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Lebanon publishes ambitious Reform Programme
- 4th, May, 2020
The Lebanese government published 52-page Reform Programme at the end of April, spelling out how it plans to lift the country out of its current crisis and set the economy on a sustainable path.
Among the most striking features of the programme are those that deal with the Banque du Liban – the central banking authority – and the commercial banks. The document exposes the measures that have been used by the BdL in recent years to maintain its appearance of solvency, and it proposes debt write-offs for the commercial banks that will wipe out their capital at a stroke.
The programme assumes that the exchange rate moves to $1 = LP 3,500 and then devalues by 5% per year. The dollar peg, in place since the early 1990s, has been $1 = LP 1,500.
The programme says that foreign holders of Eurobonds are expected to suffer significant losses.
The summary below follows the structure of the original document.
The original document is attached at the foot of this post.
A. Programme Objectives and Strategy
- The programme rests on nine central and interrelated pillars that include unpegging the Lebanese pound, a comprehensive debt restructuring, and comprehensive structuring of the financial sector to address accumulated FX mismatches in both the central bank and the commercial banks, and fiscal adjustment.
B. Exchange rate and balance of payments dynamics
1. Exchange rate and monetary policy
- The programme uses an exchange rate of $1 = LP 3,500 as its starting point, while recognising that the informal rate is currently around $1 = LP 4,400. Moving forward, the government will devalue the Lebanese pound by a further 5% each year.
- Capital controls will start to be lifted in 2021. Meanwhile, the controls that are currently in force, and which were introduced ad hoc by banks last year, will be reviewed to make them more consistent and fairer.
- The Programme expects that inflation will reach 53% in 2020 due to the pass-through effects of the exchange rate devaluation.
2. Balance of payments and external support
- The Programme says that, “It is difficult to imagine Lebanon coming out of such a deep crisis without the support of the international community at large.”
- Net external financing needs over the next five years are projected at around $10 bn under an optimistic scenario.
- The programme says that, “A recovery programme outside of an IMF programme…would fall short the main objective of giving a fresh start to the Lebanese economy while putting it on a viable long-term trajectory
C. Medium Term Macro-economic framework
- The framework assumes that Lebanon will benefit promptly from external financial support, and that it will successfully implement the comprehensive package of reforms and decisive actions that are described in the programme.
- Output is expected to decline in real terms by 13.8% in 2020 and 4.4% in 2021.
- The government deficit is expected to narrow from 11.3% of GDP in 2019 to 5.3% in 2020 and further to 0.7% by 2024
D. Economic Policies
1. Fiscal Policy
- Tax receipts as a percentage of GDP will fall to 13.6% in 2020, from 16.2% in 2019, but will rise to 15.2% in 2024.
Expenditure reduction measures
- Subsidies to Electricité du Liban will be eliminated (these were $1.5bn or 2.9% of GDP in 2019) and electricity will be provided 24/7.
- Reduce the wage bill by implementing a freeze on the hiring of new public employees, revising benefit packages, and freezing the headcount of military personal.
- Halve the cost of government pension schemes (that accounted for 36% of total personnel costs or 4.7% of GDP in 2019) by inter alia reallocating military retirement expenditure and abolishing the early retirement scheme.
- Rationalise and reform public entities such as railways & public transportation, university, etc.
- The fiscal reform package will be accompanied by social safety net measures to protect the most vulnerable groups.
- Improve customs collection, improve VAT collection, ‘normalise’ tax compliance measures, increase tax thresholds (e.g. raise the income tax on high salaries by 5% to 30%), recover at least $10bn of ‘stolen assets’ over the next five years.
2. Public Debt Restructuring
- Principal and interest payments on Eurobonds will be suspended.
- Domestic debt will be rolled over to longer maturities, and interest will be paid at a reduced rate.
- Debt service to multilateral lenders, which is not great, will be maintained.
- As a result of debt restructuring, debt will fall from 175.6% of GDP in 2019 to 102.8% of GDP. It will decline to 95.6% in 2025 and 68.5% in 2030.
3. Financial Sector Restructuring
- The progrmme says that, “The Lebanese economy needs a healthy and dynamic banking sector and a strong central bank to grow again. All accumulated losses have to be identified and addressed forcefully.”
- Bail-out is not an option. No foreign assistance will be available to cover a home-made financial collapse. Furthermore, the size of the accumulated losses prevents a domestic bail-out.
- Over the coming weeks, the government will elaborate a granular and detailed plan that will take into consideration the situation of each of the largest banks.
- The BdL has embedded losses of $44bn arose from two sources. First, losses against future seignorage revenues that were carried forward. Second, losses from financial engineering operations with local banks (essentially paying high rates of interest to attract foreign exchange deposits from the commercial banks) that were carried forward and amortized against future revenues.
- The BdL’s financial position will be restored in part through writing down banks deposits and in part through revenues that will be generated over time by the restructuring and privatisation of public assets. (This restructuring and privatisation process will be conducted by a newly created Public Asset Management Company, whose profits will go to the BdL.)
- An independent Asset Quality Review will be conducted of commercial banks assets. Taking into account the restructuring of public debt held by the banks, and assuming an impairment of 30% In the bank’s credit portfolio (residents and non-residents) the total losses of the banking system are expected to be LP 186 tn (thousand billion)
- These losses will be mitigated in the first instance by writing off shareholders and preferred shareholders. This will account for LP 31 tn.
- The assets of 98% of the accounts of depositors will be preserved. (That is, 98% of accounts, not 98% of deposit balances – the top 2% hold a hugely disproportional percentage of deposit balances.)
- Interest paid over the last five years on dollar deposit accounts in excess of an annual amount of $50,000 will be clawed back.
- Bank owners will be required to re-inject an amount equivalent to the dividends they received between 2016 and 2020 if they wish to be a role in the recapitalisation of their banks.
- Transactions exceeding $1mn conducted by a variety of high-profile figures (public officials, bank directors, those licensed to manage public resources, etc) will have their accounts reviewed.
- Large depositors will be offered various options, including conversion of part of their deposits to equity, conversion into long-dated subordinated obligations with low or no interest, or conversion into an equity stake in a new Recovery Fund that will receive proceed of ill-gotten assets.
- Recapitalisation of the banking sector will require new legal powers for the government and supervisory bodies.
- A key aim of the structural reforms is to achieve a smaller, more robust banking sector.
- Banks will be asked to present business plans for restructuring/recapitalisation including mergers with or acquisitions by domestic or foreign banks. The government and supervisors will take action to force mergers is necessary. Foreign players will be welcome.
- The government will consider the issuance of five new commercial banking licenses subject to them having equity of at least $200mn, 50% of which should be new money.
4. Reforms to promote a new economic growth model
- 22 measures that the government is currently implementing, including updating the public procurement law, introducing a competition and consumer protection law, developing a new customs strategy and aw including a e-single window.
- 13 short term action items to support the economy in the context of Covid-19
- 6 ‘transversal reforms’ addressing issues such as land management digital transformation of the government, customs reforms and combatting corruption.
- 6 sectoral strategies addressing trade & investment relations, industry, agriculture, tourism, financial services, and the knowledge economy.
- 12 sectoral reforms addressing the judiciary system’s governance, environmental prosecution (to enforce environmental standards), quarrying, oil and gas, electricity, telecommunications, capital markets, solid waste, air quality, water, biodiversity and climate change, and chemical management.
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