This is the second report prepared by the Lebanese Center for Policy Studies (LCPS). It updates last year's report entitled "Budgetary Politics in Lebanon" which reviewed the budgetary proposals for fiscal 1997.

Similarly, the present report will review the proposals for the 1998 budget. As in the previous report, the authors will discuss the most important issues surrounding Lebanon's fiscal situation. The first section of the report was released in October in order to contribute to the ongoing discussion regarding the fiscal deficit and ways and means to reduce it. It was followed, after the formulation of the budget proposals for 1998, by a section that reviews those proposals.

Despite serious intentions to contain the fiscal deficit in 1997, the indications are that the results for the year will be disappointing. Not only the fiscal deficit appears likely to exceed the budgeted target considerably; but the debt situation seems to be approaching the red line of 100 percent of the GDP. Important statements have been made in the press, both by the Governor of BDL and by a senior official of the World Bank that the debt to GDP ratio should not exceed the 100 percent mark. Also it may be recalled that the meeting on economic issues that was convened by the Prime Minister in July 1997 resulted in recommendations to reduce the fiscal deficit and to strictly contain expenditures. More recently the possibility of adopting a number of important revenue measures has been under consideration.

The first section of the report represents an attempt to tie together the suggestions and initiatives currently under discussion in the context of an illustrative scenario to eliminate the fiscal deficit over the four years 1998-2001. This scenario does not represent a blueprint for a deficit reduction policy. It is designed to highlight the issues and to stimulate further discussion. While there could be several permutations of deficit reduction effort, all are likely to contain certain key elements: new revenue measures, strict restraints on spending, lowering interest rates, efficient debt management, and protection of important macro-economic gains such as price stability and the balance of payments position. All these issues are explored in the LCPS report.

The report starts by estimating, in a very preliminary way, the expected fiscal results for 1997. It would appear that total budgetary expenditures are likely to reach LL8 trillion while revenues are estimated at LL4 trillion. The deficit is equivalent to 18 percent of the GDP, or 50 percent of expenditures - another measure that is commonly used. The budget had forecast a deficit of ten percent of the GDP or 37 percent of expenditures. Interest payments are the largest single component of expenditures and the one principally responsible for overspending relative to the budgetary estimates.

Deficits of this magnitude cannot continue to be incurred. If they did, they would eventually pose a serious risk to financial stability. Therefore, measures and policies need to be adopted to contain the fiscal deficit in the first instance, and to eliminate it eventually. This is a very difficult task in itself, let alone to attempt it while at the same time increasing social spending.

The only way to successfully reconcile the multiple, and to some degree conflicting, objectives is to adopt a comprehensive strategy to be followed over a number of years. Unfortunately, the present approach in the country is short-term and fragmented. For example, while the budget for 1998 was under preparation, revenue and expenditure initiatives under the so-called "$1 billion project" - that include new taxes and fees - were put forward. It was not clear how those two key segments of the state's fiscal policy related to each other. It would be prudent to include the annual spending from the $1 billion project within a consolidated state budget.

On September 24, 1997 the Council of Ministers failed to approve the so- called "$1 billion project" now reduced to $800 million, because of opposition to increases in gasoline fees. The scenario described below was adjusted in light of the fiscal plan for 1998. Initially, it was enough to note that as long as the ceiling on spending and the size of the deficit did not change, the rejection or approval of the expenditures and the borrowings components of the project, could be ignored under the assumptions of the illustrative scenario (of course the components would change). The story is different as far as the revenue measures. New sources of revenues need to be found if the objectives of the scenario are to be met. Indeed all this strongly underlines the word illustrative that has been used often in this exercise.

The report presents a framework for eliminating the budget deficit over the four years 1998-2001. The illustrative scenario used is intended to highlight the issues and the measures that may be employed in a deficit reduction strategy. In simple terms, the illustrative scenario suggests eliminating a fiscal deficit equivalent to 18 percent of the GDP by increasing taxation by the equivalent of four percent of the GDP and by exercising spending restraints over four years - through an absolute freeze on spending. This would have the effect of reducing expenditures in real terms to achieve effective spending reductions equivalent to 14 percent of the GDP. To be realistic, the freeze on total expenditure is suggested at LL7.8 trillion, much higher figure than the LL6.5 trillion budgeted in 1996 and 1997. Under the overall spending ceiling, substitution would be possible to reflect changing priorities. Equally important, as interest rates are lowered and the interest component of spending is reduced, the margin for non-interest spending is expanded. The government would have more room to spend on social and infrastructure projects.

The mechanics of fiscal adjustment discussed in the report are, unavoidably, technical, interrelated and complex. By far, the most important element is to achieve a reversal in interest payments on the public debt and the mechanisms that would be employed in this endeavor would impact on the banking sector, the balance of payments and could influence the level of economic activity in the country. Public debt management is a new field in Lebanon. Before the war, the country had no debt to speak of. Even in 1993, the net debt load was equivalent to less than 40 percent of the GDP. Four years later it is approaching the 90 percent level.

The second section of the LCPS report examines the 1998 budget proposals and suggests that the revenue, expenditure and deficit targets are tight but achievable. Successful implementation would require careful monitoring right from the beginning of the year and willingness to adopt corrective measures if the desired outcome appeared to be in danger of being derailed. While the projected reduction in the fiscal deficit in 1998 is substantial, the impact on the country's overall debt situation would just about arrest the deterioration. Therefore considerable effort will be required for many years to come if a significant reduction in debt burden is to be secured.

It is common-place in Lebanon these days to be faced by the question: What are the alternatives? The illustrative scenarios presented in the report does not pretend to supply the alternative but they do suggest a structure for an alternative. They also show that there are no easy alternatives.

On behalf of LCPS, I would like to thank the Economic Development Institute of the World Bank which has funded this study. The Bank's role is strictly limited to providing financial assistance. The views expressed in the report do not necessarily reflect the views of the Bank. The authors are Said Hitti (LCPS consultant), Kamal Shehadi (Former Research Director, LCPS) and Rana Houry (LCPS researcher).