LEBANON: ECONOMY MINISTERS UPBEAT ON FINANCES,

S E C R E T SECTION 01 OF 03 BEIRUT 000789

SIPDIS

SIPDIS

NSC FOR ABRAMS/SINGH/MARCHESE/HARDING

E.O. 12958: DECL: 06/01/2017
TAGS: ECON EFIN ETRD PGOV PREL PTER LE
SUBJECT: LEBANON: ECONOMY MINISTERS UPBEAT ON FINANCES,
DOWNBEAT ON MARCH 14 AND CBL OBSTRUCTION OF PRIVATIZATION


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

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


1. (C) Ministers Azour and Haddad met the Ambassador on June
1 ahead of a ministerial meeting scheduled to give political
affirmation to the LAF's military operations in Nahr
al-Barid. Haddad described his determination to use economic
policy to address extremism. Azour reassured us that the GOL
is meeting all EPCA benchmarks and the Lebanese economy is on
track to grow 2-3 percent this year if the security situation
does not deteriorate. Azour expressed confidence that higher
revenues, international aid, limited additional borrowing,
and adequate GOL planning will prevent a financial crunch
this year. However, Azour and Haddad were exasperated by
March 14 allies and CBL Governor Salameh's obstruction of
their privatization program. They worried that they will not
be able to set the reform program fully in motion before a
change in government. End Summary.

MINISTERIAL MEETING TO
BLESS LAF OPERATIONS
--------------


2. (C) Minister of Finance Jihad Azour and Minister of
Economy and Trade Sami Haddad met the Ambassador and Econoff
on June 1 in a Grand Serail guarded by the Internal Security
Forces (ISF),while the Lebanese Armed Forces (LAF) began
their assault on Fatah al-Islam in the Nahr al-Barid refugee
camp. Haddad noted that the ministerial meeting scheduled
for later that day would signal a political blessing for the
LAF to continue and expand its military operations. (Note:
Haddad explained that the meeting would be "ministerial"
rather than a formal cabinet meeting, because the absence of
traveling ministers would preclude a quorum and because the
meeting agenda was not delivered to President Lahoud 48 hours
in advance. End Note.)


3. (C) Haddad expressed frustration with Saad Hariri's
post-tribunal-passage television appearance, in which Saad
emphasized the army's political independence and unwittingly
highlighted the government's lack of control over the
military. Why should a government ask the public to support
the army, or ask the army to remain neutral, when the army
should be taking orders from the government, Haddad asked.
In the same vein, Haddad reiterated his frustration that the
government had not issued orders for the LAF to remove the
opposition "tent city" from downtown because the GOL feared
the army might not obey the order.

CURBING LEBANESE EXTREMISM
WITH SOCIAL PROGRAMS
--------------


4. (C) Haddad went on to describe his renewed determination
to use economic policy to address the problem of Sunni
extremism. There is no Palestinian dimension to Fatah
al-Islam and the conflict in Nahr al-Barid, Haddad told us,
because most Fatah al-Islam members arrested thus far have
been Lebanese and Syrian. While the GOL must root out all
extremists, it must also entice people away from Sunni
extremism with more moderate religious influences and a
strong social program that targets the disadvantaged. Haddad
told us that he has been far more aggressive lately toward
his colleagues in cabinet meetings, in particular urging
Minister of Social Affairs Nayla Mouawad to stop making
excuses and move quickly to start pilot programs to target
the poorest citizens. International organizations are
standing by ready to help Lebanon bring its embarrassingly
low social indicators into line with its high per-capita
spending, while Mouawad and others are dragging their heels.
This inaction is unacceptable morally, let alone politically,
Haddad told us.

DEFICIT UP, BUT
ECONOMIC INDICATORS STRONG
--------------


7. (C) Azour reassured us that the GOL is meeting
quantitative and practical benchmarks laid out in the Early
Post Conflict Agreement (EPCA) with the IMF. The GOL is
addressing any problems it foresees well ahead of time, and
does not anticipate a financial crunch this year. Economic
projections for the EPCA were conservative, based on a modest

BEIRUT 00000789 002 OF 003


1 percent growth; INSEE-supported Central Bank of Lebanon
(CBL) economic data, trusted by the MOF, as well as leading
indicators, lead Azour to believe that growth will reach 2-3
percent this year, if there is no further deterioration in
the security situation. Exports have increased and real
estate transactions remain strong, due to strong economic
growth and demand in the region and the weakening of the LL
against the Euro. Lebanon's incoming remittances rise during
periods of political instability, Azour told us.


8. (C) Responding to our concern that a recent Ministry of
Finance press release announced that the deficit increased in
the first four months of the year from 17 to 27 percent of
expenditures, Azour said that this was "not unexpected." He
attributed the overall rise in expenditures to payments to
EDL and a lump sum payment to the National Social Security
Fund to settle arrears. (Note: The press release also
attributed the rise to 16 percent higher debt service costs.
End Note.)


