Economic System

    Lebanon has a long tradition of domestic free trade and investment policies, with free market pricing for most goods and services, an unrestricted exchange and trade system and extensive links with the developed world in practically all economic activities.  The Government has maintained a generally non-interventionist stance toward private investment, and public ownership has generally been limited to infrastructure and utilities.  There are no restrictions on the movement of capital and goods by residents and non-residents of the Republic, including on entry or exit of firms or on access to foreign exchange, which makes Lebanon a supportive system for private sector development.

    The Government continues to favour a strong role for the private sector in a liberal policy environment.  It welcomes foreign investment in the economy.  There are no legal restrictions on setting up and operating private businesses in Lebanon, subject to limited exceptions (See "External Sector—Foreign Direct Investment").  Investment in infrastructure activities historically has been undertaken by the public sector.  The absence of exchange controls in Lebanon allows foreign investors freely to import and export capital in any form they wish.

    The Lebanese economy, characterized by freedom of exchange and transfers, is based on private initiative.  The private sector is estimated by CAS to contribute over 80 per cent. to aggregate demand and includes industries such as agriculture, manufacturing, construction, trade and tourism, in addition to services such as banking and finance, hotels and restaurants, media and advertising, and consulting and engineering.  The manufacturing and industrial sectors are estimated by the CAS to contribute approximately one-fifth of the national income.  They are provided only with a limited level of protection from international competition.

Recent Economic History

    The Republic had developed into a prosperous, lower middle income country by the mid-1970s.  Economic growth averaged 5 per cent. per year during the period 1960-1970 and then accelerated to 7 per cent. per year in the period 1970-1975.  The main source of growth was the services sector, in particular, tourism, banking, insurance and free port activities.  The banking sector, aided by a stable and liberal regime, a freely convertible currency, favorable regulations and skilled management, permitted Beirut to serve as a financial center to the Middle East.  This environment allowed Lebanese entrepreneurial and financial skills to evolve to a high degree, and in the 1970s its bankers and traders enjoyed an excellent reputation in the region.  Although smaller in size than the services sector, the export-oriented agricultural and manufacturing sectors also grew (at annual rates averaging between 4 per cent. and 6 per cent.), contributing to overall growth of income.  Having grown at an average of 3 per cent. per annum since 1960, per capita gross national product ("GNP") was estimated at U.S. $1,070 in 1974, just prior to the outbreak of the conflict in April 1975.

    Estimates put the Republic's GNP per capita at about U.S. $820 in 1990, barely one third of its 1975 level in real terms.  Damage to infrastructure and physical assets due to the conflict amounted to U.S. $25 billion, according to United Nations estimates, with none of the principal sectors emerging from the conflict unscathed.  While limited investment and maintenance expenditure led to the erosion of the capital base, the sizeable emigration of skilled manpower constituted a major loss to the economic potential of Lebanon.  As a result, from 1975 to 1990, aggregate national output steadily declined.  In addition, the confidence in, and credibility of, the Lebanese Pound and economic stability began to erode.  The shift in authority from the Government to non-official entities gave rise to a parallel economy that severely hampered the Government's ability to collect revenues as most trading was conducted through unofficial ports of entry.  This dearth in Government revenue and the growing expenditure on public services led to large and rapidly growing Government budget deficits.  These negative developments, along with the prevailing political uncertainty, plunged the Lebanese economy into a vicious cycle of large budget deficits leading to monetary expansion and inflation, which translated into dollarization of the economy and capital flight.  This in turn led to a dramatic depreciation of the value of the Lebanese Pound and further inflation.

    The cessation of hostilities was followed by a recovery in the economy in 1991; according to IMF estimates, GDP rose by almost 40 per cent. and inflation moderated in the course of the year.  Large capital inflows, along with a partial recovery of exports, resulted in an overall balance of payments surplus of over U.S. $1 billion.  However, the fiscal deficit remained high in 1991 (56 per cent. of expenditures).  By the beginning of 1992, the Central Bank had stopped supporting the Lebanese Pound, the value of which declined to all-time lows.  The cycle of deficit financing, dollarization and capital outflows led to escalating inflation and exchange rate depreciation, with the value of the Lebanese Pound reaching LL 2,420 per U.S. Dollar in September 1992.

    Following the appointment of the first Government led by Mr. Hariri in October 1992, the Government took measures to restore economic stability and renew confidence in the Lebanese Pound. 

