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