An economist’s opinion on the 2022 draft budget

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The finance bill for 2022 which has been submitted to the Council of Ministers provides for expenditure of 55,200 billion Lebanese pounds for revenues of 39,100 billion. The need for a 2022 budget is necessary to sanction spending and its approval by the cabinet was a prerequisite for negotiations with the International Monetary Fund.

However, the 2022 budget reveals in a more disturbing way the absence of any deep and comprehensive reform. It is simply a continuation of past policies with an inflation adjusted factor. The budget does not specify growth, inflation and balance of payments targets, nor how it can contribute to the resolution of the crisis.

First Worrying Sign: Multiple Fixed Exchange Rates

Maintaining the provision to apply multiple fixed exchange rates under the 2022 budget is in itself a setback for reform. A multiple exchange rate (MCR) regime is not only unjust, but a violation of the constitution. It shows the intention to gradually deplete the banks of a substantial amount of deposits to reduce their losses at the BDL. Either the intentions of the government and the BDL are concealed, or it is not understood that fixed rates constitute a major loss for depositors and for the economy. In fact, it is this multiple rate policy that has completely eroded what little confidence there was in the management of the system in recent years.

The frequently invoked excuse that exchange rate unification and liberalization is inflationary is a false argument. On the contrary, the current policy of multiple rates contains the ingredients of a continuous fall in the parallel (free) exchange rate and the persistence of inflation. The unified free market rate leads to equilibrium in financial markets – and allows depositors to recover the value of their dollar deposits and to absorb their losses on LBP deposits.

Given that many banks are influenced/controlled by the political elite involved in budget law decisions, it is not surprising that the budget bill mandates a multiple rate system. However, the fixed and multiple exchange rate policy that is being sponsored is very likely to prevent the conclusion of an agreement with the IMF which has always preached freeing the exchange rate – a loyal policy of the IMF.

While the persistence of a multiple rate system proposal is devoid of reform intentions, the central bank’s unsustainable monetary intervention to prop up banks seems designed to provide a false signal that reform is coming. The fact that the Banque du Liban was able to convert most of its SDR holdings into reserve currency (probably a gesture from a friendly economy) does not change the fact that this intervention in the foreign exchange market has been temporarily facilitated.

The second disturbing signal

Apart from the draft stipulation for the continuation of multiple exchange rate practices, the budget in its current draft also shows no intention of serious reform; rather, it is a collection of fragmented measures of tax rates, excise and expenditure.

The total expenditure of the budget exceeds 55,000 billion Lebanese pounds, including the credit granted to Electricité du Liban. Support for EDL cannot be classified as a loan (and therefore excluded from budget expenditures) because the utility is unable to repay its existing loans which have exceeded $20 billion. EDL tax support is a grant and has been classified as such and included in expenditures for many years. Even if a loan had to be made, the budgeted expenditure had to be classified as an increase in acquisition of non-financial assets, and the counterpart classified as an increase in financial assets as financing (a loan) of the Budget; thereby increasing the deficit and increasing financing needs by an additional £5.2 trillion.

Another notable budget item is wages and salaries, where an increase in expenditure of a full month’s salary is stipulated in addition to the increase in transportation support. Contrary to a standard recipe for administrative and fiscal reforms, the budget does not reveal any structural reform of the civil service. The apparent preference is to retain a large civil service corps which is much larger than that of any peer country. In summary of the 2022 budget, its current components are dominated by salaries and wages (12.3%), civil servants’ benefits (16.6%), EDL subsidies (10%) and the cost of the service of domestic and foreign debt (13.8% combined).

Also, in particular, within the framework of the analysis of the budget, the allocation of 9,200 billion LL to civil servants includes 7,000 billion LL of social expenditure allocated to State employees (نفقات اجتماعية غير محددة) without providing any clearly defined objective. For the payment of interest on domestic and international debt service, it is not specified whether these amounts are based on debt rescheduling agreements or not. The investment budget, meanwhile, remains low at 4% of total expenditure and is not geared towards growth.

Revenues

Revenues, however, only amount to 39 trillion Lebanese pounds. This side of the budget plan mainly reflects increases in taxes on interest earned to 10% (compared to 7% in previous budgets) and increases in the tax rate on wage income where the new top rate is 25% on top income brackets (by 21 percent) and salary bracket increases for all tax rate brackets. Also, revenue is assumed to improve based on the increase in customs rates in combination with the new exchange rate applied to customs revenue. Depending on the exchange rate used, the imposition of a new customs regime could lead to increases in customs duties – with the actual magnitude of the increase depending on the market’s reaction to these changes.

A total exemption from tax on interest is introduced on new deposits in dollars for 5 years from the approval of this finance law. Other tax relief measures include the rescheduling of taxes and excise due for a period of 3 years, the readjustment of VAT and income tax arrears for large taxpayers and the transfer of losses over one year.

The beneficial effects of the proposed tax relief measures and increased customs levies are highly uncertain. The tax exemption on new dollar deposits is unlikely to attract financial inflows, as risk factors remain dominant to repel inflows. The proposal to set a broad tariff rate of 3% on most imports could lead to conflict with trading partners who may demand compliance with existing trade protocols. The same problem can arise with the application of a 10% customs rate on imports for which there are domestic substitutes. The fiscal revenue project therefore represents an inward-looking approach to trade.

The main observation from the revenue items in the 2022 budget is that indirect taxes (which are regressive) dominate the picture. VAT is the main source of revenue. Adding trade fees and charges, indirect taxes on goods and services are the main source of government revenue at 50.3% of all tax revenue.

The budget attempts to generate foreign currency revenue by stipulating that payroll taxes should be based on the currency in which salaries and other revenue are paid. The same principle could be applied to other sources of revenue, but with a high risk that such a policy will raise public opposition while justifying the use of foreign currencies as local legal tender.

The Ministry of Finance (MoF) is surprisingly given discretion to set the exchange rate for the purpose of collecting customs duties and VAT on imports, as well as other taxes. This implies a continued lack of transparency, as no basis for such decisions has been provided in the bill. In addition, current budget policy gives the Ministry of Finance discretion to determine certain tax exemptions and rebates on unspecified taxes and fees.

The 2022 finance bill, examined here before its finalization by the Council of Ministers, is subject to debate and approval by the Lebanese Parliament. Many details will be discussed and adjusted. However, many fundamental questions are not addressed in the project and remain unanswered. The Lebanese people have the right to receive answers on two fundamental questions on which the current draft is silent, namely the question of how the budget deficit of nearly 15,400 billion Lebanese pounds could be financed and the equally important question is to what extent the budget conforms to IMF requirements.

There are vital issues (listed below) that could mark the start of Lebanon’s long journey to rebuild the economy. In addition to the economic recovery strategy and the faith of public deposits, is there consistency between the recovery plan and the Budget? Moreover, the question which preoccupies any economist relates to the sources of financing of the budget, and yet ignores the losses of popular savings through the banking system and its holding of Treasury bills and Eurobonds. It is therefore necessary to know: does the domestic market (banking and non-banking) have the will to finance the State? According to my understanding, this is very doubtful. We also ask: is there an intention to compensate, at least partially, depositors for losses related to Treasury bills and Eurobonds held by banks? The budget cannot remain silent on this.

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