LEBANON: CENTRAL BANK GOVERNOR AGGRESSIVELY

C O N F I D E N T I A L SECTION 01 OF 04 BEIRUT 000192 SIPDIS SIPDIS NSC FOR ABRAMS/DORAN/MARCHESE/HARDING E.O. 12958: DECL: 02/05/2017 TAGS: ECON EFIN PGOV PREL LE SUBJECT: LEBANON: CENTRAL BANK GOVERNOR AGGRESSIVELY WRITING DOWN DEBT, CRITICAL OF BROADER GOVERNMENT REFORM Classified By: Ambassador Jeffrey D. Feltman. Reason: Sections 1.4 (b) and (d). SUMMARY -------------- ¶1. (C) The Ambassador and Econoff met with Banque du Liban (BDL) Governor Riad Salameh on February 1. Salameh was quick to emphasize his essential role in planning Paris III and in taking action to decrease the national debt now that Paris III is over. He expressed dismay at the smaller-than-expected grants received at the donor conference and market impact, and was skeptical that the loans and investments pledged instead of grants could be implemented. In contrast, the BDL is taking rapid action to pay down the debt with a revaluation of its gold holdings, grants, and an expected private bank contributions. Salameh believes broader government reform efforts will make little progress under the current team before a solution to the political crisis. Even the planned IMF program seems more likely to politically damage the ruling majority than to support the reform program. End Summary. ANXIOUS TO BOLSTER OWN REPUTATION -------------- ¶2. (C) The Ambassador and Econoff met with Banque du Liban (BDL) Governor Riad Salameh on February 1. President Chirac featured Salameh prominently during Paris III, much to the dismay of ministers more actively involved in formulating the economic reform program. Salameh was quick to emphasize to us that he has worked hard behind the scenes as well; he claimed that he secretly worked to move the conference to Paris. "Look what they did in Beirut! The opposition would not have let the people arrive," if the conference had been held in Beirut, Salameh argued. It was important to hold Paris III under President Chirac's strong leadership and aggressive solicitation of pledges, rather than waiting until Lebanese politicians reached an agreement, Salameh told us, given that there will be less effective fundraising under the next French president. PARIS III DEBT RELIEF BELOW EXPECTATIONS -------------- ¶3. (C) Up-front, cash contributions for budget support and debt relief were well below what Salameh hoped for at Paris III. While he still needs to check with recording committee officials on the exact details of the pledges at the conference, Salameh expects that Lebanon could receive just USD 1.95 billion in 2007 of the approximately USD 7.6 billion pledged. The Ministry of Finance (MOF) will try to negotiate additional up-front payments as part of the longer term loan and investment pledges, and it began following up this week with donors to ensure that the pledges materialize. ¶4. (C) The composition of the aid pledged will also slow implementation; Lebanon's acceptance of grant and in-kind aid requires cabinet approval, and acceptances of any projects that require debt financing require parliamentary approval. Parliament is not currently scheduled to meet until late March, further delaying the implementation of project aid. (Note: The Embassy has struggled to get cabinet approvals for various aid projects, as there is a backlog of issues awaiting cabinet review and approval. End Note.) ¶5. (C) Also less than optimal was the smaller market impact after Paris III than was seen after Paris II; Salameh attributed this in part to continued political instability. Ahead of the conference the credit default swap rate -- which Salameh characterized as insurance paid to hedge a default -- dropped from 4.5 to 3 percent, and yields declined on bonds traded in the secondary market. Since the conference the markets have remained stable, with no significant improvement. Demand for dollars has declined to the point where the BDL has not had to intervene at all. BDL PROCEEDING WITH DEBT PAYDOWN... -------------- ¶5. (C) Salameh was quick to point out that BDL measures promised around Paris III can take place quickly, but broader GOL reform promises will be considerably harder to implement. The BDL plans to pay off maturing Eurobonds including those held in its accounts, beginning with a USD 1 billion tranche coming due on February 26. Salameh will use some Paris III BEIRUT 00000192 002 OF 004 grants to pay off this debt as well as nearly USD 2 billion in "profits" from the revaluation of BDL's gold. ¶6. (C) The BDL has not updated the recorded value of its gold and foreign currency holdings since shortly after Paris II. (Governor Salameh explained that he had not thus far paid out in order to avoid an inflationary effect on the economy, but this is also a way for Salameh to keep control of these significant assets at the BDL. End Note.) The