IMF Wraps Up Lebanon's 2023 Article IV Consultation

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Lebanon on June 1, 2023.

Lebanon has been facing an unprecedented sovereign-banking-currency crisis, which is ongoing for more than three years. Since the onset of the crisis, the economy has contracted by about 40 percent, the Lebanese lira has lost 98 percent of its value, inflation has been at triple-digits, and the central bank has lost two thirds of its foreign exchange (FX) reserves.

Although the economy showed some signs of stabilization in 2022, it remains severely depressed. The stabilization was supported by the expiration of COVID measures, a rebound in tourism, strong remittances inflows, and a gradual improvement in terms of trade in the second half of the year. Still, high uncertainty, banking sector restrictions, and expensive and very limited electricity supply continue to hinder economic activity. Following the dramatic exchange rate depreciation in Q1 2023, cash dollarization increased, and inflation accelerated to 270 percent y-o-y in April 2023. The fiscal deficit is estimated to have widened to 5 percent of GDP in 2022, due to collapsing revenues. The current account deficit is estimated to have widened to almost 30 percent of GDP on account of surging imports, while foreign domestic investment (FDI) has remained depressed, as have been other financial inflows.

The economic outlook is highly uncertain and depends on the authorities' policy actions. Decisive implementation of a comprehensive economic recovery plan could steadily reduce imbalances and provide a policy anchor that will help restore confidence and facilitate return to growth. However, the continuation of the status quo presents the largest risk to the outlook. Further delays of reforms will keep confidence low and cash dollarization of the economy will increase. The exchange rate will continue to depreciate, keeping inflation high. Economic activity will move into informal sectors, further complicating the collection of fiscal revenues. BdL, saddled with unaddressed losses and a lack of credibility, will continue to lose international reserves. Emigration, especially among skilled professionals, may gain pace, undermining future growth. Investment into physical capital will be limited. Banks will not be able to meaningfully extend credit and real growth will remain subdued. The external position will be highly volatile, with limited aid from multilateral and regional partners. Public debt will remain unsustainable as restructuring is unlikely to proceed in the absence of reforms, severely limiting the government's ability to borrow. Provision of services by the state will be limited, as low revenues and lack of financing will force further expenditure compression (capital investment, employment, and wages). Social conditions will become increasingly untenable.

Executive Board Assessment[2]

Executive Directors agreed with the thrust of the staff appraisal. They expressed serious concern that, for more than three years, Lebanon's deep and multifaceted crisis has led to a dramatic deterioration in economic and social conditions. While acknowledging the complex political setting, Directors regretted the very limited policy action taken to address the crisis. They highlighted the risks and surging costs from further delays and urged decisive implementation of a comprehensive reform plan to resolve the crisis and bring about a sustainable recovery. Directors stressed the critical role that donor support could play in stabilizing and reviving the economy, once reforms start to be implemented. They looked forward to deeper engagement with the Fund and other key stakeholders to support the urgent reform efforts and humanitarian needs.

Directors underscored that credible restructuring of the financial system is the key to restoring its health and viability.They called for upfront actions to address the exceptionally large losses and stressed the importance of protecting small depositors to the extent possible.A number of Directors saw merit in exploring additional options to provide some additional protection to depositors within the agreed principles, which could support restructuring efforts. Directors emphasized that the recourse to public resources should be limited and consistent with the debt sustainability objective. They underscored the importance of addressing weaknesses in the Banking Secrecy Law and strengthening the institutional framework of the central bank.

Directors stressed the criticality of reducing high inflation, addressing the sharp exchange rate depreciation and rebuilding the credibility of the central bank. They recommended tight monetary policy and strong efforts to prohibit central bank financing to the government. Directors underscored that unifying the official exchange rates would support more orderly monetary policy, reduce pressures on central bank reserves, and help increase fiscal revenue.

Directors emphasized that medium-term fiscal consolidation, accompanied by debt restructuring, is necessary to restore fiscal sustainability and create space for social and development spending. They called for prompt adoption of a credible 2023 budget underpinned by tax and revenue administration measures to support urgent social and development spending. Going forward, Directors highlighted the need for comprehensive revenue mobilization measures and efforts to improve public administration and spending efficiency. They underscored that a modern PFM law would help define stronger practices and support consolidation.

Directors called for ambitious structural reforms to address Lebanon's long-standing weaknesses and engender stronger growth. Noting the importance of limiting fiscal risks, Directors recommended measures to improve the governance and operational viability of state-owned enterprises and reform the pension system. They underscored the need to implement electricity sector reforms and improve the operational performance and financial sustainability of the electricity provider. Directors highlighted that regaining public trust would necessitate steps to enhance governance, anti-corruption, and AML/CFT standards and practices.