Public Debt Management for Lebanon: Situation Analysis and Strategy for Change

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Public Debt Management for Lebanon: Situation Analysis and Strategy for Change

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Public Debt Management for Lebanon: Situation Analysis and Strategy for Change

Imad Jomaa

ITH ACA P

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PUBLIC DEBT MANAGEMENT FOR LEBANON Situation analysis and strategy for change Ithaca Press is an imprint of Garnet Publishing Limited. Published by Garnet Publishing Limited 8 Southern Court South Street Reading RG1 4QS UK Copyright © Imad Jomaa, 2007 All rights reserved. No part of this book may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the publisher, except by a reviewer who may quote brief passages in a review. First Edition ISBN-10: 0-86372-317-9 ISBN-13: 978-0-86372-317-9 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. Jacket design by David Rose Typeset by Samantha Barden Printed in Lebanon

Contents

List of Tables and Charts

vii

1 2 3 4

1 5 11 19

5 6 7 8 9

Introduction Overview of the Debt Situation in Lebanon Public Debt Management Policies The Stock, Composition and Structure of the Lebanese Debt Fiscal Overview The Evolution of Interest Rates Lebanese Banks and Debt Service Debt Management – A New Perspective Conclusion and Recommendations

31 37 47 57 63

Appendix References

67 79

[v]


List of Tables and Charts

TABLES 1 Summary of lender country contributions 2 Paris II Eurobonds: Central Bank, bilateral lenders and commercial banks’ scheme 3 Public debt levels by type of holder (2002–2005) 4 Levels of public debt (1996–2005) 5 Public debt as a percentage of GDP (1996–2005) 6 Eurobond portfolio 7 Debt service to total revenue (1992–2005) 8 Budget total and primary deficit/surplus (1998–2005) 9 Evolution of average weighted cost of public debt 10 Evolution of primary market Treasury bill yields 11 Lebanese banks’ interest income (1992–2004) 12 Evolution of banks lending to Treasury and BDL (1992–2004) 13 Percentage of banks’ lending to Treasury and BDL vs. customers (1992–2004) 14 Regression of debt on debt service 15 Regression of net income on debt service 16 Calculation of debt with normal interest rates (1992–2005) 17 Projection of debt levels (2006–2025) 18 Total banks’ net income (1992–2004) 19 Yield on 3, 6, 12 and 24-month Treasury bill (%) 20 The share of banks, central bank and non-banks in Treasury bills 21 Public debt (1991–2005) CHARTS 1 Exchange rate (LBP/USD) (1964–2005) 2 Exchange rate (LBP/€ and LBP/USD) (2000–2005) 3 Yield on 3, 6, 12 and 24-month Treasury bill 4 Gross public debt (1996–2005) [vii]

15 16 20 21 22 25 26 31 37 43 50 52 53 55 56 58 60 67 68 72 76

6 7 8 21

PUBLIC DEBT MANAGEMENT FOR LEBANON

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

Domestic vs. foreign debt (1996–2005) Commercial banks’ vs. central bank’s proportion in domestic debt (2002–2005) Foreign debt service (1998–2005) Domestic debt service (1998–2005) Debt service ratios (1991–2005) Budget balance (1992–2005) Budget primary deficit/surplus (1998–2005) Budget revenue (1992–2005) Budget expenditure (1992–2005) Treasury bills rate (1993–2005) Distribution of Treasury bills by type of holder (1993–2005) Total banks’ net income (1992–2005) Comparison between LBP deposit rates and 12-month Treasury bills rate (1992–2005) Interest rates (1993–2004) Estimated vs. actual debt levels (1992–2005) Projected debt levels (2006–2025) Estimated debt service (2006–2025)

[viii]

23 23 27 28 29 33 34 35 36 38 47 48 49 54 61 61 62

1 Introduction

Prior to 1975, the Lebanese economy was one of the most dynamic in the Middle East. The country’s stable macroeconomic environment, liberal economy, vibrant private sector, its traditional role as an intermediary between the developed economies of Europe and the developing countries of the Middle East, and its openness to capital and labor mobility made it quite unique in the region. Lebanon’s economic stability, characterized by low inflation, high rates of economic growth, a large balance of payment surplus, small budget deficits, a floating, stable and fully convertible domestic currency, and political stability made it a highly attractive business center. All this made Beirut the financial center for the Middle East in the 1960s and early 1970s, with the largest number of representative offices of foreign banks in the Arab world, and a hub for the regional headquarters of many international companies. This, however, disintegrated with the beginning of the Civil War (1975–1990), which exacted a heavy toll in human and material terms and resulted in fundamental changes in the economy. Infrastructure and industrial facilities were destroyed, while foreign and domestic reluctance to invest in the economy resulted in the obsolescence of the remaining productive capacity. Moreover, there was a loss of professional and entrepreneurial skills through mass emigration. Emigration was accompanied by capital flight, and Lebanon’s access to flows of foreign capital was severely curtailed. Concurrently, public finances deteriorated significantly owing to a lack of central government authority and a weak and inefficient tax system, combined with the need to provide a basic level of public services. The resulting large fiscal deficits were financed primarily through the banking system. The consequent rapid growth in liquidity compared with economic activity, and the erosion of private sector confidence, led to continuous pressure on the Lebanese pound in the foreign exchange market, and to heightened inflationary pressures, and resulted in high levels of currency substitution. [1]


After the 15-year long conflict, Lebanon faced formidable economic challenges in the context of severe fiscal imbalances and a particularly difficult external environment. The government deficit and real interest rates had been extremely high; the public debt ratio had risen sharply to unsustainable levels, and real GDP growth had slowed. Given the debt cost and debt level dynamics that had transpired, the debt management capabilities of the government took longer than expected to develop to acceptable standards. In the meantime, spending beyond the available means continued unabated. Lebanon’s first significant attempts at addressing the issue of its indebtedness were witnessed with the Paris I and II conferences, where it was realized that left to its own devices, the country could not resolve its impending debt situation. These debt management attempts helped in decreasing the debt service that had been accumulating over the years. Continuous efforts to help Lebanon resolve its debt situation will be also taking place soon at the Beirut I conference which will be supported both regionally and internationally. This study questions the sustainability of Lebanon’s public debt because it reached an alarming level of LBP 58,048 billion at the end of December 2005 with a debt service of LBP 3,534 billion. Is Lebanon on the right path of sound debt management strategy or is crisis ultimately inevitable? What is an effective debt management strategy? What is the relation of the debt service to debt, and at what rate does it increase the debt level? Who is benefitting from the high rates on the debt service? And how can the public debt be reduced? Chapter 2 of this study presents an overview of the public debt situation in Lebanon. It describes the evolution of the Lebanese debt over the years. It also shows that the channels through which debt was financed are the domestic and sovereign markets. Chapter 2 also demonstrates that the main reason for the soaring debt is the high interest rates on Treasury bills strategy that was implemented in 1995 mainly because of country and currency risks. Chapter 3 provides suggestions on efficient debt management strategies. It tackles the indicators of critical debt levels and provides a definition of important aspects of public debt management. This chapter indicates the importance of debt management in coordination with the government’s need to finance its expenditures. The Paris I and Paris II conferences are studied along with their implications for the Lebanese economic and financial situation. [2]

INTRODUCTION

Chapter 4 introduces the exact level of public debt burden. Then it describes the composition of the public debt, which is divided into domestic debt, mainly in the form of Treasury bills, and foreign debt, mainly through the issuance of Eurobonds. It also describes the evolution of each type of debt over the years stressing the points where this increase or decrease was large. Chapter 4 also tackles the evolution of the public debt service which is deconstructed into domestic debt service and foreign debt service. We notice that the major burden on debt service levels was the domestic debt service levels. Chapter 5 depicts Lebanon’s fiscal overview. The evolution of each component in the budget balance is studied including the total budget balance, primary budget balance, government revenues and government expenditures. It shows that the primary budget balance is in surplus, whereas the budget balance is in deficit, showing that the debt service is behind the budget deficit. However, the primary budget surplus is increasing over the years and its level is narrowing the deficit of the total balance. Chapter 6 illustrates the evolution of interest rates over the years especially for the period between 1995 and 1996 when the rates where at their highest level. This period was critical in the history of public debt of Lebanon. Then the cost of debt is deconstructed into debt cost on Eurobonds and debt cost on Treasury bills which were the main burden on debt servicing. The interest rates decreased significantly after Paris II reducing the debt service significantly. Chapter 7 presents an assessment of total banks’ earnings. It exhibits the uses of funds by the Lebanese banks, mostly to fund the government’s debt. This chapter also shows that the majority of banks’ earnings are from interest income, mainly interest received from Treasury bills. This chapter also includes an empirical study showing that the main reason behind the soaring debt level is the level of debt service. The result is that this high debt service cost is translated into higher earnings for Lebanese banks. Chapter 8 offers a different perspective on efficient debt management strategy through interest rate decrease. This chapter demonstrates the level of debt that would have been prevailing had the interest rates been managed. It also presents a projection of debt service and public debt levels until 2025. Chapter 9 concludes the book and is followed by the Appendix and References. [3]


2 Overview of the Debt Situation in Lebanon

The accumulation of the Lebanese debt The year 1975 ignited the Lebanese Civil War that ended in 1990. This destructive war caused severe damage to the private infrastructure of the country which was coupled with degradation of the authority of the government. The total direct and indirect losses were estimated to be above USD100 billion, of which USD25 billion were estimated as losses of physical assets and damage to infrastructure. The situation was amplified by the inability of the government to collect revenues both during the conflict and in the following periods. The burden of the above-mentioned factors in addition to the urgent need for public spending on essential services led to a cycle of repeated budget deficits. This in turn caused monetary expansion, inflation and a fall in the exchange rate which inevitably led to capital flight that pressured the exchange rate causing it to depreciate even further. By the end of 1992, the Lebanese pound reached its lowest value of LBP 2,527 per USD from a value of LBP 790 per USD in 1990 (see Chart 1, p. 6). Inflation reached 120 percent. Public debt was at a level of approximately USD3 billion (40 percent of GDP at the time) and the average interest rates on government Treasury bills reached 34 percent. Chart 1 depicts the change in exchange rates from 1964–2005. The Lebanese pound was stable to a certain extent from 1964–1984, reaching its highest level of LBP 8.65 per USD in December 1984. Then, in 1985, the Lebanese pound started depreciating to reach its highest level of LBP 2,527.75 per USD in September 1992. After pegging the LBP to the US dollar in 1998, the Lebanese pound fluctuated within a range of LBP 1,507.5 and LBP 1,525.5 per USD.

[5]


CHART 1

Exchange rate (LBP/USD) (1964–2005) 3,000

Exchange rate

2,500 2,000 1,500 1,000 500 0 64 65 67 69 71 73 75 77 79 81 83 85 87 88 90 92 94 96 98 00 02

04

Year Source: BDL

However, as can be seen from Chart 2, although the Lebanese pound was stable against the US dollar, from 2002 the Lebanese pound was depreciating against the Euro because of the peg of LBP to USD which was in turn depreciating against the Euro. In 2002, LBP/€ and LBP/$ were almost equal. Then, the Lebanese pound depreciated against the Euro after 2002 to a level of LBP/€1,788. This depreciation relaxed the economy because it activated the export of goods and services to Europe. With the prevailing situation of 1992, the need for financing kept on escalating and public sector borrowing was the only available avenue for financing these requirements. However, in 1993, access to medium-term domestic or external financing was limited. The government had no alternative but to access local currency borrowing of short-term maturity. Many factors were behind a debt portfolio of short-term maturity with high interest rates. First, the government conducted monetary stabilization policies, in particular stabilizing the exchange rate. This rate is stable at 1,507.5 and Banque Du Liban handles its stabilization by selling or buying foreign currency in the market. Second, because of fiscal weaknesses, the credit default risk of the government increased which was accompanied by an increase in risk premium demanded by [6]

OV E RV I E W O F T H E D E B T S I T U AT I O N I N L E B A N O N

lenders due to the high political and security risks. This political risk was the main reason for the sharp increase of interest rates in 1995–1996 As a result of this high cost of borrowing, the public debt ballooned further. CHART 2

Exchange rate (LBP/€ and LBP/USD) (2000–2005)

LBP/€ LBP/$

2,500

LBP

2,000 1,500 1,000 500

Sep-05

May-05

Jan-05

Sep-04

May-04

Jan-04

Sep-03

May-03

Jan-03

Sep-02

May-02

Jan-02

Sep-01

May-01

Jan-01

Sep-00

May-00

Jan-00

0

Year Source: BDL

Financing the Lebanese debt Domestic borrowing In the post-war period, the government financed reconstruction and the recurring budget deficits through the issuance of LBP-denominated Treasury bills, with maturities of 3, 6 and 12 months, and Treasury bonds with maturities of 24 months. In 1995, to create demand for LBP-denominated assets, an inevitable increase in interest rates was implemented that led to a huge gap in the spread between returns on assets in LBP (37.85 percent) (see Chart 3, p. 8) and those in USD (5.513 percent). Thus, the objective of stabilizing the exchange rate versus USD was maintained but at a trade off in elevated national debt due to the soaring debt cost.

[7]


CHART 3

Yield on 3, 6, 12 and 24-month Treasury bill 40 35

Yield on 3-month Treasury bill

30


%

25


20


15 10

Dec-05

Dec-04

Dec-03

Dec-02

Dec-01

Dec-00

Dec-99

Dec-98

Dec-97

Dec-96

Dec-95

Dec-94

0

Dec-93

5

Year Source: BDL

In 1996, three-quarters of total revenues were used to service the debt. This situation worsened still further and led to the issuance of new debt at high interest rates to cover the due debt servicing payments. Interest rates on domestic credit ranged between 14.3 percent on 3-month Treasury bills and 20.5 percent on 24-month Treasury bills (see Chart 3). These high interest rates reflected the high risk placed on the Lebanese debt. In this year, 85 percent, of total debt (USD11.1 billion of USD13 billion) was short-term domestic debt in Lebanese pounds. Because of lack of confidence and uncertainty about the public finance, people were not willing to carry longer term maturity instruments. This situation forced Banque Du Liban and the Ministry of Finance to search for other ways of financing the government expenditure through the issuance of foreign-currency-denominated debt. Sovereign borrowing Sovereign debt owed by governments or their authorized institutions is referred to as external debt. This kind of debt, as opposed to domestic debt, places the government and its citizens at risk of default in international financial markets. In addition, servicing external debt exhausts export earnings and strains foreign currency reserves because of the fact that servicing external debt is paid from foreign exchange. [8]

OV E RV I E W O F T H E D E B T S I T U AT I O N I N L E B A N O N

Until 1994, the Lebanese debt was mainly denominated in local currency with high interest and short-term maturity. This debt portfolio exerted unsustainable pressure on the government forcing it to ease the situation by issuing medium-term debt denominated in foreign currency. Thus, in 1994, Lebanon looked to the international capital markets and succeeded in obtaining a USD400 million, three-year maturity, 10.125 percent coupon rate Eurobond. While Lebanon was shifting to the foreign market to fund its budget deficit, access to Eurobonds was hard because of two factors. First, the significant economic growth which was attributed to policies adopted by the government, in particular enormous government spending and stabilization policies, decreased to zero percent in 2000. Second, to make things worse, access to international liquidity was difficult due to the Asian financial crisis in 1998. Given this situation, the government had to opt for internal borrowing in foreign currency. Thus the savings of the banking system became a major source of financing of the government. However, because of lack of confidence and the rising debt level, the government had to borrow at very high interest rates which resulted in a widening of the interest rate spreads between the new foreign currency debt and US treasury benchmarks, leading to higher levels of public debt.

