Identifier
Created
Classification
Origin
06BEIRUT3008
2006-09-15 16:29:00
CONFIDENTIAL
Embassy Beirut
Cable title:  

LEBANON: CENTRAL BANK GOVERNOR PUSHES REFORM

Tags:  ECON EFIN LE PREL 
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C O N F I D E N T I A L SECTION 01 OF 04 BEIRUT 003008 

SIPDIS

SIPDIS

NSC FOR ABRAMS/DORAN/MARCHESE/HARDING
STATE FOR NEA/ELA, NEA/FO:ATACHCO
TREASURY FOR MNUGENT AND CDOWNARD

E.O. 12958: DECL: 09/15/2016
TAGS: ECON EFIN LE PREL
SUBJECT: LEBANON: CENTRAL BANK GOVERNOR PUSHES REFORM
AMIDST RUIN

Classified By: Jeffrey D. Feltman, Ambassador. Reason: 1.4 (d)

Summary
--------

C O N F I D E N T I A L SECTION 01 OF 04 BEIRUT 003008

SIPDIS

SIPDIS

NSC FOR ABRAMS/DORAN/MARCHESE/HARDING
STATE FOR NEA/ELA, NEA/FO:ATACHCO
TREASURY FOR MNUGENT AND CDOWNARD

E.O. 12958: DECL: 09/15/2016
TAGS: ECON EFIN LE PREL
SUBJECT: LEBANON: CENTRAL BANK GOVERNOR PUSHES REFORM
AMIDST RUIN

Classified By: Jeffrey D. Feltman, Ambassador. Reason: 1.4 (d)

Summary
--------------


1. (C) Central Bank Governor Salameh, who will attend the
IMF/World Bank meetings in Singapore next week, took some
credit for shepherding the Lebanese financial system through
the recent war with minimal damage. He warned, however, of
fiscal difficulties ahead as Lebanon comes to grips with a
crushing debt burden worsened by the conflict. He proposed a
transparent fund for reconstruction with donor participation
and independent auditing. Salameh reported to us that the
financial system is in good shape for now, but expressed
pessimism regarding the political sphere and the potential
for civil unrest. The March 2006 economic reform program
will continue in broad outline, but the Middle East Airlines
and other privatizations will have to be delayed to allow the
recovery of their assets. End Summary.

Singapore Meetings
--------------


2. (U) On the eve of his departure for the IFI meetings in
Singapore, Central Bank Governor Riad Salameh received the
Ambassador and Polcouns on 9/14 for a briefing and discussion
on the Lebanese economy and financial sector. Salameh will
stay in Singapore until September 19 and will participate in
the Core Group meeting as well as a bilat with USG officials
on September 18. He is also planning to meet with the IMF,
which will send a team to Lebanon in October. Salameh
confirmed for us, as he will announce in Singapore, that he
intended to adhere to the basic outline of the March 2006
economic reform program, with a delayed timeline on
privatization.

A Reconstruction Fund to Reassure Donors
--------------


3. (SBU) Salameh explained to us his proposal for a
development fund for Lebanon. Under his plan, the Fund would
be created under Lebanese law but would seek donors to
subscribe to the Fund as shareholders. The shareholders,
which would include Lebanon's bilateral donors as well as the

IMF and multilateral development banks, would elect a board
by which it would exercise control over the Fund's
activities. The Board would also contract for independent
audits of the Fund. In order to preserve sovereignty, the
executive officers of the Fund would be Lebanese nationals.


4. (SBU) Salameh predicted that with such a Fund Lebanon
could attract more capital than it is seeing now. Donors can
use the Board instrument to place whatever conditionalities
they wish on lending. This may prevent one problem Salameh
fears -- that donor requirements for reform and other
conditionalities may delay or prevent disbursement of funds
such as those pledged at the Stockholm Conference.


