Bassam Fattouh| The Daily Star

Lebanon’s waters are believed to hold large hydrocarbon reserves, making offshore Lebanon an attractive location for oil and gas companies.

While developing and monetizing these reserves will entail many geological and technical challenges, a key policy challenge that Lebanon will have to face is how to manage oil and gas revenues in a way which maximizes the economic benefits for its citizens. The challenge is grave given the country’s weak institutional framework and poor governance structure, perceptions of widespread public-sector corruption, political polarization and rising sectarian tensions.

The prospect of natural resource discoveries has already generated a lot of hype in Lebanon. Across the country, billboards sponsored by the Energy and Water Ministry have been erected along highways promising better transportation networks, a better health care system, more jobs and a better equipped army; all to be funded by revenues from potential hydrocarbon wealth. Lebanon also has plans to establish a sovereign wealth fund for future generations.

While many countries have followed the Norwegian model in managing their hydrocarbon wealth, there is no one-size-fits-all approach. Before formulating any policy recommendations, it is important to understand the macroeconomic context in which policy decisions have to be made, analyze some of the salient economic and institutional features of the country in question and try to identify the key sources of economic vulnerability.

While Lebanon has managed to navigate through various shocks and safeguard its macroeconomic stability, many sources of economic and institutional vulnerability remain. One such vulnerability is Lebanon’s high level of sovereign debt (both foreign and domestic) that requires constant rollover and entails large interest payments crowding out priority spending and capital expenditure. Persistent government deficits are expected to keep the debt-to-GDP ratio at high levels for the foreseeable future.

No matter how large or small the resource earnings could be, the clear policy prescription for Lebanon would be to initially use these revenues to pay off its large public debt, beginning with the country’s most risky liability, foreign currency external debt. This would have the effect of reducing the vulnerability of the domestic economy to external market shocks. Lebanon’s improved sovereign rating would also lower interest rates, improving the competitiveness of the economy and boosting growth. Repayment of public debt should also encourage banks to increase their lending to the private sector, and thus help support the private sector.

While the benefits of debt reduction are obvious, there are many risks associated with this strategy. Reducing public debt may not be politically feasible and may face public resistance, especially when constituencies’ expectations will press for more public expenditure, as impressions will have been created of ample availability of financial resources. Also, there is the risk that reducing the size of the public debt will improve Lebanon’s credit rating, resulting in lower interest rates, which in turn will provide an incentive and irresistible opportunity to borrow more, inducing Lebanon into a cycle of reborrowing.

In the very optimistic scenario that debt is reduced and there are ample natural resource revenues left over, the government may consider direct cash transfers to citizens given the lack of an efficient public investment system, the high perception of public corruption among citizens and the dynamism of the private sector. One drawback is that capital markets in Lebanon are underdeveloped and may not provide individuals with the appropriate financial assets to enable them to make optimal decisions. Also, if cash handouts are sizable enough to undermine politicians’ patronage, then such a scheme is not likely to receive necessary political support.

There is a strong case for increasing public spending, especially in infrastructure projects such as electricity and transportation. Infrastructure constraints pose a serious barrier to enhancing Lebanon’s competitiveness and thus devoting part of the revenues to scale-up public investment can have positive effects and induce an upward shift in economic growth or help the country escape poverty traps, or both. But the quality of spending is key. The limitations associated with increasing public spending in Lebanon are many and include limited administrative and technical capacity to scale up investment at a rapid pace – a situation that could result in suboptimal investment in addition to fostering corruption and rent seeking.

Lebanon should avoid distributing future resource revenues as energy subsidies – for instance as cheaper electricity – since these distort pricing signals and result in a misallocation of resources. Although energy subsidies constitute an important social safety net for the poor, they are regressive in nature because richer households capture the bulk of subsidies. Energy subsidies also have a negative environmental impact by encouraging wasteful consumption of fossil fuels. Energy subsidies once introduced are very difficult to reverse, reducing macroeconomic policy flexibility.

While Lebanon’s hydrocarbon law requires the establishment of a sovereign wealth fund for future generations, there is no imperative to create such a fund in Lebanon. This has been a viable and successful strategy for some countries such as Norway, which already has high levels of income per capital. However, it may not be appropriate for Lebanon, which has potential sources of vulnerability and poor physical infrastructure as well as rising poverty and inequality.

Even though it may be many years before exploration, production and monetization reach a decisive stage, the government needs to formulate without further delay a plan to manage the country’s potential oil and gas wealth. Lebanon should be wary of importing revenue management strategies from abroad, as optimal choices depend on each country’s political, economic and institutional context.

The government should also exercise considerable restraint in avoiding exaggerated claims regarding the size of the windfall and increased state expenditure.

Bassam Fattouh is director of the Oxford Institute for Energy Studies and a research fellow at the Lebanese Center for Policy Studies in Beirut. This commentary is published by permission from the LCPS.*307488/