Lebanon - Reconstruction Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-2113-LE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMI EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF LEBANON FOR A RECONSTRUCTION PROJECT June 15, 1977 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents US$ 1.00 = 3 LL ABBREVIATIONS BNDIT Banque Nationale de Developpement pour l'Industrie et le Tourisme (National Development Bank for Industry and Tourism) CEGP Conseil Executif des Grands Projets (Office for Project Implementation) CEGPB Conseil Executif des Grands Projets de Beyrouth (CEGP for Beirut) CEP Commission d'Extension et de Promotion du Port de Beyrouth (Planning Board for the Development of the Port of Beirut) OTA Omnium Technique de l'Assainissement (French firm specialized in sewerage projects) SEAED Service des Eaux d'Ain El Delbe (suburban Beirut Water Company) SEB Service des Eaux de Beyrouth (Beirut Water Company) SGE Societe de Gestion et d'Exploitation du Port de Beyrouth (company operating the Port of Beirut)  FOR OFFICIAL USE ONLY LEBANON RECONSTRUCTION PROJECT LOAN AND PROJECT SUMMARY Borrower: Republic of Lebanon. Loan Amount: US$50 million equivalent in various currencies. Terms: 17 years, including 3 1/2 years of grace at 8.2 percent per annum. Project The proposed project is intended to assist the Government Description: in its reconstruction efforts following the civil war. It would include rehabilitation of the port of Beirut and the telecommunication system thereby eliminating two critical bottlenecks for resumption of economic activity. Capacity of the two sectors would be restored to pre-war levels through replacement and modernization of most urgently needed facilities and institutional improvements. The project would also include rehabilitation of Beirut's water supply and sanitation facilities to ease the present situation and preparation of longer term projects in the sector. Finally, the project would include studies to accelerate the preparation of future projects for urban reconstruction and regional development. More specifi- cally the project would include: (a) rehabilitation of the Port of Beirut: - construction and installation of transit sheds and warehouses; - procurement and installation of cargo handling equipment, general uses equipment, maintenance equipment and marine equipment; - consultant services to assist the Government and SGE - the operator of the Port - in port reconstruction and improvement of port operation. (b) rehabilitation of telecommunication system: - construction and repair of buildings; - procurement and installation of equipment for (i) local telephone service (switching equipment and local network and subscriber plant); (ii) long This document has a restricted distribution and may be used by recipients only in the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - distance (switching equipment, cables and aerial lines and microwave equipment); (iii) interna- tional service (switching equipment, earth station and submarine cable station); (iv) telex service (exchanges and teleprinters); and (v) general use (power plants and air conditioning, vehicles, tools and maintenance equipment); and - consultant services to assist PTT in telecommuni- cation rehabilitation and improvement of financial and management practices; (c) Rehabilitation in the water, sewerage and sanitation sector: - replacement of damaged portions of Beirut's water distribution system; - procurement of leak detection and maintenance equipment; - rehabilitation of the solid waste treatment plant in. Beirut; - consultant services to assist the local authori- ties in carrying out rehabilitation works and reviewing water utility organization, management and finances; - consultant services to assist the Government in (i) preparing a project for Beirut's water supply, (ii) analyzing capacity and design of the present water distribution system to reduce losses, (iii) preparing a master plan for its future extension, and (iv) preparing a sewerage project. (d) Studies: For the preparation of a program for urban reconstruction and regional development, including sites and services for low cost housing, industrial decentralization, integrated rural development in the most deprived regions of Lebanon and mass transit projects.  - iii - Estimated Cost: Thousands of US$ Local Foreign Total (a) Port Rehabilitation - Transit sheds and warehouses 4,500 4,500 9,000 - Break bulk cargo handling equipment 100 8,400 8,500 - Container and roll-on/roll-off equipment 50 1,700 1,750 - General uses equipment 50 1,000 1,050 - Maintenance equipment 600 2,250 2,850 - Marine equipment 250 1,750 1,800 - Consultant services 800 800 1,600 - Contingencies 1,350 4,300 5,650 Sub-total 7,700 24,700 32,400 (b) Telecommunication Rehabilitation - Local Installation and Civil Works 7,700 - 7,700 - Local Telephone Service 700 11,930 12,630 - Long Distance Service 320 3,550 3,870 - International Service - 1,040 1,040 - Telex Service - 670 670 - Miscellaneous 490 4,410 4,900 - Consultant Services - 420 420 - Contingencies 2,430 2,430 Sub-total (rounded) 9,200 24,500 33,700 (c) Water Supply Sewerage and Sanitation Program (rehabilitation and project preparation) - Civil works 2,000 2,000 4,000 - Leak detection and maintenance equipment 300 600 900 - Rehabilitation of solid waste treatment plant 1,000 2,000 3,000 - Consultant Services for - rehabilitation and water utility reorganization 400 800 1,200 - Beirut's water supply 410 620 1,030 - Water distribution leak survey 400 800 1,200 - Water distribution master plan 200 400 600 - Sewerage feasibility study 490 1,080 1,570 - Contingencies 1,000 1,600 2,600 Sub-total 6,200 9,900 16,100  - iv - Estimated Cost: Thousands of US$ (Continued) Local Foreign Total (d) Studies for urban reconstruction and regional development - Urban reconsitruction 150 300 450 - Industrial decentralization 75 150 225 - Rural Development 150 300 450 - Mass Transit 75 150 225 Sub-total 450 900 1,350 TOTAL 23,600 60,000 83,600 Financing Plan: Millions of US$ Bank Loan 50.0 Suppliers credits 10.0 Government 23.6 83.6 Estimated Disbursements: Millions of US$ CY77 CY78 CY79 Annual 7.0 19.0 24.0 Cumulative 7.0 26.0 50.0 Consultants: (a) technical assistance to the Ministries of Water Resources and Public Works and to SGE (the Port Operator) for subproject implementation and preparation of reforms aimed at improving port operation and development (100 man-months); (b) technical assistance to PTT (the Ministry of Tele- communications) for sub-project implementation and preparation of reforms aimed at improving telecom- munication operation and development (52 man-months); (c) technical assistance to CEGPB (Office for project preparation and implementation in Beirut) for sub- project implementation and preparation of feasibility studies (510 man-months); (d) technical assistance to the Reconstruction and Development Board for preparation of projects for urban reconstruction and regional development (115 man-months). Average cost per man-month would be $7,500.  -v - Rate of Return: -- port rehabilitation: 24 percent. - -- telecommunication rehabilitation: 44 percent. -- water supply rehabilitation: 15 percent. The weighted average rate of return of the components of the project for which benefits can be quantified will be about 32 percent.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE GOVERNMENT OF LEBANON FOR A RECONSTRUCTION PROJECT 1. I submit the following Report and Recommendation on a proposed loan to the Republic of Lebanon for the equivalent of US$50 million to help finance a reconstruction project. The loan would have a term of 17 years, including 3 1/2 years of grace with interest rate at 8.2 percent per annum. 1/ PART I - THE ECONOMY 2. The last Bank report on Lebanon's economy (No 670a-LE of May 20, 1975) was distributed to the Executive Directors in May 1975. Its findings and conclusions are very largely outdated following the nearly two years of civil war which raged in Lebanon in 1975-76. The assessment which follows is based on the findings of Bank missions which visited Lebanon in February, March and April 1977. Except for some budgetary and monetary magnitudes and the reserve level, no reliable statistics are available to describe develop- ments since early 1975. A special economic mission is scheduled to visit Lebanon in FY78. 3. Immediately before the civil war, Lebanon was in a phase of rapid expansion led by growth of exports and private investment in construction and industry. Arab oil countries were providing vastly expanded export oppor- tunities and investment capital for real estate. Investment was increasing rapidly, surpassing 22 percent of GDP in 1974 and increasingly shifting from construction to industry. The Government's laisser-faire policies and its conservative fiscal and monetary policies provided the liberal framework conducive to full development of abundant Lebanese entrepreneurial talent and attractive to foreign capital. A shortage of local unskilled labor was met by large numbers of expatriate, largely Syrian and Palestinian, workers. Rapid development was associated with profound changes in the economic struc- ture. In 1974, the share of agriculture in GDP had fallen to 9 percent of GDP, whereas industry had risen to 21 percent and services to 70 percent. The growth of services was related mainly to international transport and trade, and to the emergence of Beirut as a center for international banking and tourism. Lebanon's GNP per capita at market prices was estimated at $1,170 in 1974. 1/ As a result of the war Lebanon's GNP per capita has dropped below $1,075, the cut-off point for higher income developing countries set in my memorandum on Grace Periods and Final Maturities (R76-206 of August 9, 1976, see also paras 8 and 23 below).  - 2 - 4. - rapid expansion of the private sector before the war was not matched by growth in public investment and change in public attitudes and institutions. Cornservative fiscal and borrowing policies had led public in- vestments to decline in real terms since 1969 to less than 3 percent of GDP in 1974. Hence, there were serious bottlenecks in the economic and social infrastructure (especially port facilities, highways, telecommunications, public schools, low-cost housing, urban public services and pollution con- trol). Increasingly acute political and social problems resulted from: growing income disparities among sectors, regions and religious and social groups; the various degrees of drive and modernization among communities; the presence of several hundred thousand foreign workers (mostly unskilled); and the tensions caused by the activities of Palestinian armed forces which had been admitted to the country following an agreement concluded in Cairo in 1969. The social security system and public investments targetted on low- income beneficiaries were insufficient in relation to the need for a better social balance. 5. The war was chiefly caused by the opposition of a large segment of the Christian population (chiefly the Maronite Community) to the increasing presence and role of the Palestinians in the country and to their attempts, backed by part of the Moslem and Druze Communities and the Lebanese left, to include Lebanon (wrhich had steered clear from involvement in the Arab-Israli wars since 1948-49) among the Arab "confrontation" countries. Continuous fighting in Beirut spread to most of the country and led to polarization and de facto partitiorn chiefly along sectarian lines. The Army was prevented from interfering because of lack of agreement on its role and of its mixed religious composition; it eventually split into several groups, each of which took dif- ferent positions during the civil war. Public administration practically disintegrated, with few exceptions. External support for the warring factions in form of money, armaments and men, kept the war going despite the casualties, the destruction and the exhaustion of the population. The Syrian army moved into Lebanon in July 1976 but did not succeed in stopping hostilities until after the inauguration in September of President Sarkis as successor to President Franjieh and the Arab summit of Riyadh in October. The key deci- sions taken at thaLt meeting were: to preserve Lebanon's territorial integrity and constitutional Government, to entrust an Arab force (mostly Syrian) with the responsibility for security, and to plan Arab financial aid for reconstruc- tion. Since then, hostilities have flared from time to time in the area bordering Israel where the Arab force has not penetrated; but security has been restored in the rest of the country. 6. The civil war has set back Lebanon's economic and social progress by several years. It has left deep scars on Beirut (where the center of the city, the port and several suburbs were devastated), several other cities and many villages. Although only a preliminary inventory of private and public losses due to the war has; been made, extensive destruction in all sectors, but espe- cially in housing, trade and public services is evident, with damages roughly estimated at $2-3 billion. Overall, the country's productive capacity was reduced by perhaps; as much as 40-50 percent at the end of 1976 by comparison with end 1974. Th,e greatest reduction in productive capacity seems to have been in services, followed by industry and agriculture. The war left even deeper scars on thie population. The death toll, mostly among young men,  -3- reportedly was in excess of 40,000, with as many as 100,000 wounded. Some 800,000 people fled the country, most of them temporarily, although a sig- nificant number will probably stay abroad permanently. The conflict also displaced perhaps as many as 50,000 families (or 250,000 people) within the country. Geographically, new population groupings along sectarian lines emerged in some regions. In this process, many workers were separated from their places of work. Today, emigration and concern for security are hindering labor mobility and are causing high wages in areas adjoining pockets of unemployment. In brief, the conflict left the economy with substantial losses of productive assets and skilled manpower, and it created political obstacles to a quick resumption of activity. 7. In sharp contrast to the total disruption in economic activity, Lebanon's financial situation remained strong throughout the conflict as a result of large transfers from abroad. Net Foreign Assets were $1.5 billion at the beginning of 1976 and $1.6 billion at year's end. These amounts include $400 million of gold valued at $42 an ounce. However, the Lebanese pound depreciated by about 20 percent vis-a-vis the dollar between April 1975 and March 1977. Payment of Government salaries was never inter- rupted. Since Government revenues ceased to be collected between early 1976 and early 1977, such payment was made out of central bank deposits and advances, totalling about $400 million during the period. This large injec- tion of money into the economy, together with external capital inflows, helped limit the impact of the drastic decrease in economic activity. Domestic prices rose substantially in the case of goods and services which could not be supplied locally or imported (essentially gasoline, eggs, meat and dairy products). For most of 1976, some imports entered free of official licensing and duties. 