5. (SBU) Political benefits might also be realized by using
the Fund, Salameh suggested. The Siniora government is
perceived as being Sunni-dominated and therefore generates
suspicion among other groups when it spends money.
Concentrating many reconstruction and development resources
in the Fund could help to shield the GOL from accusations of
corruption in disbursements.


6. (SBU) The Foreign Ministry has drafted legislation to
create the Fund and presented it to the Council of Ministers.
The Governor confirmed for us that the reconstruction fund
frequently mentioned by Prime Minister Siniora is the same
Fund he is advocating, and responded favorably to the
Ambassador's suggestion of using some of the $300 million
pledged by Kuwait and the $500 million pledged by Saudi
Arabia to seed the Fund.

Reconstruction Aid -- Early Disbursements
--------------


7. (SBU) The Governor reported that he met with the Saudi

BEIRUT 00003008 002 OF 004


Finance Minister last weekend and secured a pledge to
disburse the $500 million Saudi pledge soon. The Saudis
recently sent $20 million for school expenditures.


8. (C) Salameh told us that the Prime Minister recently
decided to retain control over reconstruction funds, rather
than to turn it over to the Council for the South. Previous
experience, according to Salameh, shows that the Council is
likely to misallocate some funds and that funds legitimately
spent will not produce any political benefit for the Siniora
government.


9. (C) When asked by the Ambassador, the Governor said he
had seen no sign of Hizballah spending on reconstruction.
However, the private banks estimate that Hizballah has
recently moved $60-75 million into the country. That money
must have been moved in cash, Salameh said, because the
private banks are under reporting requirements for large
transfers and in any case would have been unable to disguise
them. Salameh concluded that Hizballah may have spent money
on rents and direct payments for relief but had not spent
large amounts on reconstruction. The total Hizballah has
spent seems to be much lower than the publicity would
suggest, Salameh concluded.

Financial Sector -- Stable for Now
--------------


10. (SBU) Salameh described for us a financial system that
had kept its short-term stability during and after the
Hizballah-Israel War. He noted that during the fighting he
had constrained lending in pounds to tighten liquidity and
limit dollarization, which climbed from 72% to 75%. The Bank
lost $2.5 billion in reserves and the financial system lost a
similar amount in deposits, accounting for 3.5% of the whole.
Salameh compared the war with the crisis following Rafiq
al-Hariri's assassination, in which dollarization climbed to
80% and deposits dropped by 2%.


11. (SBU) There is now more inflow of deposits than outflow,
and even after the conflict Lebanon still has a net inflow of
capital for the past year. The country currently has a $1
billion positive balance of payments, which is lower than
estimates but still positive, perhaps surprising after the
damage done to Lebanon's business activity during the war.
Salameh predicted an uptick in consumer activity for the
second half of 2006 but that activity would fall short of
results for the first half of the year. All in all, the Bank
is preparing for 2006 GDP growth at zero percent. The IMF is
predicting 5% growth for 2007, which is lower than previous
estimates.


12. (SBU) Direct losses to banks were on the order of $300
million, the Central Bank has estimated, which Salameh
characterized as not insurmountable. The banks can cover
their losses with reserves and by changing the amortization
of their real estate holdings. In addition, banks and
commercial enterprises should be able to access medium-term
credit through the International Finance Corporation and
other IFI agencies directed to the private sector. Banks
will end up with a profit for 2006 but it will be slightly
less than predicted; Salameh said he told the banks, "you
can't have a war and come out richer."


13. (SBU) Even with all the political tensions, the markets
have been reassured by the Central Bank's governance through
the crisis and by the promise of funds from Arab countries,
as well as the supportive policies from the US and Europe.
These factors may continue to help Lebanon recover. In
addition, the mix of banking assets is not unhealthy -- one
third each in government bonds, private lending and
liquidity, and small exposure in eurobonds.

Trouble Ahead for Public Finances
--------------


14. (SBU) While Salameh made a credible claim to have
steered the financial system successfully through the crisis,
he intimated that trouble lies ahead in the next few months.

