EXPLAINER-What’s at stake as Lebanon tries to put finances in order

BEIRUT, May 21 (Reuters) – Lebanon, which has one of the world’s heaviest public debt burdens, is finalising a budget to rein in its deficit after years of inaction.

The prime minister has said failure to pass a “realistic” budget would be tantamount to a “suicide operation” against the economy. The president has urged Lebanese to be ready to make sacrifices to rescue the country from financial crisis.

The causes are years of heavy spending and lax tax collection in a country with weak rule of law. The state is riddled with corruption and waste.

Its main expenses are a bloated public sector, interest payments on the public debt and transfers to the loss-making power generator. These alone have ranged from $1 billion to $2 billion a year, varying with the oil price.

Public sector employment is one of the means used by Lebanese politicians from various religious sects to shore up their support. In 2017, ahead of a parliamentary election, the government approved a big public sector pay rise.

As a result, personnel costs associated with the public sector climbed 22 percent in the first 11 months of 2018, said Nassib Ghobrial, chief economist at Byblos Bank. Public sector employment went up by 31,000 in the last four years, he said.

Lebanese leaders have dragged their feet on reforms for years. But their statements today suggest greater seriousness and urgency. Hariri has said that while Lebanon is far from bankruptcy, it faced “catastrophe” without changes.

Foreign governments have been leaning on Lebanon to enact reform. Some $11 billion in project financing was pledged to the country last year, conditional on reforms.

The backdrop is years of low economic growth, partly a result of regional turmoil including the Syrian war.

For investors, one concern has been a slowdown in the growth of deposits in the banking system. Hard currency deposited in the banks by the large diaspora has for years been used to meet the economy’s financing needs, chiefly the budget deficit and the huge gap between imports and exports.

The central bank, beginning in 2016, boosted foreign currency reserves through a series of operations known as financial engineering. But its net foreign assets have been on the slide: they stood at $37.3 billion on May 15, down from $42.9 billion a year earlier.

Moody’s in January cut Lebanon’s credit rating to Caa1, denoting a higher probability of a sovereign “default event”. The government says it is committed to paying its maturing debt obligations and interest payments on time.

A credible budget will boost market confidence. Hariri has said it should also lead institutions to revise their ratings.