head of state

National government

Main political organisations

Parliamentary speaker

Central bank governor

Key ministers

Lebanon 5


Economic structure

Annual indicators

1996 1997 1998a 1999a 2000a

GDP at market prices (L£ bn) 20,417.0 23,034.0 25,337.4 25,066.7 24,678.2

GDP (US$ bn) 13.0 15.0 16.7 16.6 16.4

Real GDP growth (%) 4.0 4.0 2.0 –1.0 –0.5

Consumer price inflation (av; %) 8.9 5.2a 3.8 0.5 –1.0

Population (m) 3.1 3.1a 3.2 3.3 3.4

Exports of goods fob (US$ m) 736 634 716b 677b 705b

Imports of goods fob (US$ m) 6,992 7,479 7,081b 6,217b 6,235b

Current-account balance (US$ m) –3,687a –3,813a –3,321 –2,276 –2,147

Foreign-exchange reserves excl gold (US$ m) 5,932 5,976 6,556b 7,776b 5,944b

Total external debt (US$ bn) 4.0 5.0 6.7b 8.4b 9.2

Debt-service ratio, paid (%) 6.4 14.1 9.0b 18.2 25.5

Exchange rate (av) L£:US$ 1,571.4 1,539.5 1,516.1b 1,507.8b 1,507.5b

April 2nd 2001 L£1,508:US$1

Origins of gross domestic product 1997 % of total Components of gross domestic product 1997 % of total

Services 68.8 Private consumption 101.0

Industry 29.8 Government consumption 15.7

Manufacturing 19.5 Fixed investment 26.7

Agriculture 14.0 Exports of goods & services 10.4

GDP at factor cost 100.0c Imports of goods & services –53.8

GDP at market prices 100.0

Principal exports fob 1999 % of total Principal imports cif 1999 % of total

Food products 20.2 Food products 19.8

Jewellery 14.2 Electrical products 14.7

Chemical products 12.6 Vehicles 9.9

Metal products 11.7 Minerals & other mineral products 9.8

Electrical products 10.8 Chemical products 9.3

Textiles 8.1 Jewellery 7.4

Main destinations of exports 1999 % of total Main origin of imports 1999 % of total

Saudi Arabia 11.0 Italy 12.9

UAE 9.0 France 10.5

France 6.3 Germany 7.4

US 6.3 US 6.5

a EIU estimates. b Actual. c Total does not sum in source.

6 Lebanon


Quarterly indicators1999 20001 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

OutputCoincident indicator (Jan 1993=100) 179.1 184.7 183.4 193.0 181.9 187.3 197.1 197.2

Financial indicatorsExchange rate L£:US$ (av) 1,508 1,508 1,508 1,508 1,508 1,508 1,508 1,508 L£:US$ (end-period) 1,508 1,508 1,508 1,508 1,508 1,508 1,508 1,508Interest rates (%) Deposit (av) 12.91 12.58 12.55 11.95 11.53 11.17 11.12 11.03 Discount (end-period) 30.0 30.0 25.0 25.0 20.0 20.0 20.0 20.0 Lending (av) 19.84 19.65 19.63 18.78 18.40 18.22 18.03 17.95 Treasury bill (av) 11.73 11.73 11.63 11.18 11.18 11.18 11.18 11.18M1 (end-period; L£ bn) 1,998 1,962 2,075 2,261 2,227 2,257 2,284 2,389 % change, year on year 13.3 3.7 6.2 10.2 11.5 15.0 10.1 5.7M2 (end-period; L£ bn) 40,845 41,642 43,124 44,825 45,936 47,009 47,983 49,235 % change, year on year 16.1 12.4 11.8 11.7 12.5 12.9 11.3 9.8BDL stockmarket index (end-period; Jan 1996=100) 49.5 55.9 41.4 56.1 42.3 44.5 42.5 37.4 % change, year on year –56.1 –49.6 –52.2 –37.2 –14.5 –20.4 2.7 –33.3

Sectoral trendsConstruction permits (end-period; ‘000 sq metres) 656.4 861.8 764.4 911.3 651.6 662.1 643.8 574.5

Foreign trade & reserves (US$ m)Exports fob 135 154 179 209 164 174 185 183Imports cif –1,542 –1,493 –1,618 –1,554 –1,430 –1,533 –1,638 –1,624Trade balance –1,407 –1,339 –1,439 –1,345 –1,266 –1,360 –1,453 –1,441Reserves excl gold (end-period) 6,673 6,458 6,915 7,776 7,435 6,872 6,580 5,944

Sources: IMF, International Financial Statistics; Banque du Liban, Monthly Financial Market Data.

Lebanon 7


Outlook for 2001-02

Political outlook

Lebanon’s outlook rests heavily on the ability of the prime minister, Rafiq al-Hariri, to sustain support among the political elite for the radical economic reformprogramme he has begun to implement. For much of its two years in office theprevious government led by Salim al-Hoss found itself unable to act, con-strained by its weak domestic standing, the growing power of unelected securityofficials working for the president, Emile Lahoud, and an increasingly hostileparliament. At present, the prospects for an improvement in the politicalprocess are positive. Mr Hariri, who came to power in October 2000, is a forcefulleader and an experienced political operator. His popular standing has remainedstrong since his success in the 2000 election, and he has used this—and theincreasingly apparent need for reform—to negotiate crucial support for hiseconomic agenda from Mr Lahoud and the parliamentary speaker, Nabih Birri(the other two members of Lebanon’s governing troika). With other seniorfigures also offering their backing, and Syria apparently supporting the primeminister as well, Mr Hariri would appear to have a firm political base fromwhich to act.

As the prime minister begins to put his reform programme into effect, how-ever, the consensus he has begun to build will be placed under growing strain.Mr Birri, for example, may be willing to agree in principle to cuts in public-sector employment, but when these start to have a direct impact on his Shiaconstituency, his support is likely to wane. His commitment will weakenparticularly quickly if, as seems likely, Mr Hariri proves unable to deliver all ofthe development he has promised for the south, where the Shia are con-centrated, or to enact political reforms that would benefit Mr Birri’s supporters.Mr Lahoud’s backing has also yet to be tested. Although he appears willing toallow Mr Hariri ostensible control of economic policy, he will resist measureswhich impede on areas that he regards as his own political territory. As theseinclude the position of the army—one of the largest draws on the publicfinances—there will be considerable scope for clashes, especially as personaland political relations between the president and prime minister have longbeen poor. If the troika prove unable to set aside their own political interests topursue what they have publicly recognised as the national good—reform of thestate finances—then the compromises needed to maintain a consensus willseverely limit the impact of the reform programme. Alternatively, if Mr Haririproves unwilling to compromise his economic agenda, a return to the de-bilitating power struggles of the late 1990s could ensue, potentially cul-minating in Mr Hariri’s resignation. As the prime minister is the only figurewho has shown the drive to address Lebanon’s economic problems, such adevelopment would be a severe setback.

The other issue which threatens to test domestic stability is the increasinglyvigorous debate over Syria’s role in the country. There has long been op-position to Syria’s 25-year military presence in Lebanon, but until the end ofIsrael’s occupation of southern Lebanon, and the death of Syria’s widely feared

Domestic politics

8 Lebanon


president, Hafez al-Assad, in May 2000, debate had been restricted to themargins. Discussion has since come out into the open, with Lebanon’sChristian Maronite community leading a public—and increasingly vocal—campaign demanding the withdrawal of Syrian troops. Keen not to jeopardisethe vital relationship with Damascus, the government has so far backed thecontinued “temporary” presence of Syrian forces. If the anti-Syrian campaigngains momentum and unifies the Christian community, however, the govern-ment response risks exacerbating sectarian tensions, reviving memories of the15-year civil war that the Christians “lost” to Syrian-backed forces. Moredangerously still, if the campaign gains substantial support outside theChristian community, it will become increasingly difficult for the governmentto ignore its demands. As the government owes its position in large part toSyrian support and could not risk direct confrontation with Damascus by call-ing on Syrian troops to leave, their continued presence would erode the gov-ernment’s nationalist credentials and steadily undermine its popular support.

The dominant foreign policy issue over the forecast period will remain rel-ations with Israel and security on the two countries’ shared border. The end ofIsrael’s 22-year occupation of the south has so far resulted in a period of calmin the border region. However, the peace is fragile, undermined by Hizbullah’scontinued control of the border area and its periodic guerrilla strikes againstdisputed territory on the Israeli side of the UN-demarcated blue line. Tensionshave also been exacerbated by Hizbullah’s political support for the newPalestinian intifada (uprising) and the election in February of hardliner ArielSharon—the man who led Israel’s bloody invasion of Lebanon in 1982—asIsrael’s new premier. With Mr Sharon elected to allay Israel’s security fears, thecontinuation of the Hizbullah campaign seems likely to prompt substantialIsraeli retaliation at some stage, particularly if the situation in the West Bankand Gaza begins to calm. This would not lead to an attempt to reoccupy thesouth, but could readily result in airstrikes against military targets andpunitive raids against civilian infrastructure. The situation could escalaterapidly if Hizbullah retaliated by attacking targets outside of the disputedborder territories.

