LEBANON Lebanon Public Disclosure Authorized ECONOMIC Sinking MONITOR (To the Top 3) Public Disclosure Authorized Spring 2021 Public Disclosure Authorized Public Disclosure Authorized Middle East and North Africa Region Lebanon Economic Monitor Lebanon Sinking (To the Top 3) لبنان يغرق )نحو أسوأ ثالث أزمات عاملية( Le Naufrage du Liban (Top 3 des pires crises mondiales) Spring 2021 Global Practice for Macroeconomics, Trade & Investment Middle East and North Africa Region 1818 H Street, NW Washington, DC 20433 LEBANON ECONOMIC MONITOR Document of the World Bank The Deliberate Depression Fall 2020 Middle East and North Africa Region TABLE OF CONTENTS Acronyms . vii Preface . ix Executive Summary . xi xv . الموجز Résumé . xix 1 . The Policy Context . 1 2 . Recent Macro-Financial Developments . 3 Output and Demand . .3 Fiscal Developments...........................................................................4 The External Sector ............................................................................9 Money and Banking . .11 3 . Global Crises Comparators: Looking for the Minimum . 19 Per Capita Output ............................................................................21 Depreciation-Inflation . .22 Fiscal . .23 Debt ........................................................................................24 External Position . .24 Overall ......................................................................................25 4 . Outlook and Risks . .27 The FX Subsidy . .28 Large Scale Interruptions to Vital Public Services . .28 Special Focus I: FX Subsidy Reform in the Deliberate Depression . .31 Background . .31 Macroeconomic Considerations ................................................................32 Design a Broad-Coverage Subsidy Reform Compensation Scheme . .36 iii Implementing Broad-Coverage Subsidy Reform Compensation Scheme . .38 Complementarities between the BC-CT Program and other SSN Programs ...........................39 Special Focus II: Public Service Delivery in the Deliberate Depression . 41 The Electricity Sector . .41 Water and Sanitation..........................................................................42 Education . .43 Annex . 47 Forecasts of Lebanon’s Real GDP Growth Using MIDAS Regressions: An Update for 2020 and 2021 47 Dynamic Response of Inflation to Currency in Circulation in Lebanon................................51 Unit Root Tests . 51 VAR Variables in Difference . .52 VAR Variables in (Log) Levels . 53 The Cointegrated VAR: Vector Error Correction Model . 55 References . 57 Global Financial Crises Episodes . .58 The Argentinian Banking Crisis of 1980 . 58 The Philippines Financial Crisis of 1981 . 59 The Mexican Debt Crisis of 1981–82 . 60 The Chilean Banking Crisis of 1981 . .61 The Venezuelan Banking Crisis of 1994 . 63 The Argentinian Financial Crisis of 2001–02 . 64 The Uruguayan Banking Crisis of 2002 . 64 The Greek Financial Crisis 2009 . .66 References . 67 List of Figures Figure 1 While the Contraction in Real GDP Commenced in 2018, it Accelerated Sharply in 2020 . .4 Figure 2 Net Exports are Expected to Be the Sole Positive Contributor to Real GDP . .4 Figure 3 Firm Status . .5 Figure 4 Large Shortfalls in Revenues Will Induce a Significant Deterioration in the Fiscal Position......10 Figure 5 Valuation Effects from Exchange Rate Depreciations Will Pressure the Debt-to-GDP Ratio . .10 Figure 6 A Steady Depletion in the Gross Foreign Exchange Position at BdL. ........................11 Figure 7 Ratios of C1, C2b, Luxury and Other Imports Were Stable Until the Period Leading to the Crisis… ................................................................11 Figure 8 …when Ratios of C1 and C2b Imports Rose at the Expense of those for Luxury and Other Goods.....................................................................11 Figure 9 A Sharp Depreciation in the Exchange Rate along with Surging Inflation and Narrow Money 13 Figure 10 Inflation in Basic Items is a Key Driver of Overall Inflation, Hurting the Poor and the Middle Class.....................................................................13 Figure 11 Food Expenditure Shares by Deciles for Lebanese Nationals . .13 Figure 12 Heavy Deleveraging of Assets (Private Loans) and Liabilities (Private Deposits) in Financial Sector ................................................................... 