DONOR'S PREPARATORY MEETING FOR SOUTHERN LEBANON

Thursday 27 July 2000

The liberation of South Lebanon And Its impact on future economic development

By

GEORGES CORM

Minister of Finance


The Lebanese economy has dramatically suffered since the end of the sixties from different types of violence and armed conflicts linked to the Arab-Israeli conflict, the Cold War, Middle Eastern geopolitical rivalries and the disfunctionning of its own sectarian socio­political system. Famous for being the Switzerland of the Orient, the financial centre and the commercial entrepot of the Middle East, the Lebanese economy was exposed to a succession of destructive blows. The first one took place on December 1968 when an Israeli attack on Beirut International Airport destroyed Middle East Airlines civilian fleet. The last ones took place successively in June 1999, February and May 2000 with Israeli attacks on Lebanon electricity infrastructure. As one can notice, these attacks were targeted at damaging Lebanon economic potential and its regional role.

The Israeli army occupied part of South Lebanon in spring 1978; Beirut was besieged and bombed during a second Israeli invasion in summer 1982 to uproot PLO presence in Lebanon. When Withdrawing from Central Lebanon in 1984/85, the Israeli army enlarged its occupation of South Lebanon.

Between 1975 and 1990 domestic armed militias inflicted continuous economic damages to both private and public sectors institutions; attacks on private and public property, ransoming of private sector and depriving the public sector from its sources of revenues have been generalised to all parts of the country. When national consensus was reinstated and implemented in October 1990 through regional efforts, the Syrian umbrella and the Saudi and American support, Israel occupation of the South of Lebanon continued. The Lebanese economy had to endure heavy reprisals by the Israeli army to act of legitimate resistance by the Lebanese fighters of the occupation. Thus, very severe blows were inflicted to the economy through large hostilities by the Israeli army in 1993 and 1996 and in 1999/2000.

During the last 32 years, Lebanon has shown an amazing resilience in maintaining the functioning of its political as well as economic system. The political system of Lebanon as a parliamentary democracy has resisted all the years of turmoil assuring political continuity and the survival of the Republic of Lebanon regionally and internationally. In 1989, the Constitution was renovated after the Taef Agreements. The Lebanese free enterprise system has also survived and Lebanese businessmen have shown during all these year a great sense of patriotism and a great management capacity under the most difficult circumstances. This represents one of the most valuable assets for future economic development.

During all these years, the Republic of Lebanon never defaulted on its domestic or international debt, no exchange control was introduced and the economic and financial system remained free of any government restriction. The banking system of the country resisted all the turmoil of the last 30 years and is back to its pre-war dynamism and vitality with a renewed presence of international banks. After a dramatic decline of banking assets between 1984 and 1989 from $ 12 billion to $ 4.5 billion, banking assets stand to day at $ 40 billion. Deposits represent 220% of GDP. The central Bank of Lebanon continued to operate daily without any interruption during all the period even in the worst days of fighting. Gold reserves were preserved. A law adopted by Parliament in 1985 and which has not been repealed prohibits the government from disposing in any form of the Central Bank gold assets. Central bank reserves of foreign currencies have now reached the historical level of $ 7 billion (excluding gold holdings), representing more than one year of imports.

However, there is a price to be paid for all these years of turmoil and destruction. Reconstruction effort that was deployed since 1992 by previous governments were done at a high cost due to inflation that has only been subdued in the last four years and due to the lack of fiscal discipline. It was assumed in 1992 that peace on all fronts of Arab Israeli Conflict was imminent through the Madrid Peace process and that Lebanon would immediately recover its pre-war position in the Middle East through rebuilding and enlarging its traditional physical infrastructure centered in its capital Beirut. The dramatic economic changes that had taken place in the region and in the world economy were not sufficiently taken into account. Continuous conflict and hostilities due to Israeli occupation of South Lebanon contributed also to decreasing growth rate in the economy.

After an outburst of high growth rates (1991-1995) centered on the luxurious segment the of real estate sector, flows of foreign direct investment (FDI) by Lebanese expatriates or Arab and International corporations or wealthy individuals, began to dwindle. At the same time the increasing financial needs of the Government led to higher real interest rates as inflation was decreasing. However, in 1997 and 1998, the previous Government, in spite of difficult conditions on the international markets due to the Asian and the Russian.

crisis, was able to mobilize substantial amounts of foreign funding through Euro bound issues. These borrowings were at cheaper cost for the Government than domestic borrowings.

Since the election of President Lahoud in October 1998 and the nomination of a new Government in December 1998, several changes of economic policies have taken place to address the main macro-economic imbalances that have affected negatively economic growth in the last decade. This is why it is our feeling that the Israeli withdrawal from the South Lebanon that took place on last May 24 will initiate a new positive era of well-focused economic growth. Lebanon will stop being in the headline news for acts of violence and will now be able to reassert itself as an important regional centre providing new services and goods more adapted to the needs of the global economy and the higher level of development of the neighbouring Arab economies.