9. (C) First quarter revenues increased compared to a strong
2006 due to a higher VAT, a higher tax on stable bank
deposits, taxes on higher real estate prices, increased
customs revenues as businesses restock their inventories, and
on strong transfers from the state-owned telecom sector, port
of Beirut, and the airport. In addition, Azour credited
several tax administration reforms with improving collection.



10. (C) In addition, capital flows are stable, the interest
rate is under control, and the government last week was able
to raise $400 million in new debt, largely from domestic
rather than international investors. The GOL has not yet hit
its parliamentary-imposed borrowing ceiling, and could borrow
up to $1 billion more this year if necessary.

PARIS III AID
STILL TRICKLING IN
--------------


11. (C) Finally, up to $1.3 billion in expected inflows of
Paris III budgetary support aid will further ease financial
pressures this year. The IMF, in addition to delivering its
$77 million in aid when Lebanon signed the EPCA, is
encouraging donors to provide budget support rather than
project aid. The World Bank should deliver $100 million in
budget support in June, based on power sector benchmarks, and
a second $100 later in the year based on social sector
programs. The Saudis have already delivered $100 million and
are discussing transforming some of their $1 billion in
proffered projects into cash aid. The United Arab Emirates
rescheduled its $300 million in aid to fit a Lebanese
parliamentary requirement that debt repayment not exceed 15
years. France is expected to deliver its aid after its
parliament convenes in July. Malaysia is negotiating a new,
concessional budget support loan. The Arab Monetary Fund is
still negotiating a $350 million package.


12. (C) Finally, under the currently proposed terms Lebanon
could receive up to $175 million from the United States this
year. In the final stages of negotiating the conditions for
U.S. aid, Azour requested that we return to our originally
proposed conditionality, focused on the lifting of gas
subsidies and the solicitation of bids for the sale of the
telecom licenses. Azour made this request because he thought
it would enable the U.s. to disburse the money in September
rather than in December.

MARCH 14 ALLIES
SLOWING PRIVATIZATION
--------------


13. (S) "We need the privatization train to leave the
station before we have a new president and a new cabinet,"
Haddad warned us, implying that reform would be significantly
harder under a new leadership team. Azour asked that the USG
hold its March 14 allies to their own timetable for
privatization; several of them are allowing personal
interests to interfere with the cabinet-approved reform
program. The GOL can continue reforms despite the political
impasse, Azour emphasized, and in fact, the current
government has a unique opportunity to make quick, coherent
decisions because all those who really object have left.
Clearly, it is individual March 14 ministers, then, who are
the bottlenecks.


BEIRUT 00000789 003 OF 003



14. ((S) Specifically, Azour and Haddad pointed to Minister
of Telecommunications Marwan Hamadeh and Director General
Abdel Menem Youssef as selfishly delaying the corporatization
of fixed-line provider LibanTel and slowing progress toward
the sale of the two mobile licenses. The mobile licenses
could have been sold before the war, Haddad argued, if
Hamadeh had not stood in the way. They pointed to Acting
Minister of Energy and Water Safadi as hindering the
corporatization of EDL and the authorization of an IFC
program to facilitate creation of independent power producers
to increase power generation. The Prime Minister, while a
champion of reforms, is both distracted by other issues and
does not have enough sway over Hamadeh and Safadi to change
their behavior. Less urgently, Haddad cited Nayla Mouawad as
dragging her heels on the social reform program.

CBL GOVERNOR SALAMEH
OBSTRUCTING PRIVATIZATION
--------------


15. (S) CBL Governor Riad Salameh is also resisting
privatization and "acting in bad faith" by unilaterally
delaying the sale of assets inappropriately held by the CBL,
Azour and Haddad explained. Salameh several years ago used
the IFC to help him restructure the Casino du Liban, but has
to date refused to sell the politically sensitive and
lucrative monopoly. While the Central Bank announced in May
that it would sell a 25 percent stake in Middle East Airlines
later this year, Azour and Haddad argue that it should be
sold now; if another war breaks out and MEA planes are hit,
the CBL will have to use its assets to recapitalize the
company, tying up already severely limited liquidity. Such
assets cannot be used in monetary policy, the core mission of
the CBL. The CBL balance sheet is already not as healthy as
it should be.


16. (S) Finally, in outright criticism of Governor Salameh,
Azour candidly assessed that CBL independence has moved well
beyond the independence a healthy central bank needs. There
are no legal checks on the CBL, he explained, as it does not
need to report to the cabinet or parliament, and the IMF is
the only pressure on the governor. The last time the CBL
sold an asset, it was sold in a non-transparent fashion to
Salameh's brother in law, Azour warned us.
FELTMAN