GROWTH UNEVEN AS CONSUMPTION AND …

1 Ext. 11210 Page 3 Public transfers to municipalities offset revenue gains by FebruaryPage 4 Banque du Liban sees deposits growing by 5% in 2018 Page 5 Soaring inflation should moderate to by 2019 - IIFPage 6 Robust global GROWTH threatened by trade tensions, higher yieldsPage 7 Latest data for Lebanon s keyeconomic sectorsPage 8 Key trends in the LebaneseeconomyPROLONGED CABINET FORMATION PROCESS CLOUDS ECONOMIC OUTLOOK| August 2018N 71 Elevated political tensions in July cast doubt over Cabinet formation efforts, clouding the outlook for the Lebanese economy and slowing the momentum of fiscal policy that came with the election of a President in late 2016 and the formation of a national unity cabinet shortly thereafter. Real GDP GROWTH is still projected to reach 2% in 2018, according to the Central Bank, riding on growing visitor arrivals and robust CONSUMPTION activity.

2 The process of forming a new Cabinet can last several months as the PM-designate typically seeks consensus over the distribution of ministries and key portfolios among sects and governing parties. Outgoing PM Saad Hariri had secured the support of 111 out of 128 deputies in late May for his bid to form the next national unity Cabinet. Political challenges, however, contrasted with recovery in financial markets during the month. Sovereign bond yields contracted and risk perception eased in July, marking a turnaround after a three-month rout that had rattled emerging market investors and sunk bond prices by over 20%. Five-year Credit Default Swap spreads, the cost to insure against default, contracted by 117 basis points to during the month, Bloomberg data showed. Domestic monetary conditions had shown some improvement in recent months, boosted by Central Bank operations aimed at anchoring confidence in the fixed exchange rate regime.

3 Non-gold foreign assets at BdL rose by $ in July to $ at the end of the month, only slightly below an all-time high of $ registered at the end of May. The country s balance of payments also swung to a surplus of $ in the first five months of the year, compared with deficits during the same period in each of the prior three particular, higher rates helped Lebanese commercial banks draw in $ more in deposits from their customers in the first five months of 2018, the highest for the period in five years. Private sector deposits grew by yoy to a record $ by the end of May, and are projected to pick up the pace to 5% in the remainder of the year, according to BdL. Central Bank projects GROWTH at 2% in 2018 Second oil and gas licensing round planned for end of 2018 Pressure on the economy is easing from the conflict in SyriaVisitor arrivals, cumulative (millions)Balance of payments (Jan-May, $bn)Source: MoT, Economena, SGBL ResearchSource: BdL, Economena, SGBL ResearchAugust 1, 20180.

4 00. 51. 01. 52. GROWTH was almost equally divided between local and foreign currencies, signaling some recovery in confidence among depositors in the local currency. Private sector deposits in Lebanese Pound increased by $ to $ in the first five months of the year, and by $ to $ in foreign currencies. As a result, the dollarization rate retreated to by May 2018 after hitting a decade high of in the aftermath of the PM Hariri-Saudi Arabia crisis at late activity bounced back in May 2018 after coming to a virtual standstill during the prior four months. Claims on the private sector grew by $ in May, but are still down by $ to $59bn since the start of the year on the back of a downturn in housing and contracting loans. VISITORS AND CONSUMERS ARE STILL UPBEATM eanwhile, tourism and private CONSUMPTION are helping keep economic activity afloat.

5 The country welcomed 853,087 visitors in the first six months of 2018, an increase of over the same period in 2017 and the second highest on record for the period, Ministry of Tourism data showed. As a result, visitor spending increased by an estimated 5% yoy through June, according to tax refund data by Global Blue. Similarly, the index of consumer confidence published by ARA Marketing Research and Consultancy showed an improvement of yoy to points in the first half of 2018, its highest level for the period in the post-Syrian conflict s real estate activity has also held up well over the past year, hovering around peak levels even as volumes showed signs of weakness in more recent months. The value of sales transactions registered with the General Directorate of Land Registry and Cadastre increased by yoy to $ in the 12 months through June 2018, including an increase of yoy to 1,324 in the number of sales transactions to foreigners during the activity, however, is generally pointing to slowing investment amid uncertainty over the outlook for housing loan subsidies.

