Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 34463-LB

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

COUNTRY ASSISTANCE STRATEGY

FOR

THE REPUBLIC OF LEBANON

November 22,2005

Lebanon Country Management Unit Middle East and North Africa Region

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I ts contents may not otherwise be disclosed without Wor ld Bank authorization.

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The Date of the Last Country Assistance Strategy was December 4,1997

AAA ADFD AFD

AFESD BDL

BLC

CAS CDR CEM CFAA CPI CPPR CRI EC ECOSOC EdL

EIB ENP

ESCWA ESW EU F A 0 FDI FY GDP IBRD ICT IDAL IDB IDF IFC ILO IMF IoF

CURRENCY AND EQUIVALENTS Currency Unit = Lebanese Pounds (LL) 1 US$ = 1,5075 LL (November 2005)

FISCAL YEAR January 1 - December 3 1

ABBREVIATIONS AND ACRONYMS

Analytical and Advisory Activities Abu Dhabi Fund for Development Agence Franqaise de Developpement [French Development Agency] Arab Fund for Economic and Social Development Banque du Liban [Central Bank of Lebanon] Banque Libanaise pour le Commerce [Lebanese Commercial Bank] Country Assistance Strategy Council for Development arid Reconstruction Country Economic Memorandum Country Financial Accountability Assessment Consumer Price Index Country Portfolio Performance Review Consultant and Research Institute European Commission Economic and Social Council Electricite du Liban [Lebanon Electric] European Investment Bank European Neighborhood Policy

Economic and Social Commission for Western Asia Economic Sector Work European Union Food and Agriculture Organization Foreign Direct Investment Fiscal Year Gross Domestic Product International Bank for Reconstruction and Development Information and Communication Technology Investment Development Authority o f Lebanon Islamic Development Bank Institutional Development Fund International Finance Corporation International Labour Organization International Monetary Fund Institute o f Finance

JBIC KFAED KFW

MDG MEA

MENA

METAC MIGA MOET MOF NDGI NGOs NSSF OECD OED OFID

OMSAR PEP- MENA PIP PPP QPPR ROSC SFD SMEs SOEs UNDP UNESCO UNFPA UNICEF USAID UTDP WBG WBI WHO

Japan Bank for International Cooperation Kuwait Fund for Arab Economic Development Kreditanstalt fur Wiederaufbau [German Development Credit Agency] Millennium Development Goals Middle East Airlines

Middle East and North Africa

Middle East Technical Assistance Center Multilateral Investment Guarantee Agency Ministry of Economy and Trade Ministry of Finance National Deposit Guarantee Institution Non Governmental Organizations National Social Security Fund Organization for Economic Cooperation and Development Operations and Evaluations Department OPIC Fund for International Development

Office o f the Minister of State for Administrative Reform Private Enterprise Partnership for the Middle East and North Africa Portfolio Improvement Plan Public-Private Partnership Quarterly Portfolio Performance Review Report on the Observance of Standards and Codes Saudi Fund for Development Small and Medium Enterprises State Owned Enterprises United Nations Development Programme United Nations Educational, Scientific and Cultural Org. United Nations Population Fund United Nations Children’s Fund United States Agency for International Development Urban Transport Development Project World Bank Group World Bank Institute World Health Organization

MANAGERS AND STAFF RESPONSIBLE FOR THIS CAS

Vice President: Country Director:

Task Team Leader:

Christiaan Poortman Joseph Saba Omar Razzaz

ACKNOWLEDGMENTS

Several Bank staff members contributed to the writing o f this report: Chadi B o u Habib (Economist); Sebastien Dessus (Senior Country Economist); Hadia Karam (Operations Officer); Omar Razzaz (Country Manager); and Haneen Sayed (Lead Operations Officer). Mona Ziade (Communication Officer) organized the consultations with civ i l society and Mouna Couzi (Senior Program Assistant) edited the report and provided diligent support and quality assurance throughout the process. The report was prepared under the guidance o f Joseph Saba (Country Director). The report underwent two Regional Operations Committee reviews in January and November 2005. The team i s gratefbl for the comments and suggestions received from many colleagues during the CAS process, a l l o f which helped to improve the report.

Substantial inputs were received from both the International Finance Corporation (IFC) and the Mult i lateral Investment Guarantee Agency (MIGA). IFC staff who contributed inputs included Julia Br ickel l (Country Officer) and Torek Farhadi (Strategy Officer). MIGA staff who contributed inputs included Alwaleed Fareed Alatabani (Senior Risk Management Officer) and Ke i th Mart in (Senior Marketing Specialist).

Various Government officials, advisors, elected officials, academics and researchers, private sector representatives and representatives o f the international community provided guidance to the report, a l l o f whom should be warmly thanked.

This report i s dedicated to the memory o f the late Minister Basi l Fuleihan, who conducted most o f the CAS discussions between the Government and the Bank.

TABLE OF CONTENTS

EXECUTIVE SUMMARY

I.

A. B. C. D. E.

11.

A. B.

111.

A. B. C. D.

IV.

A. B. C. D. E.

V.

A.

COUNTRY CONTEXT

The Civil War Legacy Macro-Economic and Structural Issues Poverty, Human Development, and the Millennium Development Goals Natural Resources and the Environment Governance

COUNTRY DEVELOPMENT PROGRAM AND OUTLOOK

Country Development Program Economic Outlook

LESSONS LEARNED FROM THE PREVIOUS CAS AND LOOKING FORWARD

CAS Lessons Portfolio Issues Preparing the New CAS Development Partners

PROPOSED BANK COUNTRY ASSISTANCE STRATEGY

The CAS Pillars Building Partnerships for Local and Regional Capacity Enhancement Lending Scenarios and Triggers IFC, MIGA, and WBI Programs Monitoring and Evaluation o f Results

CREDITWORTHINESS AND RISKS

Creditworthiness and Risks

i

1

1 1 5 7 8

10

10 11

13

13 14 16 16

17

17 22 23 26 28

29

29

BOXES

Box 1 Lebanon’s Debt Box 2 The Private Sector in Lebanon Box 3 Budgetary Processes Continue to be Opaque

FIGURES Figure 1. Annual Cost of Environmental Degradation by Environmental Category

TABLES

Table 1. Actual Economic Developments and 1997 CAS Base Case Projections Table 2. Base Case Scenario Projections: Selected Macro-Economic Indicators Table 3. Indicative Lending Assistance Program Table 4. CAS Consultations Timeline

CAS ANNEXES

Annex I. Framework for a Results-Based Country Program Annex 11. Activities o f Development Partners (Ongoing/Planned) Annex 111. CAS Consultations

CAS TABLES

Annex A 2 - Lebanon at a Glance Annex B2 - Selected Indicators o f Bank Portfolio Performance and Management Annex B3 - Bank Group Program Summary (IBRD, IFC, MIGA) Annex B 4 - Summary o f Non-Lending Services Annex B5 - Social Indicators Annex B 6 - Key Economic Indicators and Selected Indicators Table Annex B7 - Key Exposure Indicators Annex B8 - Statement o f IFC’s Held and Disbursed Portfolio Annex B8 - Operations Portfolio (IBRD/IDA/Grants)

2 3 9

7

1 12 25 45

31 35 41

46 48 49 51 52 53 58 59 60

MAP IBRD 33433

EXECUTIVE SUMMARY

i. The tragic assassination of Prime Minister Hariri (February 2005) was a watershed event for Lebanon. The assassination climaxed thirty years o f c iv i l strife, war, attempts at state building, and physical reconstruction in a heavily contested political environment. Throughout this period, the resilience and resourcefulness o f the Lebanese people, and the willingness o f investors to return has been impressive - due largely to the country’s talented and entrepreneurial workforce, a favorable geographical position, and a modem financial sector able to attract large foreign investment.

ii. But the challenges going forward are formidable. Public mismanagement has resulted in a huge accumulated public debt, slow economic growth, weak public institutions, and delayed structural reforms. Today, Lebanon faces: (i) severe macro-economic imbalances, with debt to GDP approaching 17 1 percent; (ii) limited employment-generating growth, resulting in higher levels o f poverty and emigration; and (iii) deficient public infrastructure and services (power, telecommunications, water, wastewater), which reduce the country’s competitiveness and degrade its environment and natural resources.

iii. The root of Lebanon’s pressing challenges lies in its governance. While it has been very effective in maintaining peace and stability (no small accomplishment after 15 years o f war), Lebanon’s governance structure has proved unable to promote economic and social development in a sustainable manner. Overlapping powers and responsibilities, clientelism, and l imi ted accountability and transparency have often resulted in pol icy paralysis, weak institutional structures in both the public and private sectors, and perceptions o f high levels o f corruption. In the absence o f c iv i l service reform, administrative reform, and the revamping o f control agencies, fiscal, structural and sector reforms are at risk o f being unsustainable.

iv. Looking forward, Lebanon faces stark choices: it could “muddle through” in a crisis management mode, losing further ground and facing a possible severe economic crisis; or alternatively, it could develop and implement a transition plan for credible public institutions and sustainable growth. Putting Lebanon back on a sustainable path to growth and stability would require a broad-based national dialogue involving a l l branches o f the Government and society in working towards a socialleconomic recovery plan. Such a plan would need to be perceived as both credible and fair, addressing the short-term transition to macro-economic stability, as we l l as laying the foundations for longer-term employment generation and growth. The transition period would include: tightening fiscal pol icy in a socially equitable manner; reforming/privatizing State Owned Enterprises (SOEs) and utilities in a transparent and productive way; reducing the stock o f debt in a concerted effort w i th local and international creditors; restoring the minimum acceptable levels o f good governance in a few critical public institutions; and mitigating the poverty effects o f the transition. But, it wou ld also include a longer-term strategy for reforming public institutions and processes to enable the public sector, in partnership with the private sector and c i v i l society, to effect quality human capital development, well-managed natural resources, and an investment climate conducive to investment, growth, and employment generation.

V. This is a tall order and a challenging agenda. But there is clear evidence of broad-based appreciation oJ and commitment to, such an agenda from the polity at large and the Government. The World Bank and other international donors and agencies stand ready to help. Indeed, reforms are already under way in many areas. The Government sees its task as laying the foundations for much o f this work in preparation for rapid implementation over the next few years. The Wor ld Bank, in partnership w i th other donors and development agencies, stands ready to provide assistance in a number o f the above aseas over the next four years o f this Country Assistance Strategy (CAS 2006- 2009). The CAS focuses on three pillars: (i) governance for economic management and growth support; (ii) the development o f human capital and the mitigation o f the poverty effects o f transition;

and (iii) resource and environmental management. To this end, a robust assistance program o f analytical and pol icy advice, institution building, and finance for investment would be deployed. For investments, up to US700 mi l l ion in IBRD lending would be made available over the CAS period, should Lebanon make an effort to significantly reduce the debt burden, carry out structural reforms, enhance the safety net and poverty mitigation program, and improve portfol io performance. IFC and MIGA would focus o n a number o f investment climate, privatization, political risk coverage, and investment promotion activities.

vi, The international response has been strong. Recognizing the need for external assistance, a concerted international effort has taken place to mobilize assistance for Lebanon if it makes a credible commitment to reform and takes concrete actions to implement a program for recovery and growth. A Donors’ Conference to assist Lebanon i s anticipated during the First Quarter o f 2006.

vii. This results-oriented CAS provides a framework for such assistance, including the ways and means for setting priorities, and assessing and monitoring progress in a rapidly shifting policy environment. While the pillars are not anticipated to change, the results framework wil l need to be updated by the mid-term CAS review, in light o f the detailed Government reform program currently under preparation.

... viii. The following issues are suggested for Board discussion:

I s the composition o f the program and the balance between lending, analytical work, and institution building adequate?

Are the levels o f assistance and the proposed triggers in l ine with Lebanon’s development challenges and current policies?

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I. COUNTRY CONTEXT

Actual Figures Gross Domestic Product (US$ billion)

CPI Inflation (%) Gross Debt Over GDP (%)

Real GDP Growth (%)

Fiscal Balance Over GDP (YO) a/ Primary Fiscal Balance Over GDP (YO) a/ Net Debt Over Revenue (YO) Primary Fiscal Balanceover Revenue (%) Gross Foreign Reserves (USS billion)

Banks’ Deposits Dollarization Rate (%) Net Foreign Reserves (US$ billion)

Current Account Balance (% o f GDP) 1997 CAS Base Case Pro.iections Real GDP Growth (%) CPI Inflation (%) Gross Debt Over GDP (%) Fiscal Balance over GDP (%)

A. The Civil War Legacy

1997 1998 1999 2000 2001 2002 2003 2004 2005” 15.6 16.9 17.0 16.7 17.1 18.5 20.0 21.9 22.3 2.7 2.7 -0.8 0.9 4.4 2.6 4.9 6.3 1 .o 8.2 0.3 0.3 -0.3 -2.4 4.5 4.3 4.8 1.4

97.8 109.2 131.4 149.9 165.7 170.0 167.0 163.9 171.4 -24.6 -15.2 -15.6 -24.6 -18.6 -15.4 -13.7 -9.9 -10.5 -10.1 -2.1 -1.5 -7.9 -1.8 1.2 2.5 2.3 1.1

587 576 600 738 877 761 711 661 730 -51.0 -1.5 1.5 -35.2 1.7 5.4 14.1 13.3 8.0

5.9 6.4 7.6 5.7 4.4 5.1 10.2 9.5 9.9

63.9 65.5 61.6 66.9 72.5 69.3 66.1 70.0 72.0 3.1 3.0 4.8 2.5 -0.8 -0.2 3.2 0.1 -0.8

-30.8 -23.6 -19.5 -18.2 -19.9 -17.9 -20.9 -18.9 -20.2 1997 1998 1999 2000 2001-2005

4.0 5.0 6.0 6.5 7.3 8.5 8.0 7.0 6.0 5.0

89.0 93.0 94.0 94.0 75.0 -18.8 -14.7 -11.8 -10.1 -4.8

1. Lebanon’s devastating 15-year Civil War (1975-1990) resulted in massive economic, social, and political destruction. Because o f Lebanon’s C iv i l War, most o f the country’s infrastructure was destroyed or severely damaged, a quarter o f the population was displaced, one in five Lebanese citizens - mostly professionals and skilled workers - left the country, and public institutions were severely weakened. Today, 15 years after the end o f the C iv i l War, Lebanon i s in the dif f icult position o f having not completed the post-war reconstruction process, f rom both physical and institutional perspectives. Lebanon i s facing severe short-term macro-economic difficulties and long-term poverty and environmental challenges. Lebanon’s current level o f per capita income i s still one-third below the level o f 1975.

2. Initially, Lebanon made a strong recovery, restoring basic services and rehabilitating basic infrastructure while maintaining economic stability. By 1997, per capita real incomes had nearly doubled from their end-war levels, many o f the country’s social indicators had returned to pre- war levels, and much o f Lebanon’s infrastructure had been rebuilt, and public services restored.

3. Public debt had rapidly accumulated to unsustainable levels, and the country experienced a slowdown o f economic growth, the continued weakening o f public institutions, and limited progress in structural reforms. The unsettled regional situation, often intractable differences in national politics and external interferences, added to Lebanon’s difficulties.

However, this period of initial recovery came at a cost.

B. Macro-Economic and Structural Issues

4. By 1997, the Lebanese public had become aware of large macro-economic imbalances. The high public and external deficits o f the init ial post-war years, while not unusual during reconstruction, were becoming unsustainable, and the newly prepared Country Assistance Strategy (CAS) at that time (December 1997) stressed the necessity for a sharp fiscal adjustment. If the accumulation o f the public debt was not contained, the base case stability and growth scenario developed in the CAS (Table 1) would be threatened.

Table 1. Actual Economic Developments and 1997 CAS Base Case Projections, 1998-2005

Source: World Bank Staff Calculations based on MOF, MOET, CRI and BDL. * Projections as o f September 2005. ai includes foreign-financed capital expenditures.

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5. Efforts made by the Authorities since 1997 were notable but were insufficient to stabilize the debt. These efforts included deep tax reforms and debt restructuring, which significantly improved tax collection and lowered the debt service. Between December 1997 and December 2004, however, the gross public debt rose dramatically - from US15.4 bi l l ion (98 percent o f GDP) to US$35.8 bi l l ion (164 percent o f GDP), and was projected to approach US$38 bi l l ion (171 percent of GDP) by end-2005. Although the primary deficit dropped significantly during this period - to eventually turn (from 2002) into a surplus, the debt dynamics i s st i l l considered highly unsustainable in the face o f current GDP growth rates and interest rates (see Box 1).

Box 1. Lebanon’s Debt

By end-2005, Lebanon’s public debt wi l l approach US$38 billion, or approximately 171 percent o f GDP, the highest ratio in the world. In 2005 the debt service wil l have stood at about 11-12 percent o f GDP, down from 16-17 percent in the period 2000-2003, thanks to the major debt restructuring efforts undertaken in 2003 following the Paris I1 Conference. The vast majority o f the debt i s held by private investors - by Lebanese commercial banks, in particular, which are highly exposed on the sovereign risk (more than half o f their assets are in public bonds or at the Central Bank). Half o f the debt i s denominated in foreign currencies, mostly in US. Dollars. Debt denominated in local currency has an average maturity o f 1.8 years, against 5.8 years for debt denominated in foreign currency. Yet maturities are not evenly distributed, with 75 percent o f the current debt to mature over the CAS period 2006-2009, including 50 percent over i ts f irst two years.