[9]


3 Public Debt Management Policies

The severity of the debt Lebanon’s public debt: Is it critical? To evaluate the severity of the public debt in Lebanon, certain indicators ought to be assessed. Important indicators illustrate the proportion of the debt cost to the total debt and the availability of resources to cover these costs. The first indicator is debt to GDP ratio which had amplified over the years. The reason for these high ratios was the continuous budget deficits incurred, leading to high debt stock which in turn was serviced with high costs. The second indicator is the ratio of external debt to national income indicating the heavy burden of the external debt on the economy. This ratio has evolved over time in Lebanon reaching 94 percent in 2004 and increasing further to 98 percent in 2005. Indicators of debt burden also include the ratio of external debt to export earnings, which is based on the fact that external and foreigncurrency-denominated debt must be paid with foreign exchange earnings, not local currency. Other indicators include debt service ratios to GDP, to revenue and to expenditure which will be discussed extensively in Chapter 4.

Definition of public debt management “Sovereign debt management is the process of establishing and executing a strategy for managing the government’s debt in order to raise the required amount of funding, achieve its risk and cost objectives and to meet any other sovereign debt management goals the government may have set, such as developing and maintaining an efficient market for government securities.” (IMF 2003) Public debt management aims at providing the government with the financial requirements to settle its obligations at the lowest cost, taking into account a given level of risk. In this context, the structure [11]


and composition of the debt is addressed, including the desired mix of foreign versus local currency debt. Moreover, the maturity of the debt portfolio and the level of the debt service should be effectively studied. Improvements in the large financial imbalances and the government’s debt burden are key to achieving macroeconomic stability and sustainable growth. High domestic real interest rates and financial uncertainty dampen private investment, constrain growth, and impede efforts to improve social conditions and reduce unemployment and poverty. The high proportion of government debt on the balance sheets of the banks constitutes the greatest vulnerability in the banking system. The government’s ability to roll over its debt depends on the stability of the banks’ large deposit base, making Lebanon vulnerable to shifts in market confidence.

The importance of public debt management Public debt management is important to ensure sustainability. Governments should make sure that indebtedness remains on a sustainable path and that a credible strategy is in place to reduce excessive levels of debt. Thus governments should ensure that both the level and rate of growth of the public debt are fundamentally sustainable over time. In other words, the government should ensure that there is enough liquidity to fund the cost of debt and the maturing debt instruments.

Public debt management policies In the last few years, public debt has reached unsustainable levels due to the high levels of interest on public debt which have forced the government to direct much of its expenditure towards debt servicing. Adding complexity to the Lebanese situation, with the Lebanese pound pegged to the US dollar, the very high debt-to-GDP and debt-to-export ratios, makes the economy extremely vulnerable to adverse shocks. In 2004, Lebanon’s primary budget surplus reached LBP 2,790 billion or 9.48 percent of GDP due to a strong increase in government revenues and expenditure discipline. Public debt-to-GDP ratio reached 184 percent and increased further in 2005 to 197 percent. In addition, Lebanon is very vulnerable to shocks facing the economy which may lead to doubts about the sustainability of the debt. Fears and uncertainties in 2005 arose following the assassination of former Prime Minister [12]

PUBLIC DEBT MANAGEMENT POLICIES

Rafic Al-Hariri. Lebanon faced enormous challenges in keeping the debt sustainable when high political tensions and high unemployment prevailed. For these reasons and in order to keep the debt sustainable and reduce Lebanon’s vulnerability to financial shocks, active debt management, sound public debt management practices and management of the costs and risks facing the public debt should be implemented. The basis of debt management begins by the evaluation of the various indicators of debt sustainability mentioned at the beginning of Chapter 3. By studying the Lebanese public debt, one can identify the high levels of debt accumulated over the years and the high ratio of public debt to GDP. Thus the government needs to cut back its public debt by first curtailing its budget deficit, which would in turn help in avoiding a serious “crowding out” effect and restrict the burden of debt service. Intuitively, decreasing the budget deficit can be achieved through the government’s expenditure and revenue levels; on the other hand, reducing debt service can be accomplished through lower interest rates. Moreover, the government should aim at limiting debt expansion and should generate a debt portfolio consisting of key risk indicators of the existing and projected debt portfolio. To ensure sustainability of the public debt, debt management should be linked to a clear macroeconomic framework that aims at controlling the level and rate of growth of the debt. Maturity structure is an important indicator of the sustainability of the debt. A government faces a trade off between short-term debt with lower interest rates on one hand and long-term debt with high interest rates on the other. However, excessive reliance on short-term debt with lower servicing costs leaves a government vulnerable to risk of default in the event that a government cannot roll over its debt. So, the debt portfolio should be better examined and structuring of the maturity of the debt should be implemented in such a way as to decrease the probability of default and liquidity risk. The composition of the debt is made up of two parts; owners of the debt and currency composition of the debt. Debt managers should set strategic benchmarks against which to compare the currency composition of the debt such that the debt would not be at vulnerable levels. To better understand the debt management practices that happened in Lebanon a detailed study of the Paris I and Paris II conferences is shown below. [13]


Paris I conference The severity of the situation forced the government to adopt a reform program to help revive the economy. This program was thought to be effective only with external help. The program was presented on 27 February 2001 at the Paris I conference. The first aim of the government was to control non-interest expenditures, which dropped by 22 percent in 2001. The second aim of the government was to increase revenues. The largest source of revenue for the government was custom duties, however, revenue collection was in decline because of recession. Nonetheless, the government worked at improving tax administration and collection. Thus, in 2002, the government succeeded in increasing revenues through the introduction of a value added tax (VAT) on consumption. Paris II conference In 2002, the problem of debt maturity and high costs of debt aggravated. Official reserves at the Central Bank were depleted. Lebanon was unable to attract low cost and long-term debt. To help Lebanon avert an impending financial crisis, the Paris II conference was organized on 23 November 2002. The Paris II conference objective was to restructure the portfolio of the stock of debt. The conference, which was considered a last minute rescue, resulted in commitments for debt reduction and management totaling USD3.1 billion. Of the total funding, USD1.85 billion was structured in Eurobonds with a 15-year maturity, a five-year grace period for principle repayment and a 5 percent annual coupon rate payable semi-annually. In addition, the government of France provided a Euro 500 million loan (USD540 million at a rate of USD/€ 1.08), which was structured with the same maturity and coupon rate as the Eurobonds, although with a shorter three-year grace period for principal repayment (see Table 1). The Paris II conference contributed approximately USD 2.4 billion received from seven countries, with KSA the biggest contributor followed by France (see Table 1). These amounts formed 77 percent of the total USD 3.1 billion promise of support for the purpose of debt management. The aim of these funds was to replace the maturing debt. The following table presents the seven contributor countries with their corresponding amounts.

[14]


TABLE 1

Summary of lender country contributions Creditor

Amounts received

Date of receipt of funds

Type of financing Eurobonds

Terms

Malaysia

US$ 300 million

Dec. 27, 2002

Sultanate of Oman

US$ 50 million

Dec. 30, 2002

Final Maturity date: 15 years from issue date

United Arab Emirates

US$ 300 million

Jan. 15, 2003

Coupon rate*: 5% per annum payable semiannually in arrears

Kuwait

US$ 300 million

Jan. 22, 2003

Amortization of Principal: Redeemable in 20 equal semi-annual payments starting from year 6 (grace period of 5 years)

Kingdom of Saudi Arabia

US$ 700 million

Mar. 7, 2003

Representations, warranties, and covenants: As per the issuer’s Global MTN program

State of Qatar

US$ 200 million

May 27, 2003

Listing: Luxembourg Stock Exchange

France French Treasury and Agence Française de Développement (AFD)

US$ 540 million** Mar. 3, 2003

Loan through AFD

Issue Price: 100 percent

15-year maturity Coupon rate*: 5% per annum payable semiannually 3-year grace period for principal repayment

Source: Ministry of Finance Notes: *This coupon rate represents a spread of approximately 85 basis points above 10-year US treasuries at the time of the Paris II conference. This represents a major improvement given that the average cost of the Republic’s foreign currency debt was at around 9.2% before Paris II, i.e. a spread of 505 basis points for shorter maturities. **Counter value of contributions in Euro at USD/€1.08 rate.

As for the share of the Central Bank and the commercial banks in the Paris II conference, the details are highlighted in Table 2 (p. 16). The [15]


government reached the following agreement with the Central Bank. First, USD1.79 billion worth of a 2-year LBP-denominated Treasury bond was agreed to be cancelled against reserves due to the Lebanese Treasury. Second, a USD1.87 billion-denominated Eurobond ($1.04 billion dollardenominated Eurobond and USD0.83 billion LBP-denominated Treasury bills) was exchanged for a 15-year 4 percent coupon Eurobond with a five-year grace period for amortized principal repayment. Third, a USD0.43 billion of principal and interest on maturing Treasury bills held by the Central Bank was rolled over into a new 5-year 4 percent special Treasury bill. In addition, as part of the Paris II conference, the commercial banks agreed to subscribe to a 2-year zero-coupon Eurobond for 10 percent of their overall deposits (totaling USD3.6 billion at the time) either in cash or through the delivery of previously issued Treasury bills and Eurobonds. As shown in Table 2 below, 85 percent of the subscription was done through cash and securities maturing within three months; and the 15 percent in the form of securities with longer than three months maturity. TABLE 2

Paris II Eurobonds: Central Bank, bilateral lenders and commercial banks’ scheme Eurobond

Issue amount

Central Bank and bilateral lenders (USD millions): a $ 1,870 due December 2017 1,870,000,000 b $ 950 due December 2017 950,000,000 c $ 700 due March 2018 700,000,000 d $ 200 due March 2018 200,000,000 Total 3,720,000,000 Commercial banks: January 2003: $ tranche February 2003: $ tranche February 2003: € tranche March 2003: $ tranche April 2003: $ tranche April 2003: € tranche May 2003: $ tranche May 2003: € tranche Total

77,313,000 72,580,000 16,027,000 109,330,000 54,851,000 71,486,000 108,831,000 148,737,000 659,155,000

Outstanding amount

Coupon rate (percentage)

Issue date (month/day/ year)

Maturity date (month/day/ year)

1,870,000,000 950,000,000 700,000,000 200,000,000

4 5 5 5

12/31/2002 12/27/2002 3/7/2003 5/27/2003

12/31/2017 12/27/2017 3/7/2018 5/27/2018

77,313,000 72,580,000 19,584,994 109,330,000 54,851,000 87,355,892 108,831,000 181,756,614

– – – – – – – –

4/16/2003 4/16/2003 4/16/2003 4/16/2003 4/22/2003 4/22/2003 5/20/2003 5/20/2003

1/18/2005 2/18/2005 2/18/2005 3/18/2005 4/18/2005 4/18/2005 5/16/2005 5/16/2005

Source: Ministry of Finance, Government of Lebanon. Available at http://www.finance.gov.lb.main.govfin/external Notes: Amounts calculated according to a euro/dollar exchange rate of 1.222. A dash (–) indicates that the amount is nil or negligible. a b c d Banque du Liban. Kuwait, Oman, Malaysia and United Arab Emirates. Saudi Arabia. Qatar.

[16]


For the following nine months, the government withheld its issuance of new short-term bills in the local market. In 2004, the debt-to-GDP ratio declined to a little less than 184 percent by the end of the year. This was possible mainly through the debt restructuring resulting from Paris II and to a lesser extent through an improvement in revenues collected, particularly VAT receipts.

[17]


4 The Stock, Composition and Structure of the Lebanese Debt

The stock of the public debt By the end of December 2005, gross public debt reached LBP 58,048 billion (see Table 3, p. 20) (equivalent to USD 39 billion), increasing by LBP 3,987 billion (or 7.4 percent) from the end of December 2004 debt level. Domestic debt amounted to LBP 29,140 billion (equivalent to USD 19 billion), registering an increase of LBP 2,769 billion or 10.5 percent from the end of December 2004 level. This increase was largely attributed to a rise in treasury bills holdings by commercial banks, reflecting a strong market demand for these instruments. Foreign currency debt by the end of December 2005 amounted to LBP 28,909 billion (equivalent to USD 19 billion), increasing by LBP 1,219 billion (or 4.5 percent) from the beginning of the year. Part of this increase reflected the issuance of USD 278 million (equivalent to LBP 419 billion) for the settlement of expropriations pursuant to Law No.450 dated 29 July 2002 and according to Council of Ministers resolution No.24 dated 18 August 2002. The BDL portfolio continued to decline as appetite for LBPdenominated treasury bills during December continued to be strong, especially from commercial banks and public institutions. Domestic debt held by BDL decreased from a peak of LBP 15,236 billion in March 2005 to LBP 11,686 billion in December 2005 (a 23 percent decrease), owing to the resumption of interest from commercial banks in LBP-denominated treasury bills, starting April 2005. Domestic debt held by commercial banks increased from a trough of LBP 7,387 billion in March 2005 to 14,128 billion in December 2005 (a 91 percent increase). Public sector deposits reached LBP 5,418 billion, up by LBP 1,059 billion from the December 2004 level. This large surplus resulted mainly from the strong appetite for Treasury Bills. [19]


TABLE 3

Public debt levels by type of holder (2002–2005) Public Debt Outstanding by Holder LBP billion Assumes full LBP replacement

Dec-02

Dec-03

Dec-04

Dec-05

Gross public debt

47,276

50,285

54,061

58,048

3,987

7.40%

Domestic debt a. Central Bank (including REPOs and loans to EDL to finance fuel purchases)* b. Commercial banks c. Other domestic debt (Treasury bills)

25,302 723

26,843 8,938

26,371 10,652

29,140 11,686

2,769 1,034

10.50% 9.70%

17,211 7,368

12,303 5,603

12,220 3,500

14,128 3,325

1,909 -175

15.60% -5%

0/w Public entities

Change % change Year-to-date Year-to-date

3,221

2,564

2,187

2,446

259

11.80%

Foreign debt Ratio to total debt a. Bilateral, multilateral and foreign private sector loans b. Paris II related debt (Eurobonds and Loans) c. BDL Eurobond (Paris II) d. Market Eurobonds e. Expropriation bonds f. Accrued interest on foreign currency debt

21,974 47% 2,752

23,442 47% 2,934

27,690 51% 2,983

28,909 50% 2,855

1,219

4.40%

-128

-4.30%

1,432

3,731

3,814

3,681

-134

-3.50%

2,819 14,569

2,819 13,631

2,819 17,686

2,819 18,729

1,043

5.90%

402

327

388

406

18

4.70%

Public sector deposits Net debt Gross market debt** % of total debt

2,964 44,312 36,765 78%

3,019 47,266 29,638 59%

4,360 49,702 31,861 59%

5,418 52,630 34,759 60%

1,059 2,929 2,898

24.30% 5.90% 9.10%

Source: Ministry of Finance, Banque du Liban Notes: *The BDL has extended loans to EDL for the equivalent amount of USD 300 million to purchase fuel oil. These loans are listed as public debt as they are government guaranteed. **Gross market debt equals gross debt less the portfolios of the BDL, NSSF, bilateral loans, and Paris II related debt.