Economic policy outlook

Economic policy will continue to be the focus of Mr Hariri’s energies, as heseeks to move Lebanon out of recession and find a means to bring theescalating fiscal deficit under control. In his first months in office the newprime minister stressed the growth element of his programme, targeting rapideconomic expansion as a means to boost medium-term fiscal revenue. Overrecent weeks, however, his emphasis has switched towards implementing cost-cutting measures that will slow the pace at which the fiscal deficit is growing.The shift is timely, and appears to reflect a growing recognition that unless thedeficit is brought under control, the resulting imbalances will threaten thestability of the whole economy, and prevent the return of local and inter-national confidence.

Policy trends

International relations

Lebanon 9


However, the government will find it extremely difficult to make significantinroads into the deficit. Over 2000 the deficit rose by more than 60% toL£5.9trn (US$3.9bn), the equivalent of almost 24% of estimated GDP, pushingthe net public debt stock to more than 140% of GDP. The draft budget for 2001targets a lower deficit of L£5.1trn (51% of expenditure), but even this seemsoverly optimistic. Revenue is unlikely to rise by the 7.6% on last year’s outturnenvisioned in the budget, given the impact tariff cuts introduced in Novemberhave already had on customs earnings. The modest economic growth the EIUprojects this year is also unlikely to boost tax revenue substantially. Meanwhile,the 4% fall in expenditure reportedly targeted in the budget appears un-realistic. Even based on a conservative projection of growth in the public debtstock, we expect service payments to rise by over 10%, pushing totalexpenditure well beyond the government’s target. Overall, we project a deficitof L£6.1trn, the equivalent of almost 25% of GDP and 58% of expenditure.

The sustainability of an escalating deficit of this magnitude is increasinglyunder question, with initial signs already emerging that the commercialbanks—which have bought the bulk of public-sector debt—are beginning tolose confidence. If this trend is to be reversed, the government will have toimplement the fiscal reform measures it has begun to outline in recent weeks.These include wide-ranging cuts to the public sector and undertaking to pri-vatise a number of state-owned firms. Previous governments have outlinedsimilar measures, but have lacked the political strength to follow themthrough. Mr Hariri has already begun to act, however, closing a loss-makingtelevision service and sacking more than 500 workers. He has also negotiatedpolitical support for further cuts, and drafted privatisation legislation. Divest-ments would reduce the draw of loss-making public utilities on the publicpurse, and more importantly, would generate substantial capital inflows, whichthe prime minister has said would be used to pay down the debt stock, therebylowering servicing costs.

However, even if Mr Hariri manages to sustain sufficient support to implementthe cuts, their initial impact will be offset by the cost of high severancepayments. Given the extensive restructuring many state enterprises require, theprime minister’s hopes of generating revenue from privatisation this year alsoappear optimistic. Nevertheless, such steps would at least mark a change in thepolitical culture surrounding the bloated public sector and would begin topersuade investors that the government is serious about addressing imbalancesin public finances. Should the government prove unable to deliver the prom-ised reforms, though, or the deficit accelerate in the short term beyond ourmodest expectations, investor confidence would wane, throwing the sustain-ability of the deficit into doubt. The secondary effects of such a developmentwould be severe, breaking the currency’s peg to the US dollar and undermininggrowth and investment levels across the economy.

Monetary policy will remain tight, as the Banque du Liban (the central bank)continues to focus on maintaining the currency’s peg to the dollar. Given thescale of the government’s borrowing requirements, and fears over the sus-tainability of the budget deficit, there is little short-term prospect of a cut ininterest rates, despite pressure from the government for an easing of rates to

Fiscal policy

Monetary policy

10 Lebanon


lower its debt-servicing costs. The widening differential on US rates, however,should ease pressure for a rise in domestic rates in 2001; rates are expected tostay at some 14-15% for the benchmark two-year Treasury bill.

Economic forecast

International assumptions summary(% unless otherwise indicated)

1999 2000 2001 2002

Real GDP growthWorld 3.5 4.8 3.0 3.9OECD 3.0 4.0 1.8 2.6EU 2.4 3.3 2.6 2.6

Exchange rates (av)¥:US$ 113.9 107.8 122.5 122.0US$:€ 1.07 0.92 0.97 1.07SDR:US$ 0.731 0.758 0.765 0.737

Financial indicatorsUS$ 3-month Libor 5.42 6.53 5.10 5.60US$ 3-month commercial paper rate 5.18 6.32 4.89 5.39

Commodity pricesOil (Brent; US$/b) 17.9 28.4 23.9 23.0Gold (US$/troy oz) 278.8 279.3 258.8 255.0Food, feedstuffs & beverages

(% change in US$ terms) –18.6 –6.1 8.0 14.8

Industrial raw materials (% change in US$ terms) –4.6 13.4 2.6 5.1

Note. Regional aggregate GDP growth rates weighted using purchasing power parity (PPP)exchange rates.

We have revised our world economic outlook downwards since our previousreport, to reflect the impact of the downturn in US growth on the globaleconomy. At present, we expect the US economy to begin to recover in thesecond half of 2001, supporting stronger world growth in 2002.

The most significant element of this new outlook for Lebanon is likely to bereduced yields on US T-bills in 2001, which will widen the differential on local-currency assets. US rates should pick up in 2002, however, as growth resumes,increasing pressure for a rise in local rates as the differential falls. In the light ofweaker world growth, we have also revised downwards our projections forgrowth in average commodity and manufactured goods prices in 2001, al-though we still expect most prices to rise. International oil prices will be anexception, with prices projected to fall by some 16% in 2001, before stabilisingin 2002. The positive impact of lower prices on Lebanon’s import bill will beoffset by an anticipated appreciation of the euro against the US dollar, in-creasing the cost of the country’s EU-sourced imports.

Although data remain incomplete, we have revised our growth estimate for2000 down to –0.5%. Available indicators suggest that most sectors of theeconomy suffered a second year of recession, with only the tourism industryperforming well. We continue to expect growth to return this year, however,

Economic growth

International assumptions

Lebanon 11


driven by a recovery in the services sector and steadily increasing domesticconfidence, provided Mr Hariri consolidates his hold on economic policy andbegins to implement his reform programme. Given the scope of the reformagenda, the likely pace of growth is difficult to judge, but we expect it to beslow, at some 1% this year and 2% in 2002, held back by uncertainty associatedwith the parlous state of government finances. The 2001 figure falls short ofthe official growth projection of 3-5% for this year, and may prove overlyconservative if the reform programme has the immediate impact Mr Hariri ishoping for. The most serious risks are on the downside, however, and if thefiscal deficit does push government finances and the currency into crisis, theeconomy will return to recession.

Official data—treated with some scepticism—suggest that consumer prices fellby some 2% last year, held down by weak domestic demand and the strengthof the Lebanese pound against the euro. A return to growth will generate someinflationary pressures over the forecast period, but with only a slow recoveryanticipated, and the economy operating well within capacity, demand-driveninflation will be modest. There will be more significant external pressures, withthe euro strengthening against the dollar and, by extension, against theLebanese pound, and with average international prices for a range of goodsforecast to rise. However, the impact on consumer prices will be offset by cutsin customs duties, and overall we expect inflation to remain low, at some 1.5%in 2001 and 2% in 2002.

Forecast summary(% unless otherwise indicated)

1999a 2000b 2001c 2002c

Real GDP growth –1.0b –0.5 1.0 2.0

Consumer price inflation Average 0.5b –1.0 1.5 2.0 Year-end –0.3b –2.0 1.8 1.0

Two-year Treasury-bill rate 14.6 14.6a 14.6 14.6

Government balance (% of GDP) –14.3b –23.8 –24.2 –24.4

Exports of goods fob (US$ bn) 0.7 0.7a 0.7 0.7

Imports of goods fob (US$ bn) 6.2 6.2a 6.6 6.8

Current-account balance (US$ bn) –2.3b –2.1 –2.4 –2.6 % of GDP –13.7b –13.1 –14.5 –15.0

External debt (year-end; US$ bn) 8.4 9.2 11.0 12.7

Exchange rates L£:US$ (av) 1,507.8 1,507.5a 1,507.5 1,507.5 L£:¥100 (av) 1,323.7 1,398.9a 1,230.6 1,235.7 L£:€ (year-end) 1,514.4 1,415.4a 1,545.2 1,680.9 L£:SDR (year-end) 2,069.1 1,964.1a 2,010.5 2,080.8

a Actual. b EIU estimates. c EIU forecasts.