While Lebanon was in turmoil in the seventies and the eighties, the Arab economies have undergone tremendous positive changes. Closed and centralized economies like Egypt have liberalized and opened up. The Gulf economies that were lacking basic physical infrastructure, commercial and banking facilities, are now highly developed; industry is also on a growing trend in this region. Thus, Lebanon has now to face strong competition, not only from the global economy, but also from its Arab neighbours with which it has concluded several free trade agreements. Energy and labour costs in Lebanon are higher than in most Arab countries. This is why Lebanon is called upon to enter into a special national effort to recover a competitive edge in the region. With its territory liberated, it can now devote all its numerous energies and capacities to cure its economy from the years of turmoil and suffering as well as from the era of lack of fiscal discipline which began in the middle seventies with the eruption of generalized violence on its territory . Lebanon will recover its full potential to attract Foreign Direct Investments. It is already one of the main recipient countries of Arab direct investment; now that the Israeli army has withdrawn from South Lebanon, the country will no doubt be able to attract more investments from OECD countries.

Lebanon, in the present context, has a great potential both in rehabilitating and modernizing traditional services as tourism, banking and insurance, and in developing the modem services of the new economy, as well as taking more advantage of its water and agricultural resources. The existence of a skilled manpower and a highly educated

multilingual elite, the international commercial and financial network of its business community, both resident and non-resident, the reconstructed physical infrastructure, the richness of its archaeological sites in all parts of its tiny territory, its stable currency and traditional, free enterprise system: all these favourable factors will contribute, no doubt, to an economic renaissance.

We believe that our Government has put in place all the main elements for such a renaissance.

- The reform of the public finances

1. We have produced a fiscal consolidation plan aiming at bringing down the level of domestic and foreign debt under 100% of GD P and the level of budget deficit from 14% to 5% of GDP. This plan has received the support of international financial institutions, namely that of the World Bank. Support has also been expressed by the European Union which has attributed a grant of 50 million Euro as budget support to the Republic of Lebanon.

2. We have implemented a legal framework through which all arrears due by the State to the private sector are to be recognized and cleared. Law 95 of June 1999 has established such a framework and 70% of such arrears has now been paid through handling three years T-bills to the beneficiaries of the arrears. Most of these T-bills have been discounted by the beneficiaries to the banking system. We have thus relieved the economy from this very burdensome situation for the private sector.

3. We are now preparing another legal framework to clear arrears inside the Public sector between autonomous public entities and between the Central Government and the entities and the municipalities.

4. We have begun to implement a full modernization of our outdated and inefficient tax system. The main elements of this modernization are the introduction of V A T and the creation of a global income tax system. This will allow decreasing dependency on custom duties and a number of cumbersome excise taxes and stamp duties. The V A T law has been prepared and forwarded to the Parliament in the hope to begin implementation in year 2001.

5. In addition, an amnesty on tax penalties was introduced last year to improve relations between the taxpayer and the tax administration. Substantial amounts of tax arrears have thus been recovered. We are also preparing a restoration of the status of limitation in relation to tax controls. This status has been waived during the war and not restored by the previous governments. We believe that this tax policy contributes greatly to improving investment climate in Lebanon.

6. We raised very moderately the various income tax rates that were lowered to minimal levels in 1994 in spite of all the financial needs due to reconstruction. At the same; time we have been granting substantial tax incentives. Some of these incentives are targeted to help overcome the deep sluggishness of the real estate sector; others are designed to induce family owned business to introduce shares on the Beirut Stock Exchange or to open their share capital to foreign companies which shares are quoted on a stock exchange.

- Privatization plans

Our Government has also committed itself to implement privatization in a clear and transparent legal framework. In fact, Lebanon never had a large Public sector producing goods and services, as has been the case in most Arab countries. Rather, the role of the Public sector in Lebanon was traditionally confined to providing for the main public services as water, electricity and telephone. Airport transport was in the hand of a private company (MEA) till a few years ago when the Central Bank of Lebanon had to recapitalize the company and land transport has been mainly in the hand of the private sector, especially when train and tramways facilities came at a stop before the war. The previous Government introduced the BOT formula to create and develop cellular phone network, the postal distribution and new services at the Beirut International Airport. However, no overall legal framework has been put in place to regulate the development of Private sector financing capabilities and management skills in the supply of public services.

This is why our Government since taking office has prepared a general law for privatization, which was recently approved by Parliament. The law provides for general rules and procedures applying to the transfer of ownership and/or management of public services to the Private sector. It also stipulates that all receipts accruing from privatization should be applied to reducing the public debt. In addition, our Government has prepared three regulatory laws for the sectors of water, electricity and telecommunications so that strategic investors interested in the management and partial ownership of Public entities to be privatized would know how the concerned economic sectors will be opened to private competition and regulated by the State. The law on water has already been approved by Parliament

We also finalized an agreement with IFC to assist the Government and the Central Bank in divesting their shareholding assets in MEA In addition, the World Bank is appraising a support loan to privatization to assist in the financing of compensation schemes to be paid to redundant personnel in Public entities to be privatized.