8. Economic recovery has been underway since October 1976 when fighting ended in the whole country, save the South. Real GDP is however probably still roughly 30-40 percent below its 1974 level, and the immediate financial out- look is uncertain. Supply of foodstuffs and essential consumer goods seems adequate throughout the country, in part thanks to external relief assistance. Public utilities are functioning, although at a low level of service since plants were partly destroyed and stores were looted. Ships unload at the ports, despite the quasi total destruction of port equipment in Beirut. Manu- facturing is reportedly back to 60 percent of the still existing capacity, restrained by limited labor mobility, difficult input supplies and insuffi- cient working capital. Banks re-opened on January 17, but are still in the process of normalizing creditor-debtor relationships with most of their borrowers. Government services are still greatly diminished by comparison even with their insufficient pre-war capability for overall policy making and planning as well as for project preparation and implementation. However, they have been resuming work progressively since January 1977. In particular, the Ministry of Finance is functioning nearly normally. Since early March 1977, it has resumed collection of tax revenues. The 1977 current budget anticipates revenues in an amount of about LL 1.0 billion while expenditures would reach nearly LL 1.3 billion, resulting in a current budget deficit of about LL 300 million. Estimates of capital expenditures for reconstruction and development are being prepared and some outlays have begun. While external financing from Arab and other sources has been pledged to cover part of the capital expenditures, it is likely that reliance on Central Bank advances will  - 4 - continue to be substantia1. This and some credit expansion to the private sector would mean a relatively rapid growth of domestic demand, and probably pressures on the domestic price level, exchange rate and external reserves later in 1977. Lebanon's substantial foreign exchange reserves are expected to absorb such pressures. 9. President Sarkis and the new Cabinet formed in December 1976 were given full legislative powers by Lebanon's Parliament until June 30, 1977, and have the support of the quadripartite commission (Saudi Arabia, Syria, Kuwait and Egypt) overseeing the peace-keeping efforts of the Arab force in Lebanon. The Government priority objectives have been the restoration of security, the resumption of economic activity, and the reconstitution of the Lebanese Army. Substantial progress has been made on the first two objectives, while a new Army is slowly taking shape. In the economic field, a wide ranging set of measures has been taken which is expected to limit the claims on Government for war damages and relies on the banking system and on the resiliency of the economy to spur reconstruction and economic activity. The country's response to these measures has generally been encouraging. On the other hand, the resolution of the basic issues related to the Palestinians' presence and role in Lebanon and to the domestic political and social imbalances has been deferred and may have to await a settlement of the broader Middle-East problems. 10. Lebanon's public external debt and debt service are low. At the end of 1976, total public debt amounted to an estimated $74 million, of which $40 million was disbursed. Bank loans represented respectively 65 and 37 percent of these totals; loans from government accounted for nearly all the remainder. In 1976, public debt service was only an estimated $7.4 million. Despite the exceptional circumstances, most Government services were able to meet their obligations almost on time; the difficulties met by the PTT in conjunction with payments on suppliers' credits are in the process of settlement, with Government assistance (see paragraph 38). In future, while public external debt is expected to increase, the growth of debt service obligations should be relatively slow since the Government's policy is to rely mostly on official sources offering concessional terms. Assuming conservatively that exports regain their 1973 level ($1.2 billion) around 1979, and grow thereafter by 5 percent a year in real terms, total debt could rise to $1.5 billion by 1980 without causing debt service to exceed 10 percent in any year over the long run. The large scope for additional borrowing within prudent debt management limits, the likelihood, if security is maintained, of a minimum recovery and expansion of private export production, and the likely availability of sub- stantial external funds on concessional terms are the basic elements pointing to continued soundness of Lebanon's creditworthiness. Moreover, the resiliency demonstrated by its people in rebuilding Lebanon's economy immediately follow- ing the end of the civil disturbances justifies confidence in sustained economic growth in the longer run. Lebanon can therefore be considered creditworthy for the proposed emergency Bank loan.  - 5 - PART II - BANK GROUP OPERATIONS IN LEBANON 11. In keeping with the conservative borrowing policy followed by the Government since independence, Lebanon's recourse to Bank lending has been very limited so far, although there was an increased awareness of the need to resort to external financing for economic and social investments in recent years. Prior to the outbreak of hostilities in 1975, the Bank had made three loans only to Lebanon for power (in 1955), education and highways (in 1973) totalling US$66.6 million equivalent of which US$47.0 million were outstand- ing as of May 31, 1977. Negotiations for the South Bekaa Irrigation project were completed in 1974 and Board presentation had to be delayed pending Parliamentary approval of bills on land betterment tax and regulation of water rights. A second education project, intended to follow up on the first one, was appraised in early 1975 and negotiations scheduled for September 1975 could not take place because of hostilities. The main focus of the Bank's activity in Lebanon was to participate in much needed investments for infra- structure and social services and in projects intended to reduce disparities between the various population groups. IFC has been active in Lebanon in the years immediately before the war. It approved three loans totalling $6.03 million for the financing of textile and ceramic industries and a participa- tion in the equity of Bank of the Near East which was established to provide medium and long-term finance mainly in the mortgage field. Service on Bank loans was only temporarily interrupted during the second half of 1976 and all arrears were promptly settled when contacts with the Government resumed. Annex II contains a summary statement on Bank loans and IFC investments as of May 31, 1977 and notes on the execution of ongoing projects (also see para 19 below). 12. The outbreak of hostilities brought to a complete halt the implementa- tion of the Education project (Ln. 877 LE) and the Highways project (Ln. 944 LE). Initial difficulties in staffing the Project unit delayed the commencement of execution of the Education project for which construction had not yet started in April 1975; consequently, no disbursements were made out of the $6.6 million loan. Execution of the First Highways Project (Loan 944-LE) was progressing satisfactorily when construction activities had to be interrupted in October 1975. Apart from flooding of excavations for a tunnel near Chekka, no damage has occurred to major road structures already built and contractor's equipment, for which a total of about $5 million were disbursed from the $33.0 million loan. The Government has requested that it be allowed to use the undisbursed balance of the above two loans to finance respectively the rehabilitation of its vocational and technical education system and a priority road construction, and Highway maintenance program as well as urgently needed highways feasibility and engineering studies. Amending documents for proposed changes in the Project Description and Reallocation of proceeds of Loan 877-LE and Loan 944-LE are being circulated to the Executive Directors simultaneously with the documents concerning the proposed loan. 13. The new cabinet constituted in December 1976 had as major task the reactivation of the economy. After a broad preliminary assessment of the damages, the Government contacted potential donors and specifically requested  - 6 - the assistance of the Bank. A Bank mission visited Lebanon in February/March 1977 to review the reconstruction and development priorities set out by the Government as well as the needs and available resources and, in the light of the findings of a previous IMF/Bank mission, determine how the Bank could most effectively assist in Lebanon's reconstruction. It reviewed needs in trans- portation, education, telecommunication, agriculture and low-cost housing. A subsequent mission to Lebanon in April assessed the needs in the water supply and sewerage sector. PART III - RECONSTRUCTION PROGRAM 14. The Lebanese economy played before the civil war the role of an international service center in the Middle East. The need for such an expe- rienced and well structured service center in the Middle East remains; none has developed to replace Beirut over the past two years. With the otherwise limited resource base of the country, neither substantial expansion of agri- culture beyond its previous stage of development nor of industry considering the sector's limited manpower basis could replace the services sector as main basis of the Lebanese economy. The top priorities of the Government are therefore to reestablish the conditions necessary to facilitate the recovery of the private service sector, including international transport, which critically depends on free and efficient communications. At the same time, the Government is committed to taking steps towards redressing the severe social and economic imbalances that contributed to the civil disturbances. 