    Between 1993 and 1998, the economic program of the successive Hariri Governments rested on the dual, and sometimes conflicting, tasks of economic revival and stabilization.  This framework aimed to rehabilitate the country's damaged infrastructure, replenish the depleted capital stock, reinstate traditional public services, and implement programs for the return of displaced persons to their villages and provide a conducive environment for the return of the expatriate Lebanese community, while pursuing exchange rate stability and anti-inflationary policies.  This strategy has been successful to a certain extent.  As the Government-led reconstruction program got underway and with the normalization of the economic environment, real economic growth averaged 5.7 per cent. over the period from 1992 to 1997.  At the same time, the foreign exchange rate gradually appreciated, reaching LL 1,516 per U.S. Dollar at the end of 1998.  The inflation rate was reduced from over 120 per cent. in 1992 to approximately three per cent. in 1998.  Interest rates have gradually declined since 1995 but remained high.  However, efforts at improving monetary stability and expenditures on large scale reconstruction projects contributed to increased fiscal deficits and consequential public borrowings.  As at December 31, 1997, the fiscal deficit represented 23.64 per cent. of GDP.

    The previous Government which was headed by Dr. Al Hoss and which held office from December 1998 until October 2000, continued to foster monetary stability.  Inflation was further reduced to 0.25 per cent. in 1999, the foreign exchange rate remained stable and the balance of payments registered a surplus in 1999.  The Al Hoss Government prepared and adopted a five year fiscal reform plan which was designed to reduce the budget deficit and gross public debt to 5 per cent. and 95 per cent. of GDP, respectively, by December 31, 2003. 

    When it assumed office, the current Government faced a number of challenges including an economic slowdown, a large fiscal deficit and a significant debt service burden. For the years ended December 31, 1999 and December 31, 2000, the fiscal deficit represented approximately 14.4 per cent. and 23.6 per cent., respectively, of GDP and debt service represented approximately 74 per cent. and 88 per cent. respectively of total revenues. Net Public Debt (consisting of Net Domestic Debt and Public External Debt) represented approximately 120 per cent. of GDP as at December 31, 1999 and 142 per cent. of GDP as at December 31, 2000.  See "Public Finance - The Budget Deficit."

    To address these challenges, the Government has started implementing a three-pronged strategy:

·                     revitalizing the economy by inducing the private sector to act as the conduit for growth, through the adoption of measures designated to promote investment and growth, and further integrating Lebanon into the global economy; the measures include the adoption of a new customs law, the extension by the Central Bank of interest subsidies and partial guarantees of loans to enterprises in certain sectors, and the easing of restrictions on foreign ownership of real property;

·                     attempting to improve the fiscal position by controlling discretionary expenditures (including the elimination of subsidies for sugar) and seeking to enhance revenues; the Government is actively preparing for the implementation of the VAT.  See "Tax Reform"; in addition, the Government is looking to reduce its heavy debt service burden by attempting to obtain supranational guarantees for some of its external debt.  See "External Sector - Foreign Borrowings and Grants", and

·                     maintaining monetary stability and lower inflation.

    The current Government focused initially on revitalizing the economy through measures designed to encourage the development of the private sector and the integration of Lebanon into the global economy.  The current Government's objectives consist of maintaining monetary and price stability and improving fiscal performance through a reduction in the debt service burden, the curtailment of other public expenditures and privatization of state assets. As a result of these policies, economic activity slightly improved, recording a growth rate of 1.5 per cent. while inflation remained at 0 per cent. The fiscal deficit declined by 7 percentage points of GDP to 16.7 per cent.

    The balance of payments was in overall surplus during the period from 1993 to 1997, despite growing trade deficits.  The balance of payments was U.S. $1.13 billion in surplus for 1994.  In 1995, 1996, and 1997, the balance of payments registered a surplus of U.S. $256 million, U.S. $786 million, and U.S. $420 million respectively.  However, the balance of payments registered a deficit of U.S. $487 million for 1998.  For the year 2000, the balance of payments recorded a deficit of U.S. $289 million, as compared to a surplus of U.S. $261 million for 1999. During 2001, the balance of payments recorded a deficit of U.S. $1.17 billion mainly due to a large trade deficit and the effect of regional developments.

Role of the Government in the Economy and Privatization

    Lebanon has a long and established tradition of having an open and free market economy.  The state sector has traditionally been small, with the Government having a history of minimal intervention in economic activity.

    For the first eight years of the conflict (until 1983/84) Government authority was still present, albeit in a much weaker form than before the conflict began, and some tax revenue was forthcoming.  From 1983/84, the Government effectively lost control of all ports, and non-payment of direct taxes and bills to state-owned utilities became widespread, leading to a financing of current Government expenditure through money creation.