BEIRUT 00003008 003 OF 004


The GOL's budget deficit will be exacerbated by expenses
related to the crisis. The government has not yet made
allowances for the energy sector either; the drop in cheap
fuel and electricity imports from Syria will add costs, in
addition to the cost of rebuilding infrastructure damaged
during the war.


15. (SBU) All in all, Salameh estimated, $3 billion will
have to be expended by the Central Bank to cover public
debts. This is the time for the GOL to go to the markets to
raise money, but a proposed law to allow borrowing in dollars
will not be ready until after the reconvening of Parliament
in mid-October. Even then, Salameh said, the law may be held
hostage by Speaker Berri seeking funds for the Council of the
South.

Debt Relief
--------------


16. (SBU) Lebanon's debt is pushing 200 percent of GDP,
according to Salameh, up from about 175 percent of GDP before
the conflict. "Market debt" to private lenders is at $26.5
billion approximately. These sums are manageable now, but
will reach a "catastrophe" if something is not done to
reverse Lebanon's growing debt trend within a few months.
The large stock of debt is currently manageable, Salameh
said, because the Bank managed to buy 23% of it without
increasing inflation. The trick, he said, would be to buy
back more of it when necessary without provoking massive
inflation; and that may not be possible.


17. (SBU) Meanwhile, the GOL's deficit has reached 15% of
GDP because of the war. Lebanon's economy is very sensitive,
Salameh said, and government finances doubly so because they
are built on customs and VAT. Central Bank net reserves are
over $3 billion, Salameh said, but a sum like that "could be
taken away in gas prices" should Lebanon begin subsidizing
fuel.


18. (SBU) In answer to the Ambassador's question, Salameh
said that he has not yet begun to focus on a possible Beirut
I conference, but that he would like to see a date set by the
end of the year. Before the war, Lebanon needed $6 billion
of debt relief and now needs $10 billion, he added.
Lebanon's preparationQr the Paris II conference in 2002, in
which Lebanon realized $2 billion in relief, took two years
or more to prepare.

Politics
--------------


19. (C) Salameh, a Maronite who (like most prominent
Maronites) has aspirations to the Presidency, expressed
general support for the Siniora government "because there's
no way to change it". He agreed that Siniora had come out of
the recent crisis strengthened. He approached Michel Aoun
for consultations during the time before Aoun's alliance with
Hizballah and met with him and his economic advisors twice.
However Aoun -- who, Salameh said, wants the Presidency to
the exclusion of all else -- saw him as a competitor.
Salameh convinced Aoun he was no threat and that is why, he
says, Aoun does not attack the Central Bank.


20. (C) Salameh confided to us that he had met with
Hizballah SYG Hassan Nasrallah in the spring and told him
that Lebanon needs peace during the economically important
period of June through September. Nasrallah replied that he
understands the importance of "the people having money" and
promised to remain business-friendly and not to stir up
international trouble during the summer. The opposite, of
course, happened, Salameh said, saying that he can't trust
Nasrallah. Now all the emphasis is on bringing down the
Siniora government, Salameh said. Lebanon can ill afford the
kind of civil disturbance and turmoil that would accompany
such a move.

Middle East Airlines
--------------


BEIRUT 00003008 004 OF 004



21. (SBU) Privatization of a share of Middle East Airlines,
which the Central Bank has held since a bank failure in the
1970's, has been put on hold until at least the end of 2006,
Salameh said, in order for the airline's value to rise back
to its prewar level. MEA lost $20 million in the July-August
period, whereas it usually makes $44 million out of its
yearly $50 million profit during those two months. Clearly,
the disruption of the summer's air traffic was a disaster for
MEA. Despite its losses and imminent privatization, MEA
will, under the Central Bank's guidance, have to make a
decision in the next two months on replacing three leased
Airbus A330s. MEA will tender for bids from Airbus and
Boeing for replacements.

FELTMAN