15. Despite lack of staff and destruction of physical facilities the Government has managed to partially restore operation of public utilities and services and to introduce an impressive array of measures under the emergency powers given to it by Parliament. The pattern in these measures is to direct Government intervention towards the strengthening of the public sector and to improve regulation of the private sector, on whose initiative and resources the bulk of the responsibility for repairing war damage will fall. The general policy followed is three-pronged: (a) to restrict the State's liabi- lities for war damnages to the public sector and to extreme hardship cases in the private sector; no compensation is envisaged for losses incurred by individuals and businesses; (b) to ensure that the private sector receives the full support of the banking system, with the Government assuring part of the risk for reconstruction loans; and (c) to seek external aid in order to restore public finances and the balance of payments and to secure financing for both public and private reconstruction. 16. Overall economic planning has been traditionally weak in Lebanon. To overcome this weakness, a major step has been taken by the new Government through the estabLishment of a Reconstruction and Development Council. The Council, staffed with some of the best Lebanese talent, has been vested with broad powers to develop and implement a national reconstruction and develop- ment program, to ensure coordination between ministries and to assume respon- sibility for foreign and domestic borrowing. It is currently reviewing the reconstruction plans prepared by various public institutions and negotiating external assistance to finance them.  -7- 17. Operation and project implementation capability in the public sector is being rebuilt. A number of public agencies such as the Ministry of Posts and Telecommunications (PTT), the Electricity and Water Companies and the Airport Authority are back in operation. The public company responsible for operating the port of Beirut--Societe de Gestion et d'Exploitation du Port de Beyrouth (SGE)--is handling reduced traffic but rapidly expanding as well as possible under existing circumstances. The Conseil Executif des Grands Projects (CEGP)--an autonomous agency within the Ministry of Public Works, responsible for administration and control of major construction projects--is gradually rebuilding its prewar capacity. Other Government agencies are operating under considerable difficulties which will take time to overcome. 18. To assist in private sector reconstruction several measures have been taken. The role of the industrial bank--Banque Nationale pour le Develop- pement de l'Industrie et du Tourisme (BNDIT)--has been expanded, a new housing bank has been created and a system of special bank advances has been put into effect to help traders who have lost their assets during the civil war. In- creased responsibility has been lodged in the cooperative credit union and the Green Plan authority to assist farmers in their reconstruction and re- equipment efforts. 19. Apart from emergency relief from several sources and FAO assistance, and pending the availability of prepared reconstruction and development proj- ects, little external assistance has been mobilized so far. Several Arab Funds have recently agreed on a substantial assistance program which is sub- ject to approval by the national authorities concerned. A $50 million quick- disbursing aid package has been granted by the USA in February. The same month, Lebanon signed an agreement with the EEC providing for the equivalent of US$34 million in financial assistance over the 1977-81 period, as well as for trade concessions on the part of the EEC. PART IV - THE PROJECT 20. The Bank missions referred to in para 12 concluded that the Bank should assist in the rehabilitation of the Port of Beirut and telecommunica- tions as the most effective means to open up the major bottlenecks impairing the resumption of economic activity, especially in the crucial services and industrial sectors where fast recovery was deemed possible. The Bank would also assist in financing most urgent rehabilitation works for the water dis- tribution system in Beirut and preparing technical studies for reconstruction and development projects in selected sectors such as low-cost housing, indus- trial estates, mass transit, water and sewerage, and integrated rural develop- ment for the most deprived regions of the country. Also, amendments to Loans 877-LE (Education) and 944-LE (Highways) were necessary to help meet the most urgent needs in the respective sectors. Memoranda proposing such amendments are being circulated concurrently to the Executive Directors.  - 8 - 21. T case for Bank assistance on an emergency basis in support of Lebanon