Inflation

12 Lebanon


We expect the pound to stay within its trading range of L£1,501-1,514:US$1over the short term. Defence of this peg is the focus of monetary policy, andthe central bank has sufficient authority over interest rates and access to largeenough reserves to mount a strong defence. Beyond a six-month horizon,however, the outlook is far less certain. Confidence in the pound remainsweak, and if the prime minister’s reform programme falters, or the deficitaccelerates faster than we expect, pressure on the currency will mount sharply.In such circumstances interest-rate increases would have little credibility, giventhe pressure servicing costs already place on the budget, while the 23% fall inofficial gross reserves (excluding gold) over 2000 is a reminder that evenreserves as large as Lebanon’s cannot sustain a currency indefinitely. Theliquidity of the local banks—which hold the overwhelming majority of local-and foreign-currency government debt—and Mr Hariri’s allies in the Gulf couldbe tapped to provide support for the currency, but this could not maintain thepeg indefinitely, and a steep devaluation remains likely if the premier’s reformprogramme fails to deliver results.

Lebanon’s overwhelming dependence on imported goods will ensure that thetrade and current-account deficits remain high over the forecast period. Weexpect import spending to rise from US$6.2bn in 2000 to US$6.6bn in 2001, aslocal demand strengthens and recent tariff cuts take effect. Spending willincrease to US$6.8bn in 2002, as growth picks up and average prices continueto rise. The growth in spending will be partly offset by expanding exportearnings, but the trade deficit will still rise steadily, from some US$5.5bn in2000 to US$6.1bn in 2002. The complete absence of data on non-goods trans-actions makes estimates of the current account highly unreliable. However, anincrease in tourism-related invisibles earnings should offset higher incomepayments on the state’s growing external debt, and stronger services charges,leaving a current-account deficit of some US$2.4bn in 2001, increasing toUS$2.6bn in 2002 (the equivalent of some 14.5% and 15% of projected GDP,respectively, compared with a deficit of an estimated 13.1% in 2000).

Exchange rates

External sector

Lebanon 13


The political scene

Tension on Lebanon’s southern border with Israel has persisted over recentmonths, fuelled by further attacks by Hizbullah guerrillas against Israelimilitary targets, and the election of the hardline right-winger Ariel Sharon asIsrael’s new prime minister in February. As well as increasing fears that the newgovernment—elected to offer a more robust response to Palestinian threats toIsrael’s security—will retaliate more firmly against Hizbullah attacks than itsmore dovish predecessor, Mr Sharon himself has a special significance forLebanon. As defence minister in the early 1980s, it was Mr Sharon who led the1982 invasion of Lebanon, exceeding authorisation given to him for a limitedincursion when he ordered Israeli forces to occupy Beirut. Mr Sharon is heldresponsible for many of the civilian deaths that occurred during thesubsequent occupation, including the massacre of between 800 and 2,000Palestinians at the Sabra and Shatilla refugee camps. The killings were carriedout by Christian Lebanese forces allied to the Israelis; even an Israeli board ofenquiry into the massacre held Mr Sharon indirectly responsible, ruling that heshould never again be allowed to serve as defence minister.

His return to power revived memories of this period, prompting dire warningsin the local press that the election of the “Butcher of Beirut” would return theregion to war, less than one year after Israel withdrew its troops from the10-km strip of Israeli territory it had occupied since the invasion. Mr Sharonhas stoked these fears by claiming that Iran—one of Hizbullah’s main foreignsupporters—has supplied new, medium-range missiles to the group, capable ofreaching central Israeli cities. Mr Sharon threatened to strike the depots in theBekka valley where he claimed the missiles were being held, appearing toprepare the ground for an offensive by warning that Lebanon was becoming an“international centre for terrorism”. The new prime minister has also linkedHizbullah to the resurgence of violence in the West Bank and Gaza, claiming tohave uncovered Hizbullah cells operating in the West Bank and Gaza insupport of the Palestinians. In mid-March he also raised the prospect ofmilitary action against Lebanon to defend Israel’s water resources, claimingthat diversion of the Hasbani river (which feeds into Lake Tiberias in Israel) tosupply local farmers was a threat to Israel’s security.

There appears to be little substance to any of Mr Sharon’s claims. The Hasbaniriver project is little more than a four-inch pipe feeding a small local settle-ment, and as UN—and later even Israeli—officials recognised, will have nonoticeable effect on flows into Israel. There also seems little prospect that Syria(Hizbullah’s other main external sponsor) would allow the group control ofmedium-range missiles, as their use would draw Damascus into direct con-frontation with Israel. Hizbullah is also unlikely to have involved itself directlyin the conflict between Israel and the Palestinians, recognising that it wouldhave little to gain and much to lose if it became part of a war than it could notcontrol or fight on its own terms.

Border tensions rise onelection of Israeli hardliner

Hizbullah attacksIsraeli patrol

14 Lebanon


Hizbullah has, however, offered strong political support for the Palestinianuprising, and has stepped up its anti-Israeli rhetoric, antagonising the Israeliadministration and confirming Israeli opinion that the country continues toface an enemy across its northern border. Hizbullah has also continued itssporadic campaign to “liberate” the Shebaa farms—a small parcel of territoryon Israel’s side of the UN-demarcated blue line separating the two states. Israelclaims that the territory is Syrian, and has maintained control over it pending apeace agreement with Syria. Syria and Lebanon, however, say that the territoryis Lebanese, and Hizbullah has carried out a series of attacks against Israeliforces in the area. In the most recent of these incidents, guerrillas in mid-February killed an Israeli soldier in a missile attack against a patrol in thedisputed territory.

Despite Mr Sharon’s harsh rhetoric, Israel’s response to the attack was confinedto shelling the area from which the missile was launched. The modest responsehas added to speculation that there is an implicit understanding between thetwo sides that Israeli retaliation will be circumscribed, provided that Hizbullahattacks do not stray out of the Shebaa farms region. However, military sourcesin the area have told the EIU that they fear Hizbullah attacks will prompt amore robust response, warning that Israel’s northern command is seeking anopportunity to re-establish its credibility by regaining the offensive against theguerrilla movement. They also point out that as the attack took place afterMr Sharon’s election victory but before he took office, the restrained responsemay not be characteristic of the new administration’s approach. Even withoutthe new missiles that Israel claims Hizbullah has been given, the end of theoccupation would allow the militia to fire missiles from close to the borderitself, extending the reach of the 25-km Fajr rocket that the group has hadsince the early 1990s. This places towns such as Nahariya within ready range,opening the way for a possible—and rapid—escalation of violence should anyunderstanding between the two sides break down.

In addition to Mr Sharon’s reputation and rhetoric, and Hizbullah’s campaignover the Shebaa, the continuing power vacuum on the Lebanese side of theborder remains a cause for concern. The Lebanese government has yet toestablish control in the border region and, under pressure from Damascus, isunlikely to secure the area until Israel returns the occupied Golan Heights toSyria. UN peacekeepers have also been prevented from playing a full role in thearea, blocked by the reluctance of the Lebanese government to allow them toact, and Hizbullah’s apparent determination to maintain control over thesouth. This has been underlined by a series of confrontations between the UNforces and Hizbullah in recent weeks, notably in mid-February, when a patrolof Indian UN peacekeepers were prevented from establishing a new hilltopposition close to the Shebaa farms. In early March Hizbullah also stopped aFijian battalion of UN soldiers from establishing a new base closer to theborder. Frustrated by their inability to perform their peacekeeping role, the UNhas already announced plans to reduce its troop level from 5,700 to 4,800,with rumours in Beirut suggesting that without real support from the Lebanesegovernment, the mission could be withdrawn altogether.

UN cuts border force

Lebanon 15


The absence of a force committed to securing the border has heightened Israel’sanxieties, compounding fears that it will respond forcefully to Hizbullah“provocations” in order to damage the militia’s control of the region and forcethe Lebanese government to take control. These fears appear to be shared byLebanon's prime minister, Rafiq al-Hariri, who was clearly angered by theguerrilla group’s February attack. While paying lip-service to Hizbullah’s role asthe “national resistance” against Israel, Mr Hariri’s overriding concern isLebanon’s economy, and he is keenly aware that to fulfil his vision of boostingforeign investment and re-establishing the state as the region’s service centre, itis imperative that peace on the border be maintained. The timing of the latestattack was particularly unfortunate; Mr Hariri was in France calling on foreigndonors and investors to support Lebanon at the time. Moreover, the incidentcame only days after Mr Hariri had said publicly that Lebanon would not offerMr Sharon any provocation to attack Lebanon.

Mr Hariri immediately returned to Lebanon, holding first a meeting with theUS ambassador, David Satterfield—seeking to prevent Israeli retaliation—andthen with the Syrian president, Bashar al-Assad, presumably to discuss Syria’sattitude towards the attack. Mr Hariri also issued a statement criticisingHizbullah—an unprecedented step—before holding four hours of emergencytalks with the group’s leader, Hassan Nasrallah. The limits of Mr Hariri’s in-fluence were apparent, however, when the meeting ended with a statementthat the government would not interfere with Hizbullah’s actions in the south,while Hizbullah would not interfere with government efforts to rebuild thecountry—a vague compromise that seems neither satisfactory nor sustainable.

