LEBANON: HOW THE USG CAN PROMOTE ECONOMIC REFORM

C O N F I D E N T I A L SECTION 01 OF 04 BEIRUT 000692 SIPDIS DEPT FOR NEA/FO, NEA/ELA, EEB/IFD/ODF - RDEMARCELLUS ALSO FOR IO A/S BRIMMER F FOR RNAPOLI P FOR DRUSSELL, RRANGASWAMY STATE PASS USTR FRANCESCKI STATE PASS USAID LAUDATO/NANDY/SCOTT PARIS FOR RWALLER USUN FOR WOLFF/GERMAIN/SCHEDLBAUER NSC FOR SHAPIRO, MCDERMOTT DOD/OSD FOR FLOURNOY/KAHL/DALTON DRL/NESA FOR WHITMAN OVP FOR HMUSTAFA TREASURY FOR PARODI/BLEIWEISS/AHERN USDOC FOR 4520/ITA/MAC/ONE E.O. 12958: DECL: 06/22/2019 TAGS: EFIN ECPS ENRG PGOV KCOR LE SUBJECT: LEBANON: HOW THE USG CAN PROMOTE ECONOMIC REFORM IN THE NEW GOVERNMENT REF: BEIRUT 222 Classified By: Ambassador Michele J. Sison for reasons 1.4 (b) and (d). SUMMARY -------------- ¶1. (SBU) One of our key priorities at U.S. Embassy Beirut is to support Lebanon's state institutions and the extension of the state's authority throughout all of Lebanon's territory. The upcoming formation of a new Lebanese government offers us an opportunity to re-engage on fundamental reform issues that can strengthen the Lebanese state and provide the credibility and stability necessary to counter the influence of Hizballah and its outside backers. To that end, post recommends a strong push with the new government to make progress on key economic issues: budget transparency, telecom and electricity reform, and trade. End summary. ¶2. (C) U.S. security assistance to the Army and police has contributed to building the capabilities of Lebanon's security forces in an effort to provide the Lebanese people with credible security institutions (and an alternative to dependence on Hizballah or other militias). We propose a similar effort on the economic side, focused on improving the Lebanese state's ability to provide basic services, such as electricity, public works, and health. ¶3. (C) Building up the capabilities of the state will involve more than simple technical assistance, however, because of the reticence of Lebanese political leadership -- across the spectrum -- to give up the political patronage it gains by providing services directly to its own followers, bypassing the state. Strong high-level U.S. political pressure on the leadership will be necessary to force reforms in the transparency of the state budget, distribution of resources for citizens, and provision of basic services. ¶4. (C) Post recommends that we engage with presumptive PM Saad Hariri and other high level officials early, both as the process of government formation continues, and after the new government is formed, on key economic reform issues. (We also note that until the GOL's institutional capabilities improve, Lebanese citizens not living in Hizballah-controlled areas will in many cases see their compatriots in such areas receive better services than they do, to the detriment of the credibility of the state.) BUDGET TRANSPARENCY AND DEBT MANAGEMENT -------------- ¶5. (SBU) The most recent statistics put Lebanon's debt burden at over 160% of GDP, one of the highest debt figures in the world. Despite the GOL's excellent debt payment record, the size of Lebanon's debt puts the country at constant risk of a debt crisis, which could destabilize the country politically, as well as economically. While the debt to GDP figure has come down since the 2006 war, when the ratio stood at more than 180%, much of the reduction has been due to increased donor assistance and high GDP growth figures, rather than to any structural reform of the budget process. In fact, parliament has not passed a budget in Lebanon since 2005. Though Lebanese law mandates that in the absence of a budget, the government must spend only what it was allocated in the previous budget passed by parliament, the budget deficit has continued to grow in absolute terms. With no transparency in the spending process, it is not clear where this extra money is going. and Lebanon's debt continues to grow. BEIRUT 00000692 002 OF 004 ¶6. (C) Even the budgets that have been prepared in recent years are woefully devoid of detailed accounting of where money goes. The budget of the Prime Minister,s office, for example, contains one-line allocations for entire state institutions, with no breakdown of how funds are to be spent. The Council for Development and Reconstruction (CDR),which manages almost all GOL infrastructure spending, falls under the control of the PM's office, with no institutionalized system for prioritizing projects, making even the smallest project a topic for political horse-trading at the highest levels of Lebanon's political system. Meanwhile, the Ministries of Public Works, Transport, Energy and Water, and other ministries centered on infrastructure development are allotted funds to pay their civil servants only, and have no budget or authority to spend money for projects in their areas of specialization. ¶7. (SBU) In a June 11 donor coordination meeting, representatives from the French government, the EU Commission, and the World Bank all stressed the need for decentralization, i.e., giving money and authority to ministries, as well as regional and municipal governments, to manage development and infrastructure projects in their specific areas. This would redistribute funds and authority from the political echelons to lower levels of government. While this would not eliminate corruption, it would reduce the tribal-sectarian delivery of public services, instill faith in state institutions, and hopefully put a dent in the current patronage system which supports the political and administrative status quo. ¶8. (SBU) Concrete USG actions to move forward: -- Pressure political leaders to put in place more transparent budget procedures and a realistic plan for debt reduction. -- Identify key government institutions that could benefit from technical assistance and international monitoring on budget procedures for