    After the conflict, the Government continued the policy of reliance on private sector initiative, which had served the country well in the pre-conflict era.  However, the Government has assumed a larger role than it has done historically by making substantial investments in infrastructure needed to create an environment conducive to long-term growth based on private sector activity  See "Public Finance—Operations of the Central Government".  However, the various post-conflict governments have also been seeking to increase the private sector participation in infrastructure financing. 

    In May 2000, Parliament adopted a privatization law, which sets the framework for the privatization of state owned enterprises.  The privatization law establishes a Higher Privatization Council and provides that the proceeds from privatization will be applied towards debt repayment.  A law regulating the water sector, in anticipation for its privatization, was adopted by Parliament in May 2000.  Other sector laws relating to telecommunications and electricity have been prepared by the Government and submitted to Parliament.  While the state sector in Lebanon does not account for a large portion of GDP (7.4 per cent. of GDP in 1995, excluding certain government agencies), it nevertheless includes several enterprises and types of assets which have been successfully privatized in other emerging markets.  The Government owns Electricité du Liban (which supplies virtually all electricity in the Republic), Société des Eaux de Beyrouth and other water companies, the airport and port companies, the fixed-line telephone monopoly and other assets, many of which may be eligible for privatization.  The Central Bank also owns significant commercial assets, including substantially all of the shares of the national air carrier, Middle East Airlines.  With the exception of the sale in 1997 by the Central Bank of its shares in Credit Libanais S.A.L., a commercial bank, prior governments did not conduct sales of state-owned enterprises.  The Government believes that privatization is likely to result in significant economic benefits, including a reduction in public debt levels, and a consequent decrease in the budget deficit, an increase in capital inflows, the acquisition of new technology and a broadening of domestic capital markets.  Electricité du Liban and the fixed line telecommunications operator are currently being prepared for privatization.

 Gross Domestic Product

    With the restoration of peace and stability, the GDP registered high growth rates for the period from 1993 to 1995, averaging an estimated real growth rate of 7.2 per cent. per annum.  Real GDP grew at slower estimated rates of 4 per cent. in 1996 and 1997, 3 per cent. in 1998, 1 per cent. in 1999, and 0 per cent. in 2000. Real growth is estimated to have been 1.5 per cent. in 2001.

    The following table shows estimates of gross domestic product for the years 1996 to 2001:

	1996	1997	1998	1999	2000	2001
GDP (at market prices) billions of LL	20,417	22,880	24,509	24,816	24,816	25,188
Exchange rate, LL per U.S. $  (period average)	1,571	1,539	1,516	1,507.5	1,507.5	1507.5
GDP (at market prices) millions of U.S. Dollars(1)	12,996	14,867	16,167	16,462	16,462	16,708
Growth of Real GDP	4.0%	4.0%	3.0%	1.00%	0.0%	1.5%
Growth of Nominal GDP	13.2%	12.1%	7.1%	1.27%	0.0%	1.5%
GDP Inflation	8.8%	7.8%	4.0%	0.25%	0.0%	0.0%

Source: Ministry of Finance/Banque du Liban. 

    No official GDP calculations have been made since 1977.  The CAS has calculated the GDP for 1994 and 1995 (see above) and is in the process of calculating GDP for 1996 and 1997.  Prospective readers should be aware that actual amounts may differ from current estimates included in this Document.

    The following table shows the composition of the Republic's GDP for the years 1994 and 1995, as calculated by the CAS.  No figures are available for later years but it is believed that the composition of the Republic GDP has not changed significantly since 1995.

Composition of GDP by Sector	1994	1995
(at current prices)	(per cent.)
Agriculture	12.0	12.4
Energy, Water and Industry	17.7	17.3
Construction	9.4	9.2
Transport and Communication	2.8	2.8
Commerce	28.7	30.1
Housing	4.5	4.2
Other Services (1)	16.7	16.4
Public Administration	8.3	7.4
Total	100.0	100.0

Note: ⁽¹⁾ Includes financial services, hotels, restaurants, health services and education.

Principal Sectors of the Economy

    At the end of the conflict, all sectors of the Republic's economy were characterized by widespread damage to physical assets and an obsolescence of remaining facilities, given the reluctance during the years of conflict to invest in new capital or spend funds on maintenance.  In addition, there was an outflow of professional and entrepreneurial skills from Lebanon.  A lower production capacity, together with rigidities in internal flows of goods and labor, led to very low levels of output.

    The end of the conflict in 1990 marked the unification of the internal market and an upsurge in output in most sectors of the economy.  Since then, there has been an increase in investment and a gradual return of skilled workers to the country.  However, the economy suffered a slow-down in 1998 to 2000 and has resumed a slow recovery in 2001.

