Lebanon: Can Donor Conference Success Right The Ship?

April 6 was, by any measure, a good day for Lebanon. Asking for $6bn to finance phase-1 of its capital investment plan (CIP) at the Cedre conference in Paris, the cash-strapped government received $11.5bn in pledges from international donors. Prime Minister Saad Hariri called the contributions a “clear and concrete indication of support,” whilst French President Emmanuel Macron praised the success amidst “one of the worst moments in the Levant’s history.”

All told, Lebanon received about $11.1bn in credit lines and soft loans—meaning interest rates under 1.5% and seven to ten year grace periods for repayment—including a $4bn loan from the World Bank to be paid out over five years (see table). Modest grants of around $400mn from France, the United States and the United Kingdom will provide some flexibility as well. Several donors stipulated higher disbursements contingent upon Beirut fulfilling certain conditions, which MEES estimates could fetch another $650mn if all stipulations are met.

CRUMBLING INFRASTRUCTURE

Lebanon badly needs an overhaul. Days before the conference, the World Bank released its CIP document outlining around 250 projects identified to help kickstart the economy and repair creaky infrastructure. The total plan calls for investment of $24.3bn (see chart 1) to be allocated over three separate phases, each lasting about four years. The transportation and power generation sectors will receive about half of the allocated spending, while the government plans to allocate another 28% toward water/irrigation (with plans to construct two large dams) and waste water treatment.

Unlike previous development plans, investment is to be allocated across the country rather than focused on the capital. The wealthier Beirut and Mount Lebanon governorates are only allocated 35%.

The Cedre conference is part of a larger push to address Lebanon’s systemic problems with a little help from its allies (MEES, 16 March). The army and internal security forces received around $550mn in pledged support last month at the Rome II conference, whilst the European Union (EU) has already pledged about $700mn in grants to be announced later this spring at a Brussels conference to prop up countries hosting Syrian refugees. And more could be on the way.

IT’S THE ECONOMY, STUPID

Lebanon’s run-down infrastructure is the result of decades of instability and public mismanagement. The last major infrastructure push was carried out by President Fouad Chehab in the early 1960s—investment since has been marginal at best. The 1975-1990 civil war destroyed much of what was once called the “Switzerland of the Middle East,” and the subsequent 15-year Syrian occupation saw little done to repair the war-torn country. Governance ground to a halt after the 2005 Syrian withdrawal, punctuated by the devastating 2006 July War in which Israel strategically targeted Lebanon’s already piecemeal facilities.

Rafic Hariri, Saad’s father and the most prominent post-war politician until his assassination in 2005, took a similar approach to revitalizing the Lebanese economy with his $18bn ($28bn in today's terms). But while this did attract international attention and helped rebuild some vital physical infrastructure, debt tripled between 1992-96 to $10.5bn. Debt has been an ever-present problem since.

Since 2011, the war in neighboring Syria has crippled economic growth (see chart), stunting the 9.2% average annual growth from 2007-2010 to a paltry 1.7% from 2011-2017 (see chart 2). With a bloated public sector, subsidized (yet inadequate) utilities and corruption a problem even in the best of times, the collapse in growth saw Beirut rack up a massive debt: its debt to GDP ratio of 150% is the third highest globally. Lebanon’s 2018 budget projects a $4.8bn deficit.

Advocates of the Cedre approach insist that foreign borrowing and a commitment to better governance will not only modernize infrastructure but also turn around the economy. Mr Hariri claims the investment plan will yield 90,000 new jobs—a boon for a country where young talent flees to the Gulf for employment. He also claims reforms in the power sector alone will end the nearly $2bn a year deficit state-provider Electricité du Liban (EDL) routinely racks up.

With financing secured, reforming the power sector is the government’s top priority. EDL is a perennial strain on the public sector—accounting for 45% of the current $80bn debt—and yet Lebanese still suffer from 12+ hour daily power cuts. Current maximum installed generation capacity stands at 2 GW, while peak demand reaches north of 3.3 GW in the summer months, forcing citizens to rely on costly generator mafiosi to bridge the demand gap. The presence of 1.5mn refugees has further exasperated the shortage.

The investment plan calls for 17 new investment projects totaling $5.6bn to be spent over three cycles from 2018 to 2030, with heavy private sector involvement. The plan includes four new gas-fired powerplants: two in north Lebanon at Selaata and two in southern Lebanon at Zahrani and Jiyeh. Each plant is estimated to cost $500-600mn and produce 500MW. The CIP appears to prioritize plant one at Selaata and Zahrani as phase-1 projects, whereas the other two would be implemented later.