bank is legally bound to turn over 80 percent of its earnings to the GOL, and can keep legally 20 percent to add to its assets. Salameh plans to use the GOL's share of those profits, worth USD 1.5 billion, to pay off BDL holdings of Eurobonds. ¶7. (C) The BDL has agreed to "sacrifice" the USD 150 million a year in interest earnings it will forgo when those Eurobonds are paid off, but now may begin charging the MOF for other costs incurred. Again reminding us of his value, Salameh told us that since he has been in office the BDL has paid USD 4.3 billion to the GOL and BDL funds have increased from USD 60 million to USD 2 billion; Salameh argued that he has effectively produced USD 6 billion in 14 years. ¶8. (C) Salameh in early February finally began making his long expected request that Lebanon's banks contribute to debt reduction. He argues that such a contribution will improve the quality of the GOL assets that comprise much of the banks' balance sheets, and thus increase the value of banks' assets. Salameh told us he expects the banks to allow the BDL to take out of circulation up to USD 2.5 billion in GOL debt, which will require them to sacrifice USD 1 billion over 5 years on interest payments. (Comment: Lebanon's commercial banking sector earned USD 450 in profits in 2005, and Salameh said he thought that they could afford to absorb USD 100 million in reduced annual profits. End Comment.) In return, the BDL will not require the banks to hold reserves on all donor-funded loans -- including those backed by OPIC, the IFC, and the EIB. This will lower the cost of funds to both banks and borrowers, and help address the banks' fear that they will have a hard time meeting more stringent Basil II capital adequacy criteria. ...WHILE MOF ECONOMIC REFORMS WILL BE HARDER -------------- ¶9. (C) Salameh again contrasted his own rapid and aggressive efforts with much more difficult and slower GOL reform efforts. The MOF will need to aggressively follow up with donors to ensure they deliver on their loan and investment pledges, and then need to wait until at least March for Parliament to convene and accept any new loans. Salameh reiterated that political impasse is not an appropriate environment for a reform program, but was optimistic that Lebanon now has a "financial platform" to launch an economic reform program when it eventually reaches a political understanding. ¶10. (C) Beyond contrasting the pace of action at the BDL and GOL, Salameh was quite critical of the content of the GOL reform plan, calling it "fit for IMF models, but without an economic vision for the country." He also criticized the GOL economic team, saying "the people in charge are not capable of executing the plan they've come up with; they have promised too much and are delivering too little...All you will get is better GOL budget discipline; there will be no popular loyalty to the GOL because (citizens) won't feel they've received anything. It will take a miracle to implement reform," Salameh told us. "There are good points in the plan, including deregulation of the energy sector and privatization, but they need to put in place anchors for future development, to bet on value-added industries, and postpone planned tax increases. The best part of the plan is the plan for decreasing debt payments, and the GOL could decrease the debt-to-GDP ratio to less than 100 percent in 10 years...with discipline and effort." (Note: Salameh's criticisms were an eerie echo of what we hear from March 8 economists, who tend to personally criticize the current GOL economic team, fault the MOF and Prime Minister for not having an "economic vision," ask for greater attention to the productive sector, and criticize planned tax increases. End Note.) ¶12. (C) Salameh promised he will campaign for privatization if the GOL proceeds with transparency in carrying out the program, and again contrasted the BDL's sale of 2 banks and a large hotel to the GOL's non-transparent sale and re-nationalization of the telecom sector. Passing a new BEIRUT 00000192 003 OF 004 privatization law and privatizing GOL assets through public offerings would help allay the Shia fear that the Prime Minister will sell GOL assets to the Sunnis. The BDL would like to privatize its holdings, which include Middle East Airlines (MEA),35 percent of the holding company Intra, and various real estate entities, but the market conditions and MOF objections are key obstacles. The BDL is progressively selling its real estate holdings, and has already liquidated BLC Bank and its largest real estate holding, Coral Beach. The BDL has retained three investment banks -- Merrill Lynch, Citibank, and Lazard -- to support privatization of MEA, but they have advised that the BDL should wait until the market environment will ensure they earn the full value of $500-600 million. Salameh