Sustainability analysis suggests that the primary surplus, at less than 2 percent o f GDP in 2005, would need to increase rapidly to 6-7 percent to maintain the debt to GDP ratio at its current level under adverse circumstances (a rise in interest rates, exchange rate fluctuation, growth deceleration). In the absence o f fiscal and structural reform measures, World Bank projections suggest that the debt to GDP ratio would start to rise again (base case), placing Lebanon in a situation o f greater vulnerability with dampened growth. In contrast, measures that would result in a significant r ise in the primary surplus, coupled with the privatization o f some public assets, would permit to lower the debt to GDP ratio (high case) by the end o f the CAS period.

6. Estimated economic growth did not exceed 2-3 percent (in annual terms on average) over the period 1997-2005 - down from 6-7 percent during the in i t ia l post-war phase o f recovery and reconstruction (1992- 1997). Furthermore, economic growth was very volatile over this period and strongly responsive to external and political shocks. Lebanon can structurally benefit f rom massive financial transfers and capital inf lows from abroad. However, most o f these savings are consumed or unproductively invested, hence preventing the extension and modernization o f supply capacities, and in turn, economic growth and j o b creation. Over the years, the Lebanese economy has progressively entered into a slow growth trap, whereas declining investment’ reflects lack o f profitable business opportunities and weak external competitiveness. The latter suffer f rom the upward pressure on price levels’ exerted by transfers and capital inflows, which i s not compensated w i t h productivity gains. In turn, the economy has gradually abandoned important sectors o f activity to foreign competition and concentrated its productive resources into non-tradable activities where the demand i s moribund and productivity gains potentially scarcer. In the face o f high reservation wages (with high price levels), would-be domestic workers prefer to emigrate (skilled youths in particular) or not participate in the labor market (women notably). T w o percent o f the labor force i s emigrating every year, and Lebanon’s human capital is progressively eroding, despite massive education spending. Structural impediments to private investment ( f rom costly utilities, to a configuration o f high regulatory barriers, to private investment and monopolies, see Box 2), high real interest rates, and macro-economic uncertainty l inked to the debt overhang most l ikely prevented Lebanon from channeling a greater share o f its large financial base towards productive investments.

Growth slowed down after the initial boom o f post-war reconstruction.

’ Investment as a percentage o f GDP decreased from for 31 percent in the period 1994-1997 to less than 21 percent since 2001. Banks’ credits to the private sector have been saturated since 2001 (Source: MOET, ABL).

While broadly similar in 1992, pr ice levels in Lebanon were almost twice that o f comparator upper- middle-income countries in 2004 (Source: W D I indicators).

2

Box 2. The Private Sector in Lebanon: Entrepreneurship in the Midst o f Institutional Malaise

I t i s ironic that Lebanon’s entrepreneurs, who have flourished just about everywhere in the world, are struggling in Lebanon. Obviously, macro-economic conditions can explain much o f the weaknesses in the private sector, but numerous surveys have suggested that the problems extend well beyond the macro-economic conditions, into the very structure of Lebanon’s economy and governance.

Lebanon has the one rare ingredient o f economic productivity that most countries in the region lack: a multi-lingual, talented, entrepreneurial, and relatively well-educated workforce. In general, Lebanon also has a strong banking sector and a strong services sector (tourism, the media, retail and wholesale trading, professional services, including education and health). But, Lebanon lacks some o f the common ingredients that most countries now take for granted: a reliable and affordable power supply; a modem Information and Communication Technology (ICT) infrastructure; efficient trade facilitation systems (including customs, border crossing and transport logistics); a streamlined regulatory system for business entry, operation and exit; modem corporate governance and capital market regulations; protection for intellectual property rights; and a legal framework to ensure competition in competitive markets, as well as for restricted markets

Empirical studies by the World Bank Group and others have shed light on the above constraints in Lebanon:

State Owned Enterprises and the Role of the Private Sector: The Bank has long maintained that privatization i s not an end in itself, but a means to achieving an end. In Lebanon, the end should not be seen solely in terms o f getting the highest return from privatization to reduce the public debt. Indeed, the total valuation o f enterprises wi th the potential for privatization i s quite small in relation to the total debt (around 10-15 percent). Rather, the end should be to reduce the cost and enhance the quality o f service in key industries such as power and telecommunications, with the ultimate aim o f spurring economic growth. A Public-Private Partnership Strategy needs to be developed which conceives o f the full scope o f private participation options, from service contracts all the way to full privatization, and i s applied differently to SOEs that are very different in nature (water, electricity, telecommunications, tobacco, airline, ports, casinos, etc.).

Barriers to Entry and Operation: Administrative barriers were highlighted in the recent cost o f doing business survey.* In Lebanon, 46 days are needed to register a business, compared with the best practice o f less than 1 day. Contract enforcement takes 721 days, three times as long as the OECD average. Other studies have highlighted similar areas o f regulatory concern.

Corporate Governance: Corporate governance is also poor, with a disclosure index significantly worse than the MENA average. This area requires immediate attention in terms o f developing the appropriate regulations, laws, enforcement systems, and professional associations. This i s particularly fundamental to Lebanon’s financial services sector aspirations, including the development and deepening o f capital markets.

Monopolies and Oligopolies: About half o f al l Lebanese markets in agriculture, manufacturing and services are considered oligopolistic or monopolistic; and one-third have a dominant firm w i th a market share o f about 40 percent. This might be due partly to the small size o f the economy, but artificial barriers do exist and they reduce opportunities for competition.

Expanding Economic Activities Beyond the Greater Beirut Area: As in many small countries, Lebanon’s capital city, Beirut, captures the bulk o f economic productivity. This i s natural in many sectors which require agglomeration economies, access to universities, and a high quality o f l i fe . But, real opportunities beyond tourism exist for local economic development in secondary cities such as Tripoli, Sidon, Tyre, Ba’albeck, and Zahle which are not fully exploited. In these areas, the opportunity exists to identify industrial clusters around transshipment and trade logistics, agro-industry, and small manufacturing.

Trade Facilitation: Lebanon’s traditional role as a trade link between the East and the West is being undermined by substandard and outmoded infrastructure, operating systems, and regulations. Important improvements have been made to the airport’s infrastructure, management and customs systems, but ports, highways linking the ports to Syria (especially through Tripoli), border crossings, and other logistics need to be upgraded. The availability o f trade financing i s another area which requires further investigation.

The World Bank Group i s providing assistance to reduce a number o f the above constraints, but Lebanon is still far behind many countries o f similar income levels. A national strategy with a timetable and clear deliverables is needed to improve the investment climate.

*Doing Business 2005, The Wor ld Bank, Washington, DC.

es, public services, natural monopolies).

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7. The Lebanese macro-economic environment i s highly dependent on its financial and fiscal situation. Wi th domestic banking deposits exceeding 260 percent o f GDP and a full openness o f the capital account, confidence shocks can at any time entail massive capital outflows, which would inevitably entail a large contraction o f the demand resulting f rom a forced closure o f the current account deficit. In turn, depositors’ confidence in the financial system i s ultimately linked to the fiscal situation, given the very high level o f exposure o f the banking system to the sovereign, in foreign currency in particular. In the face o f potentially high vulnerabilities related to the public debt overhang, Lebanon’s financial system seems particularly r e ~ i l i e n t . ~ This was notably evidenced in the weeks fol lowing the assassination o f former Prime Minister Raf ik Har i r i in February 2005, during which financial stability was severely threatened.4 Fortunately, the financial authorities managed to contain capital outflows and the situation eventually rebounded. But the fiscal, economic, and financial costs implied by these events are very substantial and have left the country in an even more precarious financial position. And while there i s a widespread sentiment in Lebanon that the financial system can withstand any shock after it managed to avoid a ful l-blown confidence crisis in early 2005, past experience around the wor ld systematically demonstrates that private markets cannot indefinitely accommodate rising public debt ratios. Even the most faithful investors can eventually lose confidence in the Government’s capacity to honor i t s debt, and a major crisis can then ensue, w i th potentially devastating effects on economic and social fabrics.

8. Addressing the unsustainability o f the public debt dynamics and improving the investment climate are national priorities for setting the country on a higher growth path. The country has strong comparative advantages that should al low much faster longer-term real GDP growth, above 5 percent every year. These advantages include: strong entrepreneurial skil ls, high human capital, an open economy, a favorable geographical position, and a modem financial sector able to attract large foreign in~es tment ,~ a l l o f which wou ld help provide Lebanon with a base for future growth and the development o f a modern, competitive, and outward-oriented economy. However, this potential cannot be realized unless: (i) the underlying macro imbalances are rapidly addressed, through a significant drop in the debt stock and fiscal deficits; and (ii) the investment climate i s improved so that the private sector can absorb a greater share o f savings currently invested in public debt.

9. Lessons from the failure to implement the Paris I1 reform plan should guide the design of a new social and economic reform plan. In November 2002, the Government convened a donors’ meeting - Paris 11, during which i t presented a program o f fiscal and structural policies intended to reduce fiscal imbalances, maintain financial stability, and restore growth. The program consisted o f three pillars. The first pi l lar was fiscal and reflected a major effort to bring the primary surplus to 8-9 percent o f GDP by 2007, through a combination o f tax increases and expenditure containment. The second pi l lar was financial and constituted restructuring the public debt towards longer maturities and lower interest rates. The third pi l lar considered the privatization o f major State Owned Enterprises whose proceeds would be used entirely to reduce the stock o f the debt. These

Lebanon probably benefits from the fact that most o f i ts public debt i s intermediated by domestic banks, which have large access to foreign savings (commercial banks’ deposits represented 261 percent o f GDP by end-2004; and current account deficits have been well above 20 percent o f GDP on average since 1992) from the Lebanese Diaspora and Gulf countries. Over the years, the banking sector has progressively become locked into financing the growing public sector financing needs, and has found itself trapped in a situation in which it becomes critical for i ts own viability to maintain the solvency o f its most important client, the Government. This country-specific characteristic could explain to some extent the greater resilience o f the Lebanese financial system to what i s perceived to be an unsustainable debt dynamics.

In the month following Prime Minister Hariri’s assassination, US$5.2 billion (23 percent o f GDP) worth o f Lebanese Pound-denominated deposits were converted into foreign currency, out o f which US$2 billion (9 percent o f GDP) left the country. The Central Bank’s net reserves dropped and became strongly negative.

A l l these characteristics are considered, in the long-run, growth empirical literature as being fundamentally favorable to growth (see Sachs and Warner, 1997, for instance). In contrast, the same literature underlines the negative impact o f high government deficits and a poor institutional framework on long-run growth.

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three pillars were embodied in the Budget Law o f 2003. Yet, only the second pillar materialized with the assistance o f donors and Lebanese banks. Other components o f the Paris I1 reform package proved too ambitious in the face o f Lebanon’s weak institutional capacities and diffusion o f decision- making power. In particular, the Government’s privatization program, which was foreseen as strongly reducing the debt stock and fostering economic activity, did not materialize. Lack o f consensus on the ultimate role o f the existing public enterprises in the provision o f public goods, together with insufficient technical preparation, probably explained this lack o f progress. Similarly, Lebanon was unable to raise its primary surplus as much as i t had envisaged in the face o f the population’s growing opposition to further fiscal adjustment. This suggests the need for strong consensus-building efforts on key reforms areas, and a reinforcement o f social protection and safety nets to insure a fair sharing o f the adjustment burden across the various political and social groups in Lebanon.

C. Poverty, Human Development, and the Millennium Development Goals

10. An accurate understanding of the poverty situation in Lebanon and o f progress made over the past decade i s very difficult to obtain, given the weakness o f baseline information and the lack o f recent data on income or expenditures. The most recent source o f statistical information’ on income and consumption dates back to 1997 and data at that time focused only on the Greater Beirut Area, excluding most o f the country and population. In addition, there i s no official poverty line in Lebanon. Along with a Living Conditions Survey, a new Household Budget Survey (nationally representative) was conducted in 2004, but expenditure data necessary for poverty calculation were not yet available at the time o f writing o f the CAS (November 2005).

11. Regional disparities in poverty levels are believed to be significant. Recent indirect indicators o f poverty (based on the knowledge o f local social actors, or the consumption o f particular items for which data exists at a detailed geographical level) suggest large geographical disparities in poverty rates.’ Poverty i s concentrated in suburbs o f large urban poles, or on the contrary, in remote rural areas (from an accessibility perspective). Zones o f conflict during the war also still appear to constitute major pockets o f poverty.

12. Unemployment i s high among youth, prompting emigration in large numbers. According to a Living Conditions Survey conducted in 2004, the active population stood that year at 1.17 mill ion (31 percent o f the estimated population, excluding Palestinian refugee camps), out o f which 8 percent declared themselves unemployed. Sixty-four percent o f the unemployed are aged between 15 and 29 years (while the same age category represents 33 percent o f the active population). In other words, the frequency o f unemployment among youth, at 16 percent, i s twice higher than the

US$4.4 billion was pledged by the donors at the Paris I1 Conference, out of which US$3.1 billion was for debt restructuring, and the remainder for project finance. US$2.4 billion worth o f soft loans was eventually transferred for debt restructuring in 2003. Lebanese banks contributed to the debt restructuring effort through the acquisition of 2-year public bonds at zero percent and the write-off o f some public debt detained by the Central Bank. Paris I1 contributions from donors and Lebanese banks permitted to restructure part o f the debt profile and lessened the terms on which the Government could borrow on the domestic market. These contributions also encouraged private capital inflow and enabled the Central Bank to replenish i ts stock of foreign reserves. Regional developments, through greater tourism inflow, growing oil prices, and the repatriation of Arab funds in the region, coincidentally came to the rescue of Lebanon and eventually amplified the positive impact o f Paris I1 on market confidence, private capital inflow, and interest rates. ’ Available informatioddata sets include: the Population and Housing Survey conducted in 1994-1996 by the Ministry of Social Affairs, based on a method o f unsatisfied basic needs, which does not include income or household expenditures; and the 1997 Central Administration of Statistics Survey on Household Income and Budget, which includes information on household income and budget but i s not publicly available.

Source: “Formulation of a Strategy for Social Development in Lebanon”, Council for Development and Reconstruction, Beirut, February 2005.

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national average. These figures confirm those o f an earlier survey’ conducted in 2001 (although not strictly comparable f rom a statistical sense), which also estimated the unemployment rate among youth to be twice the national average. The 2001 survey indicated that 58 percent o f the unemployed youth were considering emigration as a response to their poor economic conditions, and that 1.5 to 2 percent o f the active population had been emigrating every year between 1996 and 200 1.

13. While Lebanon does spend significantly on health, education, and social welfare programs - about 21 percent o f GDP, excluding pensions - the outcomes are not commensurate with this level of spending. A unique feature i s the l ow public sector share o f this spending - only 6 percent o f GDP (compared to the international average o f 11 percent), and much o f the public spending on human development has a l imited impact.” Most social sector programs, including health and education, are not targeted to the poor. Rather, a significant share o f public social spending takes the fo rm o f demand-side support (such as subsidies to c iv i l servants), instead o f support for a more desirable increase in the supply and quality o f public social services. Thus, instead o f supporting, for example, better schools or greater access to health services, a significant part o f public spending i s allocated, via the government payroll, to families that may not necessarily be the neediest.

14. The Government has sought Bank assistance in developing a social strategy. Given the anticipated fiscal contractionary environment in the coming years, i t i s important that the Government develop a comprehensive poverty strategy that would focus on how to mitigate the effects o f the transition o n the poor and the near poor. The first critical step towards such a comprehensive poverty strategy would be to develop a nationally representative poverty survey. The Government, through the Ministry o f Social Affairs and the Central Administration o f Statistics, and with the support o f the World Bank, U N D P and UNFPA, i s in the process o f implementing a multi-purpose household survey - the f i rst o f i t s kind in Lebanon. The Wor ld Bank is also providing technical assistance on pension and social security reform, social publ ic expenditure reform, and creating a safety net.

15. As in the case of poverty, little accurate data exist on the status o f women in Lebanon. Nevertheless, various studies point to the fact that women have made significant gains over the past two decades in areas such as education, where the gender gap has been closed in primary and secondary enrollment rates (indeed, women have higher rates o f enrollment in higher education), although this has not necessarily translated into equal access to economic activity o r to decision- making at the national level. For example, only 20 percent o f the female working age population (15- 64 years old) are working or are seeking a j ob compared to 76 percent o f men. In 2004, the unemployment rate for women approached 11 percent, against 7.5 percent for men. The reasons behind the seemingly low levels o f participation in the labor force are not fully understood. Further investigation o f this issue (which should include some original data collection) i s necessary, as i s further investigation into other factors which are impeding further empowerment o f women in Lebanese society.

16. With respect to the remainder o f the Millennium Development Goals, Lebanon i s considered as “probably or potentially” meeting them by 2015, with the majority o f the goals classified as “probably will be met” by the UN MDG Report.” Ninety-eight percent o f children in Lebanon enroll in primary education, and the percentage o f students completing primary education has increased from 91 percent in 1997 to 95 percent in 2003. Mortal i ty rates for children under age 5 years have declined significantly in the past decade. But compared to other middle-income countries

Source: “L’entree des jeunes Libanais dans la vie active et l’emigration,” Saint-Joseph University, Beirut, June 2002. lo Per the recent World Bank’s Public Expenditure Review draft, which was delivered to the Government for comments and clearance. ‘ I See Millenium Development Goals Report (MDGR) for Lebanon, by the Lebanese Government and UN Country Team (September 2003).