As well as finding itself with limited control over Hizbullah, Mr Hariri’s govern-ment is encountering difficulties in managing increasingly vigorous localdemands for a reduction in Syrian influence over Lebanese affairs. Syria hasbeen the dominant force in the state for much of the 23 years since it first senttroops to Lebanon in a bid to bring the civil war to a close. Syria brokered andenforced the Taif treaty which ended the war in 1990, and has maintainedbetween 20,000 and 30,000 of its troops in Lebanon subsequently. Theirpresence, coupled with the country’s influence over members of the Lebanesepolitical elite, has allowed Syria to remain the country’s chief powerbroker, andhas ensured that all major political appointments and decisions over sensitivesecurity or foreign policy issues are made only with Syrian approval. The end ofIsrael’s occupation of southern Lebanon removed the immediate justificationfor the continued presence of Syrian forces, however, while the death of thefeared Syrian president, Hafez al-Assad, at the same time, weakened Syria’s gripon the state. Sensing their opportunity, those who have long opposed Syrianinterference in Lebanese affairs have begun to mount a public and forcefulcampaign demanding that Syria withdraw.

The campaign has been led by Lebanon’s Maronite community—the sectariangroup that lost its dominant position within the state’s pre-war institutionswhen its militias were defeated by Syrian-backed forces. While several Maronitefigures have come to the fore in the past year, the campaign has been led inrecent weeks by Cardinal Nasrallah Sfeir, the community’s spiritual leader.Using his clerical position for political protection, Cardinal Sfeir has made

Prime minister alarmed byinsecurity on the border

Anti-Syria campaigncontinues

16 Lebanon


increasingly uncompromising demands for the end of Syrian control. Herepeated these calls during a six-week tour of North America in February andMarch. While there are many Christians who are sceptical of his calls, thestrength of his popular support was apparent in the large crowds that greetedhim on his return to Beirut. While the cardinal was on his tour, supporters inLebanon attempted to stage protests, even attempting to demonstrate outsideSyrian military bases.

The Syrian-backed elite owe their political position to support from Damascus,and they have appeared uncomfortable in their efforts to counter the anti-Syrian campaign. Officials have found it difficult to respond to the language inwhich Cardinal Sfeir has presented his demands—he has called for therestoration of full Lebanese sovereignty and an honouring of the Taif treaty,which promised that Syria’s presence in Lebanon would be temporary—without appearing unpatriotic. Mr Hariri has said that the presence of Syrianforces is essential to maintain peace among Lebanon’s confessional groupings,but this argument is hard to maintain 11 years after the end of the civil war. Itis also too close to Syria’s justification for its continuing presence to counterthe nationalist argument that Syria is, in effect, occupying Lebanon. There hasbeen some effort to silence the Maronite critics—an attempt in March to markthe 12th anniversary of Michel Aoun’s “War of Liberation” against Syrianforces led to gridlock in Beirut, as the security forces mounted a large operationto stop protestors gathering. An attempt to remove the political censor fromthe country’s largest television station, the Christian-controlled LebaneseBroadcasting Corporation (LBC), also failed, despite the efforts of its owner,Pierre Daher. However, the efforts to restrict the anti-Syrian campaign havebeen insufficient to quiet demands, while Syrian concessions—such as therelease of Lebanese (mostly Christian) detainees from Syrian jails—have beeninterpreted as signs of weakness.

As well as unsettling the elite, the vocal Maronite demands for a change in thepolitical order have raised fears of renewed sectarian conflict. Despite theefforts of leaders such as Cardinal Sfeir to stress the campaign’s nationalistgoals, the focus of the movement within a single confessional group has in-evitably given it a sectarian edge. This has been fuelled by the readiness withwhich some of its backers have demonstrated their support for men such asMr Aoun and Samir Geagea—wartime militia leaders who fought againstSyrian-backed Muslims during the civil war. The fact that senior Sunni clericssuch as Sheikh Taha Sabounji, a senior mufti in Tripoli, have been at theforefront of the criticism of Cardinal Sfeir adds to the sectarian dimension.Alongside fears of heightened sectarian tension, Syrian and Lebanese leadersare concerned that the campaign might spread outside of the Maronite com-munity. If the anti-Syrian campaign were to turn into a broad movement, itwould become more difficult for them to ignore its demands, forcing a difficultchoice between imposing Syria’s presence by force, or accepting a withdrawal—both of which would carry uncertain implications for domestic stability. So faronly one senior figure—Walid Jumblatt, leader of the Druze community—hasidentified himself with the campaign, calling for a “minimal parity inLebanese-Syrian relations” at a meeting in March, despite being firmly rebuked

Sectarian tensions revivedby withdrawal demands

Lebanon 17


by Damascus for similar comments in late 2000 (January 2001, page 15). Therewere reports later in the month that the Syrian army had deployed troopsaround Moukhtara—Mr Jumblatt’s home village—as part of efforts to pressurehim into silence.

However, while the elite has struggled to establish control over policy towardsSyria and Israel, there have been signs that improved co-operation within the“troika” (comprising the prime minister, the president, Emile Lahoud, and theparliamentary speaker, Nabih Birri) is enabling the government to deal withimmediate issues more effectively. With the need for urgent action to addressLebanon’s economic problems increasingly apparent, Mr Hariri appears to havenegotiated agreements with Mr Birri and Mr Lahoud to support his economicreform programme (see Economic policy). The deals seem to confirm thedivision of power within the elite, with Mr Hariri’s position as the dominanteconomic policymaker apparently accepted by its other members. In return,Mr Hariri can be expected to allow the president the lead over security andforeign policy issues. Indicative of this arrangement is the fact that Mr Haririhas left the management of the cuts in military spending to the army itself,recognising that as its former head, Mr Lahoud counts the military as part ofhis political territory. The agreement with Mr Birri—reached after two days ofclosed negotiations—appears to be firmer, with the parliamentary speakerconceding the necessity of public-sector cuts, provided that job losses for hisown Shia community are kept to a minimum. In return, Mr Birri has won anundertaking from Mr Hariri that the prime minister will promote legislationreplacing the multi-member, multi-constituency electoral system with a singleelectoral district. As the Shia are the largest single confessional grouping inLebanon, the move would consolidate Mr Birri’s influence over parliament.

While the developments are positive, until they are tested it will be unclearhow robust the agreements will prove in practice (see Outlook for 2001-02). AsMr Hariri’s outburst over the Hizbullah raid underlined, there are a range ofissues where the claims of the president’s security portfolio, the prime min-ister’s economic portfolio and Syrian demands for control of strategic issuesclash. The development of a single electoral district system—whatever thismight mean in practice—will also prove difficult to deliver, given the sensi-tivities surrounding any development that could alter the sectarian balancewithin parliament. As soon as rumours of the agreement emerged, there werevigorous protests from Christian and Druze leaders, including Mr Jumblatt andDory Chamoun, head of the National Liberal Party, who feared they would losetheir own influence. Discussion of the proposal was continuing as this reportwent to press, but the consensus in Beirut was that the legislation would fail togain parliamentary approval, potentially throwing Mr Hariri’s agreement withMr Birri into doubt.

Mr Hariri seeks nationalconsensus for reforms

18 Lebanon


Economic policy

Despite the distractions generated by domestic and regional political develop-ments, the prime minister, Rafiq al-Hariri, has continued to focus on economicpolicymaking, outlining a further series of reform measures over recent weeks.However, while he has continued to talk bullishly of Lebanon’s growthpotential, there has been a clear shift in the emphasis of economic strategy. Inthe run-up to the general election in September 2000, and in the first monthsafter his appointment in October, the prime minister stressed the growthelement of his reform programme. He introduced a series of liberalisationmeasures designed to grow Lebanon out of its fiscal crisis, implicitly acceptinga short-term deterioration in the budget balance to boost medium-term budgetrevenue. However, the emphasis has since shifted, with Mr Hariri pressing forradical cost-cutting measures, in a bid to shore up the government’s short-termbudget position.

Whether the government will have the political strength to implement therange of measures the prime minister has outlined remains to be seen, but themotivation for the shift in focus is readily apparent. The final fiscal outturn for2000 left a deficit of some L£5.9trn (US$3.9bn), by far the largest Lebanon hasever generated. The shortfall was the equivalent of 56% of expenditure, oralmost 24% of GDP. The ratio to GDP is the second largest in the world (afterZimbabwe) according to EIU estimates, and marks an increase of more than60% on the deficit of L£3.6trn generated in 1999. A deficit target of L£3.75trnhad been set for the 2000 budget.

Budget outturns(L£ trn unless otherwise indicated)

1999 2000 % change

BudgetRevenue 4.5 4.1 –8.3 of which: customs revenue 2.0 1.7 –10.9Expenditure 7.2 8.2 13.7 of which: debt payments 3.6 4.2 15.8 % of total 42.9 40.3 –6.1

TreasuryRevenue 0.4 0.5 14.0Expenditure 1.3 2.2 78.3

Total revenue 4.9 4.6 –6.5

Total expenditure 8.5 10.4 23.3

Balance –3.6 –5.9 63.8 % of expenditure –42.4 –56.3 – % of GDP –14.3 –23.8 –

Source: Ministry of Finance.