    The following table sets forth selected indicators of economic activity in significant sectors for the periods indicated:

Selected Indicators of Economic Activity

	1996	1997	1998	1999	2000	2001
Industry Recorded Exports (million of U.S. Dollars)	919.5	513.0	715.9	676.8	714.6	889
Electricity Production (million kwh)	7,492	8,364	9,009	9,025	9,111	9,438
Cement Production ('000 tons)	3,812	3,654	3,514	2,970	2,623	2,710
Construction Construction Permits in ('000 sq.  meters)	13,487	11,397	9,817	8,422	6,725	6,879
Commerce Beirut Airport(no.  of passengers '000s)	1,715	2,007	2,060	2,222	2,343	2,445

Source: Ministry of Finance/Banque du Liban. 

Services

    The Lebanese economy is based primarily on the service sector, which accounts for approximately 60 per cent. of GDP (down from approximately 70 per cent. in the 1970s).  Major subsectors are commerce, tourism and financial services.  Other components include health care and higher education.

Tourism

    The strategic position of Lebanon, its mild climate and natural beauty, consisting of snow-capped mountains, valleys and the Mediterranean Sea, make it a natural tourist attraction.  Apart from its privileged geographical and natural situation, Lebanon benefits from qualified and experienced human resources in the tourism industry.

    Prior to the outbreak of the conflict, tourism (including hotels and restaurants) contributed approximately 20 per cent. to Lebanon's GDP.  This is notable given that, at that time, the international tourism industry was not as developed as it is today.

    Significant private investment is currently being made in the modernization and expansion of this sector and international hotel companies have returned to Lebanon.  Casino du Liban, which historically constituted a major tourist destination, reopened in 1996.  Lebanon is the only country in the Arab world that offers skiing and related winter sports activities.  The largest ski resort in the country has been expanded and modernized.  The Government believes that, because of the return of peace and stability to the country and with the development of the necessary infrastructure, tourism will again contribute significantly to Lebanon's economy.  Lebanon's tourism industry also relies on the large number of Lebanese living abroad, who return regularly to the country during the summer season.

 Financial Services

    From the 1950s to the start of the conflict in 1975, Beirut was the region's financial services center.  At the onset of the oil boom starting in the 1960s, Lebanon-based banks were the main recipients of the region's petrodollars.

    Currently, the main financial services offered are commercial banking, investment banking and insurance.  Despite the conflict and a crisis in the late 1980s involving a small number of banks, the commercial banking sector remains a centerpiece of the Republic's service-oriented economy.  The Lebanese banking sector witnessed unprecedented growth during the period from 1992 to the present.  Total deposits with commercial banks increased from U.S. $6.5 billion at the end of 1992 to U.S. $40.1 billion at the end of 2001.  In addition, since 1996, Lebanese banks have been successfully accessing the international capital markets. Since 1996, several banks raised over U.S. $2.5 billion on the international debt markets and three banks raised approximately U.S. $300 million through the issuance of global depositary receipts on the international equity markets.  The banking system is seen as having a key role by being the entry point for capital inflows for the region's development.  At the same time the authorities are aiming at widening and deepening the financial sector by facilitating the establishment and evolution of, and providing a regulatory framework to, more diversified private financial institutions.  Several investment banks, with capital raised offshore, have been established in Beirut and offer a variety of traditional investment banking services, including debt and equity raising and corporate finance advisory services.  Several commercial banks have established investment banking subsidiaries offering similar services.

    As part of the Government's strategy of reestablishing Beirut as a regional financial services center, the Central Bank established in 1994 a central depositary, settlement and clearing agency, MIDCLEAR, which is a joint stock company organized under the laws of the Republic.  The Government reopened the Beirut Stock Exchange in 1996.

 Construction

    Prior to the conflict, the property sector had always been important, with a substantial portion of the activity concentrated in Beirut, where the housing needs of the city's rapidly increasing urban population had to be met.  Beirut saw an almost uninterrupted boom from the late 1950s to the early 1970s, when it expanded dramatically, eventually to house half of the country's population.  Mountain towns and villages close to Beirut favored by tourists, such as Aley and Bhamdoun, also experienced a boom.

    The post-conflict era has witnessed a significant construction boom.  Real estate prices have risen steeply, especially for prime property, but have recently stabilized.  The boom has been fuelled by a mixture of local, expatriate and Gulf Arab funds.  With respect to residential property, it has been concentrated mostly at the upper end of the housing market.  As the stock market has resumed its operations only recently, land and construction have been viewed by many as attractive investment opportunities. Construction projects are financed mainly by equity investments.  In 1995, construction activity accounted for 9.2 per cent. of GDP, a significant increase from approximately 4.5 per cent. in 1972.  Since 1996, construction activity has slowed, as witnessed by lower cement deliveries and a decline in the number of construction permits being issued.

