BEIRUT: The International Monetary Fund suggested Friday that Lebanon should raise the interest rates on the Lebanese pound to make the currency more attractive for the country’s commercial banks.The recommendation was made in a report issued by the IMF’s staff on the performance of the Lebanese economy and the country’s fiscal deficit.

“Staff argued for allowing pound interest rates to rise. The [Lebanese] authorities felt that holding interest rates steady after the fall of the government in January has helped to prop up confidence. Staff noted that pursuing interest rate stability under the currency peg over an extended period has been costly for the Banque du Liban’s balance sheet and foreign reserves,” the report said.

IMF staff argued that letting interest rates on T-bills with maturities of less than seven years rise would compensate for higher risks and make them more attractive to banks, allowing the treasury to reduce its reliance on the BdL or the seven-year T-bills.

“This could also lower the average cost of borrowing and allow targeting a smoother maturity profile of government debt. The authorities broadly agreed, but felt that under current uncertainty marginally higher interest rates might not bring investors back while letting rates rise rapidly would risk undermining depositor confidence,” the IMF said.

The IMF hoped that a recent pickup in pound deposit inflows would eventually translate into greater demand for T-bills.

Staff supported a gradual move, but noted that the yield curve in the secondary market already shows higher rates for T-bills with lower maturities

International Investment Bank Merrill Lynch has also backed the idea of raising interest rates on the Lebanese pound.

The IMF also commented on the Lebanese Eurobond market.

“Steps to tap the Eurobond market are appropriate. Lebanon successfully placed $1.5 billion 7-, 9-, and 15-year Eurobonds in November 2011 ($1.2 billion of which involved exchanging Eurobonds maturing in 2012). Staff welcomed the reduction in financing needs in 2012,” the IMF said.

It supported the authorities’ intention to seek parliamentary approval for new foreign currency borrowing to take advantage of banks’ ample foreign exchange liquidity and globally low interest rates, and to reduce reliance on BdL reserves.

IMF staff noted that financing government spending through additional foreign currency borrowing could increase banks’ pound liquidity, which could then be channeled to the local currency T-bill market.

The IMF noticed that employment opportunities in Beirut were higher than in other Lebanese regions.

“Rapid [employment] growth during 2006-10 [was] concentrated in and around Beirut. Anecdotal evidence suggests that employment creation was limited and focused on low-paying jobs in the construction, retail and hospitality sectors,” the report said.

It added that as a result of this, unemployment, especially among the youth and educated, remains chronic and poverty is widespread.

“There was agreement that achieving higher and more sustained growth and, ultimately, making a tangible dent in unemployment and poverty requires a better infrastructure, business environment and labor market,” the IMF said.

It also praised the government’s efforts to invest more money in infrastructure projects.

“Telecom investments are making information technology services faster and more accessible throughout the country. Unlocking the sector’s growth potential, though, requires opening it up to competition and upgrading its regulatory framework; privatization could also be considered,” the IMF stressed.

It added that public-private partnerships could help attract private infrastructure investment, but these should operate within a sound framework that minimizes contingent liabilities for the public sector.

The IMF underlined the need to improve the business climate and labor market in Lebanon.

“While Lebanon’s business regulations fare relatively well compared with the region, staff noted that it is equally important to ensure transparent and even enforcement of rules. Labor market efficiency should be improved by attuning education to the needs of the market and reforming the end-of-service indemnity, which impedes labor mobility, while limiting government interference in private sector wage setting,” the report said.

The fund also insisted that strengthening competitiveness would support the currency peg.

“The peg to the U.S. dollar has served Lebanon well and remains the linchpin for financial stability in a highly dollarized economy,” it said.

However, the IMF believes that Lebanon’s economy lost momentum in 2011 after four strong years.

“Increased polarization of political parties since mid-2010, the fall of the coalition government in January 2011 and prolonged talks over the makeup of the new government until its formation in June shook market confidence. Compounded with the regional unrest, this led to an economic downturn, adversely affecting fiscal balances and financing conditions,” the IMF explained.

It noted Lebanese authorities have so far skillfully managed the downturn.

“[BdL] relied on its large foreign reserves built up during the upswing to intervene forcefully when the Lebanese pound came under pressure from deposit outflows and currency conversions in the wake of the government crisis in January 2011,” the report said.

It indicated that the improved fiscal position – thanks to the marked drop in the debt-to-GDP ratio since 2006 and the sizeable primary surplus in 2010 – freed up room for an accommodative fiscal stance in 2011 and allowed the government to maintain favorable access to the foreign currency debt market.

It also called on the government to implement strong domestic policies to counter rising risks.