The earmarked projects, along with proposed subsidy reforms, would meet peak demand, enable Beirut to wean itself off costly and inefficient Turkish ‘power ships’ producing around 370 MW from fuel oil, and nix plans to tender another two power ships for 800 MW. A shift from fuel oil toward gas-fired plants would also ease the eventual transition toward domestically produced gas, should offshore exploration efforts pan out (MEES, 15 December 2017). But if exploration wells turn up dry, Lebanon will need to either secure gas from its neighbors (likely Syria) or invest in regasification plants.

IF IT WERE ONLY THAT EASY…

There are considerable reasons to share the ruling elites’ optimism surrounding the Cedre result. Namely, the present state of Lebanese governance is so poor that a few sensible reforms would go a long way. Its bloated public sector bill, payments on debt interest and electricity generation eat up 78% of public spending (see chart 2), and the services the Lebanese receive are minimal.

For years, the government has suffered from a perennial cycle in which low growth leads to less revenues, and less revenues translate to a greater share of public spending allocated toward servicing the debt. This means less investment in economic development (capex only accounted for 5% of spending in 2017), which in turn fosters lower growth—and a larger public debt.

The influx of $11.5bn over five years into a relatively small economy could help break the cycle and remove some structural factors inhibiting growth. After all, the World Bank estimates that Lebanon’s pitiful traffic congestion alone results in a whopping 5-10% reduction in GDP—a problem the $6.9bn investment in transportation would aid.

But critics remain skeptical of the government's most recently hatched plan nonetheless—and for good reason. Businessman Mohamed Zeidan, who served as an auditor for the Paris II and Paris III conferences, told UAE newspaper The National “Instead of begging the French to give us this money, why aren’t the reforms being made? I don’t think Lebanon should be asking others for help. The international community has treated Lebanon like an alcoholic that promises he will change.” If Lebanon’s elites were unable to curb deficit spending in the late-2000s, when growth pushed 10%, why would the latest Cedre plan be any different?

The state may chronically overspend, but its inability to raise revenues is a problem in itself. The lack of revenues can be put down to low tax rates (personal income tax maxes out at only 21%; corporate taxation at 15%), overreliance on indirect taxation, and a high level of tax evasion. Tax evasion is fueled by a widespread perception of rampant government corruption and incompetence, which in turn leaves the government broke and unable to perform services, only serving to reaffirm the perception.

Lebanon’s political class broadly benefits from the current status quo and therefore has little reason to upset it. Economist Jad Chabaan has shown that interest on the public debt accounts for about one-third of Lebanese banks’ dividends, which in turn are mostly owned by prominent political families, meaning the banking sector (and its stakeholders) are partially propped up by a perpetual debt crisis.

Awarding bid-less infrastructure contracts to cronies has proven another source of profiteering at the public expense, but this time—Cedre’s advocates insist—there will be mechanisms to prevent corruption. Public-private partnerships will play a role, as will increased transparency mechanisms, but Beirut lacks a track record of such prudence. Critics are correct in asking why promised reforms must take place after $11.5bn has been pledged, and not beforehand.

But there are indications that Lebanon is making moves to be more transparent. The energy ministry this month published the two EPA contracts signed with Total, Eni and Novatek in an unprecedented display of openness (see table).

Ratings agency Moody’s weighed in on Cedre, offering a positive take on Lebanon’s prospects. Pointing to the 2007 Paris III conference, it noted that only half of the $7.6bn pledged was actually disbursed due to a lack of enacted reforms. But the agency appears more optimistic that Beirut will pull through, citing improved incentives for fiscal reform implementation that could “significantly boost economic growth.”

DONATION DIPLOMACY

The conference’s timing enabled Beirut to capitalize on prevailing geopolitical winds as well. With the United States, Saudi Arabia and to a lesser extent their European partners looking to counter Iranian influence in the region, a stronger Lebanese state holds the promise of a marginalized Hezbollah and a more robust pro-western ally in the region. Conference speeches repeated the mantra that a strong “legitimate” government in Beirut is the only path to stability in the Levant. Western and Arab governments paid dearly to help strengthen the Lebanese state at the Cedre conference—whether its officials capitalize on the opportunity or squander it is in their hands.