MGLE01: CENTRAL BANK GOVERNOR DISCUSSES ECONOMIC

C O N F I D E N T I A L SECTION 01 OF 03 BEIRUT 001470

SIPDIS

SIPDIS

STATE PASS USTR
NSC FOR ABRAMS/DORAN/WERNER/SINGH

E.O. 12958: DECL: 05/10/2016
TAGS: EFIN ECON ETRD EINV KIPR LE
SUBJECT: MGLE01: CENTRAL BANK GOVERNOR DISCUSSES ECONOMIC
HEALTH AND REFORM EFFORTS


Classified By: Ambassador Jeffrey Feltman. Reason: Sections 1.4 (b) a
nd (d).


1. (C) Summary. On May 9, Ambassador and Econ/Commercial
Officer met with Central Bank Governor Riad Salameh to
discuss the health of the Lebanese economy and the prospects
of PM Siniora's economic reform program. Salameh began the
meeting by briefing the Ambassador on two recent reports by
the International Monetary Fund (IMF) discussing the health
of the Lebanese banking sector. According to the reports,
the benefits to banks of contributions to a donors'
conference would likely be small, unlike the scenario
following the Paris II donors' conference. Salameh was
optimistic about many of the leading economic and financial
indicators for the Lebanese economy, but he conceded that
significant job growth could only come after serious
structural reform and privatization. He stated that a
transparent privatization of mobile telephones could serve as
a practical reform that could regain the confidence of the
Lebanese population and provide much needed momentum for
further reform. Salameh told the Ambassador that the recent
Libancell judgment against the GOL had adversely affected the
reputation of the GOL. Salameh also briefed the Ambassador
on his discussions with USG officials in Washington during
his April visit. End Summary.

SALAMEH DISCUSSES
IMF REPORT CONCLUSIONS
--------------


2. (C) Salameh began by briefing the Ambassador on the
conclusions of a confidential IMF April 2006 draft of
"Lebanon: An Assessment of Banking System Soundness," and
the May 3 "Summary Conclusions" of the IMF's 2006 Article IV
Consultations with Lebanon. Salameh stated that Lebanese
banks' return on equity and return on assets are well below
regional and world averages. Salameh pointed out that the
IMF didn't like the heavy exposure of Lebanese banks to the
sovereign debt. According to the IMF banking system report,
the large maturity mismatch between short-term deposits and
long-term assets compels banks to hold large amounts of
less-remunerating assets; this reduces profitability, and for
this reason the profitability ratios in Lebanon are lower
than in other countries.


3. (C) An IMF stress test of Lebanese banks suggested that
banks have high exposure to interest rate risks due to
maturity mismatches and a sudden increase in interest rates
would create severe stress. The IMF report stated that
Lebanese banks are also very vulnerable to liquidity risks
and face reinvestment risks if interest rates were to come
down. In the IMF report's discussion of a proposed
contribution from Lebanese banks to a Beirut donors'
conference, their projections suggested that the positive
effects on banks' profitability from an improvement in the
macroeconomic environment due to a donors' conference is
likely to be small as a result of deposit rates being
projected to fall only marginally. Salameh said he would not
release the conclusions of the confidential IMF report to
Lebanese banks, as they would use the report to bolster their
own political arguments against making a contribution to a
donors' conference. According to Salameh, one of the Central
Bank's next reforms will be the creation of an institution
that guarantees deposits. This new configuration will
receive half of its revenue from the GOL and half of its
revenue from banks.

SALAMEH OPTIMISTIC
ABOUT ECONOMIC INDICATORS
--------------


4. (C) Salameh was optimistic that the Lebanese regional
role in the banking sector would remain strong. He noted
that there are currently five Lebanese banks in Syria, two in
Jordan, two in Sudan, two in Algeria, two in Egypt, and two
or three in the Gulf States. He said that changes in
Lebanese law that allowed equal treatment in buying shares
for Lebanese and non-Lebanese contributed to the strength in
the sector. He foresees an even bigger role for big Lebanese
banks in the region. Salameh noted that Audi Bank raised USD
600 million in equity, Blom Bank raised USD 300 million in
equity, and Byblos Bank raised USD 400 million in equity.

BEIRUT 00001470 002 OF 003


The IMF report stressed the many strengths of the Lebanese
banking system that allowed it to withstand the Hariri
assassination shock, including a loyal customer base, high
capital adequacy and liquidity, and low foreign currency
risks.


5. (C) Salameh told the Ambassador that banks were right in
their criticisms of the GOL's plan to increase the tax on
interest from five to seven percent. Salameh said he was
opposed to the tax on interest of five percent when it was
initially proposed.