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and to the level o f expenditure on health and education, Lebanon is considered to have relatively poor quality health and education indicators, especially in the public sector. The Government i s keen to achieve the Environmental Sustainability Goal, although it faces the challenge o f the absence o f a national environment strategy and o f specific intervention programs that would respond to the need o f this sector. For al l the MDGs, there are important regional disparities in access, quality, and efficiency issues.

D. Natural Resources and the Environment

17. Lebanon’s natural resources are being mined and degraded at an unsustainable rate. Lebanon’s water resources, its landscape, and its overall environment are among its main assets and are sources o f attraction to tourists and Diaspora Lebanese. The years o f war, however, fol lowed by a long period wh ich lacked a clear environmental strategy, regulations, or enforcement, have severely degraded these resources. In 2000, the cost o f environmental degradation in Lebanon was estimated at between 2.8 percent and 4.0 percent o f GDP per year.” The estimated costs o f this damage are broken down by environmental category in Figure 1.

18. The cost of environmental degradation measured here i s not limited to the resources themselves. The cost spi l ls into areas o f public health, household budgets, the competitiveness o f the economy, and inter-generational equity, where the rate o f mining and degradation means that many o f these resources wil l not be available in the future.13

0 Water: Although service coverage i s high, w i t h 90 percent o f municipal households connected to the public water system, the country’s infrastructure i s generally o ld and deteriorated, and leaving or overf lowing wastewater results in severe sanitary conditions and contaminates surface and ground water resources. Operations and management and billing deficiencies are equally weak, which l im i t the abi l i ty to recover operating costs, let alone any maintenance or capital

Figure 1. Annual Cost o f Environmental Degradation by Environmental Category (mean estimate as a

percentage o f GDP).

1.20% , 100%

0 80%

0 60%

0 40%

0 20%

0 00% Water Air Coastal Land Waste

investment costs. cost o f water i s extremely high:

Still, the private [ Lebanon’s population consumes a large quantity o f bottled water, due mostly to the perception that the municipal water supply i s o f l o w quality. The cost associated w i th this perception i s estimated at around US$90 mi l l ion per year. This high consumption also contributes to increased plastic and glass bottle waste. F rom a health perspective, it i s estimated that about 260 children die every year (10 percent o f a l l chi ld deaths) f rom diarrhea-related diseases associated w i th inadequate potable water, sanitation, and hygiene.

0 Air Quality: Despite significant improvements in overall air quality levels due to the recent banning o f light diesel vehicles, the impact o f air pol lut ion o n human health i s st i l l significant, w i th an estimate o f about 350 premature deaths each year that are due to urban

Sarraf e t al., 2004, “Cost o f Environmental Degradation - The Case o f Lebanon and Tunisia,” Environmental Economics Series, Paper No. 97, World Bank Environmental Department. l3 Cost measures include: (i) loss o f a healthy l i fe and the well-being o f the population; (ii) economic losses (reduced soil productivity, value o f lost resources, loss in tourism); and (iii) loss o f environmental opportunities (reduced recreational value for beaches, forests, etc.).

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air pollution. Additional cases o f chronic bronchitis and other forms o f respiratory illnesses are counted by the thousands. About 80 percent o f air pollution i s generated by vehicles, whi le the rest can be attributed mostly to power generating plants.

0 Coastal and Land Degradation: Both types o f degradation are the result o f untreated and often illegally dumped municipal solid waste and wastewater, as well as uncontrolled development on shorelines and fragile landscapes (including quarries, deforestation, and industrial development in watershed areas). Combined, their cost exceeds 1 percent o f GDP.

E. Governance

19. Some aspects of governance in Lebanon are unique to the country and reflect i t s confessional mosaic. But this should not justify a lack o f transparency of public processes or accountability o f public officials. Lebanon’s governance structure reflects i ts confessional mosaic o f 17 different sects: the seats in the National Assembly are shared equally between Christians and Muslims; the President must be a Maronite Christian; the Prime Minister must be a Sunni Muslim; and the Speaker o f the Assembly must be a Shia Muslim. This formula ensures that no single leader can dominate national decision making and that most public affairs issues are subject to consensus among the major groups o f the Government. This is, perhaps, an aspect o f governance deeply embedded in the Constitution and the Ta i f Accord, and has many virtues in the Lebanese context. The downside o f this arrangement, as has been made clear in the past few years, i s that it can potentially paralyze structural reforms in the absence o f full consensus and render it dif f icult to hold Government officials accountable for ultimate executive responsibility.

T h e root of Lebanon’s problems lies in its governance structure.

20. On the positive side, Lebanon has many of the constitutional institutions which have a positive influence on g~vernance . ‘~ Indeed, Lebanon ranks among the highest o f countries in the region in terms o f political participation, c iv i l liberties, and a free press. Among the most important features o f such accountability are the following: (i) Lebanon holds regular parliamentary and local elections; (ii) supervision by the media and c iv i l society i s fair ly strong, and unfettered public debates on governance are a regular feature o f public life; and (iii) the Lebanese L a w o f Associations i s one o f the most liberal and one o f the oldest in the region, reflecting the large number o f NGOs active in al l parts o f the country. This i s an important and unique asset for Lebanon in the region, and the country can build o n this asset by enhancing public awareness o f national challenges so that “participation” becomes a more meaningful exercise by informed citizens.

21. On the negative side, Lebanon ranks low in terms of the quality of i t s bureaucracy, the independence of civil service from political pressure, corruption, and tax evasion.” The country lacks the modern, flexible, and business-friendly regulatory framework and apparatus needed for the sustainable development o f the private sector. Civil service reform i s o n hold, which leaves the c iv i l service staffed with people who have little training and are unprepared to tackle the modern demands o f public administration. Budgeting and capital expenditure procedures need to be revamped. Lebanon’s legal framework also needs modernization, especially in the area o f commercial law and courts. At the local level, elections and participation are guaranteed, but without the corresponding decentralization of, or financial autonomy for, the local councils. Addressing al l o f these issues is complicated by the governance structure itself, which, by design, diffbses political authority among various sects and branches o f the Government. These governance issues are reflected in most sectors and in the Bank’s own portfolio, in which physical components have tended to move (albeit slowly)

l4 “Better Governance for Development in the Middle East and North Africa: Enhancing Inclusiveness and Accountability”, The World Bank (2003).

Indeed, in terms o f the perception of corruption, Lebanon has slid in ranking from 78 in 2003 to 97 in 2004 according to the Transparency International Corruption Perceptions Index. 15

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while reforms, especially those requiring coordinated actions beyond a particular ministry,I6 have stagnated.

Box 3. Budgetary Processes Continue to be Opaque

While the Government has made progress in reporting the budgetary position on a regular basis, many activities are conducted in an opaque manner. These activities include: (i) transactions o f extra-budgetary funds and entities; (ii) loans to selected public autonomous agencies that are converted to expenditure at the end o f the financial year; (iii) unutilized investment authority that i s carried forward without additional parliamentary disclosure; (iv) major funds for health, social services, and municipal financing that are not disclosed to parliamentary budget scrutiny or for review o f actual performance against the budget plans; and (v) the absence o f a formal audit opinion by the Court o f Accounts on the fairness o f the Government’s annual financial report.

The CFAA which was delivered to the Government for comments and clearance has proposed a number o f key refoms that, if implemented, would have direct impact on reforming the public financial management system o f the Government. The priorities for the next 2-3 years, as proposed by the CFAA, should be focused on: (i) establishing a unified budget framework that accounts for the financial activities o f the public sector and presents it in a consolidated, audited set o f financial statements for the public sector; (ii) strengthening internal controls by making the amendments to the Law on Accounting through the introduction o f an internal audit function; (iii) reforming the Court o f Accounts to make i t independent o f the Government, remove i t from the Government’s internal financial control processes, and focus i ts work on expressing an opinion on the fairness o f the Government’s annual financial statements and on performance audits o f Government entities.

22. The challenges going forward will be to build a national consensus needed around a governance reform agenda and the commitment to implement it; and to insure that national reforms are “unstuck” by streamlining the reform process itself. Areas o f actions include: (i) budget consolidation and expenditure tracking; (ii) civ i l service reform, including transparent processes for hiring based on meritocracy; (iii) enhanced judicial capacity and independence; (iv) revamping and empowering the control agencies responsible for ensuring public accountability and transparency (Civ i l Service Board, Court o f Accounts, Central Inspection); and (v) to build the capacity o f executive ministries/agencies at the middle management level and insulate them from frequent political interference. All these are hndamental ly sovereign initiatives - that is, the political w i l l has to be endogenous for them to succeed. The Bank and other international organizations can only play a helping role in sharing international best practices, technical know-how, and capacity building.

l6 Indeed, some ministries, such as the Ministry o f Finance, Ministry o f Health, and Ministry o f Telecommunications, and the Office o f the Minister o f State for Administrative Reform (OMSAR), have undertaken important internal reforms o f their structures and systems.

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11. COUNTRY DEVELOPMENT PROGRAM AND OUTLOOK

A. Country Development Program”

23. The Government o f Lebanon fully appreciates the severity o f the current economic situation, f r o m both a sustainable development perspective and a financial perspective, and has expressed i ts commitment to undertake deep structural reforms supported by national consensus. This sense o f urgency i s compounded by an awareness o f the limited and diminishing impact over t ime o f the financial package put forward at the Paris I1 Conference to contain the growth o f the public debt. The Government also acknowledges the utmost need to undertake deep structural reforms, and considers the development o f a national pol i t ical consensus necessary to embark on a program o f reforms that wil l profoundly reshape Lebanon’s political, economical, social, and judicial systems.

24. pillars. These are:

The Government i s articulating i t s economic and social program around four main

0 Modernizing the real economy;

0

0

0

Addressing Lebanon’s fiscal and debt sustainability challenges;

Improving the Government’s governance capacities and reforming the public sector; and

Improving social conditions and strengthening social safety nets.

25. On the real economy front, the Government foresees privatization, trade liberalization, the improvement o f the investment climate, and the development o f capital markets as major elements o f i t s strategy. The Government would seek greater private participation in public utilities (telecommunications, electricity, water), with private involvement ranging f rom contract management to full transfer o f public assets to the private sector, depending on the situation o f various public entities. Privatization wou ld be accompanied by the establishment o f independent regulatory authorities, with the objective to increase competition in these sectors. The Government wou ld seek full accession to the Wor ld Trade Organization, and envisages, in this regard, enforcing the legal protection o f intellectual property rights. I t i s also committed to pursuing its gradual trade liberalization with the European Un ion (EU) and Greater Arab Free Trade Area countries. The Government foresees the simplification o f the business regulatory environment (reducing entry and exit barriers to private sector operations; and enhancing the effectiveness o f the judiciary system) and the development o f capital (debt and equity) markets as critical to the promotion o f private investment.

26. On the fiscal front, the Government i s a iming for the rationalization o f public expenditures, the introduction o f a global income tax, and the reform o f the tax and debt management administration. The rationalization o f expenditure comprises public and private pension reform, power sector reform, and public expenditure management reforms. Proceeds from privatization would be entirely used for debt reduction.

27. On the governance front, the Government envisages developing a comprehensive strategy to restructure public institutions based on a new appraisal o f the role o f the State, and to overhaul the civil service through a large human resource plan. The strategy would address: (i) public finance transparency; (ii) civi l service reform; (iii) procurement reform; (iv) reducing red tape; and (v) improving and enforcing anti-corruption measures.

” This section i s based on the presentation made by the Government o f Lebanon to donors in New York, United States, on September 19,2005.

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28. On the social front, the Government foresees the necessity o f reinforcing social safety nets and developing targeted programs to reach poverty clusters through NGOs and municipalities. This includes the reform o f Social Security, the institutionalization o f current social fund type projects, and the rationalization o f public social expenditures, in order to achieve greater coverage and better targeting o f the latter.

29. In terms o f capital investment priorities, the Council for Development and Reconstruction’s (CDR) Three-Year Development Program emphasizes the detrimental effects o f l imited investments on water resources, the Lebanese coastline, and the agricultural sector. Regionally, it acknowledges a “glaring” level o f regional disparities and calls for bridging the gap towards achieving a “balanced development,” translated into full equity for basic services (potable water, electricity, and telephone networks), and prioritization o f other services such as sewerage and solid waste according to population density.

30. In light of these priorities, the Government (represented by the Prime Minister’s Office, the Ministry o f Finance, the Ministry o f Economy and Trade, the Central Bank, and the Council f o r Development and Reconstruction) has been in close coordination with the Bank and other international agencies to align donor advisory services w i th re form and investment priorities.

B. Economic Outlook

3 1. The sources o f uncertainty regarding Lebanon’s economic outlook are considerable. They range f rom uncertainty about the external economic environment (oi l prices, global interest rates, global growth) to uncertainty about regional political developments (the Arab-Israeli conflict; developments in Iraq, Syria, and Iran), the readiness o f donors to provide financial support, and Lebanese domestic developments, whether economic, financial, political, or social. This, added to the absence o f sol id statistical information (balance o f payments, real economy indicators) renders any forecasting exercise dif f icult at best. Nevertheless, some important parameters need to be considered in assessing Lebanon’s possible outlook.

32. On the external side, i t i s unlikely that the environment w i l l continue to be as favorable as it has been in recent years. Global interest rates are projected to rise over the medium term (by some 300 basis points over the CAS period)I8, which will exert a significant upward pressure o n the Government’s borrowing costs. A t the regional level, capital f lows in the aftermath o f September 11, 2001 have been significant, and may continue for the foreseeable future, depending, notably, on the evolution o f o i l prices.

33. On the regional side, uncertainties are likely to remain high. An Israeli-Arab peace settlement i s not yet in sight, nor i s a rapid stabilization o f the political situation in Iraq, wh ich could open sizeable outlets to Lebanese exporters. Growing tensions between Syr idIran and Western countries could also have some repercussions o n the domestic political scene. Donors, who expressed their intention to support the Government’s reform program, might, nevertheless, require the ex-ante implementation o f reform measures before substantial additional assistance (for debt restructuring notably) can be disbursed.

34. On the domestic policy side, coherence among various branches o f the Government and broad political support w i l l be a deciding factor in Lebanon’s capacity to undertake such a challenging fiscal adjustment, in particular when it i s designed to re form and rationalize public expenditures, raise tax revenue, and transfer public assets to the private sector. At the t ime o f writing the CAS, the Government had not yet articulated in detail i t s reform plan. The adoption o f

’* “MENA Economic Development and Prospects”, The World Bank, April 2005.

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such a plan by the Cabinet, the Parliament, and more broadly by the population, has, therefore, yet to be seen.

35. I n the short run, the likelihood of a market-driven financial disruption seems low, but the prospect o f a confidence crisis cannot be dismissed. Short-term r isks are reduced by the level o f gross foreign currency reserves at the Central Bank, which by end-2005 should approach 40 percent o f GDP and cover 48 percent o f the money supply in local currency. But w i th such a high debt to GDP ratio, combined w i th a pegged exchange rate and high capital mobility, Lebanon w i l l remain vulnerable to a confidence crisis. In light o f the aforementioned considerations, three scenarios could be envisaged:

36. A first scenario would correspond to a “muddling-through’’ situation: The Government would continue to undertake some policy measures in the right direction, but these measures would be too weak and would be dependent on the political mood of the moment. Overall, the policy framework would be insufficient to stabilize the debt dynamics, which would inevitably expose the country to greater r isks o f financial disruption and would further hamper its growth prospects. From a CAS perspective, this scenario would define the Wor ld Bank’s base case engagement. (Table 2 shows base case scenario projections for selected macro-economic indicators). At the time o f writ ing the CAS, Lebanon was considered by the CAS team to be in the base case.

Table 2. Base Case Scenario Projections: Selected Macro-Economic Indicators, 2005-2009

2005 2006 2007 2008 2009

Real GDP 1 .o 3.0 2.5 2.0 2.0 Real Private Consumption 2.7 1.8 1.7 0.9 0.9 Real Gross Domestic Investment -5.0 2.9 1.2 0.6 0.7

Growth Rates (%)

Export Volumes, GNFS -4.0 4.0 4.2 4.3 4.3 Import Volumes, GNFS 0.0 2.6 -0.7 -1.5 -1.6

Ratios to G D P (%) Gross Domestic Investment

Gross Domestic Savings Resource Balance Fiscal Primary Balance a/ Fiscal Balance a/ Gross Public Debt

20.0 20.0 20.0 20.0 20.0 -0.9 -0.5 0.3 1.5 2.7

-20.9 -20.5 -19.7 -18.5 -17.3 1.1 1.2 2.3 2.9 3.5

-10.5 - 10.4 -10.7 -11.7 -12.2 171 175 179 186 193

Fiscal Triggers Fiscal Primary Surplus Over Fiscal Revenue 8.0 8.1 9.7 12.4 14.7 Net Public Debt Over Fiscal Revenue 730 716 718 742 774

Source: World Bank Staff Projections. a/ Includes foreign-financed capital expenditures.

