LEBANON: CENTRAL BANK GOVERNOR DESCRIBES

C O N F I D E N T I A L SECTION 01 OF 03 BEIRUT 000387 SIPDIS SIPDIS NSC FOR ABRAMS/DORAN/MARCHESE/HARDING E.O. 12958: DECL: 03/13/2017 TAGS: ECON EFIN PGOV PREL SY LE SUBJECT: LEBANON: CENTRAL BANK GOVERNOR DESCRIBES DIFFICULT NEGOTIATIONS FOR AN IMF PROGRAM Classified By: Ambassador Jeffrey D. Feltman for reasons 1.4 (b) and (d ). SUMMARY -------------- ¶1. (C) Negotiations with the International Monetary Fund (IMF) for an Emergency Post Conflict Agreement (EPCA) are proceeding, but some of the IMF's conditions are unacceptable, Banque du Liban (BDL) Governor Salameh told the Ambassador and Econoff in mid-March. Several of the IMF's conditions will make it hard for the BDL to manage the Lebanese economy, Salameh fears, including limits on BDL's lending to the government and use of foreign exchange reserves. Lebanon should wait for a new president to start reforms, he told us. The Governor is considering several new financial engineering schemes to reduce debt and debt service costs by more than USD 3 billion over 5 years. He expressed concern that no promised Paris III grants and few reconstruction grants have arrived yet. As the meeting wrapped up, Salameh commented that he had just returned from a banking conference in Syria. End Summary. ¶2. (C) Negotiations with the International Monetary Fund (IMF) for an Emergency Post Conflict Agreement (EPCA) are proceeding, but some of the IMF's conditions are unacceptable, Banque du Liban (BDL) Governor Salameh told the Ambassador and Econoff in mid-March. Salameh has formally requested clarification or alteration of several points. He argues that the IMF staff feels that Lebanon's debt is unsustainable, they do not want Lebanon to have an EPCA program, and are trying to take an unrealistic plan to the IMF board which is forcing them to implement the program. While the IMF staff wants to highlight Lebanon's weaknesses, Salameh is pushing to show the board a realistic plan in March or April. (Note: Salameh was unaware that lead negotiator Mohsin Khan had postponed his visit until the third week of March. End Note.) SALAMEH SEEKING A CENTRAL BDL ROLE -------------- ¶3. (C) Several of Salameh's objections, as presented to the Ambassador and in a letter to the IMF, reflect his desire for the program to reinforce a strong BDL role in managing the Lebanese economy. The Governor believes that legally only he can commit Lebanon to a program; he wants IMF recognition of this authority, and he has sought a separate assurance that the BDL will have access to any report or comment to the IMF board. In addition, Salameh is seeking an assurance that the IMF will not share publicly the weekly data the EPCA demands; Salameh fears leaks could cause market turbulence. LIMITING LENDING TO THE GOL -------------- ¶4. (C) Salameh also told us and the IMF that he fears strict IMF benchmarks limiting BDL lending to the government and use of foreign exchange reserves will prevent the BDL from maintaining stability. The Ministry of Finance (MOF) is down to its last USD 20-30 million in the treasury accounts, Salameh said, and will certainly need to borrow from the BDL again to support Electricite du Liban (EDL),pay debt, and pay other bills. If the GOL is unable to pay even one bond it will experience cross default, Salameh explained, and if the GOL does not have money to pay salaries, it can't maintain the army or internal security forces. "The government is dependent upon the BDL now," Salameh told us. ¶5. (C) The government's lack of funds caused the BDL to lend to the government as recently as February 26, when a USD 1 billion tranche of debt matured and the MOF had no money to pay off the Eurobonds as promised. Prime Minister Siniora called on the BDL to help pay off the debt. The BDL rolled over the USD 430 million it held, and also rolled over and took on the USD 570 million previously held by outside creditors, thereby reducing its cash assets by USD 1 billion. The MOF has outstanding demands on the BDL of USD 452 million for a letter of credit for fuel purchases and USD 622 million borrowed against Arab Fund and Islamic Development Bank deposits; approximately USD 1 billion in BDL reserves are committed to financing the GOL. Without a parliament to issue a law allowing the GOL to borrow more, Salameh will need to continue to issue CDs in dollars from the BDL to the MOF to help them pay their bills. BEIRUT 00000387 002 OF 003 REPORTING NET RATHER THAN GROSS RESERVES -------------- ¶6. (C) Salameh is also concerned that the IMF insists on monitoring and changing the calculation of the BDL's net foreign exchange reserves. (Note: The BDL has for years reported gross rather than net reserves, and has at times maintained negative net reserves. Lebanese commercial banks maintain in-house research economists who read the tea leaves of GOL statistics subtract from Lebanon's USD 13 billion in gross reserves USD 11 billion in commercial bank deposits at the BDL and approximately USD 1 billion in Saudi and Kuwaiti deposits. In addition, the BDL by law includes its gold holdings in reserves, although they cannot be used for intervention. End Note.) ¶7. (C) Salameh was frustrated that the IMF will no longer allow the BDL to include GOL bonds as a reserve asset, even though Lebanon has been able to sell them or use them as collateral in deals with international banks. The IMF also does not want to consider the Arab deposits as an asset, while Lebanon has to date amortized them over five years. Finally, the IMF insists that Lebanon subtract from its books now the CDs that mature in 2013, while the GOL has amortized them. PRIVATIZATION -------------- ¶8. (C) Salameh is resisting the IMF's call for him to commit himself to privatize BDL assets this year. He argues that the investment bank hired to help sell shares of Middle East Airlines (MEA) believes the shares are worth about USD 500-600 million, and has advised the BDL to wait until market