The outturn figure is higher than we had previously expected, and appears tobe the result of a deliberate effort to push the figure upwards. Budget revenuein November and December—the two months after the new government took

Emphasis shifts fromgrowth to austerity

Fiscal deficit hitsrecord highs

Lebanon 19


office—fell a remarkable 45% below its 1999 levels, while total expenditure inthe same two months stood some 40% above that in the same period of theprevious year. This has prompted speculation that the government heldrevenue for 2000 over to the new fiscal year, and made allocations for2001 spending in 2000, to make the record of its predecessor—which heldpower throughout the bulk of the year—appear as poor as possible. Distortingthe allocations will also make the 2001 deficit figure appear lower than wouldotherwise be the case. Without this interference, we estimate that the deficit in2000 would have stood at L£5.2trn, still an increase of some 45% on theprevious year’s outturn. At 21% of estimated GDP, it would also have remainedthe second highest in the world.

Even allowing for the distortions in the official outturn, the figures underlinehow difficult it is for the government to slow the pace at which the deficit ismounting. The cost of servicing the public debt stock rose by 16% over theyear, despite efforts to meet a growing proportion of the official borrowingrequirement from lower-cost foreign sources. In total, interest paymentsamounted to an astonishing 97% of total government revenue, and 40% oftotal spending. With capital spending restricted to the bare minimum, theoverwhelming majority of the remainder of government expenditure is re-current, with most taken up by spending on wages and benefits. Non-debtspending rose by almost 12% over the year, highlighting the difficulty ofcontaining these costs, given rising unemployment levels and the politicaltensions surrounding public-sector employment levels. While total spendingrose by 23% in what was supposed to be a year of austerity, revenue fell bymore than 6%, as weak growth negated the impact of higher taxes. Customsrevenue also fell by 11%, in part as a result of tariff cuts introduced byMr Hariri in November—which pushed down earnings by some 40% in the lasttwo months of the year—and also because of weak import demand.

The government’s initial response to the fiscal imbalance—its draft budget for2001—disappointed most observers, and offered few solutions to ease mount-ing fiscal pressures. Full details of the bill, which was still being debated inparliamentary committee as this report went to press, are unavailable, butcomments from ministers point to an overall projected fiscal deficit of someL£5.1trn, the equivalent of 50.9% of expenditure. The budget is predicated onrevenue of L£4.9trn—a 7.6% rise in revenue on the 2000 outturn—andspending of L£9.98trn, a fall on last year’s actual expenditure. Of the ex-penditure, L£4.3trn has reportedly been set aside to meet debt-servicing costs,compared with L£4.2trn in 2000, and some L£3.7trn has been earmarked tomeet spending on salaries, wages and benefits—a figure below last year’s total.Reports suggest that the government has also committed itself to payingarrears left by the previous administration, including a reported US$40m to theItalian power group Ansaldo for construction work and US$170m to theprivate company Sukleen for garbage collection. It is not clear if this expen-diture is included in the draft budget.

Budget proposals offer fewsolutions to fiscal crisis

Debt-servicing absorbs allgovernment revenue

20 Lebanon


Initial outturns for the first two months of the year offer a misleadingimpression that the government’s projections of a falling fiscal deficit arecredible. During this period the overall deficit stood at “just” L£262bn (theequivalent of less than 26% of expenditure), a fall of almost 86% on theprevious year’s figure for the same period.

A breakdown of the figures, however, suggests that the sharply downwardtrend is unlikely to be sustained. Budget revenue during this period soared bymore than 34% on its 2000 level, despite sharp falls in tax and customs rev-enue. The “other revenue”, which increased fourfold on its 2000 level andaccounted for all of the gains, most probably comprises transfers from thestate-owned fixed-line telephone network, and may include elements held overfrom 2000. The timing of transfers does vary from year to year, and as therehave been no commercial developments to support such large increases intelecommunications revenue, it must be assumed that non-tax revenue will fallsharply later in the year. The 70% fall in the figure for total expenditure is alsounconvincing, and appears to support suggestions that funds were disbursed inthe previous fiscal year to massage the 2000 and 2001 outturns in favour of thecurrent government. The delay in passing the 2001 budget may also haveserved to curtail new government spending.

The downward trend is thus likely to be sharply reversed over the comingmonths, and over the full year we currently expect the budget deficit target tobe exceeded. Notwithstanding the outturns for the first two months, thegovernment’s revenue projections appear overly optimistic. Tariff cuts seemcertain to push down revenue over the year, even allowing for an increase inimport spending, while economic growth is unlikely to be sufficiently rapid topush up tax yields. The expenditure projections also seem unrealistic. Non-debt expenditure is highly unlikely to be contained within the sum targeted inthe budget, especially if reports that the military and security services havealready been granted 60% increases in their allocations are confirmed. Theassumption that debt-servicing costs will rise by just 2.45% on last year’soutturn also appears unduly optimistic, with local interest rates unlikely to falland borrowing requirements certain to rise. Even a conservative projection of a10% increase in the local-currency net debt stock (compared with last year’srise of 14%) appears set to drive an increase at least four times greater than thatprojected in the budget. We are currently projecting a deficit for 2001 ofL£6.1trn, the equivalent of just below 58% of expenditure.

The sustainability of chronic, and escalating deficits of the scale Lebanon hasgenerated over recent years is increasingly under question. Local doubts havebeen increasingly apparent in the currency markets, where the Lebanesepound’s peg against the US dollar has come under growing pressure. To defendthe peg, the Banque du Liban (the central bank) was required to draw downsome US$1.5bn from its reserves between February 2000 and the time ofMr Hariri’s appointment in October. Despite hopes that his election wouldrestore confidence, the initial recovery was fragile, with reserve levels easingfurther over the subsequent two months. They have since stabilised, but at theend of February remained at just US$6bn, still some 20% down on the previous

Deficit is likely to exceedbudget target

Budget deficit increasespressure on currency

Lebanon 21


year. The other key measure of demand for the Lebanese pound—thedollarisation rate—also suggests that confidence has yet to recover. From a lowof 54% in March 2000, the value of foreign-exchange deposits as a percentageof M3 rose to 60.4% by the end of October, as a growing number of investorsswitched their holdings away from local-currency assets. While the dollar-isation rate stabilised following Mr Hariri’s election, the trend has yet to bereversed, and in February the rate picked up again to more than 61%. Thetrend is confirmed by patterns of M2 growth, which showed a 7% fall in local-currency savings over the 12 months to the end of February. M2 contracted by2.6% in February alone, as local-currency holdings were liquidised.

Currency indicators

2000 2001Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Jan Feb

Gross reserves (US$ m)a 7,498 7,313 7,239 6,898 6,744 6,796 6,735 6,537 6,059 5,902 5,889 5,918 6,002 % change 0.4 –2.5 –1.0 –4.7 –2.2 0.8 –0.9 –2.9 –7.3 –2.6 –0.2 0.5 1.4

M2 (% change) 24.3 25.1 23.5 18.4 18.3 16.6 13.8 6.9 –2.1 –2.7 –3.7 –3.3 –6.9

M3 (% change) 11.3 11.9 12.2 11.7 12.1 11.4 11.7 10.9 10.0 10.4 9.6 9.8 9.3

Dollarisation rateb 54.4 54.1 54.9 56.2 56.2 56.1 56.5 57.7 60.4 60.4 60.3 60.1 61.2

a Excluding gold; derived from balance-of-payments data. b Foreign exchange as a percentage of M3.Source: Banque du Liban.

Of greatest concern are initial signs that the commercial banks are becomingreluctant to purchase local-currency government debt. The overall debt stockhas risen sharply over the past year, as the government has looked to domesticand foreign sources to bridge the fiscal gap. The total net public debt stockstood at L£35.9trn (145% of estimated GDP) at the end of February 2001, anincrease of almost 19% year on year. The domestic banks have been the mainsources of credit, attracted by Treasury bills currently offering yields of 14.64%on benchmark two-year bills. However, having increased their stock of T-billsfrom L£13.7trn at the start of 1998 to a peak of L£19.6trn in August 2000,holdings fell by 6.6% over the following two months, as political uncertaintypeaked during the general election. Holdings have since recovered—reachingL£19trn by the end of February—but demand has been insufficient to meetsupply. The surplus has been taken up by the central bank, whose holdings ofT-bills rose from 0.01% of the total in early 2000 to some 6% by the end ofthe year.

The central bank has built up holdings of T-bills in the past when local de-mand has faltered, notably in 1995, early 1998 and early 1999. However,these have never reached as much as the L£1.6trn accumulated by end-February 2001, and in the past have been held for three or four monthsbefore being sold back into the market. The current build-up in central bankholdings has now continued for ten months, apparently underlining howstrained confidence in government debt and the pound’s dollar peg has

Banks lose appetite forlocal-currency debt

22 Lebanon


become. If this persists, it will become increasingly difficult for the govern-ment to meet its funding requirements, and the risk of a forced devaluation ofthe pound will rise.