37. A second scenario would see the policy framework envisaged by the new Government being fully implemented. This would involve bold fiscal efforts to increase the primary fiscal surplus; pension and civil service reform; active debt management; significant overhauling of the power sector; and enhanced private sector participation in utilities. In this scenario, the fiscal primary surplus would reach 6-7 percent o f GDP by the end o f the C A S period, a level that would initially stabilize and then progressively reduce the debt to GDP ratio”. Structural reforms that would improve the business environment, competition, the entry and operation o f SMEs, and better service

’’ The magnitude o f the decline in the debt to GDP ratio would then depend to a large extent on donors and banks’ debt restructuring contributions. A very optimistic scenario would foresee the debt to GDP ratio going down to 120-130 percent by 2009; a less optimistic one to 140-150 percent.

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delivery (o f power in particular) would upgrade, to some degree, the long-term growth potential o f the Lebanese economy2’. However, the situation would remain fragile and would require broad public support. Also, social policies would be needed to bridge the gap in public services, health and education, and better protect the most vulnerable segments during the adjustment. This scenario i s ambitious if it i s judged by the track record o f several years o f pol icy paralysis. Nevertheless, it i s realizable in l ight o f the following: (i) the Government’s announced intentions to curb the debt dynamics through structural reforms while shielding the poorest f rom negative impacts o f the adjustment2’; (ii) the probable large impact o f the power sector’s overhaul o n fiscal accounts, economic activity, and Government credibility; (iii) the l ikely financial support o f the donor community to the implementation o f the reform program (social and economic) and debt restructuring; and (iv) the l ikely large response o f the market to the perceived ability o f the Government to command a strong mandate for carrying out the adjustment program. From a CAS perspective, this scenario would define the Wor ld Bank’s high case engagement.

38. A third scenario would correspond to a rapid deterioration of the financial situation should investors lose confidence in Lebanon’s capacity to honor its debt. A major economic crisis would then ensue in the face of insufficient liquidity to finance the deficit and to roll-over the debt stock. A negative shock, or simply the inability o f Lebanon to consolidate the fiscal adjustment efforts undertaken in recent years, could be at the origin o f this reversal in investors’ perceptions. F rom a CAS perspective, this scenario wou ld define the Wor ld Bank’s low case engagement and warrant a CAS Update. The latter would re-evaluate the situation and, accordingly, the World Bank’s engagements w i th a view to contain the growth in poverty, improve safety nets, and guarantee the delivery o f basic services.

111. LESSONS LEARNED FROM THE PREVIOUS CAS AND LOOKING FORWARD

A. CAS Lessons

39. The 1997 CAS predicated Bank Group assistance upon satisfactory macro-economic performance (particularly in reducing the fiscal deficit) and good performance in the implementation of the portfolio. As the “Review o f the 1997-2000 C A S Period” indicates, outcomes, with respect to both o f these areas, were poor. Yet, there were important islands o f success and progress in pol icy dialogue and project performance. The experience offers the fol lowing important lessons for future engagement:

0 The complexity of the political environment for decision making in Lebanon should not be underestimated. The Bank, l ike other donors, has often made the erroneous assumption that simply because a piece o f pol icy reform i s in the national interest o f Lebanon it wil l be implemented. In Lebanon, the confessional system o f governance and the resulting diffusion o f political authority make such reforms subject to collective action, and such collective action is, for the same reasons, far f rom guaranteed.

0 I t i s important to stay out of lending in sectors where consensus on reform has yet to be developed and to focus instead on non-lending analytical and advisory work until a credible commitment can be ascertained.

*’ This scenario envisages an average 5 percent nominal GDP growth (3 percent real) throughout the period, a rate broadly similar to that observed since 1997. I t i s assumed here that the negative short term impact o f fiscal adjustment on aggregate demand would be offset by a rapid decline in interest rates spreads and a more progressive improvement in the investment climate. ’’ In the absence o f any reliable poverty data (at the time o f writing o f the CAS), projecting poverty rates in the various scenarios remain highly speculative, though, i t i s likely that a fiscal adjustment strategy only aimed at reducing the public debt (Le., not accompanied with specific measures to protect the most vulnerable segments o f the population) would aggravate the poverty situation in the short run.

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0 The Bank’s analytical work, and i t s dissemination through dialogue wi th the Government, Parliament, civil society, and the media have been as important as lending (if not more so) in having a positive impact on strategic public choices in Lebanon.

0 I t i s important to learn to build on the country’s strengths: i t s private sector, c iv i l society, and local governments. The country’s strengths l ie in: (i) its highly entrepreneurial private sector, which has survived, and in some sectors prospered, in spite o f the dif f icult environment; (ii) i ts vibrant c iv i l society/NGO sector, which has provided many o f the social services and public goods traditionally provided by the Government; and (iii) its nascent elected local councils, which have provided local services with l imited resources.

0 In the absence o f comprehensive c iv i l service reform, public sector programs should a im to: (i) help spin o f f public services that can be performed by the private sector, and (ii) focus policy reforms and capacity building on successful public sector “islands” crit ical to the management, monitoring, and regulation o f the economy, the social services, and the environment.

0 Simpler projects should be designed, and adaptable instruments should be considered.

0 I t i s important to keep an eye on short-term fiscal trends, but a deep understanding o f structural and institutional constraints to long-term development should also be developed.

B. Portfolio Issues

40. Every project in Lebanon i s bo rn w i th two exogenous “flags,” signaling the risk associated with the macro-economic record and poor t rack record o f completed projects.22 Any additional “flag,” such as the “effectiveness” f lag that results f rom delayed ratification in Parliament, immediately brands that project as a “potential problem project” for several years, and before the concerned ministry or the project team has a chance to start implementing the project.

4 1. Measurement issues aside, the Lebanon portfolio i s a challenging one, t o say the least. A confluence o f macro, governance, organizational, capacity, and implementation problems has helped put Lebanon’s portfolio o n the Bank’s “watch list,” wh ich raises serious questions about the abi l i ty o f the Bank to make a positive contribution to development in Lebanon through lending, and about Lebanon’s ability to absorb and make good use o f foreign-funded projects. In the past year, and in the context o f pol i t ical turmoil, the portfolio deteriorated even further. There have been important exceptions in this portfolio picture, w i th several projects performing very well.

42. The Lebanese authorities have historically argued that W o r l d Bank conditions and procedures have been much more onerous than those o f other donors, and have thus contributed to complications and delays. The Bank has accepted the responsibility for its o w n part, and has worked to design simpler projects and, as part o f its overall internal streamlining effort, continues to work o n simplifying procedures. However, the performance o f the Lebanese portfol io remains weak vis-&vis the Bank’s overall regional and global portfolios and the portfolios o f other major donors, which suggests a need to address systemic problems in the Lebanese portfolio.

22 The two flags are Country Environment and Country Record. The first i s based on a composite indicator o f a country’s weak macro management. The second i s based on an independent evaluation o f samples o f completed projects (selected by the Operations and Evaluations Department), where net commitments associated with unsatisfactory projects represent more than 40 percent o f commitments for completed projects over the previous five years.

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43. Joint efforts to diagnose and address portfolio problems have resulted in a two-pronged approach to improving the portfolio: (i) a short-term approach to adapt the portfolio to current macro and implementation conditions; and (ii) a medium-term CAS-driven approach, to launch the type o f incentives, policies, procedural reforms and capacity building needed to realize the development objectives o f the country.

44. To address the short-term portfolio management issues, the Bank and the Government have made concerted efforts to proactively address project issues, as well as restructure or cancel projects when ne~essary.’~ In 2004, the Bank rol led out the “Client Connection” to provide the Government w i th full access to project information, and in partnership with the Government (Prime Minister’s Office, Ministry o f Finance, and CDR), started a Quarterly Portfol io Performance Review (QPPR) to ensure a proactive monitoring/problem solving approach to the portfolio. An intensive procurement training program i s also under way.

45. However, these measures by themselves are not sustainable in the absence of systemic improvements in a number of areas o f public management/policy making. These areas are discussed in the fol lowing six paragraphs.

46. Agreement on sector strategy up front: Going forward, all proposed investment lending operations need to be strongly justified within a broad sectoral approach, agreed upon ex ante with the various branches o f Government. Such a dialogue o n reform has already begun in the areas o f debt and fiscal management, health, pensions, safety nets, water, and power with significant potential on the upside in terms o f rationalizing fiscal pol icy and reducing poverty. Other potential sectors for future agreement include the reform o f oversight and control agencies, education, municipal finance, procurement, and solid waste management.

47. Parliamentary ratification procedures: Effectiveness delays in Lebanon are highest in the MENA region, and have considerable implications for the cost of projects and the realization o f their development objectives. While the Parliament has a constitutional responsibility to rat i fy al l foreign loans, there i s considerable room for streamlining the procedures. Such a discussion has already begun with members o f Parliament and should result in concrete steps to reduce the ratification time.

48. Counterpart funds and land expropriation: In an attempt to contain and manage the budget deficit from year to year, the slow release of project counterpart funds and the absence of budget appropriations for land expropriation have resulted in considerable delays in project implementation. A move, currently under way, to accrual-based accounting and medium-term budgeting w i l l reduce any incentives to delay payments by fully budgeting and accounting for project costs up front.

49. The attracting and retaining of quality civil servantskonsultants in the public sector to ensure the sustainability o f improvements: A Government freeze on al l new hiring, subject to approval by the Cabinet o f Ministers, has helped to put the lid on an expenditure item that had been growing without control. However, i t has also made i t dif f icult to hire critical staff to managehn systems aimed at modernizing the public sector, or even to retain o r replace skilled c iv i l servants who are going into retirement.24 This, typically, has thrown into doubt the sustainability o f the institutional development components o f many previous Bank projects. As the Government i s

23 Under the first CPPR (June 2001), U S 7 8 million was cancelled from three problem projects, and a fourth one was cancelled (because o f the suspension o f an undisbursed amount o f US$16.5 million). The second CPPR (October 2002) focused on bringing the problem projects to a satisfactory status and preventing hrther deterioration o f the projects at risk. The 2003 PIP reduced unsatisfactory projects by half through the cancellation and restructuring o f non-performing projects. 24 The average age o f civil servants in the public sector i s 58 years, and mandatory retirement i s 64 years o f age, implying a high rate o f attrition in the years to come.

15

contemplating broad reforms and capacity building, the issue o f hiring, compensating, or redeploying c iv i l servants and consultants needs to be fully addressed.

50. Procurement reform: World Bank projects implemented by CDR have frequently faced procurement problems and delays. A recent diagnosis carried out by the International Training Center o f the ILO pointed to a number o f deficiencies including the high centralization o f decision making, the lack o f a “manual o f procedures,” and the need for further capacity building o f procurement staff o n Wor ld Bank procedures. CDR has recently moved to address these constraints in an attempt to quickly turn around the performance o f the portfolio. Beyond CDR, however, other ministries and public agencies have to abide by an antiquated Public Procurement L a w and procedures dating back to 1959 and 1963. A revised draft publ ic procurement law was prepared with an IDF grant. If approved and implemented, i t would greatly enhance the efficiency and transparency o f public procurement procedures and would al low the Bank to rely increasingly o n national public procurement systems.

51. Portfolio triggers: The base lending scenario envisioned in this CAS partly reflects the poor state of the portfolio (see Section IV, Part C.). Mov ing to higher levels o f engagement wil l require reducing problem projects (no more than 33 percent); increasing the disbursement rate (equal to or above 15 percent) and ensuring more rapid ratification o f loans (9 months or less).

C. Preparing the New CAS

52. The CAS preparation process has overlapped three consecutive Governments, establishing a much broader consensus around its broad strategy and pillars. In anticipation o f a change in Government in 2004, extensive CAS consultations were carried out with a broad set o f stakeholders, within and outside the Government, to ensure broad endorsement o f the strategy and the pillars. Indeed, the pillars and broad direction identified w i th the previous Government’s counterpart team (representing the Prime Minister’s Office, the Ministry o f Finance, and CDR), were validated and elaborated w i th the new counterpart team. A CAS workshop held with the core counterpart team (the Prime Minister’s Office, the MOF, and CDR), and later with the extended Government, confirmed Government endorsement o f the CAS pillars and matrix.

53. CAS consultations in Lebanon have been extensive. Given the substantial freedom o f the press in Lebanon and the considerable tolerance for publ ic discourse, the Bank planned and implemented an extensive CAS consultation process w i th Parliament, the private sector, c iv i l society, and the press o n the three pillars o f the CAS. Among the main outputs o f the consultations have been the following: (i) refinement and augmentation o f the CAS outcomes and indicators, and Bank inputs; (ii) agreement o n enhancing the relationship with Parliament through the C A S and project cycles by organizing regular briefings on project preparation, implementation performance, and outcome evaluation; and (iii) jo in t Wor ld Bank-IFC follow-up with the Chambers o f Commerce o n progress in removing regulatory constraints to the entry and operation o f the private sector (see Annex 111).

54. going to take stock o f the progress made towards the intermediate and CAS outcomes.

Given the outcome orientation of the CAS, it was agreed that consultations would be on-

D. Development Partners

55. The Bank has been working very closely with its international and regional partners to forge a well thought out and coordinated strategy for Lebanon. The partners’ programs are described in the CAS Results Matr ix (Annex I) and in Annex 11. The present section outlines the programs o f the main partners and the jo in t efforts and activities.

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56. International Monetary Fund. Although the IMF does not have a formal program with Lebanon, i t has carried out Art icle 4 Consultations and capacity building o f the macro-economic, fiscal, and financial sector management. Field missions have coordinated very closely on analytical work, and have joined forces in preparing the IMF’s Fiscal ROSC and the Bank’s Country Financial Accountability Assessment (CFAA). Since the recent opening o f the IMF’s Midd le East Technical Assistance Center (METAC), coordination on capacity building in several areas is poised to grow.

57. European Commission. The EC’s Lebanon National Indicative Program 2002-2004 identifies four priorities: (i) the development o f the trade sector/implementation o f the Association Agreement; (ii) the integrated rural development program for alleviating poverty; (iii) support for environmental protection; and (iv) support for exchanges and cooperation in the education sector. The Bank and E C are in close coordination with the Lebanese Government o n the power, water, and capacity building o f CDR to ensure strategic complementarities and improved absorptive capacity o f donor-funded projects. Going forward, E C assistance to Lebanon would be governed by the European Neighborhood Policy (ENP). The ENP provides a framework for the Lebanese Government to develop a five-year Action Plan that would enhance economic integration and deepen political cooperation with the EU. The Act ion Plan i s s t i l l to be developed, pending the Government’s more precise identification o f i ts pol icy priorities. The E C has sought Bank feedback o n that front, and regular exchange o f information and review by the Bank o f E C programs i s envisaged.

58. Regional and Bilateral Donors and UN Agencies. These donors and UN agencies provide advisory services and finding to projects aimed at supporting development efforts and social sectors, and improving physical infrastructure and vital services in the country. The Bank participates in regular donor and agency coordination meetings. These meetings provide an opportunity for participants to present their programs and address common issues. The main activities o f each donor/agency are spelled out per pi l lar in Annex 11.

IV. PROPOSED BANK COUNTRY ASSISTANCE STRATEGY

59. The proposed Bank Country Assistance Strategy i s guided by the Bank’s current portfolio and by lessons learned from the previous CAS period. Namely, Bank resources would be focused o n the fol lowing priori ty areas: (i) improving the performance o f the current portfol io through supervision and through building implementation capacity; (ii) expanding analytical and advisory activities in support o f the improved economic, social, and environmental management o f the transition process; and (iii) limiting lending activities to sectors in which a credible commitment to reform i s established ex ante.

A. The CAS Pillars

60. The objective o f the CAS i s to help Lebanon build its public institutions to transition out of its current macro-economic imbalances; to address the social and environmental implications o f the transition in an equitable fashion; and to lay the foundations for job creation and growth. Bringing down the public deficit i s a necessary condition for sustained debt reduction and economic growth; but this requires greater fiscal tightening, wh ich in turn i s l ikely to have a negative impact o n the most vulnerable in the society and o n growth i tself in the short run. The success o f a painful transition period to sustainable growth requires several ingredients simultaneously: (i) a credible fiscal adjustment program to improve investors’ anticipations and lower interest rates; (ii) a better investment climate to enhance the growth response to the restored macro-economic conditions; and (iii) a more efficient social program geared towards social protection for the most vulnerable groups. In addition, many capital investments and maintenance operations o f a public good nature are l ikely to be postponed during the transition, and this might cause irreversible degradation to the natural environment. Hence, there i s a need to move strategically and selectively o n investments in these areas.

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61. Three pillars are envisaged to help Lebanon in this transition and beyond: (1) governance, economic management, and growth support; (2) developing human capital and mitigating the poverty effects of transition; and (3) resource and environmental management. These pillars overlap very we l l with the Government’s strategy (see Section 11. A.) that i s to be considered in a high case scenario, as wel l as with the Bank’s assessment o f what needs to be or can be achieved over the next four years in light o f the current macro-economic and political outlook and the status o f the existing portfolio. Their expected outcomes are described in the next paragraphs and in Annex I in greater detail.

