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Lebanon: Selected Issues © 2006 International Monetary Fund June 2006 IMF Country Report No. 06/200 Lebanon: Selected Issues This Selected Issues paper for Lebanon was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on April 19, 2006. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Lebanon or the Executive Board of the IMF. The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information. To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to [email protected]. Copies of this report are available to the public from International Monetary Fund ● Publication Services 700 19th Street, N.W. ● Washington, D.C. 20431 Telephone: (202) 623 7430 ● Telefax: (202) 623 7201 E-mail: [email protected] ● Internet: http://www.imf.org Price: $15.00 a copy International Monetary Fund Washington, D.C. ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution INTERNATIONAL MONETARY FUND LEBANON Selected Issues Prepared by Edward Gardner, Joannes Mongardini, Tushar Poddar, Juan Solé, Julian di Giovanni, and Axel Schimmelpfennig Approved by the Middle East and Central Asia Department April 19, 2006 Contents Page I. Overview ................................................................................................................................3 II. Balance Sheet Analysis of Lebanon’s Vulnerabilities..........................................................4 A. The Balance Sheet of The Public Sector.....................................................................4 B. The Balance Sheet of the Private Financial Sector.....................................................8 C. The Balance Sheet of the Private Non-Financial Sector...........................................10 D. Conclusions and Policy Implications........................................................................11 III. Interest Rate Determination in Lebanon............................................................................16 A. Introduction...............................................................................................................16 B. Theoretical Background............................................................................................17 C. Empirical Strategy ....................................................................................................17 D. Trends in Interest Rates ............................................................................................19 E. Results.......................................................................................................................24 F. Conclusions...............................................................................................................25 References.......................................................................................................................27 IV. A Stochastic Approach to Debt Sustainability ..................................................................28 A. The Model ................................................................................................................29 B. Conclusions...............................................................................................................32 References.......................................................................................................................33 V. Macro and Microeconomic Aspects of Competitiveness in Lebanon ................................34 A. Competitiveness and External Sustainability............................................................34 B. Macroeconomic Aspects of Competitiveness...........................................................35 C. Microeconomic Aspects of Competitiveness............................................................39 D. Policy Conclusions....................................................................................................44 References.......................................................................................................................45 ©International Monetary Fund. Not for Redistribution - 2 - Tables II.1. Foreign Currency Positions............................................................................................7 II.2. Foreign Currency Liquidity ...........................................................................................8 II.A.1. Sectoral Balance Sheet Matrix, December 2003 .........................................................12 II.A.2. Sectoral Balance Sheet Matrix, December 2004 .........................................................13 II.A.3. Sectoral Balance Sheet Matrix, June 2005 ..................................................................14 II.A.4. Sectoral Balance Sheet Matrix, December 2005 .........................................................15 V.1. Growth Competitiveness Index, 2005 ..........................................................................40 V.2. BMI Composite Risk Scores and Rankings.................................................................40 V.3. Ranking in World Bank Doing Business Survey, 2005...............................................41 V.4. World Bank Doing Business Survey, 2005 .................................................................42 V.5. Governance Indicators, 1996-2004..............................................................................43 V.6. Minimum Wages and Per Capita GDP in Emerging Markets, 2002...........................44 Figures II.1. Government Debt...........................................................................................................5 II.2. Primary Fiscal Balance and Debt-Stabilizing Primary Fiscal Balance..........................5 II.3. Government Creditors....................................................................................................5 II.4. Maturity Structure of Government Debt........................................................................6 II.5. Composition of Assets of Commercial Banks...............................................................9 II.6. Banks’ Foreign-Currency Exposure to the Sovereign .................................................10 III.1. Interest Rates, May 1995–January 2005......................................................................20 III.2. Gross Foreign Exchange Reserves and M5, May 1995–January 2005 .......................21 III.3. Interest Rate, Deviations from Trend of M5 (in percent) and Gross International Reserves (in logs), May 1995–January 2005............................................................23 IV.1. Adjustment Scenaio's Debt-to-GDP Confidence Intervals: Temporary Shocks, 2005–11.......................................................................................................31 IV.2. Adjustment Scenario's Debt-to-GDP Confidence Intervals: Permanent Shocks, 2005–11.......................................................................................................31 V.1 Current Account and Capital Account Balances, 1995–2005 .....................................34 V.2. Saving-Investment Gap, 1997–2005............................................................................35 V.3. LL/USD Exchange Rate, 1995–2005 ..........................................................................36 V.4. Mashreq Region: Nominal and Real Effective Exchange Rates, January 1995– December 2005.........................................................................................................37 V.5 Mashreq Region: Non-Oil Export Performance, 1995–2005 ......................................38 V.6. Mashreq Region: Real GDP Growth, 1995–2005 .......................................................38 V.7. Unemployment Distribution by Age, 2004..................................................................43 ©International Monetary Fund. Not for Redistribution - 3 - I. OVERVIEW 1. The four papers below helped inform the Article IV consultation discussions in regard to the evolution of macroeconomic vulnerabilities in Lebanon (first paper), interest rate determination (second paper), the debt sustainability assessment (third paper), and the scope for competitiveness gains to sustain growth throughout the process of fiscal adjustment (fourth paper).1 2. The first paper provides an update of the vulnerability assessment carried out for the 2004 Article IV consultation based on the balance sheet approach. The main conclusions are that: (i) the solvency of the state and the high mutual exposure between the government and the domestic banking system remain the key vulnerabilities (distress in one of these sectors would rapidly be transmitted to the other one); and (ii) balance sheet risks have generally increased since end-2003. 3. The second paper explores interest rate determination in Lebanon, and in particular the strength of the link to international interest rates, and thus exposure to international interest rate shocks. The econometric investigation confirms that the level of gross international reserves, government debt, and liquidity conditions are key determinants of domestic interest rates, all with the expected signs. Domestic interest rates also react to movements in international
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