Investment bank blames expansion of budget deficit to 14 percent of GDP on last summer's war

Mar. 09, 2007- A recently published report from global investment bank Standard Chartered expressed concern about the ability of Prime Minister Fouad Siniora's government to push for fiscal and economic reforms amid the acute political division in the country. The three-month-long standoff between government supporters and opposition parties has crippled Lebanon's already battered economy and damaged the prospects of quick reforms needed to speed the receipt of international aid.

Siniora managed on January 25 to garner $7.6 billion in pledges from donor states at the Paris III conference.

However, the momentum soon evaporated as opposition groups threatened to carry out a nationwide civil disobedience campaign if their demands for power-sharing are not met.

International credit-rating agencies warned the government that any delay in reforms would only complicate the task of correcting fiscal imbalances.

Central Bank governor Riad Salameh warned earlier that the absence of a political consensus would hurt the prospects for economic recovery.

Other analysts stressed that soft loans pledged by the donor states may not be forthcoming if the Parliament does not approve new laws on tax reform and privatization.

International investment bank Standard Chartered did not hide its concern about the political deadlock in Lebanon.

In its last report on Lebanon, the bank said that the country's fiscal and debt positions had deteriorated markedly in 2006 owing to the summer 2006 war with Israel. The budget deficit widened to 14 percent of GDP, from 7.9 percent in 2005.

"Revenues fell as a result of a war-related drop in customs revenue and VAT receipts, while expenditure increased by 16.4 percent year on year," the bank's report said.

It added that the conflict's impact on the fiscal and debt position was twofold, causing both higher financing needs and sharp contraction in GDP, which resulted in an increase of the debt-to-GDP ratio.

Final figures for 2006 show that debt increased to 181 percent of GDP.

"Positively, there was strong international support at the Paris III donor's conference held at end-January, when $7.6 billion was pledged in grants and concessional loans.

During the conference, the Lebanese government announced a structural and fiscal reform package aimed at reducing debt to manageable levels, including tax reform and a privatization program. The main purpose of Paris III was to refinance Lebanon's debt, although some level of the aid will be directed towards reconstruction," the report said.

It added that while international financial support has been strong, political tensions have been running high and arguably sectarian tensions are at their highest level since the end of the Civil War. The report recounted all the major security incidents in Lebanon that have contributed to the tense situation in the country.

Furthermore, Hizbullah has been looking for greater political representation following the group's self-proclaimed victory over Israel last year and is calling for the formation of a national unity government.

The report stressed that the financial market weathered all the shocks thanks to the Central Bank's monetary policy and huge foreign currency reserves.

It added that the Central Bank has generally remained on the margins of the foreign exchange market. Foreign reserves are at record highs, standing at $13.1 billion at mid-February, up 13 percent year on year, bolstered by the international pledges and remittances.

"The strong reserve levels will continue to support the US dollar peg. Furthermore, short-term aid disbursements linked to Paris III will not be dependent on progressing with reform program.

The government indicated to the donors that they should expect little progress at the initial phase of the 5-year development plan," the report said.

"Consequently, as with the Paris II aid round, without progress on fiscal reform, the international support will result in only short benefits to the debt position. The aid package is likely to result in an improvement in the debt servicing position."