CAS Pillar (1): Governance, Economic Management, and Growth Support

62. This pi l lar aims to support the central objective o f the CAS, Le., to address the underlying deficiencies in the governance and management o f public finance in terms o f transparency, accountability, information, and capacity building. Such reforms would reduce the sources o f macro- economic imbalances and put the economy on a path towards sustainable growth in the medium to long term. The challenge for the Government is to: (i) bring the country’s indebtedness to a clearly declining trend through governance reforms, fiscal discipline, and debt management; and (ii) move aggressively to remove the structural constraints to investment through a combination o f regulatory reforms and public investments aimed at enhancing the competitiveness o f the private sector. This pillar, therefore, i s divided into two components: governance and economic management o n the one hand, and growth support o n the other hand.

63. Governance and Economic Management. This component wou ld contribute to the realization o f three main outcomes: (i) improved transparency o f budget processes and tracking o f public expenditure incidence and impact; (ii) improved capacity in fiscal and debt management, statistical information and public investment planning; and (iii) increased financial autonomy and private sector participation in SOEs. A credible bundle o f pol icy measures, as opposed to disjointed efforts, wou ld have a significant payoff in terms o f investor confidence in Lebanon. Such a bundle would include fiscal and debt management measures, as we l l as long awaited structural reforms to the economy. Bank lending operations for economic management wou ld be conceived within a broader strategic commitment by the Government, w i th a focus on public sector restructuring operations which could result in significant savings/loss reduction to the public sector and to a better rationalization o f expenditure/public sector management.

64. Obvious targets for improved fiscal management are public autonomous agencies and pension reform. As o f January 2005, Lebanon counted n o less than 72 public autonomous agencies and enterprises, as we l l as several participations to the capital o f various commercial activities. These entities exert a strong influence o n the Government’s accounts, some in the fo rm o f a major drain on the budget (the most prominent example being Electricite du Liban, which cost Lebanon in 2004 one- f i f th o f its overall public deficit) and others in the form o f important additional entrepreneurial revenues (the telephone companies, for instance, which in 2004 covered about ha l f o f the deficit). Over the last few years, the Government has legally paved the way for the privatization o f some o f these assets, but a lack o f consensus o n the role o f the public enterprises in the provision o f public goods, and insufficient preparatory measures, have prevented any serious progress f rom being made. Furthermore, most o f these entities’ financial activities are not transparent to the Government, to Parliament o r to the public. These include loans to selected public autonomous agencies that are converted to expenditure at the end o f the financial year, unutilized investment authority that i s carried forward without additional parliamentary disclosure, and major funds for health and social services and for municipal financing that are not disclosed to parliamentary budget scrutiny, or for review o f actual performance against the budget plans. As for pensions, the current pay-as-you-go schemes to c iv i l and mil i tary services and end-of-service indemnities to government contract workers (the latter being managed by the National Social Security Fund [NSSF]) are not sustainable. This would impose, over the CAS period, an additional annual cost to the budget o f approximately ha l f a percent o f GDP, which would grow further thereafter. Various reforms can be envisaged, most o f which would require technical assistance and financial assistance in the transition.

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65. Public expenditure management i s another important element of the bundle of reforms. Currently, the capital investment budget of CDR i s not consolidated into the budget, though it significantly affects the future stream of current expenditures and debt repayments. Public procurement procedures are also antiquated and non-transparent, which leaves the door open for lack o f competition and widespread perceptions o f corruption. With a view to developing a medium-term expenditure framework in the near future, expenditure information systems (including tracking surveys) need to be developed in the relevant agencies. The entire investment planning cycle - from planning, approvals, implementation, and monitoring and evaluation - needs to be improved through procedural reforms, improved systems, and capacity building. A draft public procurement law, which has been languishing since 1999, needs to be revived and considered for revamping procurement procedures.

66. Debt management i s another field in which capacity needs to be built (at the Ministry of Finance in particular, in coordination with the Central Bank), in order to minimize the r i s k s of financial disruption while maintaining the lowest possible borrowing costs. The Ministry o f Finance and the Central Bank, w i th support f rom the Wor ld Bank and the IMF, have supported the creation o f a specialized Debt Management Department. Management systems and capacity building for the Department wil l be needed to make i t fully operational.

67. The statistical capacity to support policy formulation remains crucially limited. Attempts to build statistical capacity have not been sustainable in the absence of a clear institutional design o f roles and responsibilities for various sets of statistics. Assistance in this area wou ld include: (i) assistance with a Statistical Master Plan to define the institutional needs, funding sources, and data needs at the national and sectoral levels; (ii) partnership w i th the IMF in improving economic/fiscal/financial statistical data; (iii) assistance with methodologies for poverty/social data analysis; and (iv) making statistical information available to the public through a clear dissemination strategy.

68. services, as described below:

More specifically, Bank activities in this area could include both lending and advisory

Lending operations would include investment/TA lending for power sector restructuring; SOE refodrestructur ing; statistical capacity; publ ic expenditure information systems; pension and social security reform; and modernization o f the role o f control agencies (Audit Court, Civil Service Board, and Central Inspection).

Bank diagnostics would include Public Expenditure Review (ongoing); Country Financial Accountability Assessment (ongoing); Country Procurement Assessment Review; governance reform; municipal finance and decentralization; pol icy notes on pensions; and public investment planning.

Technical assistance would concentrate o n debt management, SOE restructuring, and financial sector assessment capacity.

69. Growth Support. The second component o f the first pi l lar i s concerned w i th improving the growth potential o f the Lebanese economy, which could reach up to 5 percent (in real terms) in the medium to long run. For such growth to have a progressive distributional impact, policies would need to focus o n removing obstacles to investment in labor-intensive sectors (services, ICT, agro-industry), and policies wou ld need to be developed to address labor market and segmentation issues (skilledunskilled, domestic/foreign, and maleifemale) to facilitate local economic development in and around secondary cities with high unemployment rates.

70. Obviously, a necessary pre-condition for such growth would be enhanced macro- economic stability, but other structural and regulatory constraints also play a role in depressing private investment and growth and need to be removed in preparation for a recovery stage.

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These constraints include the high cost and inefficiency o f public services and utilities (power, telecommunications, and water); weak trade facilitation systems (trade policy, transport, customs, administrative procedures, trade finance, and information supply); regulatory obstacles to private sector entry and operation; monopolistic market structures; and rudimentary corporate governance rules (see B o x 2).

71. undertake a series of lending and advisory activities.

Going forward, and in coordination with the IFC and MIGA, the B a n k i s prepared to

0 Lending operations would include local economic development projects focused on secondary cities in labor-intensive sectors w i th clear comparative advantages, with national level support in export finance, and with efficient trade facilitation systems (customs, border crossings, transport logistics, one-stop-shop service).

Bank diagnostics would include Investment Climate Assessment; Trade Strategy; Sources o f Growth Study; Labor Market and Gender Assessment; and technical assistance on administrative barriers and industrial zones.

ZFC and MZGA would focus on a number o f investment climate, privatization, pol i t ical risk coverage, and investment promotion activities (see Section IV. D: IFC, MIGA, and WBI Programs for details).

0

0

CAS Pillar (2): Developing Human Capital and Mitigating the Poverty Effects of Transition

72. This pillar supports the CAS outcomes of reducing poverty levels, enhancing the efficiency o f the social protection scheme, rationalizing health expenditure and improving i t s poverty focus, and enhancing the quality o f education.

73. Recent international experience has shown that periods of economic turbulence have a profound impact on the social fabric o f a developing country. The poor and near-poor are particularly vulnerable to crises even though they are not directly exposed to the financial sector. Even when a country manages to successfully shelter the economy against crises, the poor st i l l suffer disproportionately f rom the impact o f fiscal contraction, and thus the new poor emerge. These groups begin to “disinvest” in their human capital by withdrawing their children f rom schools, delaying needed health care, and similar types o f behavior.

74. T o prevent the above from happening, Lebanon as a first step needs to develop a comprehensive “social protection” strategy that i s shared among the various segments of society, The development o f such a strategy wou ld help build social consensus around the recovery program. Elements o f the social sector and safety net strategy would include: (i) reforming the end- of-service indemnity program and the c iv i l servants and mi l i tary pension funds; (ii) enlarging the scope of social assistance programs and seeing that they are more effective and better targeted; (iii) increasing labor market flexibility; and (iv) evaluating the impact o f social programs through a Poverty and Social Impact Analysis-type approach. The strategy would also need to consider how to protect publ ic social spending (health, education) during adjustment and fiscal consolidation, which would require increasing the efficiency o f spending in these sectors. The current household survey presently being undertaken by the Ministry o f Social AffairdCentral Administration o f Statistics/UNDP/World Bank wil l shed light o n the profi le o f the poor and wil l serve as the building block for the development o f a poverty assessment. In the event where the survey would reveal high incidence o f rural poverty, an explicit rural poverty alleviation program could be considered, in close coordination w i th the EC.

75. Beyond the safety nets, Lebanon needs to continue to develop i ts human capital, which can be i t s most vibrant resource when utilized efficiently and effectively. This will require pushing on with reforms in the health and education sectors to achieve better outcomes f rom the

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significant level o f spending already taking place. In the health sector there is a need to focus Government efforts on a few health pol icy objectives, such as containing overall health care costs, improving financial protection for households, and strengthening the primary health care system. Pharmaceutical reform, particularly the issue o f drug pricing, i s one such key area. Another i s the issue o f integrating the various public health insurance funds to provide wider and better coverage for the poor. In education, there is a need to build the system’s pol icy development capacity and to agree on a sector-wide strategy, to introduce governance models and institutional structures that can adequately manage the sector efficiently and yield quality outcomes, and to address regional educational disparities.

76. This pi l lar would support lending and advisory activities aimed at mit igating poverty and reinforcing the existing safety nets through community or municipality-driven development programs (by focusing the delivery o f services through NGOs and municipalities). M o r e specifically, the fol lowing are considered:

Lending operations would focus o n fostering financially viable, effective and efficient anti- poverty and social safety net programs, and supporting reform in key areas o f pensions, health and education. N e w operations could include the expansion o f community- or municipal- based development programs; a health technical assistance project focused o n rationalizing health expenditures through big-ticket items such as the drug bill; greater financial protection f rom illness for the poor; greater use o f primary health care; and a pension reform technical assistance project.

Bank diagnostics would focus on supporting the following: (i) a pension reform strategy; (ii) a poverty assessment and strategy; (iii) a labor market and gender assessment; and (iv) a multi-year programmatic Economic Sector Work program to develop a comprehensive “social protection strategy” that would consist o f the integration o f analytical work on pension reform, social safety nets, labor market impediments, health and education, and the impact evaluation o f social programs.

Technical assistance would include a small grants program for NGOs (grants), and an H IV /A IDS IDF grant.

CAS Pillar (3): Resource and Environmental Management

77. use management and air pollution control.

This pillar would contribute to the CAS outcomes o f improved water management, land

78. Currently, Lebanon’s natural resources - water, soil, air, fauna and flora - are being mined at such a rate that many of the resources will not be available in the future. A key objective o f the CAS is to reverse these trends and enable Lebanon to move to more sustainable use patterns. The resource most in need o f better management i s water. This wou ld require an integrated approach addressing the balancing o f the competing demands o f a l l water users (irrigated agriculture, urban water supply, industry, recreation, fisheries and ecosystems) as we l l as those that affect water quality (industrial pollution, urban wastewater, urban solid waste, new development, agricultural pollution). This approach wou ld focus o n obtaining the maximum benefit f r om water extracted and on ensuring minimal degradation o f water quality in the country’s rivers, coastal zones and aquifers.

79. Over the next four years the Bank can help Lebanon improve the quality o f surface and groundwater and improve urban and rural water delivery. Such help wou ld not only make Lebanon’s natural resource use more sustainable, but would also bring immediate benefits to agricultural productivity, human health and ecosystems. The Bank wou ld help the Government strengthen its nascent Water Authorities and change the water management system to a system based on basins and sub-basins rather than administrative units. The Bank wou ld also help the country to develop and adopt a more efficient environmental agency to set and enforce environmental pol icy and

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to assess and monitor the environmental impacts o f new development. These changes would help the authorities to reduce the agricultural, industrial and municipal pol lut ion o f surface and groundwater, and to control excess abstraction. A new system o f pol icy and enforcement wou ld provide predictable environmental guidelines for private sector development. The approach wou ld be based o n the national land use plan recently prepared by CDR, the waterhrrigation sector notes prepared by the Bank to justify water management at the basin and sub-basin level, and the Act ion Plan for the water sector aimed at stepping up sector reforms (consensus o n strategy, regulatory framework, cost recovery and subsidy policy, the implementation o f regional tar i f f schemes; and the expansion o f private sector involvement in sector operations).

80. On solid waste, the challenge i s to develop a comprehensive solid waste strategy that i s sustainable, i s acceptable to Lebanese society, and i s underpinned by an appropriate policy, institutional, and financial framework. A Bank proposal has been drafted to address this strategically and to seek the support and consensus o f key stakeholders. No Bank lending would be conceived in this area in the absence o f a clear and broadly endorsed strategy.

8 1. Bank activities under this pillar would include both advisory and lending services.

e Lending operations would include an integrated water and environmental management program in two basins - the Beka’a and the Litani. This program would: (i) establish a mechanism for environmental management, including reducing pol lut ion in the Upper Li tani Basin; (ii) rehabilitate and develop new urban water, wastewater, irrigation, and drainage infrastructure to improve water use efficiency and increase productivity; (iii) protect biodiversity and the natural heritage; (iv) implement the land use plans for this basin; and (v) build capacity among local officials and raise public awareness regarding the sustainable management o f water resources. The environmental program wou ld be complemented by an urban water and wastewater project targeting several areas o f Lebanon, in l ine w i th national priorities.

Policy notes would include a Country Environmental Analysis, wh ich wou ld focus primari ly o n water quality, costal zone management, environmental compliance and enforcement, and wou ld identify win-win solutions based on a cost-benefit analysis o f mitigating adverse productivity and health impacts.

Technical assistance would include the harmonization o f Lebanese policies for environmental assessment and resettlement with those o f the Bank, the preparation o f financial schemes for solid waste management, and support to the Ministries o f Environment and Justice to improve the enforcement o f environmental regulation.

e

B. Building Partnerships for Local and Regional Capacity Enhancement

82. Lebanon i s known for its high caliber specialists and academic institutions, and for a high capacity in certain sectors of the economy, which for years it has “exported” to the rest of the region and the world. The Bank’s strategy proposes to build upon Lebanon’s human capital advantage by developing partnerships with local universities, institutions, associations, and NGOs for the delivery o f capacity enhancement activities local ly and for the region. For this purpose, Lebanon has several key advantages: (i) it can offer training in three languages - Arabic, French, and English - and, therefore, can serve the eastern and western parts o f the region; (ii) it offers a wide range o f good facilities and infrastructure for learning activities, including high connectivity; (iii) it provides easy travel access; and (iv) it hosts key regional institutions such as ESCWA, UNESCO, ILO and others that would be natural partners in this work. For these reasons, Lebanon has become a virtual “sub- regional training hub,” complementing the Bank’s knowledge hub in the ci ty o f Marseille.

83. The Government has indicated its commitment to developing Lebanon as a regional hub for learning and i s willing to facilitate the resources needed for the implementation o f this

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objective. As an init ial step, the Government has signed a knowledge partnership Memorandum o f Understanding among the Institute o f Finance, the Wor ld Bank Middle East and Nor th Afr ica region, and the W o r l d Bank Institute. On January 18, 2005, the Wor ld Bank opened i ts Public Information Center at the Institute o f Finance as a first phase o f the partnership. In parallel, the IMF announced Lebanon as i ts regional base for the Middle East Technical Assistance Center. This should provide for significant synergies in realizing the full potential o f Lebanon as a regional training center.

C. Lending Scenarios and Triggers

84. The Bank’s financial assistance i s tailored to the scenarios envisaged below (see also Table 3). These various scenarios take into account the Donors’ Conference expected to be held in early 2006 in Beirut. This conference may result in donor funds being made available for debt restructuring.

85. Lending envelopes, triggers, and a mix o f lending instruments (project finance vs. development policy lending) have been identified with a view to support the Government in implementing its structural reform agenda. The stronger Lebanon’s commitment to and implementation o f key structural reforms, the larger the lending envelope and the accessibility to quick disbursing programmatic development pol icy lending. The size o f the lending envelope and accessibility to quick disbursing programmatic lending are directly related to specific demonstration o f commitment to and implementation o f critical structural reforms.

86. Al l lending in the base and high case i s subject to the fol lowing principles o f engagement: (i) upfront reforms; (ii) readiness for implementation at the t ime o f negotiations (operations manual completed, TORS and draft contracts agreed upon, etc.); (iii) agreed-upon strategies with the Wor ld Bank; and (iv) clear social impact andor support to the fiscal adjustment effort.

Base Case Scenario

87. Up to US$100 million for investment could be lent by the World Bank to Lebanon over the four-year CAS period in the Base Case Scenario. The Bank’s engagement wou ld be l imi ted to investment lending and advisory services (i.e., n o development pol icy lending).

88. treasury) outcome and portfolio indicators:

The Base Case Scenario would require meeting the following fiscal (budget plus

a

a

0

The ratio o f fiscal primary surplus over total fiscal revenue not below 8 percent25;

The disbursement ratios on existing Wor ld Bank portfol io not below 10 percent each year; and

Effectiveness delays not to exceed 9 months.