implementation of a USAID-funded program. -- In concert with other international donors, encourage decentralization of tax collection and project finance to minimize political interference. TELECOM MODERNIZATION AND PRIVATIZATION -------------- ¶9. (C) Lebanon's publicly-owned telecommunications sector has been a moneymaker for the GOL, yet the quality of service has suffered from years of public mismanagement. While recent GOL efforts have improved service in fixed-line, mobile, and broadband service, Lebanon still lags far behind its neighbors. The USG (as well as France) set privatization of the mobile telecom licenses as a condition for the release of $75 million in budget support at the 2007 Paris III conference, part of the United States' $250 million cash transfer pledge. More importantly, a partial or full privatization would allow the private sector to improve service, making Lebanon a more attractive place to invest, while bringing in billions of dollars to the GOL to pay down its public debt. While GOL officials publicly claim recent delays in privatization are due to market conditions because of the international financial crisis, political will across the political spectrum has been weak on this issue, particularly because the Ministry of Telecommunications is known as a "profitable" ministry, for ministers and civil BEIRUT 00000692 003 OF 004 servants alike. ¶10. (SBU) Concrete USG actions to move forward: -- Encourage the incoming Telecom Minister and the cabinet in general, as well as key influential parliamentarians, to move forward on privatization as soon as market conditions allow. -- Continue USG support to the autonomous Telecom Regulatory Authority in its preparations to regulate the various public and private actors in the mobile telecom and broadband internet space. ELECTRICITY REFORM -------------- ¶11. (C) Lebanon's public sector has also mismanaged the electricity sector for many years. The GOL has made no investments in equipment maintenance or upgrades to production infrastructure, and the state-run utility, Electricite du Liban (EDL) has a civil service staff with an average age of 59, due to civil service hiring freezes. Lebanon's plants run at a fraction of capacity, and the country faces an annual shortage of more than 1200 MW of electricity every year. Every Lebanese family faces electricity cuts, sometimes of more than 12 hours per day, requiring them to pay extra for a generator. Pre-election polling found electricity to be one of the top concerns of voters in most districts. Political leaders capitalize on this concern, providing generators and fuel to their constituents, undermining the state and eroding citizens' faith in the government to provide service. Meanwhile, GOL electricity subsidies, as well as losses from theft, cost the government more than one billion dollars annually, exacerbating Lebanon's budget and debt problems. ¶12. (SBU) The Arab Fund and the Kuwaiti Fund have both expressed interest in providing subsidized loans to the GOL to build new plants and increase capacity. (Note: This money would pass through the PM's office, not through the Ministry of Energy. End note.) The Egyptian government recently agreed to provide natural gas to the GOL, via Syria, which would reduce production costs and ease the strain on GOL finances. Nonetheless, production increases will not solve Lebanon's electricity problems without fundamental reform, and eventual privatization, of EDL. ¶13. (SBU) Concrete USG actions to move forward: -- Encourage immediate GOL action to increase production capacity, with assistance from Arab donors. -- In concert with other western donors, push the political leadership to move forward on corporatization of EDL, i.e., restructuring it in preparation for privatization. -- Encourage the GOL to allow private distribution of electricity, taking pressure off EDL to deal with customer service and billing, where it is very weak. TRADE AND INTELLECTUAL PROPERTY RIGHTS ENFORCEMENT -------------- ¶14. (C) The U.S. has funded a WTO accession project at the Ministry of Economy and Trade (MOET) since 2000, for which USAID will be implementing a new phase in 2010. WTO accession would open up markets for Lebanese business while making the country a more attractive place to invest, and implementation of WTO requirements would contribute to transparency in state institutions dealing with trade, from the MOET to Customs to the tax authorities. While Lebanon BEIRUT 00000692 004 OF 004 has made progress in its multilateral and bilateral accession negotiations, political instability and -- more recently -- lack of political will have stalled the process. Important legislation needed for accession awaits parliamentary passage. Many Private sector stakeholders who fear foreign competition, particularly lawyers, are vehemently against accession, and are an obstacle to the completion of negotiations. Above all, Lebanon's poor enforcement of intellectual property rights (IPR) has been a particular sticking point, as everyone from low-level customs officials to judges to friends of the political elite profit from a lack of enforcement. ¶15. (SBU) Concrete USG actions to move forward: -- Continue USAID, MEPI, and INL support to Lebanese institutions responsible for trade issues and intellectual property rights enforcement. -- Work with parliamentarians to get important WTO-related legislation passed. -- Continue to engage Lebanon's private sector stakeholders to help build support for WTO accession and IPR enforcement. -- Use the current USAID program on the judiciary, in addition to contacts at the U.S. Department of Justice, to establish links between the U.S. and Lebanese judicial systems, with programming specifically to educate the Lebanese judiciary on the importance of IPR. ¶16. (U) We welcome Department and interagency feedback to this message. SISON