As can be seen from Table 4 and Chart 4, the level of public debt had been growing by large amounts. Gross public debt increased from LBP 20,188 billion in 1996 to a level of LBP 58,048 billion. Comparing domestic debt to external debt, we see that both domestic and external debt had been increasing since 1996. Domestic debt increased from LBP 17,229 billion in 1996 to LBP 29,140 billion in 2005. On the other hand, external debt increased from LBP 2,960 billion to LBP 28,909 billion. Notice that the ratio of domestic to total debt was at a level of 85 percent at 1996; whereas, external to total debt was 15 percent. [20]

THE STOCK, COMPOSITION AND STRUCTURE OF THE LEBANESE DEBT

External debt increased over the years making the proportion of domestic to total debt 50.20 percent while the proportion of external to total debt rose to 49.80 percent TABLE 4

Levels of public debt (1996–2005) LBP billion

1996

1997

1998

1999

2000

2001 2002

2003

2004

2005

I. Gross domestic debt II. Public external debt2 Gross public debt (I + II)

17,229 19,787 21,686 25,383 27,161 28,214 25,302 26,843 26,371 29,140 2,960 3,713 6,283 8,351 10,828 14,431 21,974 23,442 27,690 28,909 20,188 23,500 27,969 33,734 37,989 42,645 47,276 50,285 54,061 58,048

III. Public sector deposits3 IV. Net domestic debt (I–III) Net public debt (II + IV)

3,871 1,406 2,142 4,006 13,358 18,381 19,544 21,377

2,631 1,913 2,964 3,019 4,360 5,418 24,530 26,301 22,338 23,824 22,011 23,722

16,318 22,094 25,827 29,728 35,358 40,732 44,312 47,266 49,701 52,631

Source: Ministry of Finance/the Central Bank

CHART 4

Gross public debt (1996–2005) 70,000

LBP billion

60,000 50,000 40,000 30,000 20,000 10,000 2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

0

Year Source: BDL

Moreover, the ratio of public debt to GDP increased over the years from 99 percent in 1996 to reach 184 percent in 2004 (see Table 5, p. 22) and 197 percent in 2005 (its highest level).

[21]


TABLE 5

Public debt as a percentage of GDP (1996–2005) (as a % of GDP)

Gross public debt Net public debt

1996

1997

1998

1999

2000

2001 2002

99% 80%

103% 97%

114% 105%

136% 120%

153% 142%

170% 181% 162% 170%

2003 185% 174%

2004 184% 164%

2005 197% 179%

The composition of the public debt As mentioned before, the Lebanese public debt is divided into domestic debt and foreign debt. Domestic debt constitutes the Central Banks’ loans (direct loans, loans to public entities, Treasury bills and repurchase agreements), commercial banks’ loans (Treasury bills, other loans and factoring) and other domestic debt (public Treasury bills, public entities’ Treasury bills and financial institutions’ Treasury bills). As for the foreign debt, it is comprised of bilateral, multilateral and foreign private sector loans, Paris II related debt including Eurobonds and loans, BDL Eurobonds from Paris II, market Eurobonds, expropriation bonds, and accrued interest on foreign currency debt. Domestic debt As can be seen by Chart 5, the level of domestic debt has been increasing over the years. The reason for this is the high interest rate offered on the LBP-denominated assets which reached a very high level of 37.85 percent in September 1995. The proportion of foreign debt versus domestic debt is shown in Chart 5. As can be seen, from 1996–2001 the majority of the debt was comprised of domestic debt. Since 1996 the proportion of foreign debt in total debt has increased until in 2004 external debt exceeded domestic debt by LBP 1319 billion. Following this point foreign debt decreased below domestic debt by LBP 231 billion. Treasury bills as part of domestic debt The Lebanese banks were the major contributors in debt financing. Their share of total domestic debt held as Treasury bills reached 76 percent at the beginning of January 1995. After 2000, commercial banks became reluctant to invest in additional Treasury bills, and hence decreased their share of Treasury bills as a percentage of domestic debt to 56 percent at the end of 2001 (see Table 20 in the Appendix). However, after Paris II, commercial [22]


banks increased their investment in Treasury bills to reach 68 percent at the end of 2002. In the following years commercial banks started decreasing their portfolio of Treasury bills to 47 percent in 2004 and 48.7 percent in 2005. Faced by this situation, the Central Bank had no other choice but to hold a larger share of debt. The Central Bank’s share in Treasury bills increased from 2.39 percent at the end of 2002 to 39.48 percent at the end of 2005 (see Chart 6). CHART 5

Domestic vs. foreign debt (1996–2005) 35,000 30,000

LBP billion

25,000 20,000 Gross domestic debt

15,000

Public external debt

10,000 5,000 0

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year Source: BDL

CHART 6

Commercial banks’ vs. central bank’s proportion in domestic debt (2002–2005) 30,000

LBP billion

25,000 20,000 Commercial Banks Central Banks

15,000 10,000 5,000 0

2002

2003

2004 Year

Source: Bilanbanques

[23]

2005


External debt The second division of the Lebanese debt is the foreign debt. However, a unique characteristic of the Lebanese foreign debt is that it is actually foreign currency debt and not foreign debt because of the fact that the majority is held by local entities in foreign currency. This characteristic has protected Lebanon from internal and external political shocks. Dependence on external financing has been increasing over the years as shown in Chart 5 (p. 23). In 2002, foreign debt increased to LBP 21,974 billion from LBP 14,431 billion in 2001 (an increase of 52 percent). This is due to the structuring of debt after the Paris II conference. After that, the external debt increased further in the following years to reach a level of LBP 28,909 billion in 2005. Eurobond portfolio out of external debt Lebanon’s outstanding Eurobond portfolio with projections of the principal and coupon repayment schedule in terms of foreign currency debt in 2005 is depicted in Table 6. It shows that at the end of December 2005, total outstanding Eurobonds were at a level of USD 15,895 million.

Public debt service levels Servicing the debt is considered the heaviest burden on the government. Fortunately, Lebanon has succeeded so far in accommodating this high cost of debt. Interest payments on debt soared from LBP 518 billion in 1992 to LBP 3,534 billion in 2005 (see Table 7, p. 26). Notice the huge increase in debt servicing from LBP 1,875 billion in 1995 to LBP 2,653 billion in 1996 (an increase of 41.5 percent). This is due to the extremely high interest rates levels at the end of September 1995. As can be seen from Table 7 (p. 26), the majority of the government revenues are allocated to public debt service. The percentage of debt service to total revenues reached its highest levels during 2000 and 2001 with 100.21 percent and 101.15 percent respectively. Then, it decreased reaching 50.6 percent in 2005. Thus, half of the government revenues were paid to service the debt leaving the other half for the various components of expenditure. These high levels of debt servicing lead to higher budget deficits which in turn lead to more borrowing, increasing the level of national debt.

[24]


TABLE 6

Eurobond portfolio Fixed income securities – Lebanese public sector Eurobonds Luxembourg Stock Exchange Maturity

Currency

Issued Amount (million)

Outstanding Amount (million)

Lebanon / 24-04-2006 Lebanon / 15-05-2006 Lebanon / 27-06-2006 Lebanon / 02-08-2006 Lebanon / 06-10-2006

USD USD USD USD EUR

1115 350 500 750 300

1110.0 321.0 104.7 640.6 263.6

Lebanon / 25-02-2007 EDL / 02-07-2007 Lebanon / 31-10-2007

USD USD USD

750 100 400

Lebanon / 12-03-2008 Lebanon / 11-05-2008 Lebanon / 20-06-2008 Lebanon / 06-08-2008

USD USD USD USD

Lebanon / 20-05-2009 Lebanon / 06-10-2009 Lebanon / 30-11-2009 (FRN) Lebanon / 14-12-2009

Issue P

Spread

9.88 10.50 10.50 10.50 8.88

100.00 100.00 100.00 100.00 99.65

1.98 1.52 1.13 1.06 1.69

750.0 100.0 368.7

6.50 7.50 8.63

– 99.72 99.61

1.57 1.18 1.73

700 250 250 750

700.0 250.0 250.0 750.0

6.38 7.00 7.38 10.13

100.00 100.00 99.67 100.00

– – 1.81 1.64

EUR USD USD USD

225 650 625 425

225.0 635.5 625.0 425.0

7.25 10.25 Libor+3.25 7.00

100.00 99.53 100.00 99.48

2.96 1.98 1.73 1.95

Lebanon / 05-03-2010 Lebanon / 12-11-2010

USD USD

1265 300

1265.0 300.0

7.13 6.88

100.00 100.00

2.11 –

Lebanon / 20-05-2011

USD

1000

1000.0

7.88

99.34

2.23

Lebanon / 07-09-2012

USD

600

600.0

7.75

100.00

2.35

Lebanon / 20-06-2013

USD

250

250.0

8.63

99.29

2.47

Lebanon / 19-01-2016 Lebanon / 11-05-2016

USD USD

750 400

750.0 400.0

8.50 11.63

99.18 100.00

2.75 3.12

Lebanon / 27-12-2017 Lebanon / 31-12-2017

USD USD

950 1870

950.0 1870.0

5.00 4.00

100.00 100.00

– –

Lebanon / 05-03-2018 Lebanon / 27-05-2018

USD USD

700 200

700.0 200.0

5.00 5.00

100.00 100.00

– –

Total Total

EUR USD

525 15900

488.6 15315.4

Source: Banque du Liban, Financial Markets Department

[25]

Coupon

TABLE 7

Debt service to total revenue (1992–2005) (LBP billion)

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Budget revenue Tax revenue Non tax revenue

1,138 n.a n.a

1,855 1,208 647

2,241 1,656 585

3,033 2,100 933

3,533 2,869 665

3,510 2,894 616

3,979 3,097 882

4,466 3,350 1,116

4,188 2,936 1,252

4,263 2,961 1,302

5,385 3,995 1,390

6,219 4,502 1,717

7,075 5,169 1,907

6,984 4,867 2,117

Budget expenditure Wages and salaries Interest payments Other current expenditure Capital expenditure

2,219 660 518 895 146

3,017 1,295 784 545 393

5,204 1,710 1,488 756 1,250

5,856 1,869 1,875 896 1,216

7,225 2,261 2,653 1,088 1,223

9,162 2,466 3,378 1,851 1,467

7,563 2,352 3,352 798 1,061

8,190 2,760 3,624 709 1,097

8,868 2,908 4,197 863 900

8,255 2,992 4,312 626 325

8,931 3,008 4,622 691 610

8,810 3,087 4,874 870 714

8,306 3,094 4,021 936 817

7,802 NA 3,534 NA NA

-1,081 45.52

-1,162 42.26

-2,963 -2,823 66.40 61.82

-3,692 75.09

-5,652 96.24

-3,584 84.24

-3,724 81.15

-4,680 100.21

-3,992 101.15

-3,546 85.83

-2,591 78.37

-1,231 56.83

-817 50.60

Budget balance % of total debt service to total revenue

Source: Ministry of Finance


The evolution of foreign debt service Debt servicing can be divided into foreign and domestic debt service. Looking at the chart below, we see that foreign debt servicing has increased since 1998 from LBP 300 billion reaching a level of LBP 2,002 billion in 2005. The major increase in foreign debt service was in 2002. This was accredited to the funds received after Paris II, especially the funds received from Eurobonds. Foreign debt service in 2002 was at a level of LBP 1,345 billion, an increase of 60 percent from the previous year. In 2003, foreign debt service increased further to LBP 1,766 billion, maintained its level in 2004, and then increased further to LBP 2,002 billion in 2005. CHART 7

Foreign debt service (1998–2005)

2,500,000

LBP million

2,000,000 1,500,000 1,000,000 500,000 0 1998

1999

2000

2001

2002 Year

Source: BDL

[27]

2003

2004

2005


The evolution of domestic debt service On the other hand, because of lower ratios of domestic debt in total debt, domestic debt service has decreased since 2002, especially after the steps followed in the Paris II conference. Moreover, the yield on 3-month Treasury bills was reduced from 6.96 percent in 2003 to 5.22 percent in 2004. The yield on 6-month Treasury bills decreased from 8.18 percent in 2003 to 6.31 percent in 2004. And the yield on 12-month Treasury bills decreased from 9.13 percent in 2003 to 6.69 percent in 2004 (see Table 20 in the Appendix, p. 72). Hence, this added to the drastic reduction in domestic debt service after 2003, which decreased from LBP 3,108 billion to LBP 2,246 billion in 2004 and to LBP 1,533 billion in 2005. Chart 8 shows the evolution of domestic debt service from 1998 to 2005. Domestic debt service decreased from LBP 3,051 billion in 1998 to LBP 1,533 billion in 2005. CHART 8

LBP million

Domestic debt service (1998–2005)

4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 1998

1999

2000

2001

2002 Year

Source: BDL

[28]

2003

2004

2005


Debt service ratios Some indicators of the severity of debt service levels are debt service to GDP, to revenue and to expenditure. The chart below depicts the evolution of debt service ratios. The ratio of debt service to GDP decreased from 17.17 percent in 2001 to 12 percent in 2005 due to the decrease in debt service from LBP 4,312 billion in 2001 to LBP 3,534 billion in 2005. Ratio of debt service to expenditure increased from around 17 percent in 1991 to 41 percent in 1999. It slightly declined in 2000 to 38 percent before it further increased to 47 percent in 2001. It slightly declined in subsequent years to 46 percent in 2002 and 2003, and then increased to 48 percent in 2004 and declined to 45 percent in 2005. Ratio of debt service to revenues reached 92.87 percent in 2001, decreased to 73 percent in 2003 although debt service was increasing, mainly due to the introduction of value added tax in 2002. However, in 2004, debt service decreased, thus, decreasing the debt service to revenue ratio to 53.5 percent in 2004 and to 50.6 percent in 2005. Nonetheless, the level of debt service to revenue remains at a high level as half of the government revenues are allocated to debt servicing. Proceeding in this manner, the government would continuously need to borrow in order to settle the debt service payments and hence the public debt level would inevitably reach unsustainable levels. CHART 9