Treasury-bill holdings(L£ bn unless otherwise indicated)

2000 2001Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb

Commercial banksValue 19,064 19,207 19,402 18,800 19,980 19,273 19,620 19,165 18,299 18,460 18,667 19,132 18,999 % of total 74.8 74.9 75.2 73.5 74.0 73.2 73.3 72.7 69.8 69.1 69.2 69.4 69.0

Central bankValue 2.6 3.1 3.6 304 636 644 641 656 1,294 1,598 1,598 1,610 1,624 % of total 0.01 0.01 0.01 1.19 2.35 2.44 2.39 2.49 4.94 5.98 5.93 5.84 5.90

OthersValue 6,419 6,432 6,390 6,470 6,396 6,410 6,516 6,552 6,622 6,662 6,698 6,830 6,918 % of total 25.2 25.1 24.8 25.3 23.7 24.3 24.3 24.8 25.3 24.9 24.8 24.8 25.1

Total value 25,486 25,642 25,796 25,574 27,012 26,327 26,777 26,373 26,215 26,720 26,963 27,572 27,541

Source: Banque du Liban.

Concerns over the impact of government finances on Lebanon’s economicstability have already prompted the main international ratings agencies toissue credit warnings, with Fitch-IBCA in February the latest to issue a down-grade. The president of the World Bank, James Wolfensohn, also travelled toBeirut to warn senior politicians of the dangers the economy faces, calling onLebanon to “learn to live within its means” in order to prosper. Whether as aresult of these warnings, or as a product of the alarming signs that confidencehad not rebounded as he hoped, Mr Hariri in February began to talk forcefullyof the need to attack fiscal expenditure. With the cost of debt service in effectbeyond the government’s control, this has inevitably required the governmentto address the issue of spending on the military and on broader public-sectorwages and salaries. There have been calls to cut the bloated public sector in thepast, but political concerns surrounding the issue have prevented any progress.Each of Lebanon’s main sectarian groupings receives a proportionate share ofposts within the public sector, and guaranteeing employment has been animportant way for political leaders to channel patronage to their supporters.

However, Mr Hariri signalled his intention to push forward more aggressivelywhen he oversaw the closure of the loss-making state television station, Télé-Liban. Following the closure, which took effect on March 1st, all 523 of thestation’s staff were dismissed, ahead of a three-month restructuring programmeto establish a commercially viable company. As Télé-Liban ran an aggressivelyanti-Hariri campaign ahead of last year’s election, it is perhaps not surprisingthat it should be the first to feel the effect of the cost-cutting programme. Theactual savings that will be made are open to question; the cost of severancepay, for example, could readily outstrip the short-term savings associated withthe temporary closure of the station. Nevertheless, it marks an important firststep towards attacking the culture surrounding the public sector, which haspreviously impeded efforts to cut waste expenditure.

Mr Hariri wins politicalsupport to cut public sector

Lebanon 23


Building on this initial measure, Mr Hariri held two days of talks with NabihBirri—Lebanon’s parliamentary speaker and the most senior leader of the Shiacommunity—at the beginning of March at the prime minister’s residence inFaqra. Mr Birri’s Shia community joined the civil service and state companiesin large numbers during the civil war, and he has been one of the staunchestopponent of public-sector job cuts in the past. However, at the Faqra meetingMr Hariri appears to have won an undertaking that the parliamentary speakerwill support sharp cuts in civil service numbers and within the 64 state“commercial” enterprises. Subsequent statements suggested that as many as4,000 state employees could be sacked, while the Ministry of Finance wascharged in March with drafting a law to increase working hours for govern-ment employees. Divergent estimates suggest that overall the reduction in thenumber of civil servants will save between L£200bn (US$133m) and L£450bn.

Having struck an agreement with Mr Birri, Mr Hariri held talks with thepresident, Emile Lahoud, the following day to discuss cuts to military spend-ing. At an estimated US$1bn, the military budget accounts for some 15% of allspending—a figure which many outside the military have long considered tobe too high. However, the army has always commanded considerable politicalpower, and its influence has grown since Mr Lahoud—formerly head of thearmy—took office. The 2001 budget, for example, reportedly includes a 60%increase in military spending and an rise of more than 50% in “security andjustice” allocations. After talks with Mr Lahoud, reports suggested thatMr Hariri had won presidential backing for cuts to the army budget. The armycommander general, Michel Suleiman, has been tasked with determining howto rationalise spending, and in an early development announced that generousend-of-service benefits would be cut, with some suggesting that this could saveas much as L£120bn. There was also agreement to transfer some 2,000 stafffrom the Sûreté Générale (a uniformed, lightly armed security force) to theInternal Security Force (ISF). The ISF, a paramilitary police force, had previouslybeen planning a large recruitment drive.

The agreements Mr Hariri has won from the other two members of Lebanon’spowerful troika (comprising the president, prime minister and speaker) arecrucial, and offer the strongest indication yet that the country is preparing toaddress its fiscal crisis with some urgency. The agreements also provide theadministration with a far firmer political base from which to act than thatenjoyed by its predecessor, which had also sought to bring spending undercontrol. Moreover, the consensus appears to be widening; after gaining supportfrom Mr Lahoud and Mr Birri, the reform plans were endorsed by other seniorpoliticians, including four former prime ministers—Amin Hafez, Rashid Solh,Salim Hoss and Omar Karami. In addition, the former parliamentary speakerHussein Husseini, the deputy speaker Elie Ferzli, leaders of the various parlia-mentary blocs and others offered political support to economic reform.

The apparent consensus, however, will only be convincing when it leads to realaction and all of the leaders demonstrate that they are ready to compromisesectarian interests for what Mr Hariri believes to be the national good. Thepromised cuts are unlikely to be incorporated in revisions to the 2001 budget,for example, leaving an uncomfortable dual framework for public spending.

Military spending istargeted

24 Lebanon


The lack of published detail in the agreements is also a cause for concern. Notargets have been set for the reduction in military spending, for example, andthe appointment of a senior general—reporting to the former head of thearmy—to determine how expenditure can be brought down may not lead tothe rigorous rationalisation programme that has been hoped for. Similarly,leaks following the Faqra meeting indicated that Mr Birri had demanded thatall possible efforts be made to find sacked Shia workers employment elsewherein the public sector, suggesting that the number of employees will not beallowed to fall quickly. It is also unclear what concessions Mr Hariri offeredduring the course of the two-day meeting to win the parliamentary speaker’sbacking, with most reports pointing towards increased development spendingin the south (Mr Birri’s heartland) and electoral reform (see The political scene).This package—especially the latter element—will prove difficult for Mr Haririto deliver. If the short-term benefits of cost cuts are not to be outweighed byhigh severance payments, the government will also have to win internationalfinancial support, similar to that granted by European bodies in late February(see Foreign trade and payments).

Another important test of the administration’s political strength will be thesupport given to its privatisation programme. The proposed divestments arecentral to the reform programme, both as a means to reduce the draw of loss-making public enterprises, and to generate capital inflows which can be usedto pay down the public-sector debt stock. Without these inflows, even themost dramatic of expenditure cuts will not restore balance to the fiscalaccount, given the high demands of the debt-servicing programme. Mr Haririhas said that he intends to see two state firms partly privatised this year, thefixed-line telephone network and Electricité du Liban (EDL), the nation’s mainpower supplier.

A parliamentary report issued in early 2001 underlined the problems EDL faces,and how radical a restructuring is required, if privatisation is to be achieved.According to the report, EDL receives L£600bn in revenue from consumerseach year, but spends some L£750bn on oil purchases alone. Of the powerproduced, some 30% is used by consumers who do not pay, either as a result ofillegal connections to the power grid or because bills are never paid. Reportssuggest that less than 50% of issued bills are actually paid, and outstandingresidential arrears stand at some L£180bn. Another 15% is lost duringtransmission (compared with a regional average of 5-8%), and the companytherefore only receives revenue for 55% of its output. Much of this is boughtby ministries and state agencies at subsidised prices, leaving only a smallproportion to be sold at market cost.

The government is now considering several means by which the utility couldimprove revenue collection, as the first step to privatisation. This wouldinvolve either providing consumers with new meters based on prepaid units, orturning collection over to a private company, or to the local municipalities,which would have an incentive to improve collection as they levy a 10% taxon the bills. In March it was announced that the French bank BNP Paribas hadbeen appointed as a consultant to EDL to assist in reducing losses and to makethe firm ready for privatisation. The government has said that it plans to select

EDL requires extensiverestructuring

Lebanon 25


a foreign strategic partner for EDL before the end of the year. The partner willpurchase a minority stake in the firm, but take full control of operations as partof a three-year programme of restructuring, leading to its eventual listing onthe local stockmarket.

A law to support the restructuring is currently being prepared, as is legislationto support the partial privatisation of the fixed-line telephone monopoly. Thelaw envisages merging some departments of the Ministry of Telecom-munications and Post with Ogero (the state-owned fixed-line operator). Thenew entity, to be called Liban Télécom, will operate the 750,000-line networkand be granted a licence to become the third cellular operator. Under ministryplans, an investor should be offered a strategic stake of up to 35% in 2001, inpreparation for full privatisation at a later date. How likely it is that a strategicpartner will be found so quickly is open to question, as is the government’scommitment to the sale as a whole. The fixed-line network is an importantsource of recurrent revenue, and its contribution will rise further when it isgranted a mobile licence. It is also unclear what stage negotiations to selllicences to the current two mobile phone companies have reached—thecompanies’ build-operate-transfer (BOT) contract expires soon. The firms hadoffered to pay a total of US$2.7bn for 20-year licences, but the deal was rejectedby the previous administration. The sharp global downturn in the valuation oftelecoms assets—and of firms such as France Télécom, which owns a 67% stakein one of the operators, Cellis—appears to have thrown the sale into doubt.