Low Case Scenario

89. The inability to meet the above indicators would suggest a limited political willkapacity to carry through with fiscal, portfolio and structural reforms and, therefore, a high and growing probability for a financial and economic crisis. Thus, lending as envisaged in this CAS to support structural reforms would become irrelevant and unjustified. Lending wou ld cease until the country meets again the triggers in the base case, o r i f a rapid deterioration o f the financial and economic situation warrants a CAS update. The latter wou ld then reevaluate the situation, and accordingly, the Wor ld Bank’s level o f engagement.

25 As projected for end-2005 by the MOF, as o f September 2005, excluding foreign-financed capital expenditure. Unlike the more traditional primary surplus over GDP, this measure presents the advantage o f being easily monitorable, as reported every month by the MOF. In contrast, GDP figures are not easily available.

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High Case Scenario

90. Up to US700 million could be lent by the World Bank over the four-year CAS period in the high case scenario; US$250 million before the mid-term CAS review, and another U S 4 5 0 million afterwards.

91. treasury) and indebtedness indicators:

Before the mid-term CAS review, up to US$250 million could be committed should the following conditions be met:

The High Case Scenario would require meeting the following fiscal (budget plus

The fiscal primary surplus over total fiscal revenue ratio gradually improving above 8 percent;

The net public debt26 to total fiscal revenue ratio gradually declining from 730 percent;

Strong Government and Parliament commitment to raising the fiscal primary surplus, through the implementation o f structural reforms in pension (public and private) and power sectors, safety nets and civ i l service. Commitments would be clearly spelled out in official declarations;

Implementation initiated in pension (public and private) and power sectors, and safety nets;

The disbursement ratios on existing World Bank portfolio not below 15 percent each year;

Effectiveness delays not to exceed 9 months; and

Projects in “problem” status not to exceed 33 percent o f total portfolio (by number o f projects) - down from 71 percent as o f October 2005.

Out o f the USS250 million, up to US$lOO mill ion could take the form o f development policy lending. In addition to the conditions above, development policy lending would be considered in connection with the adoption by the authorities o f a major policy package financially supported by the international community.

After the mid-term CAS review, up to another US$450 million could be committed should the following conditions be met:

The fiscal primary surplus over total fiscal revenue ratio above 17 percent by end-2007;

The net public debt to total fiscal revenue ratio declines below 650 percent by e11d-2007;~~

Observed implementation of, and continued Government and Parliament commitment to significant structural reforms in the pension (public and private), power sectors and safety nets; and

Implementation initiated in civil service reforms.

Out o f the US$450 million, up to US$300 mill ion could take the form o f development policy lending. Such lending would support the continued implementation o f substantive incremental reforms as proposed in the above-mentioned policy package.

26 As projected for end-2005 by the World Bank staff, as o f September 2005. The net public debt i s defined by the difference between gross public debt and public deposits in the banking sector. This measure i s also reported every month by MOF. 27 For a 5 percent nominal GDP growth, these triggers broadly correspond to a 2 percentage points o f GDP increase in the primary surplus and a 4 percentage points of GDP decline in the net public debt between 2005 and 2007.

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Table 3. Indicative Lending Assistance Program

Engagement

Base Case

High Case

Lending

Social Funds/Public Works

Municipal Infrastructure Project (supplement to the existing loan)

Utility Investment and Management Improvement Program (including power and water, could be split for simplification)

Grants Small Grants Program to NGOs (ongoing)

HIViAIDS IDF Grant

Sub Total

Utility Investment and Management Improvement Program (expanded beyond the base case)

Investment/TA Loan for Public Sector Restructuring (SOEs, Public Investment Information System, Pension and Social Security Reform, Statistical Capacity Building, Public Monitoring Authorities)

Health Project (new loan)

Trade Facilitation/Local Economic Development Projects in Secondary Cities Integrated Litani Basin Management Program

Development Policy Lending for above mentioned structural reforms

Total High Case Envelope

Loan Amount (US$ million) *

20-50

15-50

50-100

100

100-300

50-60

15-20

50-100

50

400

700

Analytical and Advisory Activities

Diagnostics Public Expenditure Review (06) Country Financial Accountability Assessment (06) Country Procurement Assessment Review (06) CEM - Sources o f Growth (07) Poverty Assessment and Strategy Based on New Household Budget Survey (07) Investment Climate AssessmenUTrade Facilitation (06) Labor Market and Gender Assessment (07) Social Protection Strategy (07)

Policv Notes Pension Policy Note (06) Country Environmental Analysis (07)

Technical Assistance

TA on Financial Sector AssessrnenUPublic Debt Management (ongoing) TA administrative barriers and industrial zones (07) TA on governance reform and municipal finance (07)

Technical Assistance

Capacity Building and Information Systems for Relevant Economic and Financial Administrations (ongoing)

Public-Private Sector Partnership in the Water Sector (06)

Capacity Building (solid waste, environmental performance, and social safeguards) (07)

Enforcement o f environmental regulations (07)

* While individual projects may vary in amount, as indicated above, the total for the base case wil l not exceed US$lOO million, and the total for the high case wil l not exceed US$700 million.

25

D. IFC, MIGA, and WBI Programs

IFC

92. Lebanon was previously one of IFC’s largest exposure countries in the region. However, in the past few years, due to the country’s macro-economic situation, I F C has been selective with i t s investments and has rather focused on managing its portfolio in Lebanon. In FY05, IFC approved a US$8 m i l l i on loan for a new international school in Adma. In September 2005, the portfolio contained seven investments totaling US$32 million. A majority o f the portfol io is composed o f credit lines to Banks, through which IFC helps address the financial sector, including leasing and on- lending to SMEs. IFC has signed three banks under the Global Trade Finance Program, w i t h the intention o f addressing the international trade finance needs in the country. Furthermore, IFC has been providing advisory services and technical assistance (TA) in Lebanon. Over the last CAS period, I F C has provided advisory services and TA in the successful restructuring o f Midd le East Airlines and for the development o f the insurance industry.

93. IFC i s presently assisting the Lebanese Government through technical assistance in addressing urgent economic and business environment reform issues. The Private Enterprise Partnership for the Middle East and Nor th Afr ica (PEP-MENA) i s IFC’s new facility to deliver TA throughout the Region. In Lebanon, PEP-MENA plans to have interventions in the financial sector, strengthening SME development, business enabling and regulatory environment, privatization o f SOEs and public-private partnerships. Currently, PEP-MENA i s working in several areas as described below:

a

a

a

0

94.

a

a

a

95.

Corporate Governance: I F C PEP-MENA i s working with the Association o f Banks o f Lebanon and its member banks to strengthen standards o f corporate governance in the banking sector.

Bank Privatization: I F C PEP-MENA i s carrying out a valuation o f Banque Libanaise Pour le Commerce (BLC) - for Banque du Liban. This valuation i s a necessary f i rs t step in the return o f this bank to the private sector.

Business Environment: In November 2005, IFC, in conjunction with the Ministry o f Economy and Trade, held a conference on Do ing Business in Lebanon, which discussed the barriers the private sector faces. PEP-MENA i s now discussing a number o f additional programs to address the various issues identified by the session. Programs under discussion w i th the Government include Alternative Dispute Resolution, and administrative reforms targeting various Government approvals.

In the coming months, PEP-MENA i s also proposing to provide technical assistance in the housing finance, microfinance and the SME sectors, to assist banks in better serving these markets, and i s also considering rol l ing out the Business Edge Program, wh ich provides training to small businesses to help them improve their business systems.

During the CAS period, IFC will focus on three broad objectives:

Enhancing the Climate for the Private Sector;

Reform o f SOEs, privatization, and Public-Private Partnerships;

Supporting Private Sector Investment.

In the near term, the key focus o f the IFC i s enhancing the investment climate for the private sector in Lebanon. T h e W o r l d Bank’s Do ing Business Survey, 2006 edition, continued to highlight a number o f obstacles. Indicators place Lebanon towards the high end o f regional economies in terms o f the cost to start a business, the number o f days needed, and number o f approvals required. Significant delays in the time i t takes to enforce a contract, in addition to some o f the highest costs o f

26

enforcement in the region, place a constraint on the effective operation o f the private sector, and in turn negatively affect the growth o f the economy and o f employment, as businesses are unable to expand and operate effectively. The IFC’s PEP-MENA w i l l provide assistance to the Government to review procedures for registering a business, enforcing contracts, including alternative dispute resolution and refocusing government regulation on oversight and protection.

96. Reform of SOEs, privatization and public-private partnerships. IFC’s PEP-MENA i s already working o n a bank privatization project in the country. Provided the Government moves ahead w i th reform in certain areas such as infrastructure, IFC would expect to pursue opportunities in advisory work and potential selective investments. The proposed reform o f the electricity sector i s an area that PEP-MENA stands ready to assist the Government in. Other potential areas where IFC might be able to assist the Government include port and airport privatization.

97. Supporting private sector investment: IFC’s traditional involvement in Lebanon has been in financing the private sector. To enhance international opportunities for Lebanese companies, link and integrate them w i th the global economy, IFC wil l continue to increase i t s assistance in Trade Finance by pursuing additional banks for the Global Trade Finance Program. In the meantime, as one o f the Bank’s strategic focuses i s on mitigating the poverty effects o f transition, IFC w i l l continue to look for investment opportunities in microfinance, which will address critical financing needs for the lower end o f the SME sector. In the context o f improved macro-economic and regulatory conditions, IFC could quickly scale up its investments and target a number o f sectors, including labor intensive and export oriented manufacturing facilities, energy, health and education, and more interventions in the financial sector. A particular emphasis will be placed on identifying south-south financing opportunities, capitalizing o n Lebanese expertise and capacity on a regional or international level, where IFC’s global reach may provide value.

MIGA

98. MIGA’s activities are designed to encourage productive foreign direct investment (FDI) flows into developing countries. To this end, MIGA’s package o f risk mit igation instruments w i l l be an integral part o f the overall Wor ld Bank Group (WBG) efforts under the C A S to support the private sector development agenda in Lebanon, particularly in infrastructure development, the attraction and retention o f investments, access to the international capital markets for Lebanese companies and banks, and support for Lebanese investors venturing abroad. A t this critical moment in Lebanon‘s economic and political development, MIGA guarantees, by effectively mit igating the pol i t ical risks associated w i th private investments, can play a significant role in providing comfort to foreign investors whose risk perceptions may have increased in recent months.

99. Infrastructure: MIGA can support private investments, as well as privatizations/public- private partnerships (PPPs), through the provision o f political risk guarantees to foreign investors, particularly in the infrastructure sector. MIGA’s guarantees can alter investor’s risk perceptions and facilitate access to financing, extending the tenor and reducing the interest rates on loans. In this regard, MIGA will continue to work w i th the Bank and the I F C in order to identify potential privatizations and PPPs in the power and water sector and provide support to investors that are particularly interested in the breach o f contract (breach o f government undertaking) cover that MIGA offers. Investors interested in investing in the water sector in Lebanon have approached MIGA.

100. Following on initial contacts during fiscal years 2004 and 2005, M IGA i s prepared to deepen its collaboration with the CDR, the Privatization Council, and the Investment Development Authority o f Lebanon (IDAL), focusing on assisting those agencies in the targeted marketing o f infrastructure opportunities to investors, including through MIGA’s suite of on- line investment promotion sites, and providing investors with information on risk mitigation instruments available for the projects.

27

10 1. Attraction and Retention o f Investments. The Government and the investment promotion agency IDAL have expressed an interest in MIGA’s assistance in overcoming Lebanon’s image problem in the investor community, particularly outside o f the MENA region. With support f rom partners, and a full commitment f rom the Lebanese authorities, MIGA i s prepared to launch a full- scale, multi-year program o f targeted assistance for IDAL under the new CAS, with a view to making IDAL a state-of-the-art investment promotion agency that will have a measurable impact on the attraction and retention o f FDI into Lebanon, consistent with the Government’s goal o f increasing and diversifying FDI inflows. Targets in this regard would be sectors that are labor-intensive and that have significant potential for FDI, such as tourism, services and SMEs.

102. In addition, M IGA i s planning to conduct a regional enterprise benchmarking program for the MENA region, and Lebanon will be included in that list. This wil l give IDAL and others in Lebanon concrete, enterprise-level data on obstacles to and opportunities for investment in key sub- sectors o f the economy. Finally, an important component, in conjunction with the Lebanon country office, will be to ensure that al l relevant actors in Lebanon are aware o f the full range o f WBG risk mitigation instruments available f rom the Bank, IFC, and MIGA, to mitigate r isks - real or perceived -that may inhibit investors f rom investing in, or obtaining financing for, projects in Lebanon.

103. By assuming the Lebanese sovereign risk, MIGA’s guarantees can al low strong Lebanese companies and banks going to the international capital markets to significantly exceed the (currently sub-investment grade) sovereign ceiling o f Lebanon and achieve significantly higher ratings, resulting in both increased investor interest and lower all-in financing costs. Banks can also use this program when arranging mortgage-backed securitizations or private placements in the international capital markets.

Access to International Capital Markets for Lebanese Companies and Banks.

104. Support for Lebanese Investors Investing Abroad. Lebanese investors and banks have long played an important regional role in the Middle East and in Africa. Unl ike their counterparts in most developed countries, Lebanese investors do not have access to national schemes to support them as they venture abroad. MIGA can bridge this gap and can thereby also increase the potential for Lebanese f i r m s to obtain financing, either locally or abroad, for their investments. Moreover, the presence o f MIGA investors could increase tenors and decrease interest rates o n loans sourced domestically or abroad. MIGA has already supported Investcom, a Lebanese telecommunications company, for its investments in Benin, Ghana, and Syria with more than US$165 mi l l ion in guarantees. In the forthcoming CAS period, MIGA will seek to enhance this role, as Lebanese investors and banks become more active abroad, and as their knowledge o f MIGA’s services increases.

WBI

105. The WBI has embarked on several initiatives to support government officials, NGOs, the media, private sector and academia by offering policy dialogue and training opportunities to promote knowledge and capacity building. I t has provided in-country and regional training in several sectors such as finance, education, social protection, health, and gender. I t has also established partnerships with universities and “think tanks” in order to build national capacities and promote in-country technical expertise. I t will also be the key partner within the Bank Group for the implementation o f Lebanon’s “regional training hub” strategy.

E. Monitoring and Evaluation o f Results

106. The Lebanon Country Team has organized itself into three clusters corresponding to the three pillars o f the CAS. Each cluster will have the responsibility o f periodically validating the CAS outcomes, monitoring intermediate indicators, and adjusting staffing and Bank resources strategically to avoid fragmentation and ensure the prioritization o f Bank involvement. The main focus o f monitoring and evaluating results o n the Government side will be CDR, the main

28

agency in charge o f implementing the bulk o f capital investments for the country. The CDR has just established a monitoring and evaluation department which will be supported with capacity building by the Bank. A t the country level, given the lack o f timely economic and social data for policy formulation, an important part o f the Bank’s strategy w i l l be the development o f a Statistical Master Plan, which wil l be the basis for ensuring that timely statistics can be obtained for the evaluation o f the outcomes o f national policy on the economic and social fronts. In addition, the Bank wil l work wi th partners and the Ministry o f Social Affairs to implement a new household level survey for poverty assessment. For the capacity enhancement activities (nationally and regionally), the Bank w i l l monitor and evaluate directly the impact o f such initiatives.

107. The results-based monitoring framework for the CAS reflects work in progress in a rapidly shifting policy environment. The framework presented in Annex I will need to be updated by the mid-term CAS review or before, in light o f a detailed Government reform program which i s currently under preparation. The updated framework w i l l become the basis for program performance evaluation in the CAS Completion Report, which in turn w i l l be rated and validated by an OED review.

V. CREDITWORTHINESS AND RISKS

A. Creditworthiness and Risks

108. Lebanon’s limited creditworthiness and the considerable uncertainties regarding future policy direction require caution in managing the World Bank’s exposure to Lebanon. Simultaneously, the World Bank remains deeply committed to its role, together with the entire international financial community, in reducing poverty and helping Lebanon to return to a sustainable growth performance consistent with its potential. Lebanon’s debt to the IBRD (disbursed and outstanding) reached US$346 mill ion as o f October 2005 (excluding guarantees). With undisbursed amounts at US$222 million, exposure could increase in the next few years i f disbursements improve.

109. Financing Requirements. In the most likely scenario, Lebanon would need to receive, on average, US$4.7 bil l ion a year over the CAS period from abroad to finance i t s current account deficit and replenish i t s commercial and central banks’ net foreign assets, excluding any privatization operations. B y way o f comparison, US$4.7 bil l ion worth o f capital inflows were required each year on average between 2000 and 2004 to perform the same operations. Given existing exposure and creditworthiness limits, the World Bank w i l l remain, in all cases, a marginal contributor to Lebanon’s financing requirements.

110. World Bank Exposure. In the event that Lebanon would be able to raise i t s disbursement ratios to 20 percent - against 15 percent by end-2004 - the share o f the IBRD portfolio exposed to Lebanon could reach 0.34 percent on average between 2005 and 2009 in the base case scenario (an outstanding debt o f approximately US$500 million, see Annex B7), slightly up from the period between 2000 and 2004, where it reached 0.32 percent (including guarantees). Such an exposure could rise sharply - and even almost double, should Lebanon decide to borrow under the conditions stipulated in the high case scenario, where up to US$400 mill ion would be made available for development policy lending (US$lOO mill ion before the mid-term CAS review, and US$300 mill ion after).