Debt service ratios (1991–2005) 100

Debt service/GDP Debt service/revenue Debt service/expenditure

90 80 70 %

60 50 40 30 20 10

Year Source: BDL

[29]

2005

2003

2001

1999

1997

1995

1993

1991

0


5 Fiscal Overview

By the end of December 2005 the total fiscal balance improved by 33.5 percent, registering a deficit of LBP 818 billion, dropping from LBP 1,231 billion at the end of December 2004. This overall improvement resulted mainly from a 6 percent decrease in total payments which compensated for the 1.3 percent decline in total receipts. Meanwhile, the primary surplus amounted to LBP 2,716 billion for the year 2005 compared to LBP 2,791 billion for the year 2004, declining by 2.7 percent. As for the total primary spending, a decrease of LBP 18 billion was reported for the year 2005 compared to the year 2004. TABLE 8

Budget total and primary deficit/surplus (1998–2005) LBP million Budget transactions Revenues Tax revenues a. Tax revenues – customs – VAT b. Customs revenues* c. Value added tax Non-tax revenues Expenditures Expenditures – debt service Debt service a. Domestic debt b. Foreign debt

1998

1999

2000

2001

2002

2003

2004

2005

3,979,371 4,463,962 4,189,978 4,290,964 5,398,940 6,218,603 7,075,268 6,984,222 3,097,185 3,321,061 2,938,014 2,962,770 3,995,251 4,501,871 5,168,747 4,866,834 1,334,147 1,361,580 1,192,049 1,335,434 1,388,516 1,498,823 1,788,976 1,905,860 1,763,038 1,959,481 1,745,965 1,627,336 1,613,977 1,642,051 1,616,573 1,267,578 992,758 1,360,997 1,763,198 1,693,396 882,186 1,142,901 1,251,964 1,328,194 1,403,689 1,716,732 1,906,521 2,117,388 6,639,941 7,200,304 8,387,241 7,748,258 8,486,953 8,809,828 8,305,821 7,802,216 3,288,028 3,575,507 4,189,827 3,436,683 3,864,663 3,935,463 4,284,335 4,267,913 3,351,913 3,624,797 4,197,414 4,311,575 4,622,290 4,874,365 4,021,486 3,534,303 3,051,300 3,214,400 3,572,320 3,470,000 3,277,700 3,107,903 2,245,915 1,532,600 300,613 410,397 625,094 841,575 1,344,590 1,766,462 1,775,571 2,001,703

Budget total deficit/ -2,660,570 -2,736,342 -4,197,263 -3,457,294 -3,088,013 -2,591,225 -1,230,553 -817,994 surplus As % of total budget -40.07% -38.00% -50.04% -44.62% -36.39% -29.41% -14.82% -10.48% expenditure Budget primary deficit/ 691,343 888,455 151 854,281 1,534,277 2,283,140 2,790,933 2,716,309 surplus As % of total budget 10.41% 12.34% 0.00% 11.03% 18.08% 25.92% 33.60% 34.81% expenditure

Source: Republic of Lebanon – Ministry of Finance

[31]


The fiscal situation showed signs of recovery after July 2005. The shock assassination of former Prime Minister Rafic Al-Hariri levied a heavy price on Lebanon in terms of foregone growth, higher domestic interest rates, and a weakened financial position of the state. The ability of the economy and the financial system to ride out the confidence shock that followed the assassination attests, once again, to the resilience of the Lebanese financial system. The skillful handling of this difficult situation by the authorities, and the Banque du Liban in particular, helped avert what could have been a very destructive financial storm.

The evolution of total budget balance As can be seen from Chart 10, the Lebanese budget balance has been in a deficit since 1992. Budget balance was at a deficit of LBP 1,081 billion in 1992 with budget revenue of LBP 1,138 billion and expenditure of LBP 2,219 billion including LBP 518 billion as interest payments. In 2003, although interest payments increased by 51 percent to LBP 784 billion, the increase in revenue to LBP 1,855 billion compensated for the extra debt service which meant the budget deficit only increased by 7.5 percent. In 1994, debt service increased by 90 percent to LBP 1,488 billion which translated to a 155 percent increase in budget deficit. In 1995, budget deficit improved by LBP 140 billion. In 1996, budget deficit deteriorated to a level of LBP 3,692 billion due to the increase of interest payments to LBP 2,653 billion (an increase of 41 percent from 1995). Year 1997 witnessed the highest level of fiscal deficit of LBP 5,652 billion (a 53 percent increase from 1996). This was because of a 27 percent increase in debt service accompanied by a slight decrease in budget revenue. However, the budget deficit in 1998 improved due to a 13 percent enhancement in the budget revenue. In 2000, budget deficit increased to 53 percent due to the decrease in revenues on one hand and the increase in debt service on the other. Although debt service was increasing from 2001 to 2003, revenues were also improving which led the budget deficit to improve. In 2004 and 2005, the budget balance continued improving, based on a reduction in debt service, reaching a deficit of LBP 1,231 billion in 2004 and LBP 818 billion in 2005.

[32]

F I S C A L OV E RV I E W

CHART 10

Budget balance (1992–2005)

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

Year

0

LBP billion

-1,000 -2,000 -3,000 -4,000 -5,000 -6,000

Source: BDL

The evolution of primary budget balance However, looking at the primary budget balance, which is the fiscal deficit excluding the interest payments on debt, we see that it is in surplus. Hence, we can conclude that the debt service comprises a huge burden on the budget balance and in fact it is because of debt service that the budget balances are in a deficit. Chart 11 (p. 34) shows the surpluses in the primary budget balance which was at a level of LBP 691 billion in 1998, increased to LBP 888 billion in 1999, then decreased tremendously to LBP 151 billion in 2000 (a decrease of 83 percent from the previous year). This was due to the low budget revenues that were achieved in 2000. From 2001 to 2005 primary budget balances increased mainly due to the introduction of value added tax. In 2005, the primary budget balance reached LBP 2,716 billion.

[33]


CHART 11

Budget primary deficit/surplus (1998–2005)

3,000,000 LBP million

2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 1998

1999

2000

2001

2002

2003

2004

2005

Year Source: BDL

Revenue outcome Total revenues in 2005 amounted to LBP 6,984 billion; this represents a 1.3 percent decrease compared to 2004 (see Chart 12). This has mainly resulted from a decrease in overall tax revenues of 5.8 percent percent (or LBP 302 billion) which was larger in magnitude than the 11 percent increase in non-tax revenues, therefore leading to an overall decline of 1.3 percent in budget revenues. Tax revenues totaled LBP 4,867 billion during 2005, compared to LBP 5,169 billion during 2004. Although revenues from taxes on income, profits and capital gains increased by 15 percent compared to 2004, this increase did not offset the near 22 percent (or LBP 349 billion) drop in revenues from taxes on international trade (customs and excises), caused mainly by the loss in fuel excise revenues resulting from the cap imposed on gasoline prices starting in May 2004, and the weaker performance of imports (those subject to customs duties) compared to the previous year. Furthermore, revenues from fiscal stamps also dropped by 10 percent (or LBP 27 billion) in 2005 compared to the previous year.

[34]

F I S C A L OV E RV I E W

CHART 12

LBP billion

Budget revenue (1992–2005)

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Year

Source: BDL

The improvement in non-tax revenues was mainly due to 15 percent higher transfers from government properties and public institutions, primarily from the Telecom Budget surplus and the Port of Beirut, by LBP 146 billion and LBP 58 billion respectively. Expenditure outcome Total expenditures reached LBP 7,802 billion for the year 2005, compared to LBP 8,306 billion for 2004, registering a decline of 6 percent. This was mainly due to the 12.11 percent drop in debt service payments – still a direct effect of the Paris II conference. Total primary expenditures for the year 2005 reached a level of LBP 4,268 billion due to two major factors: Higher transfers to the National Social Security Fund (NSSF) amounting to LBP 290 billion for 2005, compared to LBP 89 billion for 2004. A 69 percent increase in EDL (Electricite Du Liban) spending, which amounted to LBP 974 billion in 2005 as compared to LBP 577 billion in 2004. In the year 2005, EDL spending comprised the following components: • Direct treasury transfers to EDL amounting to LBP 833 billion. • Treasury advances to water authorities for their accrued electricity bills, amounting to LBP 48 billion. • Budget transfers under the line item “Materials and Supplies”, amounting to LBP 93 billion. [35]


CHART 13

LBP billion

Budget expenditure (1992–2005) 10,000 8,000 6,000 4,000 2,000 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Year Source: BDL

EDL’s deficit amounted to LBP 1,212 billion (excluding the company’s delayed payments to suppliers and others), of which LBP 974 billion was paid from Treasury accounts. The rest (LBP 238 billion) was covered through the agreements signed with Algeria and Kuwait.

[36]

6 The Evolution of Interest Rates

The reason behind this high level of debt servicing costs is the high levels of interest rates. However, the Paris II conference was a major step in the reduction of the cost of public debt as can be seen in Table 9 below. The overall weighted average cost of debt was reduced on both the total outstanding debt in addition to the domestic and foreign debt. For instance, debt service on total debt decreased from 11.97 percent prior to Paris II to a level of 8.34 percent, a reduction equal to 3.63 percent. Moreover, debt service on domestic debt was reduced by 4.64 percent while that on foreign currency debt was reduced by 1.82 percent. Interest rates on debt can be deconstructed into two major parts; yields on the domestic debt or Treasury bills and yields on foreign debt or Eurobonds. TABLE 9

Evolution of average weighted cost of public debt

Nov. 2002 Dec. 2003 Dec. 2004 Decline 2003–2004 Decline since Nov.02

Total

Domestic Debt

Foreign Debt

11.97% 8.34% 6.56% 1.78% 5.41%

13.82% 9.18% 6.04% 3.13% 7.77%

9.21% 7.39% 7.05% 0.34% 2.16%

Source: Ministry of Finance

Yields on Treasury bills The need to finance the huge budget deficits over the years and the lack of confidence in the political and economical stability of the country led to the soaring interest rates on Treasury bills of all maturities. Chart 14 (p. 38) confirms the change in the level of interest rates over the years. Notice the gigantic increase in the 12-month Treasury bill in September 1995, [37]


which reached 37.85 percent. Then in November 1995, the interest rate decreased to 19.69 percent. CHART 14

Treasury bills rate (1993–2005) 40

Yield on 3-month Treasury bill Yield on 6-month Treasury bill Yield on 12-month Treasury bill Yield on 24-month Treasury bill

35 30

%

25 20 15 10 5

Dec-05

Dec-04

Dec-03

Dec-02

Dec-01

Dec-00

Dec-99

Dec-98

Dec-97

Dec-96

Dec-95

Dec-94

Dec-93

0

Year Source: BDL

Since the beginning of 1998, secondary market rates related to these swap operations or to the sale of Treasury bills to the public declined sharply. In November 1998, the primary market and BDL secondary market converged again, putting an end to the swap operations. The Central Bank issued a circular restricting the purchase of foreign currencies from the Central Bank by banks and financial institutions for the purpose of buying Treasury bills on the secondary market for non-resident banks and institutions. The year 1999 started with Treasuries being subject to important subscriptions, allowing for a series of interest rate drops on all maturities continuously and finally stabilizing in October 1999. The yield on the 2-year bill moved from 16.19 percent at the end of 1998 to 14.64 percent at the end of 1999, down by 155 basis points. During the same period, interest rates on the 12, 6 and 3-month bills declined from 14.84 percent, 13.21 percent and 11.77 percent to 13.43 percent, 12.12 percent and 11.18 percent, losing respectively 141, 109 and 59 basis [38]

T H E E VO LU T I O N O F I N T E R E S T R AT E S

points. On average, interest rates on all maturities of bills declined by 5.5 percent from 1995 to 1999. The Treasury bills market, in both its primary and secondary market components, delivered an uneven performance in 2000. The abundant demand for Treasury bills in the primary auctions in the first quarter of the year, accompanied by consecutive increases in the State’s creditor accounts at the Central Bank, pushed the monetary authorities towards restricting the Treasury bills offer at the weekly auctions. Supply to demand ratios reached as low as 2 percent at times. Demand for Treasury bills then dropped gradually to reach levels close to nil amidst conversion pressures from LBP to FX holdings on the foreign exchange market. The Central Bank was compelled to intervene on the Treasury bills market, lifting its portfolio of Treasury bills holdings to a high of LBP 1,300 billion in October from a nil position at the beginning of the year. The lack of interest in LBP subscriptions also generated a divergence between primary and secondary market trading as the yield differential reached 150 basis points at times in the secondary market above primary market rates, a differential which vanished as soon as market pressures eased. The end of the year 2000 saw a convergence of primary and secondary market rates, but activity remained sluggish as market participants refrained from engaging in important LBP positions due to fiscal and political concerns. The numerous difficulties that the Lebanese pound faced in the course of 2001 left most LBP-denominated paper unappealing to market participants despite consecutive interest rate cuts in the US against relatively elevated rates on local Treasury bills. Both the primary and secondary markets for Treasury bills reported dull performances with very low participation from non-banks, coupled with an important intervention by the Central Bank to purchase paper on the primary market. The portfolio held by the public dropped from LBP 6,699 billion at the end of 2000 to LBP 6,133 billion at the end of 2001. The banks’ portfolio contracted from LBP 17,983 billion at the end of 2000 to LBP 14,914 at the end of 2001. In order to bridge the gap between subscriptions and maturities, the Central Bank’s portfolio of Treasury bills rose from LBP 1,598 billion at the beginning of the year to LBP 6,134 billion. Furthermore, the Central Bank resorted to swap operations in order to reschedule and thus postpone the settlement of Treasury bills maturities, allowing commercial banks to replace short-term Treasury bills with long-term ones at yields of 1 to 2 percent above primary market [39]