Meanwhile, plans to privatise the national Middle East Airlines (MEA) havetaken a step forward. After securing agreement with Mr Birri, the governmentannounced that it intends to dismiss 1,300 of the airline’s 4,500 staff, using aUS$60m soft loan provided through the World Bank to pay for redundancies.MEA, which is currently 99% owned by the Banque du Liban, is then expectedto seek a strategic partner by end-2001 to move the airline back towardsprofitability. MEA already has a code-sharing agreement with Air France, andbecause of the cultural links between the countries, most analysts expect thegovernment to invite the French airline—which is itself a loss-makinggovernment venture—to become the strategic partner.

As part of its continuing efforts to support growth, legislation has also beenapproved to revive the Council for Development and Reconstruction (CDR).The law gives the CDR unrivalled powers as an exclusive conduit of foreign-financed reconstruction projects to bypass and cut through existing legislationto win funding for projects and offer tailor-made packages for large single-investment projects. The CDR, Mr Hariri’s brainchild during his previoussix years as prime minister, was effectively closed by Mr Lahoud when he cameto office. In the draft 2001 budget, the cabinet has reportedly earmarked someUS$200m for the state body to revive some infrastructure projects. The pre-vious government of Salim al-Hoss had earmarked US$6m to be given to theCDR over a five-year period.

Law is drafted fortelecoms sale

Air France is tipped asMEA partner

More reforms include newinvestment law

26 Lebanon


A new property ownership law has also been passed, removing previousrestrictions on foreigners owning property and land, which were introduced inthe 1960s to prevent Palestinian refugees settling permanently in the country.With all sections of Lebanese society still adamant that the 250,000 Pales-tinian refugees in the country cannot settle, the new law has been drafted toexclude them by allowing only foreigners from a “sovereign state recognisedby Lebanon” to purchase land. The law permits foreigners to buy up to3,000 sq metres of land or property, with any larger amount requiringcabinet approval.

As anticipated, the National Social Security Fund (NSSF) has also responded togovernment pressure and reduced the contribution requirement fromcompanies. The fund, which provides small state pensions, health cover andmaternity leave, previously required a company to pay the equivalent of 38.5%of an employee’s earnings as its contribution. Under the new agreement, thishas been reduced to 23.5%. As the NSSF is an autonomous government bodyand already has large cash reserves, the finance ministry has said that there willbe no budgetary implications. However, it is hoped that the lower rate willencourage more companies to participate in the NSSF, while also reducing theburden on private-sector companies that already contribute. Currently, fewcompanies register all their staff members or the full amount of their income,because the contributions are seen as too high.

A report from the UN’s Interregional Crime and Justice Research departmentclaims that corruption in Lebanon is “endemic”, judging it to be the worst ofthe 26 countries surveyed. The organisation reports that the Lebanese govern-ment loses more than US$1bn annually as a result of corruption in public ad-ministration. The authors attribute the high level of corruption to the impactof the 1975-90 civil war, the low salaries of civil servants, political sectarianism,outside political interference (a reference to Syria), the non-independence ofthe judiciary, and the absence of a clear programme or strategy for combatingcorruption. According to the report, 98.6% of the Lebanese population believesthere to be corruption in the country. More than 43% of companies “always orvery frequently” pay bribes, and a further 40% “sometimes” pay bribes. Six outof ten respondents agree that Lebanon’s judiciary is not independent in itsdecisions. Some 40% say they pay bribes to civil servants to have theirtransactions completed, compared with an average of just 20% in Africa andSouth America.

The domestic economy

Economic trends

Poor data collection continues to hamper efforts to provide an accurateoverview of trends within the domestic economy. Lebanon has not publishedfull national accounts data since the civil war began in the mid-1970s, and

Social security tax oncompanies is cut by 15%

UN report says corruptionis “endemic”

Economy is estimated tohave contracted in 2000

Lebanon 27


while the World Bank has presented its own estimates for GDP, the figures areviewed with some scepticism and the most recent estimates are now more thantwo years old.

Nevertheless, the data which are available suggest that while there has beensome sign of a recovery over the first months of 2001, performance in 2000was even more disappointing than had previously been thought. Whereas theEIU previously estimated that the economy stagnated over the year aftercontracting by 1% in 1999, we now believe that the recession continued, andestimate a contraction of some 0.5%. A range of indicators support this moregloomy assessment. The value of cheques cleared within the domestic bankingsystem, for example, fell by almost 1% during the year, pointing to weakdomestic demand. The volume of imports entering Lebanon through the Portof Beirut (the main gateway for imported goods) fell by some 14%—aremarkable drop, given the economy’s overwhelming reliance on foreign-produced consumer and capital goods. The value of imports remained rela-tively stable during the same period, but this in large part appears to reflect theimpact of a 60% increase in average oil prices. The state electricity producerwas forced to import oil in increased quantities in the second half of the yearwhen shortages led to power cuts.

Real economic indicators(% change year on year)

2000 2001Year-end Jan Feb

Construction permits –20.2 48.4 –3.1

Cement deliveries –11.7 103.1 –15.1

Imports by weight –14.0 20.9 –12.0

Cheques cleared by total value –0.8 6.4 –6.1


Activity in the construction sector—the main driver of growth during theboom post-war reconstruction period—fell sharply over the year. The numberof construction permits issued in 2000 fell 20% below 1999 levels, which werethemselves 14% below 1998 levels. Cement deliveries (the other main indi-cator of activity in the sector) also declined sharply. Government revenue fromreal estate transactions—a useful proxy for local demand for commercial andprivate property—fell by almost 40%. Data suggest that the downturn was notconfined to the construction sector. The Ministry of Industry, for example,estimates that only 418 new businesses were established during the year—a fallof more than 20% on the previous year’s total. The new businesses created lessthan 3,800 new jobs and required investment of L£104.8bn (US$69.5m), downby 3.2% and 18% on 1999 levels, respectively. The picture of weak activity inthe industrial sector is supported by Banque Audi’s estimate that spending onimported industrial machinery fell by almost 17% to stand at less thanUS$100m for the year.

The only area of the economy which appears to have performed well over 2000was the tourism sector. New data show that the number of aircraft using BeirutInternational Airport (BIA) increased by 6.5% to almost 30,000, while the

Tourism sectorshows growth

28 Lebanon


overall number of passenger arrivals rose by almost 7%. Encouragingly, thestrong performance over 2000 was the result of a consistent increase in visitornumbers throughout the year, rather than a product of short, and less readilysustained increases over only a few months. Breaking down the increasedvisitor numbers between business travellers and tourists, and local and foreignnationals, is not possible from the published data. However, Banque Audireports that the number of visitors describing themselves as “tourist” on theirarrival forms rose by more than 10%.

The growth figures are also encouraging given the difficult political cir-cumstances in which they occurred. Israel’s withdrawal from the south was notcomplete until shortly before the peak summer tourism months, and wasaccompanied by fears in some quarters that cross-border violence would rise.In addition, heightened unrest in the West Bank and Gaza has damaged thetourism industry in many parts of the Middle East that are not directly affectedby it. The government is eager to build on the sector’s potential, and an-nounced in late 2000 an “open skies” policy, designed to increase traffic at theairport. Since the announcement, the civil aviation authority has reported thatseven foreign airlines have indicated that they intend to put on additionalflights to Beirut. After two lacklustre years, the government in February alsorevived the annual shopping festival—known as “Fab Feb”—with a series ofoffers to encourage more visitors. All visa charges were dropped during the six-week festival, and hotels and restaurants were exempted from a 5% service tax.The government also permanently removed the requirement for nationals ofGulf Co-operation Council (GCC) countries to obtain visas. The number ofvisitors passing through the airport in February alone increased by some 36%,while the number of private jets arriving from the Gulf also rose sharply.

While many retailers complained that “Fab Feb” did not generate as muchadditional business as they had hoped, there are some signs that economicactivity did pick up over the first two months of the year. All of the mainindictors show some gain on performance over the first two months, comparedwith the same period in 2000. This includes a sharp increase in the number ofconstruction permits issued—an indication that building work may pick upover the remainder of the year, given the lag time between permits being

Some signs of recovery inearly 2001

Lebanon 29


issued and development work beginning. The increase in import volumescould also be a sign that the cuts in customs duties have begun to revive theretail sector. While the figures support our assessment that growth will returnthis year, it is still difficult to judge how rapid this expansion will be. Indeed,while the figures for the first two months are encouraging, they mask a sharpincrease in activity in January and a slowdown in February. The value ofcleared cheques, for example, rose over the first two months overall, but thisincrease comprised a 6.4% year-on-year rise in January and a 6.1% declinein February.