 Industry

    In 1995, the industrial sector (mainly production of cement, furniture, paper, detergents, cosmetics, pharmaceuticals, batteries, garments and processed foods) accounted for 17.3 per cent. of GDP, an increase from 15.9 per cent. of GDP in 1972.  Virtually all industry is privately owned.

    Exchange rate and price stability coupled with the gradual decline in Lebanese Pound interest rates have contributed to a better environment for investment and growth in industry.  Infrastructural bottlenecks resulting from the conflict are being addressed as improvements in roads, telephones and electricity supply are realized.  The Government provides various incentives for the establishment of industrial facilities in Lebanon, including fiscal incentives in the form of reduced customs duties and tax exemptions.

    From 1993 to February 2001, the International Finance Corporation ("IFC") carried out 34 investment and financing projects in Lebanon in an aggregate amount of U.S. $336 million, with an additional U.S. $256 million raised by the IFC through loan participations.  Investments during 2000 included loans to three companies for U.S. $21 million.  As of February 28, 2001, U.S. $219 million representing IFC loans, loan participations and equity investments had been disbursed and remained outstanding.

Energy and Electricity

    Lebanon has no known fossil fuel resources.  Apart from relatively modest hydroelectric resources and the import of approximately 200 megawatts of electricity annually from Syria, all energy needs are met with imports of petroleum products, which represented over 4.4 million TOE (tonnes of oil equivalent) in 2000.  Two state-owned refineries (one in Tripoli and one in Zahrani) are currently non-operational. The power sector accounts for about two-thirds of fuel imports.

    Lebanon's energy sector is dominated by the state-owned monopoly Electricité du Liban ("EDL"). 

    The power sector sustained severe physical damage to all its production transmission and distribution facilities during the conflict.  EDL also incurred financial losses resulting from low tariffs, high technical and non-technical losses, including widespread illegal connections, and loss of control over its commercial operations.

    EDL has been regaining control over its operations.  Following the rehabilitation of existing plants, tariffs were increased significantly, and, commencing in 1996, steps are being taken to address billing and collection weaknesses as well as non-technical losses.  The program for the rehabilitation of the Republic's energy sector is further described under "Reconstruction—Electricity Generation."

    The Ministry of Energy and Water is seeking to rehabilitate the power sector through the design and implementation of an electric power sector restructuring program starting with the implementation of a three-year management contract to be awarded to an international company through an international bidding procedure.  It is expected that the outcome of the restructuring program will be the creation of a competitive market structure for the power sector.  The program also includes the preparation of a draft electricity law providing for the creation of an independent regulator and allowing for private sector participation in electricity generation and distribution. 

    The Ministry of Energy and Water is also seeking to source supplies of gas for the two gas turbine stations.  Discussions between the Government and the Arab Republic of Egypt are currently underway for the construction of a pipeline and the supply of gas.

Agriculture

    Approximately one third of the Republic is arable.  The most fertile areas are located along the coastal strip and in the Bekaa valley.  The diversity of the Republic's topography and climate enables cultivation of a wide variety of vegetables, fruits, industrial crops and cereals.  In 1995, agriculture contributed approximately 12 per cent. to the Republic's GDP, as compared to approximately 9.9 per cent. in 1972.  Food and agricultural exports, which include forestry products, provide about 10 per cent. of merchandise export earnings.

Prices and Inflation

    Movements in the exchange rate of the Lebanese Pound are intertwined with domestic price developments due to the openness of the Lebanese economy.  Since the mid-80s, Lebanon has suffered from rapid increases in prices, peaking at 500 per cent. per annum in Lebanese Pound terms in 1987.  This trend was evident until the appointment of the first Hariri Government in October 1992.  The last quarter of 1992 saw a significant appreciation in the value of the Lebanese Pound against major currencies.  This together with the gradual appreciation to date has been accompanied by a decline in the rate of inflation.  Since 1993, inflation is estimated to have declined to approximately 9 per cent. in 1996, 8 per cent. in 1997, 4 per cent. in 1998, 0.25 per cent. in 1999 and 0.0 per cent. in 2000 and 2001.  This marks the first prolonged return to relative price stability.  The current level of inflation is attributable to the following principal reasons:

·                     the implementation by the Central Bank of a tight monetary policy, including maintaining a stable exchange rate (by using a nominal anchor policy with the U.S. Dollar) and high interest rates on Lebanese Pound assets; and

·                     the openness of the Lebanese economy, which causes excess demand on the domestic market to be satisfied by a corresponding increase in imports.