1 1 1. Lebanon’s Creditworthiness and Associated Risks. Four categories o f risk pertain to Lebanon: (i) the risk o f deterioration o f the portfolio performance; (ii) the risk o f a stalled reform program; (iii) the risk o f a financial crisidhard landing adjustment; and (iv) political (domestic and regional) and related security risks. All these risks are significant, though the first two lend

29

themselves better to risk mitigation measures by the Bank. The fol lowing paragraphs explore these risks and possible mitigation measures.

112. Portfolio Risks. Lebanon’s portfolio i s on the Bank’s “watch list.” Concerted efforts have been made by the Bank and Government counterparts to close and restructure non-performing projects. New efforts are in place to reduce effectiveness delays and to proactively address emerging problems. But most portfolio r isks (Country Risk, Country Environment, Procurement, and Effectiveness) are not project specific and are mostly rooted in macro-economic, institutional processes, and capacity constraints - hence the risk o f recurring portfol io problems. The portfolio risk i s mitigated in the medium term through capacity building in fiduciary areas (procurement, financial management and safeguards). I t i s also mitigated by a selective approach to future lending conditional on up-front and credible commitments.

113. Risk o f a Stalled Reform Program. There is a significant r isk that narrow personal and sectarian interests w i l l continue to overshadow national-level interests and obstruct the implementation o f a comprehensive reform plan. This risk could be compounded in the case o f macro-economic stress, as national priorities requiring collective action could be faced w i th political paralysis and deepening social fragmentation. This risk would be mitigated by l imi t ing Bank involvement to the low case o f no lending, but intensifying the Bank’s effort to build public support and capacity for reform through analytical, advisory, and outreach activities.

114. Financial Crisis Risk. The nature and extent o f macro-economic imbalances wil l continue to make Lebanon vulnerable to a hard landing adjustment. Past international experience has forcefully and systematically demonstrated that private markets cannot tolerate rising public debt ratios and sluggish growth performance indefinitely, even though interest rates wou ld remain lucrative and the banking sector would seemingly remain profitable. Sooner or later, governments have to adopt a pol icy framework that addresses the macro-economic imbalances and the debt unsustainability. The longer governments wait, the more painful the adjustment wil l be, and the less they wil l be able to count on investor confidence. The main sources o f domestic vulnerability are the large size o f the fiscal deficit, the debt to GDP ratio and the exposure o f commercial banks to the sovereign risk. Domestic vulnerability also includes contingent liabilities such as the public pension system, which, i f not tackled in time, could weaken the fiscal situation even more. The principal source o f external vulnerability lies in the great dependence o f Lebanon on foreign capital inflows. A currency crisis or a sovereign default could be compounded by a loss o f investors’ confidence that could reduce or even reverse the needed capital inflows. Conversely, a loss o f confidence could also trigger a currency crisis or a sovereign default. These risks are compounded by the l ikely fact that the external environment (global interest rates, available liquidities in the region) w i l l no t always be as favorable for Lebanon as they have been over the past decade. The above risks are mitigated somewhat through the extensive advisory services provided by the IMF and the Wor ld Bank o n debt and fiscal management. Other sources o f external vulnerability are l inked to pol i t ical instability in the region and are discussed below.

115. Political and Security Risks. Regionally, Lebanon i s exposed to external risks that are directly l inked to the relations with Syria and the Arab-Israeli conflict next door: Relations with Syria are st i l l in flux; Lebanon i s technically in a state o f war w i th Israel; skirmishes between Israeli and Hizbul lah forces continue along the southern borders; and, finally, Palestinian refugees in Lebanon, living in destitute conditions and barred from employment in most professions (in spite o f recent improvements), continue to await their right o f return. All o f these factors combine to produce a potentially explosive situation in Lebanon if a regional settlement o f the Arab-Israeli conflict i s not ultimately reached.

30

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3 s 5 m

CAS ANNEX I11 - CAS CONSULTATIONS

Introduction

The Wor ld Bank Lebanon Country Office held a series o f CAS consultation sessions as o f early 2004, drawing more than 300 participants w i th a wide range o f backgrounds into the debate over the three CAS pillars. The discussions and workshops included NGOs, Parliament Committees, Municipal Councils and the Private Sector, in addition to line ministries and public institutions currently involved, or l ikely to be involved, in the Bank’s portfolio o f lending and non-lending activities.

The consultations slowed during the Government transition after the exit o f Prime Minister Rafic Har i r i and the advent o f Prime Minister Omar Karami (October-November 2004) to al low for the validation o f the pillars by the new Government. Activities picked up pace in December when the Bank and the new Government agreed to the CAS Matrix. With the Government’s consent, the Matr ix was distributed to active players in the public sector, the private sector, NGOs and Parliament, enriching subsequent discussions in January and February 2005.

In addition, the Bank received a number o f written remarks and suggestions for cooperation f rom participants in the discussions, including the Off ice o f the Minister o f Administrative Development, the Ministry o f Environment, the Ministry o f Interior and Municipalities, the Ministry o f Agriculture, the Ministry o f Public Works, the Consumer Association-Lebanon, Prestige Publication and the NGO Jihad al-Binaa.

Each o f the sessions began with a World Bank presentation, comprising:

1. Introduction to the Wor ld Bank; 2. Explanation o f the CAS and C A S process; 3. Lessons learned from the previous portfolio; and 4. Overview o f the three pillars in terms o f C A S outcomes and Bank inputs.

Discussion o f Pillars

In general, participants commended the Bank for a comprehensive Matr ix that established the l i n k s between fiscal and debt management, as we l l as the development o f real economy, employment and poverty issues. Others welcomed the emphasis on the development o f local economies in secondary cities and rural areas.

There was a consensus that many o f the needed reforms, whi le technical in nature, hinged largely on political economy and decision making. Many participants referred to the Bank as a “credible authority” with “convening power” - assets that could be deployed to press for reform.

The dialogue w i th Parliament and w i t h the public sector exposed complaints over the Bank’s complicated bureaucracy that had caused delays in the execution o f projects. Also, Parliament members stressed on more than one occasion the need to involve them in the project cycle at an early stage. There was an obvious sense that the Government was “parachuting” projects negotiated w i th the Bank into Parliament, without the pr ior consultation with MPs, who could better identi fy the developmental needs in the regions they represent.

The Wor ld Bank acknowledged the bureaucracy that governs i t s work, but noted that reforms were under way to streamline Bank procedures, ci t ing the Clearing Country Systems as one example. However, the Bank stressed that Lebanon’s performance i s uniquely weak, even compared with other countries o f the region, and that the country i s one o f 12 o n the Bank’s watch list, despite its human resources potential.

41

Some participants questioned why the Wor ld Bank was s t i l l involved in lending operations, despite the absence o f sector reforms, which deny the country the ability to properly benefit f rom such investments.

The Bank agreed that, indeed, this was an important lesson drawn f rom the previous CAS. Going forward the Bank wil l invest only in sectors in which a credible commitment to reforms has been established. The scenarios o f lending envisioned range f rom zero lending, where only advisory services are offered, a l l the way to substantial lending in reformed sectors.

Poverty and Social Safety Nets

The consultations culminated in increased awareness o f poverty issues in Lebanon, but it was dif f icult to determine the extent o f poverty, especially abject poverty, in the absence o f reliable statistics and off icial data. There were requests for:

1. Expediting the household survey, due in FY06;

2. Defining a poverty line;

3. Devising a strategy to mitigate the transition costs o f structural pol icy changes;

4. Improving the impact o f the social safety net through better distribution o f budget allocations, and

5. Designing a mechanism for the coordination o f interventions by local and international stakeholders.

Economic Management

The consultations underlined a widespread understanding o f the need to address, without delay, the country’s macro-economic difficulties, especially that o f managing the debt, wh ich has exceeded US$35 billion. There were serious concerns about the absence o f statistics and reliable figures to support an economic development policy. Central Bank representatives stressed the need to stimulate growth, ci t ing the development o f capital markets, to monitor the progress o f SMEs and to introduce reliable databases as some activities that would help support such a pol icy. Parliamentarians and private sector representatives voiced concerns over the distributional impact o f macro-economic policies. Some questioned the ability o f the national economy to withstand the “astronomical” profits earned by local banks, wh ich are restricting the growth in other sectors.

The Wor ld Bank noted that tension between the fiscal adjustment agenda and the growth agenda would be felt in the short term.

The Bank stressed that in the transition phase, there has to be an equitable sharing o f the burden. Any macro-economic pol icy to ensure monetary and fiscal stability should not neglect the poor. A fair tax policy, social safety nets and employment-generating growth could help mitigate the impact o f transition.

Discussants sought explanations o f the pros and cons o f privatization as prescribed by the Wor ld Bank - a process that was promised at the Paris I1 conference o f the donor community in 2001 but was disrupted by political disagreements. The Bank clarified that privatization was a means and not an end, and advised a tailored approach to each SOEs.

The Bank also clarified that some services, such as the power and water sectors, wou ld need to significantly improve their performance to become appealing for potential private sector investment, noting that the Government has to weigh core privatization and management privatization o n a case- by-case basis.

42

Entrepreneurs called on the Bank and the International Finance Corporation (IFC) to increase their interaction wi th the private sector.

The Bank acknowledged that in the past i t had been mostly focused on monitoring short-term macro- economic changes. Going forward, it w i l l devote more resources to the Investment Climate Assessment and sources o f growth. Naturally, this will require close interaction with the private sector.

Capacity Building

Local interlocutors, in both the public and private sectors, agreed that the lack o f statistics, the deficient institutional capacity, unclear designs and an absence o f a division o f labor have impaired policy development and hindered project implementation. The Bank was asked to focus on these issues in the next CAS.

Sectoral ministries expressed serious concerns about the sustainability o f World Bank projects in the shadow o f deficient institutional capacity. They singled out the dismantling o f Project Implementation Units (PIUs) after the completion o f a project, without ministries being able to absorb skilled consultants, as a major obstacle. The inability to absorb the PIUs in ministries affects both the sustainability and the continuity required to uphold Bank-Government cooperation.

The Office o f the Minister for Administrative Reform (OMSAR) stressed the unique role it could assume on a number o f levels: (i) providing assistance in capacity building, (ii) preparing a legislative draft for reform, and (iii) carrying out institutional design and organizational structures for the ministries.

The Bank concurred, and expressed a willingness to support a reform process and capacity building efforts. The Bank noted that it was involved in administrative reform through an ambitious project which was only partially implemented, largely because o f the lack o f political will. The Bank agreed that OMSAR could play a major role in moving forward, but stressed that the political w i l l would have to be evident.

For their part, parliamentarians sought technical assistance from the World Bank to obtain accurate data and devise policies that would address the key social issues such as healthcare, education and pension plans. They noted that parliamentary committees have the constitutional prerogatives to develop legislation, but that their members lack the data and the expertise.

One suggestion was for the development o f an “observatory network” that would help support Parliament.

One concern raised was the slow development o f the Information Technology (IT) sector. One Member o f Parliament attributed the deficiency to a fight for supremacy among various ministries, each seeking to annex the sector to its portfolio (Finance, Economy, Telecommunications, etc.).

Agro-industry and Trade Facilitation

Discussions touched on agriculture and agro-industry as possible opportunities for growth and employment generation. Participants asked that the Bank give more prominence in the CAS to agriculture, agro-industry and trade facilitation, given their importance for job creation, especially in poor and rural areas.

The Bank asserted that it has been involved in this sector through two projects that sought to improve irrigation and develop the agricultural infrastructure. But in national terms, agriculture was contributing only 6.5 percent to the GDP, wi th limited potential for expansion. The Bank stressed that

43

there was a need to generate other economic opportunities for employment in rural areas and to further develop the agro-industry sector. I t was also noted that the EU was active in this particular sector, but that the Bank was ready to complement EU activities in either lending or advisory work focused o n agro-industry or the Li tani Basin.

Industry

In answer to a complaint that there was no sufficient emphasis on local industry, the Wor ld Bank asserted that i t lacked the proper data to be able to evaluate the contributions o f the various sectors’ to the economy and their future potential for growth. But as far as the Bank was concerned, tackling the issue o f industrial competence should not encourage further subsidies. Instead, lowering barriers to entry and reducing production costs (water, electricity, and telecommunications) wou ld help support industries.

Housing, Vocational Training, Knowledge and Partnership

Representatives o f line ministries noted the lack o f reference to housing and vocational education, and proposed that the Bank partner w i th local universities in knowledge sharing.

The Bank agreed that housing was important for the security and l ivel ihood o f the poor, but this was in essence a private good. The Bank asserted the need to address the nature o f market failure in the housing sector, including the absence o f financing, land supply, infrastructure and inflationary pressures in the real estate market.

With regard to vocational training, the Bank’s experience in this area has been disappointing and resulted in the cancellation o f the US$29 mi l l ion Vocutionul Training Project. As for knowledge partnerships, the Wor ld Bank has been capitalizing o n the research, academic and training facilities in Lebanon, which are among the country’s most valuable assets.

Health

There were clear concerns about the absence o f a national health plan - a deficiency that has spurred piecemeal/sectoral interventions by the donors. Participants called for a national p lan that wou ld set the priorities for this sector and a mechanism that wou ld enable donor contributions to be more efficiently absorbed. Health Ministry officials complained that weak capacity and Wor ld Bank bureaucracy had delayed the implementation o f a health plan that took nine years to complete, instead o f the init ial ly envisaged maximum o f six years. They also suggested that health issues be included in the first CAS pil lar as a macro-economic priori ty and not restricted to the second pillar.

The Environment

Participants referred to Bank studies, wh ich estimated the cost o f environmental degradation at 3.5 percent o f the GDP or more than the total economic growth projected in 2004. There was significant worry about the gradual, yet consistent, degradation o f coastal areas and the pol lut ion o f the air and water in the absence o f a comprehensive national policy. The Ministry o f Environment said 45 percent o f the coastal areas were occupied, and that the country was losing 2 percent o f i ts coastline per year.

The Parliament’s Environment Committee complained that the environment has not been a priori ty for the Government, which i s grappling w i t h macro-economic and financial imbalances. B u t the Bank insisted that Lebanon could n o longer afford to put environmental issues o n ho ld as it risked irreversible ecological damage. The Bank cited threats to the country’s water resources, especially the underground tables.

44

In discussions in Parliament and w i th the Public Sector, participants lamented the waste o f water resources, wh ich were unmatched in the region. A national water strategy, combined w i th a technical action plan, wou ld al low Lebanon to sell water to i t s neighbors. A Ministry o f Environment off icial noted that Gulf countries were blessed w i th “black gold,” and Lebanon w i th potentially lucrative “transparent gold,” if the sector were properly managed. The Bank stressed the need to strengthen local water authorities.

There were calls for an urgent remedy to the nationwide problem o f sol id waste. Many municipalities, especially the 250 new ones created after the 2000 election, lacked the expertise and capacity to deal w i th solid waste. There were unanimous calls for a comprehensive approach to solid waste management - collection, disposal and treatment. The Bank noted that it was forced to close a solid waste project after a disappointing performance, but expressed i t s willingness to re-engage i f a clear national strategy were adopted by the Government.

Table 4. CAS Consultations Timeline

45

CAS Annex A2 - Lebanon Lebanon at a Glance

POVERTY and SOCIAL Lebanon

2004 Population. mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1998-04

Population (%) Labor force (%)

Most recent estimate (latest year available, 1998-04)

Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 1,000 live births) Child malnutrition (% of children under 5) Access to an improved water source (% of population) Literacy (% ofpopulation age 15+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1984

GDP (US$ billions) Gross capital formation/GDP Exports of goods and servicesiGDP Gross domestic savings/GDP Gross national savings/GDP

Current account balanceiGDP Interest payments/GDP Total debtiGDP Total debt serviceiexports Present value of debtiGDP Present value of debtiexports

1984-94 1994-04 (average annual growth) GDP 16.1 2.8 GDP per capita 13.6 1.3 Exports of goods and services 26.5 12.4

4.6 4,700 21.4

1.3 2.6

88 71 26

100 88

103 105 101

1994

9.6 31.6 7.9

-22.9 -16.1

-28.6 0.9

22.2 5.3

2003

4.9 3.6

10.1

M. East 8 North

Africa

294 2,000

589

1.8 -1.3

56 68 45

66 69

100 104 94

2003

20.0 20.3 17.2 0.5

-0.6

-20.9 7.4

39.6 16.3

2004

6.3 5.0

23.4

Upper- middle- income

576 4,770 2,740

0.8 -0.9

72 69 24

93 91

106 108 106

2004

21.9 21.1 21.3

1.4 2.2

-18.9 6.1

41.0 11.0

2004-08

2.2 1.1 2.5

Development diamond'

Life expectancy

GNI per ~

capita

Gross primary

enrollment

Access to improved water source

Lebanon Upper-middle-income group

Economic ratios'

Trade

Domestic __ Capital savings formation

Indebtedness

Lebanon Upper-middle-income group

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services

Household final consumption expenditure General gov't final consumption expenditure Imports of goods and services

Manufacturing

(average annual growth) Agriculture Industry

Services

Household final consumption expenditure General gov't final consumption expenditure Gross capital formation Imports of goods and services

Manufacturing

1984 1994

.. 6.8

.. 26.5

.. 15.0

.. 66.7

.. 107.6

.. 15.3

.. 62.4

1984-94 1994-04

.. 2.2

.. 0.8

.. 1.1

.. 3.0

.. 0.8

.. 5.0

.. -2.1 36.6 -0.9

2003

7.9 20.3 12.9 71.6

82.8 16.7 37.0

2003

4.9 4.9 4.9

10.0

1.8 0.2

13.8 1.6

2004

7.0 20.9 12.7 72.1

81.3 17.4 41.0

2004

6.3 6.3 6.3 5.9

2.5 8.8 7.1 7.0

i Growth of capital and GDP (%) 30 ~

20 - 10 - 0-2- 99 00 01 02 03 04

1:;; I -30 -

, GCF --O-GDP

I Growth of exports and impo

Note: 2004 data are preliminary estimates.

