LEBANON: CBL GOVERNOR SALAMEH PESSIMISTIC ON

C O N F I D E N T I A L SECTION 01 OF 03 BEIRUT 001208

SIPDIS

SIPDIS

NSC FOR ABRAMS/DORAN/MARCHESE/HARDING/DEMOPOLOUS

E.O. 12958: DECL: 08/09/2017
TAGS: PGOV PREL ECON EFIN LE
SUBJECT: LEBANON: CBL GOVERNOR SALAMEH PESSIMISTIC ON
ECONOMIC REFORM, CRITICAL OF GOVERNMENT

Classified By: Ambassador Jeffrey D. Feltman for reasons 1.4 (b) and (d
).

SUMMARY
--------------


1. (C) Central Bank Governor Salameh says the GOL barely met
its Emergency Post Conflict Assistance program targets, is
not making satisfactory progress on reform, will have a hard
time meeting further benchmarks, and could not meet the
higher standards required for a formal IMF program. Salameh
admitted that he does not enjoy working with the IMF, but
sees no alternative to restrain GOL spending and its demands
for the Central Bank to "subsidize" the GOL by obtaining
dollars. Salameh expressed concern that the opposition could
use a recent assessment that the currency is overvalued to
create turmoil in the foreign exchange market.


2. (C) Salameh drew several conclusions from the August 5
Metn by-election: the Maronite Church is no longer strong or
unified enough to play a role in electing the next President,
and General Aoun can no longer claim a mandate to represent a
majority of Christians, and thus will be a less valuable ally
to Hizballah. Finally, Salameh speculated that slow army
progress and high casualty rates in fighting at Nahr al-Bared
could reflect negatively on both Army Commander Sleiman and
the GOL because they unwisely allocated the army's budget on
salaries and perks rather than equipment and training. End
summary.

GOL BARELY MEETING
EPCA BENCHMARKS
--------------


3. (C) Central Bank of Lebanon (CBL) Governor Riad Salameh on
August 6 told the Ambassador and Econoff that the GOL barely
met its International Monetary Fund (IMF) Emergency Post
Conflict Assistance (EPCA) program targets, and is not making
satisfactory progress on reform. The GOL hit its ceiling for
borrowing from the CBL, but is likely to exceed that ceiling
in the second half of the year. To make this point to the
GOL, Salameh has refused to sign a GOL letter to the IMF
until the GOL shows him documentation proving that it has met
EPCA benchmarks. In particular, Salameh insists on seeing a
Ministry of Justice opinion that the Higher Council for
Privatization (HCP) does not need to pass a new law to sell
the assets of the state-owned mobile phone companies. The
IMF agreed that this opinion would replace the benchmark
requiring passage of a law through the (now closed)
parliament.


4. (C) The GOL will have a harder time meeting stricter
second half targets. The CBL will find it difficult to keep
GOL borrowing under its ceiling, and the MOF may not meet its
pledge to reform institutions such as Electricite du Liban
(EDL). The political patronage system prevents the GOL from
reforming or eliminating EDL and allowing private producers
to sell onto the national grid, Salameh assessed. He accused
March 14 leaders of favoring their supporters by allowing as
many illegal connections in pro-government areas as in the
Hizballah stronghold of the southern suburbs. The GOL is
also not exploiting opportunities to privatize telecom and
water resources. Salameh implied that the GOL could not meet
the higher standards required for a formal IMF program, and
suggested an extension of the EPCA for a second year would be
more realistic.

LEBANON NEEDS IMF
TO IMPOSE DISCIPLINE...
--------------


5. (C) Salameh admitted that he does not support or enjoy
working with the IMF, but sees no alternative to restrain GOL
spending. "If the government continues as is, it will
collapse," Salameh argued. "There is a limit to Lebanon's
financial engineering." Even if normal economic activity
resumed tomorrow, Lebanon would need a disciplined budget, he
reiterated, and the GOL is still increasing its debt by $2
billion a year.


6. (C) The GOL needs to downsize, Salameh argued, but to
maximize the value of the assets to be sold the GOL should
not privatize until all government institutions are
functioning and the GOL can ensure a transparent sale. The
CBL does not need a new law to sell the airline MEA, which it
owns, but will wait until the political crisis ends to sell

BEIRUT 00001208 002 OF 003


the company's stock to a strategic investor and individual
shareholders. Salameh does not support the government's
decision to sell state-owned mobile company assets without
passing a new law (which would be virtually impossible with
the Parliament not meeting). He argues that quality buyers
will refuse to buy the assets or licenses without an
indisputable legal title. Moreover, Salameh condemned the
Telecom Regulatory Authority's decision to auction off the
mobile licenses, and argued that the GOL should instead sell
its state-owned companies via a public offering.

...AND PROTECT THE CBL
--------------


7. (C) The CBL needs continued IMF involvement to restrain
unreasonable demands for the Bank to subsidize the GOL,
Salameh continued. The CBL's greatest vulnerability is
recurrent demands for the Bank to draw down reserves to
facilitate GOL overspending. Since January 2006, Salameh
explained, the CBL has transferred $1.5 billion to the GOL by
subscribing to t-bills, selling reserves, and giving the
dollars to the MOF. This is in addition to the CBL's $1.4
billion Paris III pledge to reduce GOL debt with profits from
gold revaluation.