6. (C) Salameh was optimistic about several economic and
financial indicators of the Lebanese economy. He estimated
that, based on preliminary first-quarter figures, Lebanon
would have GDP growth of 4-5 percent in 2006. He noted that
direct investment was increasing, particularly new
investments geared towards real estate, including
construction. He told the Ambassador that consumption
numbers were increasing, and tourism remains strong, with
hotels fully booked. He said inflation is currently at two
percent, and the GOL ran a balance of payments surplus of USD
300 million in 2005. Asset dollarization was at 72 percent
and there was not an overliquidity in Lebanese pounds. Banks
expect increased deposits of USD 3.5-4 billion in 2006,
enough deposits to secure needed funds for financing the GOL
and the private sector. Salameh also told the Ambassador
that Lebanon issued a record number of licenses for
construction in 2005.

STRUCTURAL REFORM AND
PRIVATIZATION NEEDED FOR JOB GROWTH
--------------


7. (C) Salameh conceded that, although many economic
statistics are trending the right direction, the current
Lebanese economy was not creating a sufficient number of
jobs. He said structural reforms and privatization were
necessary to create companies and institutions that could
generate job growth. He added that a thriving private sector
would allow for taxation policies that wouldn't hurt the
population further and lead to greater transparency in
economic transactions. Salameh saw two reasons why Lebanon's
economy should have a competitive edge: (1) Lebanon has a
highly dollarized economy and the weak dollar should
positively affect domestic competitiveness, and (2) Lebanon's
salaries for skilled workers are the lowest in the world.


8. (C) When the Ambassador asked Salameh why there is a
disconnect between the positive economic indicators and the
mood of the Lebanese people concerning the economic
situation, Salameh said there were two primary reasons for
the current economic pessimism. First, the Lebanese are
disappointed with a political class that has been "imposed"
on them, in the form of what Salameh called a "self-feeding,
clientele system" that inhibits people from fighting for new
policies. Second, the Lebanese middle class sees many of its
children without jobs. Salameh stated that although the
macro-economy was in good shape and there was no economic
crisis, there was not a proper distribution of wealth and
insufficient job opportunities.

REFORMS THAT ARE
REALISTIC WILL BE INCREMENTAL
--------------


9. (C) When the Ambassador asked Salameh how the USG could
help the GOL with its reform efforts, Salameh emphasized that
positive statements by the USG about their commitment to
reform in Lebanon have a positive impact on economic
confidence. When asked by the Ambassador what reforms are
realistic, Salameh said that the privatization of mobile
telephones would be a practical action that could take place
right away. He emphasized that reform had to be explained in
the right way and reformers would "have to fight" for
important reform actions. Salameh said that a transparent
privatization of mobile telephones that prohibited any
government official from subscribing could help gain the
confidence of the Lebanese people and spur further reform
efforts. He said a successful telecommunications
privatization could allow the GOL to reduce its debt by USD
1-1.5 billion. He stated that according to a 2002 law, all

BEIRUT 00001470 003 OF 003


proceeds gained from privatization would be used exclusively
to reduce the debt. He clarified his statement by saying
that the proceeds of the successful privatization of Central
Bank assets, such as Middle East Airlines, would go towards
Central Bank funds. He further added that increased Central
Bank funds allowed for increased market confidence.


10. (C) Salameh told the Ambassador that the GOL was
working to satisfy the IMF's desire to see a serious
commitment to reform and was also questioning potential donor
nations about the possible size of future financial
contributions. He said that the GOL would continue to try to
implement reform measures incrementally even if a potential
donors' conference were delayed beyoQ 2006. He said that,
although the IMF was willing to suggest a formal program for
Lebanon, he did not know if Lebanon was ready to accept a
formal IMF program now. Salameh said that increased VAT
taxes and interest rate taxes could be left for later in
order to allow the population to gain confidence in the GOL,
if incremental reforms such as the privatization of the
telecommunications sector were accomplished successfully.
When the Ambassador asked about what the 2006 budget would
look like, Salameh replied that spending would most likely
increase and the national debt would likely rise USD 1.6-1.7
billion.

LIBANCELL JUDGMENT HURT GOL REPUTATION
--------------


11. (C) The Ambassador asked how the impact of the
Libancell judgment against the GOL had affected Lebanon.
Salameh said that the lasting damage was to the reputation of
the GOL in the financial markets. He said that he would not
have cancelled the bond issue that was cancelled following
the announcement of the court verdict. He said that the GOL
should have kept the bond issue and given the money raised to
a judge to be held under a collateral account. Then the GOL
should have sent a team of lawyers to work out the details.

SALAMEH DISCUSSES SIC EFFORTS
--------------


12. (C) Salameh told the Ambassador that when he met with
Treasury officials in Washington during his recent visit, the
officials were happy with the actions of Lebanon's Special
Investigation Commission (SIC) to fight money laundering. He
said that he had brought up two points of concern to his
interlocutors in Washington: (1) Lebanon's banks are now
expanding into neighboring countries whose banking standards
are not up to U.S. standards, and (2) sometimes when the U.S.
bans financial transactions with certain individuals and
institutions the SIC has no legal authority to stop financial
transactions with those individuals and institutions that do
not involve a U.S. entity.


FELTMAN