levels. As a percentage of LBP deposits, the LBP Treasury bills, dropped from 90 percent at the beginning of the year to 84 percent in December 2001, mainly compensated for by the increase in LBP loans, which moved from 15 percent of LBP deposits in December 2000 to 20 percent of LBP deposits in December 2001. The swap operations allowed banks to enhance their average yield on Treasury bills portfolios, which however dropped by 12 basis points (to reach 13.79 percent) as a result of maturing high yield 2-year bills throughout the year. The slight drop in yields compared to a drop by 350 basis points of the 1-year Libor (and 286 basis points in the 1-year US Treasuries), which resulted in a significantly rising interest differential to the benefit of LBP, which helped alleviate conversion pressures over the last quarter. Following a relatively volatile year, the Treasury bills market ended the year 2002 on solid ground as demand for government paper became particularly strong right after the Paris II conference was concluded, and continued at a dynamic pace while interest rates dropped by around 5 percent on the benchmark 2-year paper. In fact, market participants believed that Lebanon had been offered a new chance to resolve and perhaps overcome its public finance impediments due to the international financial assistance it had received and through an ambitious budget law for 2003 that aimed to drastically cut spending while raising revenues. However, the beginning of 2002 had been characterized by very timid interest in Treasury bills, which forced the Central Bank to intervene and purchase paper directly from the weekly auctions to settle the gap between subscriptions and maturities, raising its Treasury bills portfolio from LBP 6,134 billion at the end of December 2001 to a record high of LBP 7,325 at the end of May 2002. The Central Bank also resorted to offering 2-year Treasury bills at more than 2 percent above primary rates from the end of April as it undertook swap operations with banks and individuals whereby they could exchange shorter-term paper at primary rates with 2-year paper at 16.14 percent. These swaps stimulated demand for 2-year Treasury bills and helped the Central Bank reduce its intervention on the weekly auctions. However, after the Paris II conference, demand for Treasury bills intensified significantly and interest rates started dropping gradually and hit their lowest levels in two decades after remaining stagnant for three years. The 3-month yield became 7.77 percent, while the 6-month, 1-year and 2-year yields, ended slightly above 9 percent. Expectations of additional reduction in interest rates [40]


continued to fuel demand for Treasury bills until the year’s closing session. The year 2003 was characterized by a number of changes at the level of the Treasury bills market, mainly as a result of the government’s fiscal adjustment program. The year started with subscriptions by commercial banks in zero-percent Treasury bills as a part of the reform measures after the Paris II conference, followed by the suspension of the auctions from February to November to reduce the relatively higher cost local currency indebtedness. As such, activity became confined to the secondary market where Treasury bills of all categories stayed widely in demand, yet supply was almost limited to the long-term categories. Interest rates were significantly cut during 2003. The yield on the benchmark 2-year bill continued its descending trend and was trading as of the second quarter of 2003 at 7.99 percent, 142 basis points below its level of end-2002, and nearly half its end-March 2002 level of 14.64 percent. Following a nine-month suspension, the government resorted again to Treasury bills issuance in November. Regular auctions were resumed for all buyers (commercial banks, financial institutions, and the public at large), thus helping in channelling LBP placements to the Treasury bills market again. A new category of Treasury bills (the 3-year maturity) was issued along with the 1-year and 2-year papers auctioned every other week. Subscriptions in the 3-year paper amounted to LBP 524 billion in December out of total subscriptions of LBP 26,490 billion in 2003. The above developments, within an environment of confidence on the foreign exchange market, allowed for a further decline in interest rates across the board by around 200 basis points to reach 20-year lows for all Treasury bills categories. The yield on the 3-month maturity ended 2003 at 5.48 percent, the 6-month at 6.53 percent, the 1-year at 6.87 percent, the 2-year at 7.89 percent and the 3-year at 8.70 percent. The Treasury bills were quite short on the secondary market throughout the year while demand was relatively persistant, resulting in moderate trading taking place at close to the certificates of deposits yield curve rates during the absence of the auction. Yield on Treasury bills kept on decreasing until August 2004. Yields on the 3-month Treasury bill decreased to 5.17 percent on August 2004, then increased to 5.22 on September 2004 and remained stable till end of 2005. As for the 6-month Treasury bill, its yield [41]


decreased to 6.32 on August 2004 and remained stable until February 2005, after which the yield increased to 7.24 percent and remained stable until the end of 2005. The 12-month Treasury bill followed the same path as that of the 6-month Treasury bill and reached a yield of 7.75 percent at the end of 2005. The yield on the 24-month Treasury bill remained stable at 7.89 percent in 2004 until August 2004 when it increased to 8.68 percent and remained stable afterwards.

Period between 1995–1996 The year 1995 was critical because interest rates skyrocketed in September 1995 burdening the government with huge debt service costs. Taking in to account the huge increase in debt service between 1995 and 1996, we get an increase of LBP 778 billion (debt service of LBP 2653 billion in 1995 and LBP 1875 billion in 1996). The average exchange rate at that time was LBP 1,641 per USD. Therefore, the increase of cost of debt between 1995 and 1996 in USD was equivalent to USD 474.10 million. In 2002, the Paris II conference provided contributions in the amount of USD 2.39 billion from lender countries. Comparing the funds obtained in Paris II with the extra cost of debt incurred between 1995 and 1996, we have a total of 20 percent. In other words, the extra debt service in the 1995–1996 period constitutes 20 percent of the funds granted by contributor countries.

Paris II The Paris II conference of friendly countries and international lending institutions was held in Paris on 23 November, with the participation of 22 major countries and funds represented by presidents, prime ministers, ministers, and other high ranking officials. The international community at the conference accorded Lebanon USD 4.4 billion in international assistance at relatively low interest rates. Out of this total, USD 2.0 billion would be in the form of government guarantees, USD 0.85 billion in special Treasury bills and USD 0.3 billion in soft loans. The remaining USD 1.3 billion would be in the form of investment projects financing, provided mainly from development funds. The distribution of the USD 4.4 billion loans by original source was as follows: Saudi Arabia was in the lead with USD 700 million, followed by France with Euro 500 [42]


million, the Arab Development Fund with USD 500 million, the European Investment Bank with USD 350 million, Malaysia with USD 300 million, Kuwait with USD 300 million, the UAE with USD 300 million, Bahrain with USD 200 million, Italy with USD 200 million, Canada with USD 200 million, the World Bank with USD 200 million, Qatar with USD 200 million, the Kuwaiti Development Fund with USD 150 million, the European Union with USD 100 million, the Arab Monetary Fund with USD 100 million, Belgium with USD 70 million, and Oman with USD 50 million. The success of the conference gave a clear indication of the need to preserve economic and political stability in Lebanon, and the critical role of the country within the regional landscape. After the Paris II conference, interest rates on Treasury Bills diminished by more than 30 percent. As can be seen from Table 10 below, the yield on the 3-month Treasury bills dropped from 11.18 percent to 6.96 percent after Paris II. From February to November, the Central Bank ceased the issuance of Treasury bills since Paris II provided the needed amount of liquidity. Later, in November 2003, Treasury bill issuance was resumed with the yields dropping even further. Moreover, the Central Bank extended the yield curve by introducing the longer 3-year maturity bills. TABLE 10

Evolution of primary market Treasury bill yields Pre-Paris II Post-Paris II November 24th, (End of October 2002) (January/February 2003) 2003 3-month Treasury bills 6-month Treasury bills 12-month Treasury bills 24-month Treasury bills 36-month Treasury bills

11.18% 12.12% 13.43% 14.64%

6.96% 8.18% 9.13% 9.41%

5.37% 6.55% 6.89% 7.84% 8.66%

Source: BDL

In addition, after Paris II Treasury bills on all maturities dropped, as shown in Table 10 above.

[43]


Yields on Eurobonds The Republic of Lebanon has been an active bond issuer on the international capital markets in terms of volume, introducing foreign investors to Lebanese risk, and acting as a benchmark for Lebanese institutions, mainly banks, that have frequently tapped the international bond market thereafter. The Lebanese Republic captures more than 90 percent of the total Eurobond market while the rest is issued by Lebanese banks. The first Republic of Lebanon issue was launched in October 1994 and was priced at a relatively low spread of 325 basis points over the US equivalent Treasury bond and with a three-year maturity, although Lebanon was not rated then. Since then, issue spreads started decreasing and maturities started increasing, assisted by a historical track record of credit worthiness for Lebanon and its institutions, and to constant over-subscriptions in the issues. Several issues followed, the one with the most favourable terms being a Eurobond issued in 1997 whose principal was guaranteed by the World Bank and which recorded only 100 basis points above the US Treasury bond. This bond was issued just before the East Asian crisis, revealing sustained improvement in market perception of Lebanese risk. Despite the deterioration of lending conditions to all emerging markets after the crisis, the Republic of Lebanon succeeded in raising USD 1 billion in March 1998 in debt on foreign markets with acceptable issue spreads of 246 basis points for a three-year trench and 286 basis points for a five-year trench, and accordingly won the Euromoney award of the best issue of the year. During 1999, the Republic of Lebanon issued another USD 1 billion in foreign debt denominated in USD and Euro yet with higher spreads. The longest term paper issued during the year, the USD–Republic of Lebanon 2009 was put out with an issue spread of 440 basis points. The two-trench issue was priced at a discount to the Lebanese Republic’s existing yield curve as part of the strategy to increase the level of international participation in both bonds. The international investor participation in the offering was partly driven by the fact that historically Lebanese bonds have traded with very little volatility while offering close to emerging market type returns. Most importantly, this offering showed that the Republic was prepared to pay spreads in the 400 basis points range for the first time in order to ensure international involvement at the detriment of domestic support. The new Eurobond issue, with relatively attractive pricing conditions and with a 30 percent participation by [44]


foreign investors, has actually led the way to a new adjusted yield curve. In the first half of 2000 the government issued the Republic of Lebanon 2005 for a principal amount of USD 500 million with a lower issue spread of 310 basis points, followed by a tap issue of USD 250 million at a spread linked to the October 1999 issue. Two sovereign issues followed suit in September of the same year each having a principal amount of USD 225 million and maturing in 2003. A USD 250 million Euro issue was launched in October 2000 to replace a maturing bond. The issue had a spread of 317 basis points at launch. The last Republic of Lebanon issue for the year 2000, which came out in December, was of a USD 400 million size and had a higher issue spread of 410 basis points. The year 2001 witnessed the launch of four new sovereign issues for a total amount of USD 2.55 billion almost entirely subscribed to by commercial banks. Eurobond issues started carrying higher issue spreads as the government was faced with diminishing foreign investors’ appetite for local paper. In February 2001, a USD 250 million Republic of Lebanon December 2004 tap issue was launched with an issue spread of 460 basis points. Two issues followed suit in April of the same year, namely the USD 1,150 million April 2006 Eurobond with a higher issue spread of 536 basis points and the USD 400 million May 2016 bond with an issue spread of 647 basis points. The last bond in 2001 came in July for a USD 750 million total size and a slightly lower 516 basis points issue spread. The government launched a USD 1 billion bond in March 2002, maturing in 2005. This bond was not, however, subscribed to by commercial banks, as they were increasingly reluctant to raise exposure to the government amid acute fiscal pressures. Instead, it was sold to foreign governments (Malaysia, Saudi Arabia, etc.) through government marketing efforts and to Lebanese individuals via the Finance Bank. Two months later, the Central Bank governor announced the successful closing of the said bond having an issue spread of 600 basis points. This issue became the most liquid among traded Eurobonds on the secondary market. Another USD 500 million was launched in June of the same year, but was fully subscribed to by BDL. The government had also launched a USD 350 million Eurobond in May 2002 for contractors to settle arrears for previously executed works. Another USD 750 million Eurobond issue saw the light in August to rollover a maturing contractors’ [45]


bond at an attractive issue spread of 775 basis points, which triggered some good demand for it. In 2003, confidence in sovereign papers improved because of the momentum generated by Paris II. The government did not issue any new bonds, but wanted to limit indebtedness, benefitting from the funds received from the international donors as a result of the Paris II conference. It was thus able, for the first time ever, to settle maturing Eurobonds worth USD 950 million directly from its creditor accounts instead of renewing them as used to be the common practice. As a result, the total volume of sovereign Eurobonds outstanding in the market dropped from USD 9.6 billion at the end of 2002 to USD 8.9 billion at the end of 2003. Foreign debt cost also decreased after Paris II from 9.21 percent on November 2002 to 7.39 percent on November 2003 (a change of 1.82 percent). Ultimately, the yields on Eurobond issues also declined following Paris II. For example, Eurobonds with maturity 10/06/2009 decreased from approximately 15 percent in September 2002 (before Paris II) to approximately 10 percent after Paris II conference.

[46]

7 Lebanese Banks and Debt Service

Banks’ earnings As already stated, the domestic banks constitute the major contributors in funding the Lebanese public debt especially because of their investment in Treasury bills as shown in Table 20 in the Appendix. Hence, their earnings are extremely dependent on the prevailing interest rates. Notice the percentage of investment of Lebanese banks in Treasury bills was at a level of 74 percent in December 1993, increased further to 79 percent in 1994, then decreased to reach a level of 49 percent by the end of 2005. CHART 15

Distribution of Treasury bills by type of holder (1993–2005) Share of banks in Treasury bills

25,000

Share of Central Bank in Treasury bills

20,000

LBP billion

Share of Non-banks in Treasury bills 15,000

10,000

5,000

Year Source: BDL

[47]

Dec-05

Dec-04

Dec-03

Dec-02

Dec-01

Dec-00

Dec-99

Dec-98

Dec-97

Dec-96

Dec-95

Dec-94

Dec-93

0


Moreover, with higher interest rates on Treasury bills, commercial banks decrease their loans to the riskier private sector and increase their share in the relatively safe investments. Hence, private sector participation in economic growth diminishes. The total banks’ earnings since 1992 are demonstrated in Chart 16 below. As shown, earnings increased from 1992 to 1998 after which banks’ earnings decreased up until 2002. In 2003, 2004, and 2005 earnings once more increased reaching USD 443.276 million in 2004 and USD 521 million in 2005. In 1995, the earnings of banks were at USD 179.166 million. With the massive increase in interest rates, earnings increased by USD 93.37 million to a level of USD 272.534 in 1996 (an increase of 52 percent). CHART 16

Total banks’ net income (1992–2005) 600

USD million

500 400 300 200 100 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Year


As opposed to one of the bank’s sources of earnings, which is interest from government lending, deposit rates are considered a bank’s main source of expenses. The chart opposite shows a comparison between the bank’s deposit rates paid on LBP deposits versus interest rates on 12-month Treasury bills received by banks from their investment in Treasury bills. Note the huge interest rate spreads in 1995 with more than 20 percent difference between the interest paid to the bank on its Treasury [48]

L E B A N E S E B A N K S A N D D E B T S E RV I C E

bills investment and the interest paid by the bank on the clients’ deposits. After 1996, the spread decreased gradually to become minimal from 2003. This explains the high earning levels achieved by the Lebanese banks over the years. CHART 17

Comparison between LBP deposit rates and 12-month Treasury bills rate (1992–2005) 40

LBP average rate on deposits

35


30

%

25 20 15 10 5

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

Jan-97

Jan-96

Jan-95

Jan-94

Jan-93

Jan-92

0

Year

Source: BDL

Banks’ funds and interest income To understand better the components of income of the Lebanese banks, Table 11 (p. 50) illustrates the different sources of the aggregate income. Interest received on Treasury bills increased from a level of LBP 1,162 billion in 1994 to a level of LBP 2,051 billion in 2004. By evaluating the ratio of interest on Treasury bills from total interest, we see that half of the banks’ interest income comes from the interest received on Treasury bills. This ratio was at a level of 51.03 percent in 2002, decreased to 46.71 percent in 2003 and decreased further to 34.33 percent in 2004. Thus, Table 11 shows the high dependency of banks’ profits on interest income – especially interest received on Treasury bills. [49]