6 Cement deliveries, a proxy for construction activity, slipped by yoy to million tons in the year through June 2018, as more projects reach their final phases, requiring less cement and more finishing material. CONSIDERABLE POTENTIAL FROM OIL AND GAS WEALTH, EASING CONFLICT IN SYRIAThe country announced plans to put up additional offshore oil and gas blocks for licensing in coming months. The Lebanese Petroleum Association had received a green light from the Cabinet earlier this year to begin preparations required for a second offshore licensing round by the end of oil and gas wealth would offer considerable medium-term rewards, but the economy s near-term prospects may get some lift from the easing conflict in neighboring Syria. In July 2018, the Syrian regime regained control of the Nassib border crossing with Jordan, a key transit point for Lebanese goods which has been closed to trade since 2015.

7 The re-opening of the border crossing remains uncertain amid tense relations between the two countries, but any revival of trade by land through Syria would reflect positively on export activity, particularly industrial and agricultural products. The abatement of the conflict in Syria should also improve conditions for the gradual return of refugees, relieving some of the pressure on public services. In July 2018, Russia announced a plan to secure the return of an estimated 890,000 Syrian refugees from each of Lebanon and Jordan. Real estate sales transactions increased by yoy to $ in the 12 months through June : Bloomberg, Economena, SGBL ResearchReal estate sales (12-month moving sum, $bn)Lebanon CDS spread (5yr Mid, bps)Source: MoF, Economena, SGBL ResearchRevival of trade by land through Syria would reflect positively on Lebanese export 324681012 Jun-03 Jun-08 Jun-13 Jun-18 GOVERNMEMTPUBLIC TRANSFERS TO MUNICIPALITIES OFFSET REVENUE GAINS THROUGH FEBRUARY 2018 The Lebanese government reported a modest uptick in revenues in the first two months of 2018, but a massive increase in spending caused the deficit to swell by more than five times to a record $865m during the period, Ministry of Finance (MoF) data showed.

8 Total cash receipts grew by yoy to $ through February, driven by a surge of yoy to $ in interest tax income. The government started taxing interest income generated by banks from their deposits with the Central Bank and correspondent banks, and from interbank loans, part of a series of tax measures enacted in late 2017 to raise sufficient revenues to cover the cost of the new public sector salary scale. Combined with higher deposit rates, expanding the scope of the 7% tax on interest income may bring in more than $350m in additional income for the government in 2018. The government s 2018 budget law projects $863m in revenues from the tax on interest, representing 7% of projected total revenues during the , revenues from the Value Added Tax are running below budget on an annualized basis.

9 The government expects to collect an estimated $ from the VAT in 2018, more than in 2017, but collections reached $491m through February, up by just yoy. Parliament raised the VAT rate to 11% from 10% in late 2017, but the increase only came into effect in January 2018, so public sector receipts will likely start reflecting the higher rate in the second quarter of 2018 when companies file their tax reports for the first quarter of the from telecommunications services tumbled in the first two months, down to just $72m from $ over the same period in 2017. The 2018 budget law projects an increase of 7% to $ in transfers from the Ministry of Telecommunications to the , a massive jump in spending erased the positive boost to public finances from the revenue gains through February. Total cash expenditures surged by yoy to $ as a result of the disbursement of $ to municipalities during the period, compared with $ in the first two months of the other hand, interest payments and transfers to Electricit du Liban (EdL), which together contributed to of public spending during the period, grew only modestly, despite an increase in fuel prices and a growing stock of public debt.

10 Debt service is expected to grow at a moderate pace in 2018 as a result of swap transactions with the Central Bank in recent months which helped reduce the cost of the government s local currency debt. Income from the interest tax surged by yoy to $ by February Treasury payments to municipalities reached $ in the first two months GROWTH in debt service to taper off following swap transactions with BdL Fiscal deficit (Jan-Feb, $m)Government spending (Jan-Feb 2018)Average room rate at Beirut hotels ($)Source: MoF, Economena, SGBL ResearchSource: MoF, Economena, SGBL ResearchInterest tax income (Jan-Feb, $m)Source: MoF, Economena, SGBL Research81818387951011642012201420162018 72816286502004006008001, spendingPrior years' spendingInt er es t on LBP debtMunicipalitiesTransfers to EdLInt er es t on USD debtOt hers$ DU LIBAN SEES DEPOSITS GROWING BY 5% IN 2018 Higher deposit rates helped Lebanese commercial banks draw in $ more in deposits from their customers in the first 5 months of 2018, the highest for the period in 5 years.