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.


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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