TABLE 11

Lebanese banks’ interest income (1992–2004) LBP billion

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Interest income of which interest received on Treasury bills of which interest received on deposits of which interest received on loans to customers other interest

1,077

1,556

2,256 1,162

3,099 1,373

4,131 2,114

4,771 2,393

5,781 2,729

6,155 3,013

6,730 3,164

6,279 2,892

6,097 3,111

6,133 2,865

5,975 2,051

450

561

768

692

858

907

1,041

1,238

1,728

1,442

1,613

1,926

2,081

2,274

2,041

1,629

1,481

1,418

125

204

358

369

434

439

316

549

778

51.51% 44.30% 51.17 % 50.16%

47.21%

46.06% 51.03% 46.71%

34.33%

Percentage of interest on Treasury bills Source: Bilanbanques

443

538

741

1,125

48.95% 47.01%


Moreover, comparing the banks’ total lending to Treasury and BDL as a proportion of total assets, we see that the ratio has been increasing since 1992 from 28 percent to reach its highest level of 54.3 percent in 2003 and then it decreased to 52.13 percent in 2004 (see Table 12, p. 52). We notice also that the level of exposure of banks to Treasury and BDL increased from LBP 3,944 billion in 1992 to a level of LBP 51,959 billion in 2003 and to LBP 57,112 billion in 2004 (an increase of 9.92 percent between 2003 and 2004). This shows that most of the Lebanese banks’ funds are used in financing the public debt. The banks’ investment in Treasury bills increased from LBP 3,201 billion in 1992 to LBP 8,440 billion in 1995 and to LBP 12,595 billion in 1996 (an increase of 49 percent from 1995 to 1996). This was mainly due to the high interest rates on Treasury bills at the end of 1995. Afterwards, investment in Treasury bills increased further to reach LBP 18,542 billion in 1999. From 2000, it decreased and reached LBP 12,120 billion in 2004. As for the banks’ investment in Eurobonds, Table 12 (p. 52) shows the increasing investment in Eurobonds from nil in 1992 to LBP 252 billion in 1995 and to a level of 485 in 1996. Banks’ exposure to Eurobonds increased further over the years reaching a level of LBP 13,903 billion. The increasing exposure of banks to Treasury and BDL keeps little funds for loans to customers. Table 13 shows the percentage of banks’ lending to Treasury and BDL versus their lending to customers. Banks funding to customers decreased from 49.73 percent in 1992 to a level of 27.71 percent in 2004. On the other hand, lending to Treasury and BDL increased from 50.27 percent in 1992 to 72.29 percent in 2004. The fact that banks lending to Treasury and BDL increased to 72.29 percent versus 27.71 percent to customers in 2004 is due to exceptionally high yields on Treasury bills. Chart 18 (p. 54) compares the average yield on Treasury bills to the 1-year LIBOR. Notice the huge spread between the two interest rates. The spread reached its highest level of 18.94 percent in 1995 taking into consideration that the yield on Treasury bills is an average of the yields of all Treasury bill maturities. Hence, if we take, for example, the yield on the 12-month Treasury bill in September 1995 and compare it to the 1-year LIBOR rate, we achieve a higher spread of 31.69 percent.

[51]

TABLE 12

Evolution of banks lending to Treasury and BDL (1992–2004) LBP billion

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Cash and Central Bank in LBP Sum of cash and Central Bank in FX Total lending to BDL Treasury bills in LBP Eurobonds Total lending to Treasury Total lending to Treasury and BDL Sum of total assets

600

639

1,137

1,419

1,693

1,884

1,914

2,834

2,536

2,803

3,940

16,169

16,474

143

817

1,817

2,260

2,905

4,467

4,630

4,131

4,890

8,458

8,654

12,985

14,615

743 3,201 0 3,201 3,944

1,456 4,163 7 4,170 5,626

2,954 7,352 81 7,433 10,387

3,679 8,440 252 8,692 12,371

4,598 12,595 485 13,080 17,678

6,351 13,322 1,005 14,327 20,678

6,544 15,996 2,957 18,953 25,497

6,965 18,542 4,442 22,984 29,949

7,426 17,966 6,233 24,199 31,625

11,261 14,824 8,867 23,691 34,952

12,594 17,062 10,810 27,872 40,466

29,154 12,591 10,214 22,805 51,959

31,089 12,120 13,903 26,023 57,112

14,082

18,271

24,757

30,115

40,173

50,290

60,805

67,128

73,291

77,714

84,581

95,687

10,9567

28.01%

30.79%

44.00% 41.12%

41.93%

44.98% 47.84% 54.30%

52.13%

Percentage of total exposure to assets Source: Bilanbanques

41.96% 41.08%

44.61% 43.15%

TABLE 13

Percentage of banks’ lending to Treasury and BDL vs. customers (1992–2004) LBP billion

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Total lending to Treasury and BDL Loans and advances to customers Total lending Sum of total assets Percentage of lending to Treasury and BDL to total lending Percentage of lending to customers to total lending

3,944

5,626

10,387

12,371

17,678

20,678

25,497

29,949

31,625

34,952

40,466

51,959

57,112

3,901

4,795

6,611

9,036

11,864

15,360

18,735

21,313

22,165

22,208

21,058

20,398

21,894

7,845 14,082

10,421 18,271

16,998 24,757

21,407 30,115

29,542 40,173

36,038 50,290

44,232 60,805

51,262 67,128

53,790 73,291

57,160 77,714

61,524 84,581

72,357 95,687

79,006 109,567

50.27%

53.99%

61.11% 57.79%

59.84% 57.38% 57.645%

58.42% 58.79%

61.15% 65.77% 71.81%

72.29%

49.73%

46.01%

38.89% 42.21%

40.16% 42.62%

41.58% 41.21%

38.85% 34.23% 28.19%

27.71%


42.36%


CHART 18

Interest rates (1993–2004)

%

30 25

Average yield on Treasury bills

20

1-year LIBOR rate

15 10 5

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

0

Year Source: BDL

Empirical study Regression analysis is a statistical method that tries to determine the relationship between two or more variables. It involves a variable to be explained, called the dependent variable, and additional explanatory variables that are thought to produce or be associated with changes in the dependent variable. Important outputs to be evaluated from the regression results are the following: •

•

•

Coefficient: The value of the coefficient shows how much the dependent variable increases or decreases for a 1 percent increase in the explanatory variable. P-value: The p-value or the marginal significance level shows if we reject or accept the hypothesis that the true coefficient is zero. A p-value lower than 0.05 is taken as evidence to reject the null hypothesis of a zero coefficient, implying that the coefficient is significant. R-squared: The R-squared (R2) statistic (known as Goodness of Fit Test) measures the success of the regression in predicting the values of the dependent variable within the sample. (R2) is the fraction of [54]


the variance of the dependent variable explained by the independent or explanatory variables. Debt on debt service To evaluate the impact of debt service on debt, using Eviews, we regress public debt on debt service. The coefficient is significant (p-value is 0.00) and is equal to 9.67 implying that a 1 percent increase in debt service (the explanatory variable) raises public debt (the dependent variable) by 9.67 percent (see Table 14). Looking at R-squared, we see that it is equal to 87.77 percent, implying that 87.77 percent of the variations in public debt are explained by the variable debt service. This means that the independent variable debt service explains the dependent variable debt by 87.77 percent. TABLE 14

Regression of debt on debt service Dependent Variable: DEBT Method: Least Squares Date: 02/09/06 Time: 11:51 Sample: 1992–2004 Included observations: 13 Variable Debt service R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood

Coefficient

Std. error

T-statistic

9.675037

0.488686

19.79805

0.877687 0.877687 5923.530 4.21E+08 -130.8529

Mean dependent variable S.D. dependent variable Akaike info criterion Schwarz criterion Durbin-Watson statistic

Prob. 0.0000 28732.00 16937.30 20.28506 20.32851 0.523029

In other words, to reduce the debt level, debt service should be reduced. Decreasing debt service by 1 percent reduces debt by 9.67 percent as given by the regression above. Often transactions that lower debt servicing costs represent risks for the government. Because of this trade off between debt servicing costs and risk, the most efficient channel through which debt servicing, and in turn the debt itself, can be condensed is the management of the high interest rates that the government pays on the Lebanese banks’ funds invested in Treasury bills. [55]


Banks’ net income on debt service To evaluate the impact of interest rates on the earnings or net income of the Lebanese banks, the following regression is executed using Eviews. Log of banks’ net income is regressed on debt service. The coefficient is significant (p-value is 0.00) and is equal to 0.908 implying that an increase of 10 percent in debt service (the independent variable) increases net income (dependent variable) by 9 percent. As for the goodness of fit test, R-squared, it implies that 89.58 percent of the variations in net income of banks is explained by the variations in the variable debt service. TABLE 15

Regression of net income on debt service Dependent Variable: Log NI Method: Least Squares Date: 18/02/06 Time: 21:11 Sample (adjusted): 1992–2003 Included observations: 12 (after adjusting endpoints) Variable C(1) Log debt service R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood

Coefficient

Std. error

T-statistic

-1.324053 0.908119

0.768127 -1.723743 0.097931 9.273084

0.895823 0.885405 0.237642 0.564736 1.310559

Mean dependent variable S.D. dependent variable Akaike info criterion Schwarz criterion Durbin-Watson statistic

Prob. 0.1155 0.0000 5.770388 0.702004 0.114907 0.195725 1.019843

Therefore, by analyzing these results one can conclude that as debt service increases, banks’ earnings increase. Thus, debt service constitutes a major part of banks’ income. Consequently, one can conclude that banks’ earnings depend a lot on the cost of debt to the government. Thus, one way to decrease debt is by focusing on the cost of debt which is the interest rate. Hence, by decreasing the interest, especially on domestic debt, debt service is reduced and hence debt is eventually reduced.

[56]

8 Debt Management – A New Perspective

Debt with normal interest rates Debt servicing is considered the heaviest burden on the government. The majority of total revenues are allocated to servicing the debt. Therefore, the most efficient channel through which the level of debt is decreased is through minimizing expected debt servicing costs consistent with a prudent level of risk over a medium- to long-term horizon. The major cause of the high levels of public debt over the years is the soaring interest rates paid to service the debt. To prove this hypothesis, we perform the following scenario depicted in Table 16 (p. 58). We take the 1-year LIBOR that prevailed from 1992 to 2005. We add to these LIBOR rates a risk premium of 5 percent to get the debt service cost for each year. Then, we calculate the debt level of each year by adding debt service cost and the budget primary surplus or deficit to the debt level of the previous year. Thus, the estimated debt levels are presented in Table 16 (p. 58). The accumulated debt reached a level of LBP 23,761 billion in 2005 compared to the actual debt level of LBP 58,048 billion, a difference of LBP 34,287 billion (see Chart 19, p. 61). Hence, we can conclude that the permanent increase in the cost of debt service was behind the deterioration of the fiscal situation in Lebanon, which was in turn the reason behind the high levels of public debt reached. If the interest rate structure has been properly set, the level of debt would have been at a level of LBP 23,761 billion in 2005 instead of the actual level reached of LBP 58,048 billion.

Projection of future debt levels As proved above, high interest rates are the major reason behind the high levels of debt achieved, a good debt management strategy manages the cost of debt. Thus, an estimation of the future debt levels with managed interest rates is depicted in Table 17 (p. 60). [57]

TABLE 16

Calculation of debt with normal interest rates (1992–2005) 1992 Libor 1-year Risk premium Total yield Budget primary deficit/surplus (LBP billion) Estimated debt level (LBP billion) Actual debt level (LBP billion) Difference (LBP billion)

1993 3.68% 5% 8.68%

1994

1995

5.72% 6.162% 5% 5% 10.72% 11.162%

1996

1997

5.8% 6.07% 5% 5% 10.8% 11.07%

1998 5.62% 5% 10.62%

1999

2000

5.79% 6.85% 5% 5% 10.79% 11.85%

2001

2002

2003

2004

2005

3.79% 5% 8.79%

2.17% 5% 7.17%

1.36% 5% 6.36%

2.19% 5% 7.19%

4.07% 5% 9.07%

-378

-1,475

-948

-1,039

-2,274

-232

-100

-483

320

1,076

2,283

2,790

2,716

5,623

6,489

8,660

10,574

12,755

16,441

18,419

20,507

23,420

25,159

25,886

25,250

24,275

23,761

5,623

6,652

12,054

16,097

20,188

23,500

27,969

33,734

37,989

42,645

47,276

50,285

54,061

58,048

163

3,394

5,523

7,433

7,059

9,550

13,227

14,569

17,486

21,390

25,035

29,786

34,287

DEBT MANAGEMENT – A NEW PERSPECTIVE

In Table 17 (p. 60), a projection of budget primary balances are calculated by assuming an increase of 5 percent each year. Cost of debt service is also estimated by taking a LIBOR rate and a risk premium. The LIBOR rate is projected by taking the average LIBOR of the years 2000–2005 to get an average of 3.405 percent. However, to estimate the risk premium, compare the yields on the 3, 6, 12 and 24-month Treasury bills in December 2005 which are equal to 5.22 percent, 7.24 percent, 7.75 percent and 8.68 percent respectively. Taking the average rate, 7.22 percent is achieved. Deducting the LIBOR rate of December 2005 (4.823 percent) from the average yield on Treasury bills, a risk premium of 2.40 percent is obtained. Nonetheless, in this case an overestimation is made and, hence, a higher risk premium of 3 percent assumed to calculate the cost of debt. Therefore, adding the LIBOR rate (3.405 percent) and the risk premium (3 percent), gives a cost of 6.405 percent. Moreover, notice that the risk premium on the 3-month Treasury bill in December 2005 is 0.397 percent (5.22 percent yield on 3-month Treasury bill and 4.823 percent LIBOR rate). Comparing the yield on the 6-month Treasury bills (7.24 percent) for December 2005 with the respective LIBOR rate (4.823 percent), a risk premium of 2.42 percent is obtained. Thus, the risk premium increases by a great amount of 2.023 percent on a 3-month Treasury bill compared to a 6-month Treasury bill. Table 17 (p. 60) depicts the debt service projections and the debt levels for years 2006–2025. Debt service costs start decreasing as of year 2014 with a level of LBP 3,954 billion. Chart 21 (p. 62) shows the actual debt service levels from 1992–2005, then the projected levels from 2006–2025. On the other hand, debt starts to decrease as of year 2013 to reach a level of LBP 36,915 billion in 2025. Also, Chart 20 (p. 61) depicts the actual levels of debt from 1992–2005 and the projected levels from 2006–2025.