8. (C) The GOL's inability to secure dollars could cause the
CBL to spend $1.5 billion from its reserves between August
and December 2007, Salameh told us. With $1 billion more in
debt service and $470 million in fuel import bills due by the
end of the year, the CBL will need to liquidate Eurobonds,
exceed the debt ceiling, or purchase dollars if the GOL does
not secure promised Paris III budget support or issue new
Eurobonds. Salameh urged the Ambassador to bolster GOL
stability by convincing donors to follow through on their
pledges: Kuwait has yet to deliver $300 million it pledged
in summer 2006; the UAE has not delivered $300 million
pledged at Paris III; France has not delivered its $500
million; the World Bank has not yet transferred its $175
million; and the U.S. has not transferred its $250 million.
(Note: Following the meeting, Econoff exchanged information
with CBL staff to facilitate the first $50 million tranche of
the USG cash transfer, due to replace GOL payments owed to
the World Bank in late August. End note.)


9. (C) This and other issues have led to a simmering
resentment between CBL and GOL officials, Salameh explained.
In addition to the GOL's erosion of its foreign exchange
reserves, CBL officials resent being ordered on short notice
to fill payment gaps. In February with less than a week's
notice the GOL demanded that the CBL subscribe to $1 billion
in Eurobonds, and several times this year threatened to cut
electricity nationwide if the CBL did not immediately procure
dollars to pay for fuel imports. Second, the CBL requested
the MOF issue Eurobonds instead of t-bills in exchange for
those dollars, as Eurobonds bolster gross foreign exchange
reserves and can be sold for dollars. The MOF refused,
arguing that it has no legal authorization from parliament to
increase its foreign currency debt. Finally, Salameh
expressed frustration that Prime Minister (and former finance
minister) Siniora has refused for two years to issue a
cabinet decision implementing a new bank merger law that
would provide incentives for troubled banks to merge.

IMF CONSIDERS
LL OVERVALUED
--------------


10. (C) Salameh warned the Ambassador that there would be a
delay in the IMF board discussion of Lebanon's Article IV
Review due to a global IMF board decision -- targeting China
-- to re-assess the relative value of all major currencies.
This IMF study assesses that Lebanon's Lira (LL) is
overvalued, despite recent IMF statements that it is
satisfied with the stability of Lebanon's currency regime.
Lebanon has asked the IMF to delay board discussion and
Article IV Review publication until after the political
crisis ends, for fear the opposition will use this
information to create turmoil in the exchange markets. The
IMF has been sympathetic to this request for a delay.

METN NATIVE: BOTH CANDIDATES,
MARONITE COMMUNITY LOST
--------------


11. (C) Turning to politics, Salameh, the product of several
old Metn families, expressed surprise that for the first time

BEIRUT 00001208 003 OF 003


the Maronite vote did not decide the outcome of an election
in that district. The Patriarch's leverage has declined,
Salameh commented; the Maronite church is as divided as the
rest of the Christians, and it is now clear that the
Patriarch will play no role in selecting the next president.
In contrast, the Armenian vote for the first time tipped the
balance in an election. Aside from their two-year political
alliance with Aoun, traditional Armenian loyalty to the
president probably prompted them to vote with the opposition,
according to Salameh, who noted that Lebanon's first
president gave the Armenians citizenship and earned their
allegiance to the office.


12. (C) Salameh viewed the election as a loss for both
candidates, neither of whom earned popular support.
Christians rejected Aoun's recent leadership style. Lebanon
now has proof that Aoun does not represent a majority of
Christians; he won thanks to the votes of 7,000 Armenians,
18,000 Michel Murr supporters, and 3,000 nationalized
Syrians, while Aoun loyalists contributed a mere 11,000
votes. Salameh noted that the Metn elections changed
prospects for the opposition. Now that it is clear that Aoun
does not represent a Christian majority, Hizballah will
likely start to distance itself from him, Salameh assessed.


13. (C) Amine Gemayel also lost, as many of the votes for him
were really votes against Aoun or in sympathy for his
assassinated son Pierre. An alternate candidate with less
historical baggage would likely have garnered more support,
Salameh commented.

NAHR AL-BARED
REVEALS WEAKNESSES
--------------


14. (C) The ongoing conflict at Nahr al-Bared also changes
conditions, Salameh commented, decreasing the likelihood that
army commander Sleiman will be the next president. Sleiman
would be a failure as president despite Syrian support,
Salameh assessed, because without the army he will have no
tool to help the country. Moreover, with over 200 soldiers
killed or disabled, once the fighting concludes both Sleiman
and the GOL will likely be criticized for overseeing an
inefficient army with a bloated, poorly invested budget that
did not prepare the institution to fight well. Salameh
contrasted the army's inefficient, deadly 12-week battle
against a small, confined threat to the efficient Israeli
attack on Hizballah last summer. The GOL spent $15 billion
on the army over the last 10 years, Salameh lamented, wasting
over 90 percent of the army's annual budget on high salaries,
early pensions, and privileges for officers' families. The
public is sure to note that the army and the GOL favored
officers' comfort over investment in modern equipment and
training to face evolving threats.

MEA PROFITED
DESPITE THE WAR
--------------


15. (C) On a positive note, Salameh expressed pride that
CBL-owned national carrier Middle East Airlines (MEA) earned
$30 million in profits in 2006, despite the Israeli-Hizballah
war. Salameh once again thanked the Ambassador for
negotiating the safe departure of MEA's planes amidst Israeli
bombing of the airport. Once outside Lebanon, MEA was able
to rent out the planes for $15 million, helping to ensure the
company's financial survival.
FELTMAN