conditions improve to ensure that it gets the full value. Meanwhile, MEA lost USD 11 million in the first two months of the year after making a USD 20 million profit in 2006. Salameh argued that while the BDL is ready to sell holding company Intra and has an offer to buy it, the MOF has not yet agreed to sell its shares. Telecom privatization will be very difficult this year. ¶9. (C) Lebanon needs to wait for a new president to start reforms, Salameh told us. In contrast, the IMF has set up "monitorable actions" or proposed benchmarks for 2007 that include the submission to parliament of a 2007 budget consistent with the targeted deficit and accounting for all subsidies, transfers, and extra-budgetary expenses by the end of June. It also includes submission to parliament of a comprehensive tax law by the end of December and a cabinet decree liberalizing gas prices by the end of September. In the power sector, the benchmarks include initiating an audit of EDL's accounts by the end of June and implementing legal steps to corporatize EDL by the end of December. In the realm of privatization, the IMF expects the GOL to have a fully functioning Telecom Regulatory Authority submit legislation to parliament to enable privatization of the mobile operators by the end of June, and to receive expressions of interest for the two mobile operators by late December. SAFEGUARD ASSESMENT -------------- ¶10. (C) Because the IMF would disburse any EPCA funds to the BDL, it requires a safeguard assessment of the bank. As part of this, the IMF has requested authorization to talk to the BDL's correspondent banks to verify their deposits. It is insulting, Salameh commented, for the IMF to do due diligence on a USD 20 billion balance sheet in order to make available at most USD 75 million in credit, which Lebanon may not even draw on. Instead, Salameh suggested that the IMF trust the BDL's auditors, Ernst and Young and Deloitte-Touche. NEW FINANCIAL ENGINEERING IDEAS -------------- ¶11. (C) Although he is pessimistic about the MOF's prospects for reform for the year, Salameh is considering several new BDL financial engineering schemes not included in previous IMF scenarios to reduce debt and debt service costs by over USD 3 billion over 5 years. For one, Salameh still promises to use "profits" from a postponed market revaluation of gold and foreign currency holdings -- not revalued for several years allegedly to prevent inflation -- and owed to the MOF to pay off USD 1.5 billion in debt. For another, Salameh BEIRUT 00000387 003 OF 003 proposes securitizing future profits of the BDL, selling shares, transferring the profits to the MOF, and using those funds to "call" or pay off early USD 1 billion in t-bills due over the next 2-3 years. Salameh noted that the IMF does not consider securitization "debt." (Note: Lebanon does not currently have a securitization law. End Note.) ¶12. (C) In addition, Salameh may ask the Lebanese banks to reward the GOL for meeting IMF benchmarks by increasing their interest-free deposits at the BDL by 1 percent a year over five years. The banks always say no to Salameh's proposals, but have been more receptive to this one than his last proposal, since it links their contributions to actual GOL reform performance. (Note: Salameh's last proposal asked the banking sector to sacrifice up to USD 100 million a year. End Note.) Finally, Salameh is considering asking the bank deposit agency to cancel its USD 1 billion in t-bills to settle its arrears owed to the MOF. The entity is owned jointly by the BDL and the banks, and was previously saved from bankruptcy and became profitable due to 33 BDL-sponsored bank mergers several years ago. ¶13. (C) Salameh also proposed a scheme to help the private sector rebuild after the Israeli-Hizballah War without direct GOL funding. The draft bank merger law stuck in the cabinet would serve as a model. The BDL would loan the banks USD 10 million at the 3 percent interbank rate for 7-8 years. The banks would then buy t-bills and use the interest rate differential not as profit but to reschedule loans. Business owners would be required to put in 20 percent equity. This scheme would allow the GOL to refinance a replacement value of USD 190 million at a cost of USD 40 million to the business community and would be a quasi-grant of USD 150 million, Salameh calculated. DONOR CASH NOT FLOWING -------------- ¶14. (C) No promised Paris III grants have arrived yet, Salameh told us, and many of the grants promised after the July war have also failed to materialize. Of the Paris III pledges, the United Arab Emirates USD 300 million is the most promising, but France can't disburse until its parliament convenes in July. The World Bank budget process takes 4-5 months, and even the Saudis, who have disbursed quickly in the past, have yet to send their promised USD 100 million in cash. Those who pledged during and after the July war are also not following through; Kuwait never delivered on its USD 300 million reconstruction fund, although it did provide a USD 500 million deposit at the BDL. Prime Minister Siniora is spending a lot of time following up with donors, but so far his labor has not resulted in faster delivery or greater cash promises. RECENT TRIP TO SYRIA -------------- ¶15. (C) As the meeting wrapped up, Salameh commented to the Ambassador that he had just returned from a half-day trip to Damascus where he attended a regional Islamic Banking conference. While there were no Syrian officials there, the media sought his remarks and the Mufti of the Syrian Republic congratulated him on his award last year for best central banker, Salameh told us. Lebanon has 5 banks currently operating in Syria -- Blom, BEMO, Audi, Byblos, and Societe Generale -- and is advocating for Fransabank's entrance. "Lebanese bank branches throughout Syria are a more effective integration than the occupation was," Salameh joked, "but don't tell them or they'll close the Lebanese banks down." FELTMAN