[59]

TABLE 17

Projection of debt levels (2006–2025) LBP billion

2005

2006

1-year LIBOR 3.405% Risk premium 3% Total yield 6.405% Budget primary 2,716 deficit/surplus Estimated debt service Estimated debt 58,048 level

3.405% 3% 6.405% 2,852

2007

2008

3.405% 3.405% 3% 3% 6.405% 6.405% 2,994 3,144

2009

2010

3.405% 3.405% 3% 3% 6.405% 6.405% 3,301 3,466

2011 3.405% 3% 6.405% 3,640

2012

2013

3.405% 3.405% 3% 3% 6.405% 6.405% 3,822 4,013

2014

2015

2016

2017

2018

3.405% 3.405% 3% 3% 6.405% 6.405% 4,213 4,424

3.405% 3% 6.405% 4,645

3.405% 3% 6.405% 4,878

3.405% 3% 6.405% 5,121

3,718

3,773

3,823

3,867

3,903

3,931

3,950

3,958

3,954

3,938

3,907

3,859

3,794

58,914

59,693

60,372

60,938

61,375

61,666

61,794

61,739

61,480

60,994

60,255

59,237

57,910

2019

2020

2021

2022

2023

2024

2025

1-year LIBOR 3.405% Risk premium 3% Total yield 6.405% Budget primary 5,377 deficit/surplus Estimated debt 3,709 service Estimated debt 56,242 level

3.405% 3% 6.405% 5,646

LBP billion

3.405% 3.405% 3% 3% 6.405% 6.405% 5,929 6,225

3.405% 3.405% 3% 3% 6.405% 6.405% 6,536 6,863

3.405% 3% 6.405% 7,206

3,602

3,471

3,314

3,127

2,909

2,656

54,197

51,740

48,829

45,420

41,466

36,915

DEBT MANAGEMENT – A NEW PERSPECTIVE

CHART 19

Estimated vs. actual debt levels (1992–2005) 70,000 Estimated debt level Actual debt level

60,000

LBP billion

50,000 40,000 30,000 20,000 10,000

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

0

Year

CHART 20

Projected debt levels (2006–2025)

70,000

50,000 40,000 30,000 20,000 10,000

Year

[61]

2024

2022

2020

2018

2016

2014

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

0 1992

LBP billion

60,000


CHART 21

Estimated debt service (2006–2025) 6,000

4,000 3,000 2,000 1,000

Year

[62]

2024

2022

2020

2018

2016

2014

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

0 1992

LBP billion

5,000

9 Conclusion and Recommendations

The ability of the economy and the financial system to ride out the confidence shock that followed the assassination of former Prime Minister Rafic Al-Hariri attests, once again, to the resilience of the Lebanese financial system. The skillful handling of this difficult situation by the authorities, and the Banque du Liban in particular, helped avert what could have been a very destructive financial storm. Although the new political environment presents risks and new challenges, economic, structural and political reforms are gaining domestic approval and are expected to attract both regional and international donors at the Beirut I conference. The conference aims to decrease interest rates in order to reduce debt service that reached LBP 3,534 billion in 2005, and to increase primary budget surplus that reached LBP 2,716 billion at the end of 2005. For years the Lebanese public debt has been the major concern of many international organizations, politicians, economists and the public. Doubts were shed on the sustainability of the Lebanese debt. So far, Lebanon has succeeded in resisting potential crises but is the debt still sustainable? Is Lebanon still resistant to economic collapse? Is Lebanon following a sound debt management strategy or is the crisis ultimately inevitable? What is the effective debt management strategy? What is the relation of the debt service to debt, and at what rate does it increase the debt level? Who is benefitting from the high rates on the debt service? And, how can the public debt be reduced? This book answered these questions by studying the public debt structure and its composition. The Lebanese public debt has been increasing over the years reaching a ratio of 197 percent of GDP in 2005. Domestic debt constituted the majority of the debt at the beginning of the 20th century. Then in 2001 and 2002, foreign debt increased dramatically especially after the Paris II conference. Lebanon implemented swapping operations by exchanging its domestic currency debt for foreign currency [63]


debt at lower interest rates in a step to avoid debt crisis. Hence, in 2003 and 2004, the debt became diversified between foreign and domestic debt. Nonetheless, it is important to point out that the vast majority of the foreign debt is held by local entities in foreign currency. This fact helped Lebanon survive the shocks that have occurred over the years. Debt service has been radically increasing especially during 1995 and 1996 when interest rates skyrocketed especially on the 12-month Treasury bills which reached a value of 37.85 percent in September 1995. However, these rates have been decreasing since then. The Paris II conference was considered a last minute rescue. It was an important step that helped Lebanon avert an imminent financial crisis. However, Lebanon was not immunized through the Paris II measures that have been taken. Comparing the extra cost paid as a result of the increase in interest rates during 1995–1996, we see that the extra debt service in the 1995–1996 period constitutes 20 percent of the funds granted by contributor countries. This leads us to conclude that if the interest rates on debt servicing were managed over the years, Lebanon would not have needed either the Paris II conference or the Beirut I conference for funding. This book goes a step forward in studying the contribution of Lebanese banks in the public debt. It is seen that banks are the major source of funding for the domestic debt especially through their investment in Treasury bills. Hence, the high interest rates on public debt had been advantageous to the Lebanese banks to a large extent and in return the banks’ funds for the private sector were very low thus crowding out investment in the economy. Debt service has imposed a big burden on the economy. Around 45 percent of the annual budget of the government is allocated to debt servicing. The key factor of the worsening of the fiscal budget has been the way the debt was managed. Consequently, efficient debt management policies should be implemented by reducing the burden of debt and hence reducing debt by effective interest rate management. The study shows that the Lebanese banks have to make sacrifices in terms of earnings so that lower debt service costs can be achieved and thus debt levels ultimately decrease. Decreasing debt service by 1 percent reduces debt by 9.67 percent as given by the regression done in Chapter 7. Also, the risk premium for the 3-month Treasury bills and the 6-month Treasury bills is 0.39 [64]

C O N C LU S I O N A N D R E C O M M E N D AT I O N S

percent and 2.023 percent respectively as indicated in Chapter 8. This increase in risk is unjustifiable in terms of the difference in maturities between these bonds. Given these facts, we can conclude that very high interest rates are responsible for creating high fiscal deficits which in turn are behind the soaring debt levels attained over the years. Thus, an important path to resolve the debt problem and to develop sustainable debt management policies is through managing interest rates. This will reduce the debt service and in turn reduce the public debt stimulating investment in the economy. In addition, other complementary measures ought to be implemented side by side with the debt management policies. One of these measures is forming an independent public entity for managing the public debt. Moreover, to ensure the success of the management policies, monetary and economic reforms should be executed. First, a major component in government revenue is tax collection, which should be improved. Not to forget that the tax system ought to be fair, transparent and effective, and thus a proper taxation system should be implemented fairly across all citizens; for example, restructuring the income tax of short-term capital gain. The second component of the budget balance is government expenditure, which should be audited. Higher collection of government revenue and proper and lower allocation of government expenditure are expected to reduce the heavy burden of debt. As for EDL (Electricite Du Liban), it has been an important part of the burden on the public debt. EDL suffered severe losses because of corruption. To reduce EDL’s losses and eliminate the burden of EDL on debt, operating costs have to be reduced, collection should be improved, and corruption eliminated. This study ends by introducing a model for public debt management that reduces the public debt to LBP 36,915 billion by 2025. However, if the interest rates are not managed and the primary budget surplus is not increased, the conditions are potentially disastrous. In this case, the debt will increase exponentially leading to the collapse of the Lebanese financial system. A case study was made in Chapter 8 that stresses the difference between proper management of the debt and mismanagement. Having the Lebanese debt managed would have led to LBP 23,761 billion as total debt in 2005 in comparison to LBP 58,048 billion which is the present case. This is a difference of LBP 34,287 billion and Lebanon could have saved around 59 percent of this debt. [65]


Appendix

TABLE 18

Total banks’ net income (1992–2004) Year

Net income (USD million)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

40.074 55.084 126.831 179.166 272.534 348.995 408.475 334.077 271.727 295.663 243.515 403.418 443.276


[67]

TABLE 19

Yield on 3, 6, 12 and 24-month Treasury bill (%) Date Dec-93 Jan-94 Feb-94 Mar-94 Apr-94 May-94 Jun-94 Jul-94 Aug-94 Sep-94 Oct-94 Nov-94 Dec-94 Jan-95 Feb-95 Mar-95 Apr-95 May-95 Jun-95 Jul-95 Aug-95 Sep-95 Oct-95 Nov-95 Dec-95 Jan-96 Feb-96 Mar-96 Apr-96 May-96 Jun-96 Jul-96 Aug-96

Yield on 3-month Treasury bill 17.22 17.04 16.5 16.33 16.19 16.07 15.3 14.9 14.46 14.47 13.6 12.77 13.49 13.62 15.3 16.55 16.55 17.75 19.94 20.5 22.83 25.3 24.56 17.61 16.01 15.97 15.82 15.81 15.81 15.72 15.56 14.94 14.74

Yield on 6-month Treasury bill 19.65 19.53 18.55 18.04 17.97 17.85 17.47 17.43 17.15 17.21 16 14.54 14.83 15.37 16.83 18 18 18.87 21.7 22.43 25.13 27.91 27.37 19.01 17.21 17.2 17.16 17.16 17.16 17.07 16.99 16.97 16.95



Sep-96 Oct-96 Nov-96 Dec-96 Jan-97 Feb-97 Mar-97 Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97 Nov-97 Dec-97 Jan-98 Feb-98 Mar-98 Apr-98 May-98 Jun-98 Jul-98 Aug-98 Sep-98 Oct-98 Nov-98 Dec-98 Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99 Jul-99 Aug-99 Sep-99 Oct-99 Nov-99

14.61 14.61 14.39 14.29 14.08 13.87 13.75 13.7 13.62 13.4 13.16 13.09 13.09 13.09 13.09 13.09 13.09 13.09 13.09 13.09 12.98 12.82 12.69 12.5 12.48 12.38 12.38 11.77 11.73 11.73 11.73 11.73 11.73 11.73 11.73 11.73 11.42 11.18 11.18

16.92 16.92 16.55 16.15 15.56 14.61 14.49 14.45 14.37 14.21 14.02 13.97 13.97 13.97 13.97 13.97 13.97 13.97 13.97 13.97 13.97 13.97 13.88 13.7 13.66 13.52 13.52 13.21 13 13 13 13 13 13 13 13 12.52 12.12 12.12

17.8 17.78 17.57 17.02 15.84 15.27 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 14.84 14.84 14.84 14.84 14.84 14.84 14.84 14.84 14.77 13.66 13.43 13.43

16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.73 16.66 16.66 16.66 16.66 16.66 16.66 16.36 16.19 15.95 14.92 14.64 14.64 14.64 14.64 14.64 14.64 14.64 14.64 14.64

Date Dec-99 Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02

Yield on 3-month Treasury bill 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 11.18 10.8 7.77




Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05

Source: BDL

6.96 6.96 6.96 6.96 6.96 6.96 6.96 6.96 6.96 6.96 5.44 5.48 5.47 5.37 5.29 5.22 5.22 5.2 5.16 5.17 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22 5.22

8.18 8.18 8.18 8.18 8.18 8.18 8.18 8.18 8.18 8.18 6.55 6.53 6.51 6.46 6.4 6.36 6.34 6.32 6.32 6.32 6.31 6.31 6.31 6.31 6.31 6.31 7.24 7.24 7.24 7.24 7.24 7.24 7.24 7.24 7.24 7.24

9.13 9.13 9.13 9.13 9.13 9.13 9.13 9.13 9.13 9.13 6.89 6.87 6.85 6.8 6.76 6.71 6.7 6.69 6.68 6.68 6.68 6.69 6.69 6.69 6.69 6.69 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75

9.41 9.41 9.41 7.99 7.99 7.99 7.97 7.95 7.93 7.91 7.89 7.89 7.89 7.89 7.89 7.89 7.89 7.89 7.89 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68 8.68

TABLE 20

The share of banks, central bank and non-banks in Treasury bills Date

Dec-93 Jan-94 Feb-94 Mar-94 Apr-94 May-94 Jun-94 Jul-94 Aug-94 Sep-94 Oct-94 Nov-94 Dec-94 Jan-95 Feb-95 Mar-95 Apr-95 May-95 Jun-95 Jul-95 Aug-95 Sep-95 Oct-95 Nov-95 Dec-95 Jan-96 Feb-96 Mar-96 Apr-96 May-96 Jun-96 Jul-96

Banks (LBP billions)

4,242.1 4,664.1 5,208.3 5,685 6,006.8 6,017 6,188.8 6,431.7 6,712.2 6,924.4 7,287.8 7,454 7,341 7,254.9 7,270.3 7,230.5 7,216.4 6,824.7 6,775.9 6,638 6,523.7 6,279 6,923.7 8,098.2 8,488.6 8,902.4 8,937.9 9,099.5 8,904.4 9,334.1 9,588.2 9,857

Share of banks’ Treasury bills to total Treasury bills (%) 73.92 76.41 76.97 76.77 76.44 75.75 75.83 76.05 75.72 75.03 79.41 79.52 79.23 79 79.32 79.5 77.98 74.62 72 69.4 67.55 65.79 63.18 70.25 71.71 72.44 72.18 71.98 71.26 71.49 71.28 71.35

Central Bank (LBP billions)

392.1 277.4 293.3 354.5 427 447.2 463.7 463.1 519.8 530.6 14.3 2.9 26.9 23.9 20.6 39.3 195.4 470.2 723.2 863 1,002.4 1,022.9 1,137.7 67.4 0 0 0 0 0 0 0 0

Share of central bank’s Treasury bills to total Treasury bills (%) 6.83 4.54 4.33 4.79 5.43 5.63 5.68 5.48 5.86 5.75 0.16 0.03 0.29 0.26 0.22 0.43 2.11 5.14 7.68 9.02 10.38 10.72 10.38 0.58 0 0 0 0 0 0 0 0

Non-banking (LBP billions)

1,104.6 1,162.5 1,265.1 1,366.2 1,424.1 1,479.3 1,509.4 1,561.9 1,632.3 1,773.9 1,874.8 1,916.8 1,897.9 1,904.8 1,875.4 1,825.7 1,841.9 1,850.7 1,912.3 2,063.7 2,131.1 2,242.7 2,897.3 3,362 3,349.4 3,386.9 3,445 3,542.5 3,591.7 3,723.2 3,862.4 3,957.4

Share of non-banks’ Treasury bills to total Treasury bills (%) 19.25 19.04 18.7 18.45 18.12 18.62 18.49 18.47 18.41 19.22 20.43 20.45 20.48 20.74 20.46 20.07 19.9 20.24 20.32 21.58 22.07 23.5 26.44 29.16 28.29 27.56 27.82 28.02 28.74 28.51 28.72 28.65

Total Treasury bills (LBP billions)

