August 20, 2007	Monday	Sha’aban 6, 1428

Lebanon

Lebanon has a free enterprise economy, which is based on services (banks and insurance), tourism, light industries and agriculture. Lebanon has been a popular destination for tourism and business, specifically within the Arab World. The services and real estate sector has been the major receiver of Arab Foreign Direct Investment, which has shown an increasing trend in the past years up till the Israeli attack in July 2006. During 2004 and 2005, Lebanon was the third largest recipient of Arab FDI. The war that has erupted in July 2006 has imposed major implications on the Lebanese economy and its expected future performance.

The July 2006 conflict with Israel dashed hopes of high growth and forced the government to adapt its reform strategy to the post conflict environment. According to a latest report prepared by the IMF staff, the conflict has exacerbated Lebanon’s challenges in reducing its debt and financial vulnerabilities. The overall fiscal deficit widened in 2006, partly because of conflict-related revenue shortfalls and the need to accommodate relief and reconstruction spending. Damages to infrastructure exceeded USD 3.5 billion. Donors committed $1.7 billion to help deal with the fiscal impact of the conflict, but government debt still increased to $40 billion (179 percent of GDP) by end-2006.

The five-week conflict with Israel and the month-long blockade that followed inflicted a heavy human and economic toll on Lebanon. Housing and infrastructure suffered significant damage, many professionals left the country, and economic activity came to a near standstill, with tourism being particularly hard hit. As a result, real GDP in 2006 is estimated to have been flat, while inflation reached 7 percent. Consumer price growth remained relatively strong at around 5% in early 2007, partly as a result of ongoing shortages on the back of attempts to rebuild economic capacity. The trade balance witnessed a year-on-year widening due to a growth in imports by 38.2 percent and a lower growth in exports by 30.3 percent.

Financial markets weathered the crisis surprisingly well, owing to the central bank’s skillful management of pressures, the banking system’s strong liquidity position, and the timely deposit with the central bank of $1 billion by Saudi Arabia and $500 million by Kuwait. Cumulative deposit outflows of $3 billion during the conflict were recouped by year-end, but deposit dollarization and Eurobond spreads have remained larger than before the conflict. The Israeli attack has impacted most of Lebanon’s economic sectors, particularly tourism and agriculture, which will eventually show high levels of unemployment.

Against this background, the Lebanese government is seeking to reduce its debt-to-GDP ratio by about 50 percentage points over five years. The reform programme envisages fiscal adjustment to begin in 2008 with increases in gasoline excise taxes, the value-added tax rate, and the tax on interest income. In addition, the government plans to introduce a global income tax that will distribute the adjustment effort more evenly. On the expenditure side, the government intends to contain the wage bill and reform the social and energy sectors to limit open-ended transfers from the budget while protecting capital and social expenditures. Privatization of the telecom sector should also help reduce the debt.

The international community pledged $7.6 billion in grants and loans to be disbursed during 2007–10. Of these pledges, $5 billion will go to the government in the form of budget support and project financing, and the remainder will support private sector development. Donors have indicated that their financial assistance will be conditional on steady implementation of reforms. It is clear that 2007 will be a difficult transition year. The financing strategy relies on the timely disbursement of donor assistance, which is also important to limit a further buildup of government debt.

According to the Economic Intelligence Unit (EIU), the outlook for 2007 is not fully discouraging, since the reconstruction process is expected to motivate consumption and investment levels for the year. However, if the political uncertainty persists and if the reconstruction and support funds do not occur, real GDP growth will be restrained.

The twelve months prior to the war showed a remarkable improvement in public finance. However, the aforementioned performance was reversed as a direct result of high revenue losses and large expenditure requirements.

The EIU expects that real GDP growth will return to positive territory this year, but only barely, at around 0.6 per cent, as political tensions continue and domestic demand remains sluggish. Moreover, any further political deterioration in the second half of the year could set the economy back still further, possibly resulting in another contraction. Assuming that the current government remains in place and external financial assistance is still available in 2008, the economy will begin to recover, with growth rising to about 2.3 per cent.

In recent years Lebanon has seen an extremely large visible trade deficit (averaging US$5.6bn in the five years to 2006), as the manufacturing sector is relatively small. Import spending is expected to grow fairly strongly in 2007. Export earnings will expand more slowly, as investors in export-oriented industries remain cautious, resulting in a widening of the trade deficit to around $6.5 billion. As import spending growth moderates next year, the trade deficit is expected to widen marginally further, to just under $6.7 billion.

Jordan

The Jordanian economy has performed remarkably well in recent years, due mainly to far-reaching macroeconomic and structural reforms. Despite negative shocks (including high oil prices and regional uncertainties), growth has been robust, inflation has remained low, public debt has continued to fall, and reserves have reached an all-time high. Real GDP grew by almost 6˝ per cent last year, mainly due to robust domestic demand. Although headline inflation is high, reflecting steep fuel and food price increases last year, core inflation remains low. With strong policies and continued strong inward investment, 2007 should be another good year, with six per cent growth and a modest reduction in inflation, to less than six per cent.

The current account deficit narrowed in 2006 — albeit to a still-high 16 per cent of GDP — as a result of a broad-based slowdown in import growth and continued strong performance of exports and remittances. This deficit was financed by record levels of long-term private capital inflows reflecting foreign investments in banking, mining, telecommunications, and real estate. The fiscal situation also improved in 2006. Stronger revenue performance, larger-than-expected grants and the authorities’ decision to raise domestic fuel prices more than offset higher primary spending on transfers, security outlays, and wage bonuses.

The Economic Intelligence Unit expects the economy to expand at an average annual rate of around 5.7 in 2007-08, a slowdown from the estimated growth rates of 7.7 in 2005 and 6.5 per cent in 2006. Jordan's fiscal account will stay heavily in deficit, and the government will remain reliant on overseas grants for financing. The domestic economy will continue to grow strongly in 2007-08, with investment in real estate and tourism projects driving overall GDP growth. Inflation will ease, as retail fuel prices will be held at their current levels in 2007 (despite the strength of global oil prices).

The current-account deficit will narrow as the value of exports of goods and services continues to grow strongly, offsetting the rising cost of imported oil.

The current account deficit has narrowed at a more rapid pace than earlier envisaged. A broad-based slowdown in import growth and strong export performance and remittances underpin this turnaround. The overall balance of payments surplus reached about $1.7 billion in 2006, allowing the Central Bank of Jordan to increase its reserves to $6.1 billion at end-year, equivalent to more than five months of prospective imports. Looking ahead, the underlying current account is likely to narrow by 1˝ percent of GDP this year, but the overall deficit is expected to remain practically unchanged—since budgetary grants intended for 2007 were received last year. Reserves should be close to $6˝ billion at year end.

Although easing, growth in domestic demand will remain relatively robust, fuelled partly by continuing high levels of remittances from the Gulf Arab states and persistently strong investment growth. Investment in power generation and telecommunications (part public, part private) should also remain firm, although broader public investment could be scaled back in recognition of the need for more fiscal restraint in 2008. Private investment in services sector infrastructure, particularly tourism projects, is also expected to continue to grow strongly.