* The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.

46

CAS Annex A2 - Lebanon Lebanon at a Glance (continued)

Lebanon

PRICES and GOVERNMENT FINANCE

Domestic prices I% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes cumnt grantsJ Current revenue Current budget balance Overall surpluddeflcit

TRADE

(US$ mi//ionsJ Total exports (fob)

Livestock, animal, and vegetable products Fats and oils Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (2000=100J lmpolt price index 12000=100) Terms of trade (2000=100J

BALANCE of PAYMENTS

(US$ mi//ions) Exports of gwds and selvices Imports of goods and sewices Resource balance

Net inwme Net current transfers

Current account balance

Financing items (net) Changes in net reselves

Memo: Reserves including gold (US$ mi//ionsJ Conversion rate (DEC, /oca//US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ mi//ions) Total debt outstanding and disbursed

IBRD IDA

Total debt selvice IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment (net inflows) Podfolio equity (net inflows)

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1984 1994

.. 7.9

.. 7.9

.. 13.3

.. -11.3

.. -20.1

1984 1994

.. #DIV/O! 0

2,375 40

494

1984

6.5

1984

861 29 0

125 7 0

28 23

-29 5 0

0 5 4 1 3

-2

87 84

104

1994

756 5,990

-5.234

327 2,165

-2,742

4,603 -1,861

7,375 1,680.1

1994

2,127 64

185 8 0

74 398

77 27 4

23 4

19

2003

1.3 3.2

22.2 -10.7 -13.7

2003

1.758

1,483 7,134

1,307

98 98

100

2003

3,435 7,387

-3,952

-1,232 1,003

4,181

7,566 -3,386

14,031 1,5075

2003

7,906 454

762 49 0

581 33

0 57 34 23 15 7

2004

3.0 2.9

22.9 -6.7 -9.9

2004

2,556

2,182 0.727

1,533

98 93

106

2004

4,649 8,964

4,315

-1,079 1,265

-4,129

4,298 -169

13,500 1,507.5

2004

8,957 477

893 48

0

-8 -2,548

0 49 35 14 14 0

~ _ _ _

I Export and import levels (US$ mill.)

llO.WO, I I

8 w o -

ZIExports .~lmports O3 " I 98 99 w 01 02

1 Current account balance to GDP (%)

Composition of 2003 debt (US$ mill.)

A 454

1 /

A - IBRD E - Bilateral B - IDA D - Other multilateral F - Private C - IMF G -Short-term

Development Economics 10/19/05

47

CAS Annex B2 - Lebanon Selected Indicators* o f Bank Portfolio Performance and M a n a g e m e n t

(As o f October 18,2005)

Indicator 2003 2004 2005 2006

Portfolio Assessment Number of Projects Under Implementation a

Average Implementation Period (years) Percent of Problem Projects by Number a,

Percent of Problem Projects by Amount Percent of Projects at Risk by Number a , d

Percent of Projects at Risk by Amount Disbursement Ratio (%) e

Portfolio Management CPPR during the year (yesho) Supervision Resources (total US$) Average Supervision (US$/project)

13 9 7 4.9 4.7 4.8

30.8 11.1 71.4 35.9 16.8 67.3 46.2 33.3 71.4 45.2 36.1 67.3 14.7 17.4 11.3

Yes no no 646 873 678 46 67 75

Memorandum Item Since FY 80 Last Five FYs

Proj Eva1 by OED by Amt (US$ millions) 527.2 460.5 46.2 44.4

% of OED Projects Rated U or HU by Amt 21 .I 17.9

Proj Eva1 by OED by Number 13 9

% of OED Projects Rated U or HU by Number

a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c, Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the

beginning of the year: Investment projects only. All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio,

which includes all active projects as well as projects which exited during the fiscal year.

7 5.1

71.4 67.3 85.7 92.2 4.0

Yes 600

75

48

CAS Annex B3 - Lebanon Bank Group Program Summary

(As of October 18,2005)

Tentative IBRD Base-Case Lending Program *

Strategic Implementation Fiscal year Proj ID US$(M) Rewards /b /b Risks

(H/M/L) (H/M/L) 2007 Lebanon Health Sector Development 15.0 H H 2007 Utility Investment and Management Improvement Program 50.0 H H 2007 Community Development Project (supplementary loan) 20.0 H H 2007 Municipal Infrastructure Project (supplementary loan) 15.0 M L

Result 100.0 Overall Result 100.0

l a This table presents the proposed program for the next two fiscal years. ib For each project, the strategic rewards and implementation risks are expected to be high (H), moderate

(M), or Low (L).

49

CAS Annex B3 (IFC and MIGA) - Lebanon IFC and MIGA Program, FY 2003-2006

(As of October 18,2005)

2003 2004 2005 2006

IFC approvals (US$m) 0.00 5.25 8.00

Sector (%) Education Services Nonmetall ic Mineral Total

Investment instrument (%) Loans Equity Quasi-Equity Other Total

MIGA guarantees (US$m)

100 100

0 100 100 0

100 100

0 100 100 0

0.00 0.00 0.00

50

CAS Annex B4 - Lebanon Summary of Non-Lending Services

(As of October 18,2005) ~

Completion Cost Product FY (US$OOO) Audience a/ Objective b/ Recent completions - Line Ministries 1999 147 GovernrnentlBank Knowledge generation/Problem-solving PER Social Sector 1999 1 82 GovernmentlBank Knowledge generation/Problem-solving PER Education 1999 83 GovernrnentlBank Knowledae aeneration/Problem-solvina PER Transport 1999 64 GovernrnentlBank Knowledge generation/Problem-solving PER Telecom 1999 43 GovernmentlBank Knowledge generationlProblem-solving PER Health 1999 27 GovernrnentlBank Knowledge generation/Problem-solving PER WatedWastewater 1999 84 Government/Bank Knowledge generationlProb1et-n-solving PER Solid Waste 1999 32 Government/Bank Knowledge generationlProblem-solving PER Irrigation 1999 41 GovernmentlBank Knowledge generationlProblem-solving Energy Strategy 1999 1 15 GovernmentlBank Knowledge generation/Problem-solving Assessment of Socio-Economic 1999 67 GovernmentlBank Knowledge generationlProblem-solving Poverty Note 2000 105 GovernmentlBank Knowledge generation/Problem-solving Privatization Support 2000 166 GovernmentlBank Knowledge generation/Problem-solving Social Security/Contractual Saving 2000 176 GovernmentlBank Knowledge generation/Problem-solving IDF for Public Procurement 2001 25 Government Problem-solving Sources of Growth 2001 161 GovernmentlBank Knowledge generationlProblem-solving Economic and Social Review (Note) 2002 50 GovernmentlBank Knowledge generation/Problem-solving Social Protection Note 2002 146 GovernmentlBank Knowledge generation/Problem-solving IDF for Streamlining MOSA 2004 25 Government Knowledge generation/Problem-solving Capital Market Development TA 2003 18 GovernmentlBank Knowledge generatiodProblem-solving Economic Reform Support 2003 1 1 1 GovernmentlBank Knowledge generation/Problem-solving ROSC Accounting and Auditing 2003 - GovernmentlBank Knowledge generation/Problem-solving Hydrocarbons Strategy 2004 190 GovernmentlBank Knowledge generation/Problem-solving Agricultural Policy Note 2004 65 GovernmentlBank Knowledge generation/Problem-solving Irrigation Sector Sustainability 2004 125 Governmentl Bank Knowledge generation/Problem-solving Poverty Survey/TA 2005 50 GovernmentlBank Knowledge generation/Problem-solving Underway Pension Policy Note 2006 90 Government/ Bank Knowledge generation/Problem-solving Financial Assessment (CFAA) 2006 40 Government/ Bank Knowledge generation/Problem-solving Public Expenditure Review 2006 220 Government/Bank Knowledge generation/Problem-solving IDF for Strengthening HIV/AIDS Sys. 2005-08 80 Government Knowledge generation/Problem-solving Planned Country Procurement Ass. Review 2006 1 50 GovernmentlBan k Knowledge generation/Problem-solving Investment Climate Assessment 2006 1 50 GovernrnentlBan k Knowledge generation/Problem-solving Poverty Assessment 2007 1 75 GovernmentlBan k Knowledge generation/Problem-solving Labor Market & Gender Assessment 2007 140 GovernmentlBank Knowledge generation/Problem-solving CEM - Sources of Growth 2007 1 50 GovernmentlBan k Knowledge generation/Problem-solving Country Environmental Analysis 2007 100 GovernmentlBank Knowledge generation/Problem-solving Social Protection Strategy 2007 80 GovernmentlBank Knowledge generation/Problem-solving

35 GovernmentlBank Knowledge g enerat ionlProblem-solving 1 Economic Monitoring 2006-09 vearlv a. Government, donor, Bank, public dissemination. b. Knowledge generation, public debate, problem-solving.

51

CAS Annex B5 - Lebanon Social Indicators (as o f October 18,2005)

Latest single year Same regionlincome group

8 North Africa middle-income 1970-75 1980-85 1997-2003 M. East & Upper-

POPULATION Total population, mid-year (millions)

Urban population (% of population) Total fertility rate (births per woman) POVERTY (“4 of population) National headcount index

Urban headcount index Rural headcount index

Growth rate (% annual average for period)

INCOME GNI per capita (US$) Consumer price index (1 995=100) Food price index (1995=100) INCOMElCONSUMPTlON DISTRIBUTION Gini index Lowest quintile (% of income or consumption) Highest quintile (% of income or consumption) SOCIAL INDICATORS Public expenditure

Health (YO of GDP) Education (% of GDP) Social security and welfare (YO of GDP)

Net primary school enrollment rate (“A of age group)

Total Male Female

Access to an improved water source (% of population)

Urban Rural

Total

Immunization rate (% of children ages 12-23 months)

Measles DPT

Child malnutrition (% under 5 years) Life expectancy at birth (years)

Total Male Female

Mortality Infant (per 1,000 live births) Under 5 (per 1,000 live births)

Male (per 1,000 population) Female (per 1,000 population)

Adult (15-59)

Maternal (modeled, per 100,000 live births)

2.9 3.3 2.4 1.7

67.0 79.4 4.5 3.6

23 17

4.5 1.3

87.5 2.2

4,565 126 108

3.7 1.7 0.4

90 90 89

100 100 100

96 92

311.6 334.9 1.9 1.2

58.0 75.8 3.1 2.4

2,250 5,340

2.8 3.7 4.3 4.4

83 93 86 93 83 94

88 96 78 77

92 94 92 90

65 66 71 69 73 63 64 69 67 70 67 68 73 70 77

45 38 28 44 54 44 32 54

259 241 192 193 198 181 136 143

150

19 22

197 103

Births attended by skilled health staff (%) Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year of age. World Development Indicators database August 2004, World Bank

52

7r 3 3 N

le 3 3 N

I- 3 3 N

rg 3 3 N

- vi 3 3 N

B 3 N

8 3 N

N 3 3 N

5 3 N

3 3 3 N

7r 7r 2

0

vi 2

C

VI 2

C Q 0 VI

C Q\ W d

0

d z

0

d z

0 a\ 0 d

C C m m

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o ? ? ? 0 9 s

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- 0 9 1 r . i m m

U

(I 0

2 w w

m sc m m

+ - s

N 0 m d

- m w d

m d w d

m m z P N m N

43 P m N

3

Q N N

3 N N

Q\ 0 0 N

W 0 0 N

t- 0 0 N

\o 0 0 N

- In 0 0 N

v 0 0 N

- rri 0 0 N

N 0 0 N

s 0 N

0 0 0 N

Q\ Q\ 5

3 3 1 I

e,

Q\ 0 0 N

00 0 0 N

I- O 0 N

\o 0 0 N

-

m 0 0 N

v 0 0 N

3 0 N

N 0 0 N

3 0 0 N

0 0 0 N

t\

s

10 10

d 0 m V

.- * .- !i 4

m 0 0 N

oe 0 0 N

t- 0 0 N

w 0 0 N

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B 0 N

B 0 N

3 s m

m 0 0 *

00 0 0 N

l- 0 0 *

w 0 0 N

vi 0 0 N

B 0 N

9 0 0 9 0 P t 0 9

m w m

o - + o d P - r - - l n m * ln- o r - 0

c

a 0 Q 0

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u. .m

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c

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E

CAS Annex B8 (IFC) - Lebanon

Statement o f IFC's Held and Disbursed Portfolio

(As of August, 31,2005)

(In U S Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

1997 ADC 0.42 0 0 0 0.42 0 0 0 1997 Bank o f Beirut 7.53 0 0 0 7.53 0 0 0 1996 Byblos Bank 0.78 0 0 0.62 0.78 0 0 0.62 1999 Byblos Bank 13.04 0 0 4.43 13.04 0 0 4.43

0 0.27 1996 Fransabank 0.3 0 0 0.27 0.3 0 1998 Idarat SHV 1.07 0 0 0 1.07 0 0 0 2001 Lebanese Leasing 0.75 0 0 0 0.75 0 0 0 1996 MidEast Capital 0 1.5 0 0 0 1.5 0 0 1996 SGLEB 0.47 0 0 0.47 0.47 0 0 0.47 2005 SIS Adma 8 0 0 0 5 0 0 0

Total Portfolio: 32.36 1.5 0 5.79 29.36 1.5 0 5.79

59

0 W

MAP IBRD 33433

61

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yyQurQurnatnatas Sawdaas Sawda’’(3,088 m)(3,088 m)

S O U T HS O U T H

L E B A N O NL E B A N O N

B E K A AB E K A A

M O U N TM O U N TL E B A N O NL E B A N O N

N O RN O R T HT HL E B A N O NL E B A N O N

N A B AN A B A T I Y E HT I Y E H

DoumaDouma

AfqaAfqa

BaalbeckBaalbeck

RayakRayak

AntilyasAntilyas

Al AqurahAl Aqurah

HammanaHammana

MarMaryjayounyjayoun

QaraaounQaraaoun

JiehJiehJoub JannineJoub Jannine

BeitBeited Dineed Dine

RachaiyaRachaiya

Bent JbailBent Jbail

HulaHula

JezzineJezzine

TTibnineibnine

RmaichRmaich

ZhgarZhgartata

BcharriBcharri

HalbaHalba

IhdinIhdinSibSib’’ilil

AAynataynataAl LabwahAl Labwah

HerHermelmel

QaaQaa

QoubauyatQoubauyat

FunaydiqFunaydiq

AmiounAmioun

ZahlehZahleh

NabatiyehNabatiyeh

To Qiryat

Shemona

S O U T H

L E B A N O N

B E K A A

M O U N TL E B A N O NB E I R U T

N O R T HL E B A N O N

N A B A T I Y E H

Chekka

Douma

Afqa

Baalbeck

Rayak

Antilyas

Al Aqurah

Jounie

Jbeil

Hammana

Tyre

Maryjayoun

Qaraaoun

Jieh

Damour

Joub Jannine

Beited Dine

Rachaiya

Naqoura Bent Jbail

Hula

JezzineEl Zahrani

Tibnine

Rmaich

Zhgarta

Bcharri

Halba

IhdinSib’il

AynataAl Labwah

Hermel

Qaa

Qoubauyat

Funaydiq

Amioun

Saida

Baabda Zahleh

Tripoli

Nabatiyeh

BEIRUT

Kabir

Abou Moussa

Jaoz

Ibrahim

Oro

ntes

Litani

Litani

Awwali

Hasban

i

Medi terraneanSea

To Al Hamidiyah

To Tall Kalakh

To Hims

To Al Qusayr

To An Nabk

To Az Zabadani

To Ad Dimas

To Baniyas

To Qiryat

Shemona

To Gadot

To Nahariyya

Le

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36°00'E35°30'E 36°30'E

36°00'E35°30'E

33°00' N

34°00'N

34°30'N

34°00'N

34°30'N

35°30'N

LEBANON

0 10 20

0 10 20 Miles

30 Kilometers

IBRD 33433

NOVEMBER 2004

LEBANONSELECTED CITIES AND TOWNS

GOVERNORATE (MOHAFAZAT) CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

GOVERNORATE (MOHAFAZAT) BOUNDARIES

INTERNATIONAL BOUNDARIES

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, o r any endorsemen t or a c c e p t a n c e o f s u c h boundaries.