5,738.8 6,104 6,766.7 7,405.7 7,857.9 7,943.5 8,161.9 8,456.7 8,864.3 9,228.9 9,176.9 9,373.7 9,265.8 9,183.6 9,166.3 9,095.5 9,253.7 9,145.6 9,411.4 9,564.7 9,657.2 9,544.6 10,958.7 11,527.6 11,838 12,289.3 12,382.9 12,642 12,496.1 13,057.3 13,450.6 13,814.4

Aug-96 Sep-96 Oct-96 Nov-96 Dec-96 Jan-97 Feb-97 Mar-97 Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97 Nov-97 Dec-97 Jan-98 Feb-98 Mar-98 Apr-98 May-98 Jun-98 Jul-98 Aug-98 Sep-98 Oct-98 Nov-98 Dec-98 Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99 Jul-99 Aug-99 Sep-99 Oct-99

10,056.6 10,790 11,492.8 11,866.4 12,555.8 12,760.8 12,828.3 13,039 13,274.8 13,386.9 13,507.8 13,672.7 13,768.2 13,706.5 13,094.6 13,137.1 13,423.6 13,702.4 13,817.7 13,426.9 13,200.2 13,912 14,174.8 14,603.3 14,650.8 14,841 15,527.8 15,646.1 16,151 15,570.6 15,747.1 15,708.5 15,732.2 15,991.4 16,294.6 16,383.4 16,873.7 17,521.6 18,159.3

71.27 71.87 74.05 72.61 73.76 71.93 70.75 70.14 70.05 68.65 68.2 68.74 69.57 70.27 70.64 71.34 68.57 68.74 69.37 66.61 68.95 69.71 69.67 72.44 73.05 73.9 74.45 74.78 75.35 73.15 72.38 71.63 72.68 72.82 73.25 72.77 72.1 73.59 74.59

0 0 0 0 0 0 0 0 0 0 0 0 0 0 36.1 204.1 274 457.3 477.6 1,276.8 601.7 585.7 590.4 0 0 50.7 0 0 13.5 500.3 672.9 722.3 326.6 331.3 221.4 208.6 223.8 0.6 1.6

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0.19 1.11 1.4 2.29 2.4 6.33 3.14 2.94 2.9 0 0 0.25 0 0 0.06 2.35 3.09 3.29 1.51 1.51 1 0.93 0.96 0 0.01

4,053.6 4,222.6 4,027.4 4,477.2 4,466.5 4,980.9 5,304 5,552.2 5,676.9 6,112.5 6,297.2 6,216.6 6,021.2 5,798.1 5,406.4 5,074.7 5,880.1 5,773.8 5,624.2 5,455.1 5,342.6 5,458 5,579 5,556.2 5,404.4 5,190.6 5,327.6 5,277.3 5,271.5 5,214.7 5,336.2 5,500.4 5,586.3 5,637.3 5,727.8 5,923.3 6,305.3 6,286.7 6,184.6

28.73 28.13 25.95 27.39 26.24 28.07 29.25 29.86 29.95 31.35 31.8 31.26 30.43 29.73 29.17 27.56 30.03 28.97 28.23 27.06 27.91 27.35 27.42 27.56 26.95 25.85 25.55 25.22 24.59 24.5 24.53 25.08 25.81 25.67 25.75 26.31 26.94 26.4 25.4

14,110.2 15,012.6 15,520.2 16,343.6 17,022.3 17,741.7 18,132.3 18,591.2 18,951.7 19,499.4 19,805 19,889.3 19,789.4 19,504.6 18,537.1 18,415.9 19,577.7 19,933.5 19,919.5 20,158.8 19,144.5 19,955.7 20,344.2 20,159.5 20,055.2 20,082.3 20,855.4 20,923.4 21,436 21,285.6 21,756.2 21,931.2 21,645.1 21,960 22,243.8 22,515.3 23,402.8 23,808.9 24,345.5

Date

Nov-99 Dec-99 Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02

Banks (LBP billions)

18,309.8 18,808.2 18,969 19,064.2 19,207.6 19,402.7 18,800.2 18,980.7 19,273.5 19,620.4 19,165 18,299.9 18,460.7 18,667.6 19,132.5 18,999 18,426.4 17,671.7 16,813.6 16,594.7 16,506.9 15,989.8 15,392.7 15,215.3 15,374.1 15,797.7 16,294.5 16,181.8 15,695.6 15,257.9 14,735.1 15,223.3 15,457.2 15,699.8 15,884.4

Share of banks’ Treasury bills to total Treasury bills (%) 73.98 74.89 75.06 74.8 74.9 75.21 73.51 72.97 73.21 73.27 72.67 69.8 69.09 69.23 69.39 68.98 67.08 64.1 61.74 60.13 58.82 57.98 56.51 55.14 55.33 56.34 57.39 56.25 56.7 54.48 52.13 54.71 55.22 57.41 57

Central Bank (LBP billions)

1.8 3.1 2.5 2.6 3.1 3.6 303.5 636 643.5 641.3 656.2 1,294.1 1,597.8 1,597.8 1,610 1,624.7 2,107.5 3,028 3,601.5 4,149.6 4,103.9 4,750.1 5,102.1 5,812.2 6,066.7 6,111 6,101 6,562.6 5,897.9 6,690 7,325.2 6,366.3 6,114.7 5,426.1 5,623.9

Share of central bank’s Treasury bills to total Treasury bills (%) 0.01 0.01 0.01 0.01 0.01 0.01 1.19 2.44 2.44 2.39 2.49 4.94 5.98 5.93 5.84 5.9 7.67 10.98 13.23 15.03 14.62 17.22 18.73 21.06 21.83 21.79 21.49 22.81 21.31 23.89 25.91 22.88 21.85 19.84 20.18

Non-banking (LBP billions)

6,436.8 6,302.4 6,301.7 6,419 6,432 6,390.8 6,470.3 6,396.2 6,410.9 6,516.9 6,552.1 6,622.6 6,662.2 6,698.9 6,830.9 6,918.4 6,934.4 6,870.9 6,816.4 6,856 7,452.9 6,836.9 6,742.3 6,564.4 6,347.8 6,133.4 5,995 6,024.2 6,087.4 6,059.2 6,207.9 6,235 6,418.7 6,222.4 6,358.9

Share of non-banks’ Treasury bills to total Treasury bills (%) 26.01 25.1 24.93 25.19 25.08 24.77 25.3 24.59 24.35 24.34 24.84 25.26 24.93 24.84 24.77 25.12 25.25 24.92 25.03 24.84 26.56 24.79 24.75 23.79 22.84 21.87 21.12 20.94 21.99 21.63 21.96 22.41 22.93 22.75 22.82

Total Treasury bills (LBP billions)

24,748.4 25,113.7 25,273.2 25,485.8 25,642.7 25,797.1 25,574 26,012.9 26,327.9 26,778.6 26,373.3 26,216.6 26,720.7 26,964.3 27,573.4 27,542.1 27,468.3 27,570.6 27,231.5 27,600.3 28,063.7 27,576.8 27,237.1 27,591.9 27,788.6 28,042.1 28,390.5 28,768.6 27,680.9 28,007.1 28,268.2 27,824.6 27,990.6 27,348.3 27,867.2

Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Source: BDL

16,550.3 17,117 17,163.9 17,391.1 17,058.4 17,115.9 16,550.2 15,669.3 15,516.1 14,740 15,076.2 14,445.8 12,148.4 12,057.2 12,258.2 12,953.6 13,363.5 13,662 13,464.5 14,133.6 13,741.3 13,561.3 13,366.6 13,080.3 12,518.5 11,212.1 12,170.6 12,213.5 12,031.5 9,559.6 9,509.2 9,677.8 10,479.1 11,612.7 12,664.4 13,041.9 13,284.6 13,760.8

59.32 59.39 68.29 68.85 69.04 67.63 67.52 62.31 62.5 59.92 60.12 56.33 46.59 46.58 46.27 47.91 48.76 49.76 48.79 50.54 50.05 50.11 49.9 48.79 47.23 44.48 47.05 47.67 47.38 37.62 37.31 37.57 39.94 43.89 46.48 47.43 47.8 48.7

4,544 4,497.4 601.4 661.7 660 1,332.4 1,294.7 3,141.5 3,142.2 3,846.6 4,166.3 5,416.3 8,371.8 8,530.2 8,629.6 8,579.1 8,444.7 8,337.2 8,779.6 8,784.9 8,779.6 8,723.6 8,751.3 9,586 9,800.1 10,169.2 10,197.1 10,087 10,024.4 12,562.1 12,791.9 13,005.6 12,678.9 11,590.9 11,291.2 11,180.4 11,153.7 11,154.8

16.29 15.61 2.39 2.62 2.67 5.26 5.28 12.49 12.66 15.64 16.61 21.12 32.1 32.96 32.58 31.73 30.82 30.37 31.81 31.41 31.98 32.24 32.67 35.76 36.97 40.34 39.42 39.37 39.48 49.44 50.19 50.49 48.33 43.81 41.44 40.66 40.13 39.48

6,804 7,205 7,368.2 7,207.6 6,990.2 6,861.2 6,666 6,336.7 6,166.3 6,014 5,834.6 5,782.9 5,557.3 5,294.8 5,602.7 5,502.3 5,595.9 5,454.6 5,355 5,045.8 4,932.1 4,775.7 4,667.9 4,141.1 4,187 3,825.9 3,499.7 3,322.2 3,335.2 3,289 3,186.6 3,077.6 3,077.9 3,255.8 3,293 3,275.1 3,354.2 3,338.9

24.39 25 29.32 28.53 28.29 27.11 27.2 25.2 24.84 24.45 23.27 22.55 21.31 20.46 21.15 20.35 20.42 19.87 19.4 18.04 17.97 17.65 17.43 15.45 15.8 15.18 13.53 12.97 13.14 12.94 12.5 11.95 11.73 12.3 12.09 11.91 12.07 11.82

27,898.3 28,819.4 25,133.5 25,260.4 24,708.6 25,309.5 24,510.9 25,147.5 24,824.6 24,600.6 25,077.1 25,645 26,077.5 25,882.2 26,490.5 27,035 27,404.1 27,453.8 27,599.1 27,964.3 27,453 27,060.6 26,785.8 26,807.4 26,505.6 25,207.2 25,867.4 25,622.7 25,391.1 25,410.7 25,487.7 25,761 26,235.9 26,459.4 27,248.6 27,497.4 27,792.5 28,254.5

TABLE 21

Public debt (1991–2005) Year

Total debt (LBP billion)

Domestic debt (LBP billion)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

2,737 4,844 6,538 10,799 14,156 20,188 23,500 27,965 33,715 37,641 42,616 47,221 50,285 54,048 58,048

Year

Nominal GDP

Foregn debt/GDP (%)

1991 1992 1993 1994 1995 1996 1997 1998 1999

4,147 9,642 13,088 15,284 18,011 20,402 22,872 24,501 24,950

12.23 6.90 5.61 9.50 11.99 14.51 16.23 25.63 33.39

2,229.7 4,178.2 5,804 9,348 11,997 17,229 19,787 21,686 25,383 27,161 28,214 25,302 26,843 26,371 29,140

Foreign debt (LBP billion) 507 665 735 1,452 2,159 2,960 3,713 6,279 8,332 10,480 14,402 21,919 23,442 27,677 28,909

Domestic debt/GDP (%) 53.77 43.33 44.34 61.16 66.61 84.45 86.51 88.51 101.73

Domestic debt share of total (%)

Foreign debt share of total (%)

81.47 86.26 88.77 86.56 84.75 85.34 84.20 77.55 75.29 72.16 66.21 53.58 53.38 48.79 50.20

18.53 13.74 11.23 13.44 15.25 14.66 15.80 22.45 24.71 27.84 33.79 46.42 46.62 51.21 49.80

Debt/GDP (%)

Debt service/ GDP (%)

65.99 50.23 49.96 70.66 78.60 98.95 102.74 114.14 135.13

4.97 5.38 5.99 9.74 10.41 13.00 15.22 13.68 14.53

Interest payments (LBP billion) 206 519 784 1,488 1,875 2,653 3,482 3,352 3,625 4,197 4,312 4,622 4,874 4,021 3,534

Debt service/ revenue (%) 39.45 48.96 42.26 66.40 61.82 75.09 92.78 75.34 74.47

2000 2001 2002 2003 2004 2005

24,721 25,115 26,068 27,198 29,416 NA

42.39 57.34 84.08 86.19 94.09 98.11

Year

Debt service/ expenditure (%)

Growth of internal debt (%)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

17.22 23.38 25.55 27.66 29.56 33.34 34.59 36.99 40.68 38.39 47.02 46.53 46.02 48.40 45.30

NA 87.39 38.91 61.06 28.35 43.61 14.85 9.60 17.05 7.01 3.88 -10.32 6.09 -1.76 10.50

Source: BDL

109.87 112.34 97.06 98.69 89.65 98.89

Growth of foreign debt (%) NA 31.22 10.38 97.63 48.73 37.08 25.45 69.12 32.69 25.78 37.43 52.19 6.95 18.07 4.45

152.26 169.68 181.15 184.88 183.74 197.00

16.98 17.17 17.73 17.92 13.67 11.99

Growth of total debt (%)

Growth of debt service (%)

NA 76.98 34.99 65.17 31.09 42.61 16.40 19.00 20.56 11.65 13.22 10.81 6.49 7.48 7.40

NA 151.94 51.06 89.80 26.01 41.49 31.25 -3.73 8.14 15.78 2.74 7.19 5.45 -17.50 -12.11

88.38 92.87 79.28 73.25 53.51 50.60


References

ABL (Association of Lebanese Banks). Yearly Report 2003–2004. —Monthly Bulletin. November 2004. Azour, Jihad. “Financing Development: Fiscal Reform, Debt Management And Financial Markets”. October 2004 Bank Audi sal – Audi Saradar Group. “Country and Market Update”. 2005. Bankdata Financial Services WLL. “Bilanbanques”. 1994–2005. BDL (Banque du Liban). Monthly and Yearly Reports and Bulletins. 2000–2005. —The Lebanese Financial System. May 2004. International Monetary Fund and the World Bank. “Guidelines for Public Debt Management: Accompanying Document”. November 2002. —“Guidelines for Public Debt Management”. December 2003. —“Amendments to the Guidelines for Public Debt Management”. 25 November 2003. International Monetary Fund. “IMF Concludes 2004 Article IV Consultation with Lebanon”. 2004. Makdisi, Samir. The Lessons of Lebanon: The Economics of War and Development. New York: I.B. Tauris, 2004. MOF (Ministry of Finance). “Six-Month Progress After Paris II Special Report”. June 2003. —“One-Year Progress After Paris II Special Report”. December 2003. —“One Year after Paris II”. 2004. —“Public Debt Report 2004”. 2004. United Nations. “Economic and Social Commission for Western Asia External Debt Management and the Debt Situation in the Escwa Region: Case studies on Jordan and Lebanon”. New York, 2004.

[79]

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