Questioning the 2019 Budget

The Council of Ministers has forwarded to Parliament a draft budget for the 2019 fiscal year. This draft is presented as a sign of the Government’s willingness to tackle and initiate the economic reform process and respect its commitment to reduce the size of public deficit, as stated during the CEDRE donor conference. 

Our concerns are three-fold: 

First, we are concerned about the fiscal health of the 2019 draft budget, notably the budget exercise’s sincerity and its underlying assumptions and calculations. 

• There seems to be ample signs that GDP growth this year will not reach the budget’s estimates of 1.2% growth. The IMF has similarly estimated growth projections for 2019, as of April 2019, at 1.3%. 

• 2019’s budget entails a 15.67% rise in government revenues to be achieved through introducing new taxes and public service fees in addition to raising rates on existing measures. Given the weak economic backdrop that these measures are being introduced in and the fact they have not been applied over a full year we don’t see that they will achieve their targeted returns.

• The BDL has been monetizing government debt for years now in stark contrast to conventional monetary policy guidelines leading to a quasi-fiscal deficit. BDL has communicated through its balance sheet that it has paid USD 2.152Bn on behalf of the Treasury in Eurobond coupon payments and maturities since the start of 2019.

Furthermore, an additional LBP 11,000 Bn issuance at a cost of 1% is planned in which banks have not agreed upon yet and if they fail to do so BDL has to subscribe to leading to a continuation of the quasi-fiscal deficit transfer; this will also entail the need for BDL to supply the Treasury with USD 1.5Bn to finance Eurobonds maturing in November 2019 excluding coupons. Taking the specificity of Lebanese sovereign debt we are concerned by the moral hazard these operations create.

Our second concern revolves around the country’s monetary environment. 

• The Lebanese monetary model is dependent on dollar inflows in order to maintain the currency peg; however, these inflows have reversed over the past two years. This raises the question of the sustainability of the peg as BDL burns through its dollars to defend it. As such we question this allocation of BDL’s reserves given that the cost of maintaining the peg is rising as the balance of payments deficit grows.

Our third concern is focused on the health of Lebanon’s banking sector. 

• Lebanon’s sovereign credit rating has already been downgraded by one of the three major rating agencies to CCC. Upon further downgrade by another agency, and knowing that the Lebanese banking system has vowed to comply with the Basel Accords, the levels and availability of the capital injections needed to maintain compliance should be very hard to meet.

• The Lebanese commercial banking sector has been reliant on BDL’s unconventional polices to generate a big part of their profits. Given that this has disincentivized the sector from seeking other sources of profits we ask about the risk of a sharp drop in banks’ profitability when BDL ceases these policies and the possibility of banks acquiring riskier assets to cover up for that loss when It materializes.