17 Figure 13 A Steady and Sharp Deterioration in Credit Performance as Measured by NPL Ratio for Banks ...............................................................18 iv LEBANON ECONOMIC MONITOR: LE NAUFRAGE DU LIBAN (AU NUMÉRO 3)/LEBANON SINKING (TO THE TOP 3) Figure 14 Lebanon’s Real GDP is a More Accurate Reference Point for the Start of the Financial Crisis than Real GDP/Capita . .21 Figure 15 Real GDP Per Capita for G8 Plus Lebanon . .22 Figure 16 Real GDP Per Capita for G8 Plus Lebanon . .22 Figure 17 CPI Indices for G8 Plus Lebanon.......................................................23 Figure 18 Overall Fiscal Balance for G8 Plus Lebanon .............................................23 Figure 19 CPI Indices for G8 Plus Lebanon.......................................................23 Figure 20 Overall Fiscal Balance for G8 Plus Lebanon .............................................24 Figure 21 Gross Debt for G8 Plus Lebanon.......................................................24 Figure 22 Current Account Balance for G8 Plus Lebanon . .25 Figure 23 A Steady Depletion in the Gross Foreign Exchange Position at BdL.........................33 Figure 24 Upon Removal of FX Subsidy, Direct Effects on Inflation Are Substantial.....................35 Figure 25 Proposed Monthly Benefit Amount (US$), and Coverage (%), by Year .......................37 Figure 26 Compensation Program Outlay and Net Savings from Phase I Subsidy Withdrawal, US$ mn 37 Figure 27 Evolution of High Frequency Indicators Used to Nowcast and Forecast Lebanon’s Real GDP Growth in 2020.............................................................48 Figure 28 Growth of High Frequency Real Economy Indicators Used to Nowcast and Forecast Lebanon’s Real GDP Growth in 2021 . .50 Figure 29 Time Series Dynamics of the Variables in Changes .......................................53 Figure 30 Responses to a 1 Percent Increase in the Growth of Currency in Circulation .................54 Figure 31 Time Series Dynamics of the Variables in Log Levels . .55 Figure 32 Responses to a 1 Percent Increase in the (Log of) Currency in Circulation...................56 Figure 33 Responses to a 1 Percent Increase in (the Log of) Currency in Circulation from a VECM . .57 List of Tables Table 1 Average Change in Full-Time Employees by Gender for All Firms Surveyed. .6 Table 2 Summary of Fiscal Accounts Showing Actual Numbers, WB Estimates and Government Budgets..................................................................8 Table 3 Crisis Severity: Percent Decline in Per Capita GDP, Duration of Contraction, and Years to Full Recovery in 25 of the Worst Systemic Banking Crises, 1857–2013..........20 Table 4 Selected Macroeconomic Indicators for Lebanon; 2016–2021 .............................29 Table 5 Cost of FX Import Subsidy and Impact of its Removal .....................................32 Table 6 Real GDP Growth Forecasts for 2020...................................................48 Table 7 Candidate Predictor Variables for the Real High Frequency Indicators . .49 Table 8 Forecasts of Real GDP Growth for 2021 Using Real Activity Indicators . .49 Table 9 Forecasts of Real GDP Growth for 2021 Using Real Activity and Financial Indicators..........51 Table 10 Unit Root Tests ......................................................................52 Table 11 Cumulative Effect of a 1 Percent Increase in Currency in Circulation on Inflation..............52 Table 12 Cumulative Effect of a 1 Percent Increase in Currency in Circulation on Inflation..............54 Table 13 The Johansen (1988) Trace Statistic . .56 Table 14 Cumulative Effect of a 1 Percent Increase in Currency in Circulation on Inflation..............57 List of Boxes Box 1 The Impact of Multiple Crises on Formal Firms and the Labor Market in Lebanon..............5 Box 2 Lebanon’ 2021 Budget Draft Proposal...................................................8 Box 3 Impact of Crises on Poverty . .13 Box 4 The Most Recent Financial Operation by BdL with Commercial Banks . .14 TABLE OF CONTENTS v ACRONYMS AER Average Exchange Rate LBP Lebanese Pound BdL Banque du Liban LEM Lebanon Economic Monitor BoP Balance of Payments MIDAS Mixed-Data Sampling CA Current Account MoET Ministry of Economy and Trade CBP Central Bank of the Philippines MTO(s) Money Transfer Operator(s) CBV Central Bank of Venezuela NGO(s) Non-governmental Organizations CD(s) Certificate of Deposit(s) NID National ID CFF Compensatory Financing Facility NIR Net International Reserve CPI Consumer Price Index NPL(s) Non-performing Loan(s) CSI Crisis Severity Index NPTP National Poverty Targeting Program DBP Development Bank of the Philippines NSSF National Social Security Fund ECB European Central Bank O&M Operation and Maintenance EdL Electricité du Liban PEP(s) Politically Exposed Person(s) EFF Extended Fund Facility PISA Programme for International Student EFF Extended Fund Facility Assessment EMU European Monetary Union PMI Purchasing Manager’s Index ES Enterprise Survey PNB Philippines National Bank ESSN Emergency Crisis and COVID-19 PoB Port of Beirut Response Social Safety Net Project POS Point-of-Sale FCV Fragility, Conflict, and Violence Pp Percentage Points FI(s) Financial Institution(s) PSI Private.