We feel that substantial preparatory work has now been conducted for a good implementation of the few privatization operations that will take place in the next years. We hope that the clear legal and regulatory framework that has been prepared will optimise privatization receipts. There were very conservatively estimated at 4.5 billion dollars in our fiscal consolidation plan for years 1999 to 2003. We feel now that the privatization and development of the telecom sector alone could yield 7 to 8 billion dollars in the next few years allowing a substantial reduction in indebtedness

- Interest rates and indebtedness

As mentioned earlier, Lebanon suffers from a high level of real interest rate on its domestic debt, presently standing at around $ 17 billion with an average cost to the Treasury of 13,67%. However, since our Government took office and began to implement its fiscal reform plan, domestic interest rates have been on the decline and the balance of payments turned back positive after a sharp deterioration in 1998. Yields on two years T-bills declined nominally from 16.6% to 14.6%, while on an effective basis they declined from 21.5% to 14.6%.

Today, the domestic debt represents 75% of total indebtedness and foreign indebtedness around 25%, equivalent to $ 5.5 billion. Bilateral official debt represents only $ 456 million and borrowings from International Financial institutions is equivalent to $ 760 million. In total, long-term concessional loans represent only $ 1.2 billion, while the rest of the foreign debt consists of international bond issues. For a country that has been torn by war and regional conflict for so many years, efforts to raise concessional funding have not yielded enough tangible results. We believe that the Liberation of Southern Lebanon should now open access to more concessional loans and grants, so as to reduce the burden of servicing each year more private domestic or international debt at high interest rates.

We also anticipate that the use of privatization proceeds to reduce part of the domestic debt will alleviate the burden that this debt is putting on economic growth. Interest rates will decline, thus reducing the high budget deficit which amount is equivalent to the amount of debt service.

Our Government has also made efforts to diversify and lower the cost of our foreign debt issued on international markets. Last year we were the first Arab borrower to tap the euro sector of the bond market and we intend to issue on the Samurai bond market in the next future. Our policy for foreign borrowing is quite conservative. We do not want to increase our foreign indebtedness above our capacity and in fact, last year, we reduced the amounts borrowed through international bond issues from 1.5 billion in 1998 to 1.2 billion. This year we have proceeded with our first international bond issue at the beginning of July for the amount of $ 500 million and we were able to reopen the 2009 issue of September 1999 for an additional amount of $ 250 million.

Although interest rates on the dollar and the Euro have been on the climb affecting also domestic interest rates on the Lebanese pound and preventing a further decline in rates, we believe that the withdrawal of Israeli troops from Lebanon after 22 years of occupation will definitely have a strong impact on the level of interest rates on the domestic market. The political risk attached to the persistence of conflict, violence and occupation in the South being waved, spreads paid above Libor for dollar deposits in Lebanon and the high spreads existing between interest rates on dollar deposits and those paid on Lebanese pound deposits will inevitably have to be reduced. This will require productivity adjustments on the part of the Lebanese banking system that have been accustomed to high interest rate environment to secure substantial level of profits. Foreign banks are welcomed on the domestic banking market to stimulate competition inside the sector.

As we are anticipating an upsurge in FDI and in Arab and international aid, we believe that decline in interest rate will continue, thus reducing the high cost of financing for both the State and the Private sector.

- Investment climate: the One Stop Shop

Although legislation is very liberal in Lebanon and do not differentiate between domestic and foreign investor ( except in relation to land holding), investors suffer from the weight of bureaucracy and of outdated regulations in many areas that have not been yet modernised. Conscious of this fact and pending legal and administrative reforms to modernise outdated administrative procedures, the Government has established the " One stop shop" system for domestic and foreign investors. IDAL, the Government agency in charge of investment promotion has been entrusted with the sole function of assisting investors in getting through the various administrative procedures required to complete an investment. It has already been successful accelerating quite a few investment operations that were encountering administrative difficulties.

The Government is also preparing special legislation to encourage investment in media, electronics and computers activities. In addition to the tax incentives and policies described previously, tax holiday are available for investment in rural areas or investments for the production of new products.

An economic conference of expatriated Lebanese businessmen was also held on the 5dt of June in Beirut that has attracted many prominent Lebanese form the four continents.

- International aid: more funding needed

We are very grateful that both the Secretary General of the United Nations and the President of the World Bank have declared readiness to assist Lebanon in the reconstruction of the liberated South. Arabs donors have also begun to pour grants and soft loans to rehabilitate the southern part of the country. Private donations have reached the amount of $ 30 million since the first Israeli attack on electricity infrastructure in June 1999. This is good proof of the confidence that Lebanese have in their Government.

As already mentioned, we realize that we need to do more efforts to tap funding from donors countries and this is why we have devoted all of our energies into preparing this first meeting. We hope that through adequate management and monitoring mechanisms of the use of foreign funding we could convince donor's countries to increase their aid to Lebanon. As a country that has been victim of an intractable regional conflict for 32 years, we feel that we have not received our fair share of international assistance. It is our hope that through this first preparatory meeting and then with the larger meeting that we hope to hold in early October, you will assist us in receiving adequate amount of aid to be able to overcome once for all the tremendous damages that have been inflicted on us or that we inflicted to ourselves during these three decades.

Thank you for your kind attention.