FILE PHOTO: People take part in a protest over the Lebanon's economy and politics in Beirut
By Tom Perry and Tom Arnold
BEIRUT/LONDON (Reuters) - Heavily indebted Lebanon has unveiled an unprecedented plan to bring its public finances under control but faces an uphill struggle to restore investor confidence that is needed to stave off crisis.
After years of backsliding on reform, fear of economic catastrophe has forced action on Lebanese leaders who have overseen the post-civil war policies that landed the country with one of the world's heaviest public debt burdens.
Minds in Beirut have been focused by years of low economic growth and a slowdown in deposit growth in the banking sector. This has been vital to meeting Lebanon's financing needs, helping an economy that produces very little and imports lots to "defy gravity" for years, economists say.
The budget includes some politically difficult moves such as a three-year state hiring freeze, capping bonuses and a tax on state pensions. Others were sidestepped, notably proposals for a temporary public sector wage cut.
"The main test of this budget is whether it can bolster market confidence and usher fresh hard currency inflows that are urgently needed to cover Lebanon's substantial external financing gap," said Farouk Soussa, Middle East and North Africa economist at Goldman Sachs.
"So far, there is little evidence of this."
Credit ratings agency S&P Global said the announcement of the budget itself may not be enough to restore damaged confidence among non-resident depositors and investors.
News of the budget's approval helped Lebanon's dollar bonds to climb on Tuesday and the cost of insuring exposure to its sovereign debt fell.
The budget aims to cut the deficit to 7.6% of GDP from 11.5% in 2018. It will now go to parliament for debate.
Prime Minister Saad al-Hariri has called it the start of a "long road" towards steering the economy "to safety" and shows Lebanon is determined to tackle public sector waste.
Together with a plan for reforming the waste-ridden power sector, a major drain on the public purse, the budget could help Beirut tap into some $11 billion in financing pledged at the CEDRE conference for Lebanon in Paris last year.
"This budget is a good first step, and signals a genuine commitment by the Lebanese government to take some politically difficult but economically necessary steps," said a Western diplomat from a country that took part in CEDRE.
"But the key now is in delivering lasting reform, and providing a vision for the long term growth of Lebanon’s economy."
Wissam Harake, World Bank economist in Lebanon, said the deficit cut -- if it materialises -- would be a big adjustment.
"I reserve judgement on the outcome of this, but I think it illustrates seriousness," he told Reuters.
Some economists remain wary of Lebanese government numbers. Soussa noted that the government had targeted a 2018 budget deficit of 8.4% of GDP but it ended up at 11.5%.
Soussa said he was sticking by a forecast of a 9.4% deficit for 2019 "given the government's poor track record in meeting its targets ... and the fact that the budget is unlikely to be passed into law for another month, by which time almost half of the fiscal year will have passed".
Alia Moubayed, managing director at Jefferies, said the budget targets lacked realism given optimistic revenue forecasts that ignored the recessionary impact of the proposed measures and cuts in capital spending. The government had failed to pursue critical structural reforms, she added.
"We think the total deficit is unlikely to fall below 9 to 9.5% of GDP," Moubayed said.
Revenue generating measures include a 2% tax on imports and increasing the tax on interest to 10% from 7%. This will hit both depositors and the income banks earn on treasury bonds.
The government also plans to slice some $660 million from debt servicing costs by issuing low interest treasury bonds to the domestic banks, the finance minister has said.
As cabinet debated the budget, public sector workers staged multiple strikes and army veterans protested against any cuts. Since it was finalised on Friday, there has been no sign of new protests or strikes.
Jason Tuvey of Capital Economics said the budget showed the difficulties of driving through public sector pay cuts.
"They've struggled to push through austerity and ultimately some form of debt restructuring will be needed in the next couple of years," he said.
(Additional reporting by Angus McDowall and Laila Bassam in Beirut and Marc Jones in London; Editing by Catherine Evans)