The government may postpone painful fiscal reforms, but it should be wary of relying on future oil and gas wealth to address its public finances.

Having recently resolved longstanding political stalemates, Lebanon must now address a looming public debt crisis threatening the economy. While far-reaching budgetary reforms are likely to face parliamentary opposition and fuel unrest, this may be the only option as promising offshore oil and gas deposits are not expected to come on stream for some time.

A renewed focus on the economy comes as Lebanon’s political process begins to gather momentum after years of impasse. In May next year, the country is due to hold parliamentary elections for the first time in almost a decade.  The 82-year-old former Christian army chief Michel Aoun is about to mark one year as President, a role that was previously vacant for over two years.

Now that they have achieved a degree of political stability, politicians are finally in a position to tackle the country’s parlous public finances. The Lebanese state’s total debt currently amounts to one-and-a-half times the value of its annual economic output.  Each year the government spends almost half of its tax take servicing this debt.

According to Lebanon’s energy ministry, seismic surveys estimate that the country possesses 850 million barrels of oil and 96 trillion cubic feet of gas in offshore deposits. Such reserves would, if exploited, serve to significantly reduce the country’s debts and provide a major boost to the economy. On September 19 parliament passed an oil tax law, and bids for the first licensing round of two offshore blocks were submitted on October 12 by an international consortium involving Total, Eni and Novatek.  Final development agreements for the two blocks are set for January 2018.

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Efforts to restore Lebanon’s political process received a major boost on June 16 when parliament ratified a new electoral law, paving the way for long-awaited parliamentary elections. The law’s ratification was hugely significant for a country whose Christian, Sunni and Shia politicians struggle to remain united in the face of the sectarian conflict which continues in neighbouring Syria. The breakthrough came a matter of months after another deadlock was broken with the appointment last October of a new President, albeit in controversial circumstances.  Aoun took up the position after striking a contentious alliance with Shiite militant group Hezbollah.

National assembly elections have not been held since June 2009 because the country’s political parties, which represent 11 different religious factions in parliament, disagreed over the rules of a new electoral law.  Ratification, alongside the appointment of Aoun to the Presidency, is a sign that the government may at last begin to tackle a large backlog of parliamentary bills which have accumulated during the period of political paralysis.

The priority is to pass the annual state budget, something the Lebanese parliament has not achieved since 2005.  This is badly needed to address the increasingly unsustainable public debt levels and resuscitate the economy.  Economic growth has been anaemic since the conflict in Syria broke out six years ago.

Failure to agree on annual budgets forces the government each year to re-enact the 2005 budget’s framework, with much additional funding chaotically provided for “exceptional” circumstances.  The process has led to unaccounted increases in government spending and a spiralling in the ratio of government debt to GDP, which stood at 149% by the end of 2016, according to the World Bank. The IMF forecasts that this figure is set to rise to 165% in 2022, higher than that of Greece.

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In May the cabinet of Prime Minister Saad Hariri approved a draft budget for 2017, which proposed a raft of new revenue generating measures. It is due to be debated shortly in parliament, where the budgetary process has been derailed in the past because economic policies are so politicised.

Even if the budget is passed it could prove difficult to implement, as its fiscal reforms are expected to be unpopular.  A recent proposal to increase corporation tax and VAT in order to fund civil service salary increases was met with public protests in Beirut.

Although the tax take in Lebanon is seen by economists as insufficient, the Lebanese public are very sensitive to tax increases for two reasons: their own living standards have deteriorated in the past six years; and they resent the misuse of funds by corrupt public officials. All of which suggests that the government might allow public debt to rise even further, testing the confidence of sovereign bond investors, in the hope that future revenues from oil and gas deposits will solve the debt crisis.

In 2013 the Lebanese energy ministry launched a prequalification round for development of the country’s oil and gas deposits, but the process stalled because parties could not agree on licensing conditions.  With the election of Aoun last year, the process has now been revived.

While Bank Audi, a leading bank in Lebanon, estimates that the energy fields are worth over $600 billion, many are sceptical about their value, as it cannot be accurately assessed until exploration begins. Nevertheless, some commentators suggest that much like its neighbours in the Gulf, the government could in future years call upon Lebanon’s natural resources to keep the country afloat.

The development of oil and gas deposits would also be popular with the Lebanese public because, depending on how soon they could be exploited, they may obviate the need for austerity measures and end the chronic electricity shortages that leave some parts of the country without power for as much as 18 hours a day.

However, the exploration process is unlikely to be swift.  The October 12 licensing round received only the Total-Eni-Novatek consortium’s bid, which was for just two of the five offshore blocks on offer. And of the two blocks, one includes territory disputed by Israel. So if Lebanon puts off bold fiscal reforms, it could have to wait too long for oil and gas revenues to keep it solvent.

 

Matthew Bailey is an analyst at Alaco, a London-based business intelligence consultancy.

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.
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