Is Lebanon’s Debt Sustainable? A Closer Look at Lebanon’s Debt Dynamics

1. Lebanon has one of the highest public debt stocks (relative to GDP) in the world, currently at over 185 percent of 2003 GDP. Economic policy continues to be dominated by chronic imbalances in government finances which have seen the budget deficit average over 17 percent of GDP over the past five years. 2. Recent data suggests that there are tentative signs of a certain reversal in direction of the overall debt-to-GDP ratio in Lebanon. The most recent IMF projections notes that lower financing costs and higher revenue and spending restraint have improved debt dynamics. However, in the absence of additional fiscal adjustment, and in an environment of rising interest rates, debt dynamics would again become unstable in the medium-to-long term. 3. Progress with many of the fiscal measures the government agreed to undertake in the context of Paris II has been poor, partly as a result of political bickering and the easing of the immediate pressure on the budget, sapping the reform programme of its urgency. Recent political developments ( the de facto sacking of Prime Minister Hariri after a bitter power struggle with President Lahoud and the passing of a critical resolution at the UN Security Council condemning the handling of the issue) only add to the uncertainty that the reform train will pick up steam anytime soon . 4. IMF previous medium-term projections of debt-to-GDP ratios for Lebanon in the Article IV context have been systematically over-optimistic and off-target. Projections done in 1994, 1996, 1997, 1999, and 2001 projected a conversion point in the debt-to-GDP curve within 2 to 3 years of the projection date. None of these conversion points materialized. The aim of this paper is to offer an alternative medium- term projection of the debt ratio, while trying to refine the judgment on variables and assumptions that enter into the projection. More specifically, more emphasis will be given to political and social factors that often through Lebanon’s history hindered or dwarfed any reform momentum. Consistent with a Debt Sustainability Analysis framework, a set of assumptions on public debt, primary balance, revenue and expenditure structure and trend, gross financing, and interest rate and growth dynamics will be formulated. The analysis will be complemented with a look at a reduced set of vulnerability indicators for public sector debt sustainability.