has already obtained Nabih Berri's approval to sell 25 percent of the company in a first tranche. BDL has had an informal offer from a French company to buy Intra's Casino du Liban (CDL),but will only sell the conglomerate as a whole and through a transparent public offering. The BDL would like the GOL to offer its 10 percent stake at the same time the BDL offers its stake, but Salameh has received no answer to his request. The MOF approved the sale of Intra in its reform program but is holding up the sale on accounting issues; the BDL board has audited CDL's accounts but the MOF disputes the audit and claims the Casino owes the MOF significant arrears. IMF PROGRAM -------------- ¶13. (C) Salameh expects a successful negotiation with the IMF team scheduled to travel to Lebanon in February to negotiate an Emergency Post Conflict Agreement (EPCA),which will give the GOL access to USD 100 million in aid if the IMF board approves such a program. Salameh noted that while senior IMF leaders are pushing for a program "for political reasons," IMF staff have recommended against a program. The EPCA will require nothing beyond the GOL's usual cooperation with IMF officials, and the IMF has said they will not require any change to the exchange rate policy or a haircut on the high-yield debt held by the banks. The EPCA puts the GOL on the path to negotiations for a Stand By Agreement (SBA), which could give Lebanon access to greater aid, but would require greater conditionality. Salameh told us he has never supported an IMF program because he believes the government won't be able to meet its own reform deadlines, much less those of a formal IMF program. Politically, the program will backfire on the March 14 majority, even if they can negotiate the current political impasse to implement their program, Salameh told us, but if the majority is willing to take that risk he won't object. TUG OF WAR FOR DOLLARS -------------- ¶14. (C) Salameh once again criticized Siniora and the MOF, saying that exchange rate vulnerability lies solely with government because it demands that the BDL provide dollars to meet GOL bills, but does not transfer the dollar holdings it receives to the BDL. When the BDL's foreign exchange reserves decline it is due to BDL provision of dollars to meet GOL payments, rather than to intervention in the market, Salameh argued. The BDL honors some GOL requests for dollars to meet external bills but denies others; some oil import letters of credit are a major holdup, but the BDL always authorizes the release of dollars to the GOL to make timely interest payments on bonds to avoid default. Letters of credit worth $389 million for fuel purchases are due now and in June. COMMENT -------------- ¶15. (C) Governor Salameh's criticisms of the economic team as "without vision" and incapable of executing their plan are eerily similar to the opposition's objections. His constant criticism of the GOL and withholding of financial resources is manipulative and, it could be argued, well beyond the economic imperative for policy independence at a central bank. While his plans to write down between USD 1.5 and 4 billion in GOL debt with BDL profits, donor grants, and private bank contributions will certainly help the GOL financial situation, he leaves the impression that he is by no means a part of the current political or economic reform team. We question how sincere he really is, too, about comprehensive privatization of BDL property and stock holdings. While Salameh offers self-congratulatory talk BEIRUT 00000192 004 OF 004 about a future 25 percent sale of MEA -- and even notes that he won Parliament Speaker Berri's approval -- Siniora asks why the GOL should retain any airline stock. ¶16. (C) Of course, the Salameh-Siniora antipathy is mutual. While Siniora (like Salameh) is basically polite about his rival, the PM hints that Salameh's opposition to an IMF program stems from Salameh's allergy to any close inspection of how he really has performed his financial miracles over the years. Salameh, in his negative comments about a plan that he helped shape, seems to be distancing himself from the Siniora reform program. We suspect that this is linked to Salameh's presidential ambitions, in that he will not want to be associated with painful tax increases or with a reform plan that doesn't pan out. But Salameh wields sufficient power financially and through his soaring international reputation that can make a significant difference as to whether the reform plan succeeds or fails. UN envoy Geir Pedersen told the Ambassador on 2/2 that his Hizballah contacts told him that Riad Salameh was their first choice to succeed Emile Lahoud as President of Lebanon. We hope that Salameh is not so in thrall to Syria and its proxies that he works actively to undermine the reform plan. FELTMAN