As well as weak national accounts data, the accuracy of consumer price infor-mation is a matter of some concern. Figures are collected and presented by theCentral Administration of Statistics—part of the planning ministry—but thebody is understaffed and poorly resourced, and the data provided are treatedwith some scepticism. Nevertheless, the data do provide evidence of generaltrends, and prompted the Ministry of Economy and Trade to claim in Februarythat consumer prices fell by 2.2% over 2000. Briefed by the ministry, the localpress reported that the fall in prices was a result of the cuts in tariffs introducedshortly after the government led by Rafiq al-Hariri came to power. While thecuts undoubtedly supported the fall, they were only brought into effect inNovember, and did not directly affect many of the agricultural goods whoseprices fell during the year. Instead, last year’s downward trend again seems toreflect weak local demand, as well as the strength of the dollar-peggedLebanese pound against the euro, which lowered local-currency import pricesfor a range of goods. The tariff cuts should support lower consumer prices over2001, however, and figures issued for January suggest that prices fell by afurther 0.22% compared with December.

Foreign trade and payments

Import spending remained almost flat over 2000 as a whole, at US$6.22bn (cif),compared with US$6.21bn in 1999, according to fresh data released by Banquedu Liban (the central bank). However, the figures mask a rising trend, whichsaw import spending in 2000 run ahead of 1999 levels throughout the finalthree quarters of the year. For much of the year the growth in spending appearsto mark the impact of rising import prices, especially for oil, with the bench-mark Dated Brent blend rising by more than 60% during 2000, compared withits 1999 average. There has been some local suggestion of an increase in dom-estic import demand, but low import volume figures (see Economic trends)suggest that both consumer and capital good spending remained weak.

Following the introduction of the tariff cuts at the end of November the up-ward trend accelerated further. Over the last three months for which data areavailable (December-February) spending rose to US$1.66bn, compared withUS$1.44bn for the same period of the previous year, an increase of more than15%. As well as an increase in import demand, the additional spendingreflects a rise in the dollar prices of the many goods imported from the eurozone while the euro strengthened over late 2000 and early 2001. The EU

Consumer prices fall by2.2% in 2000

Trade deficit widens asimports increase

30 Lebanon


remains the main source of Lebanese imports, with Italy accounting for 10.9%of the total bill in the fourth quarter, followed by France with 8.4% andGermany with 8.3%.

Export earnings rose by 4% over 2000, exceeding US$700m for only thethird time in a decade. Despite the gain, the overall performance wasactually a disappointment, after a strong performance over the first half ofthe year put earnings 16.5% ahead of last year’s total. Accounting for theslowdown is difficult, given that oil-driven economic growth in Lebanon’smain export markets in the Gulf (led by Saudi Arabia and the UAE) remainedstrong. There is some suggestion that a recovery in domestic demand in thesecond half of the year may have led producers to focus on local rather thanforeign markets, but there is little anecdotal evidence to support this. A 14%increase in export earnings over the first two months of 2001 would alsosuggest that other factors had an impact. The trade deficit reached US$5.5bnin 2000 for the second year in a row, but widened over the first two monthsof 2001 to US$961m, from US$809m for the same period of 2000, as importspending rose.

External accounts(US$ m)

1999 2000 %1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year change

Exports 135 154 179 209 677 163 174 185 183 704 4.08

Imports (cif) –1,541 –1,492 –1,618 –1,554 –6,205 –1,429 –1,533 –1,638 –1,624 –6,224 0.31

Trade balance –1,406 –1,338 –1,439 –1,345 –5,528 –1,266 –1,360 –1,453 –1,441 –5,520 –0.15

Net transfers & capital flows 1,803 1,228 1,547 1,671 6,249 1,136 1,345 1,575 1,175 5,231 –16.3

Balance of payments 397 –110 108 326 721 –130 –14 122 –267 –288 –


The scale of the trade deficit—exports amounted to just 11% of import spend-ing in 2000—leaves Lebanon heavily dependent on non-trade flows to hold itsoverall balance-of-payments position in check. The absence of any detailedcurrent-account figures makes it impossible to distinguish between capital andcurrent-account flows, or between equity and debt funds. However, overallbalance-of-payment data suggest that overall net transfers and capital flows fellby more than 16% in 2000. The sharpest drop occurred in the fourth quarter inthe aftermath of the general election, when net flows fell by some US$500mon their 1999 levels. As debt inflows and tourism numbers stood above their1999 levels, this would point towards a sharp drop in investment flows,indicating a downturn in confidence, even among the Lebanese diaspora,which has long been the main source of foreign capital. The downturn ininflows left the balance of payments with a deficit of US$288m, compared witha surplus of US$721m in 1999.

Though the trend is disturbing, the overall values remain small, and the deficitcan be readily met from central bank reserves, which remain large. There is alsosome evidence to suggest that sentiment may have changed, with data for thefirst two months of 2001 showing a balance-of-payments surplus of US$243m,

Net capital inflows aredown sharply in 2000

Gulf states offer additionalsupport

Lebanon 31


despite the widening trade deficit. The external account position has also beenstrengthened by undertakings from foreign lenders and donors to offerLebanon new support. Following the visit of the prime minister, Rafiq al-Hariri,in January to the Gulf—a region in which he has always had a strong personalstanding—Kuwait agreed to renew its US$100m deposit in the central bank foranother three years, and add a further US$100m. The funds, used as supportfor the Lebanese pound, were first offered in 1998 and are deposited at asubsidised interest rate of 5%. Saudi Arabia, which has US$500m on deposit atthe central bank, has also extended support for a further three years.

In addition, the Gulf states have offered to finance two infrastructure projectsin Lebanon. The first, a US$45m upgrade of part of the main east-west highwaybetween Beirut and Damascus, will be funded on concessional terms by theSaudi Development Fund (SDF), which has said that it will cover the cost of85% of the civil works. The Kuwaiti Arab Fund for Economic and SocialDevelopment (AFESD) has announced that it will support the construction of a560-km canal to bring water from Lake Qaraoun in the Bekaa valley to thesouth. What proportion of the estimated US$300-500m cost of the scheme willbe covered is unclear, but in March Lebanon was preparing tenders for theproject, with work optimistically scheduled to begin this year.

Mr Hariri’s longstanding relationship with the French president, JacquesChirac, has also opened the way to new funding from the EU. Followingtwo meetings in Paris in February under Mr Chirac’s auspices, Mr Hariri saidthat Lebanon had been granted €500m (US$443m) to support the economicreform programme. The pledged funding was divided evenly between theWorld Bank, the EU—via the Middle East and North Africa (MENA) pro-gramme—and the European Investment Bank (EIB), with 70% in the form oflow-interest loans and 30% as direct grants. While sources suggest thatMr Hariri had hoped to raise closer to US$1bn from the visit, the €500mpledged remains a significant gain, and a marked improvement on theprevious administration’s efforts to generate support from allies abroad.

The financial support is the latest sign of steadily strengthening economic tiesbetween Lebanon and the EU. Lebanon has been part of the MENA programmesince its inception, and has been negotiating an association agreement withthe EU for several years. Under such an agreement, Lebanon would join otherMediterranean countries in becoming part of an EU-wide free-trade block,receiving financial support for the restructuring of its own economy beforetrade barriers are lowered. Discussions have accelerated since Mr Hariri came topower, and last year’s import duty cuts have removed many of the mainobstacles to an agreement being reached. Some issues—notably a reduction intariffs for agricultural goods, reform to the companies law and access to thelabour market for EU nationals—have yet to be resolved. However, Mr Haririand the EU appear confident that an agreement will be concluded over the firsthalf of this year. Meanwhile, on a visit to Beirut, the president of the EUcommission, Miguel Moratinos, said that a donor conference would meet todiscuss aid for Lebanon by December 2001.

Hariri gets €500m in Parisaid pledge

EU association agreementexpected this year

32 Lebanon


Lebanon sold a further US$200m in foreign debt in February, re-opening theUS$400m Eurobond sold in December 2000. The sale lifted Lebanon’s stock ofsovereign Eurobonds to US$5.3bn, and the government has asked parliamentfor permission to issue as much as US$2bn over the coming year. The next saleis likely to occur in April, when a three-year US$500m Eurobond sold in 1998matures. The government will issue a Eurobond to roll over the maturing debt(and may in fact issue as much as US$750m to boost its net debt holdings).Despite the parlous state of the government’s accounts—which in February sawFitch-IBCA become the latest of the international ratings agencies to down-grade Lebanon’s external debt—the February issue was oversubscribed anddemand is likely to be sufficient to cover the value of the April sale. TheFebruary sale was co-managed by Credit Suisse First Boston and JP Morgan andwas placed mainly with local banks, with the bonds offering a 9.5% coupon.The government also expressed an interest in issuing yen-denominated“Samurai” bonds following Mr Hariri’s visit to Japan in January, but no furtherprogress on the plan has been apparent.

New US$200m bond sale,despite downgrade

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