Burdensome Subsidy System Exacerbating Fiscal Crisis

BMI View: Reform of Libya's subsidy system is a long way off despite recent proposals, and this will contribute to the ongoing fiscal crisis. We forecast the fiscal deficit to come in at 26.3% and 6.5% of GDP in 2014 and 2015 respectively. Although our core view is for the government to muddle through the crisis, risks to fundamental financial stability will remain significant over the coming quarters.

The Libyan government's plans to limit its costly fuel subsidies are unlikely to materialise over the coming quarters, and this will contribute to the ongoing fiscal crisis. Authorities have long recognised the need to reform the burdensome subsidy system, a legacy of Muammar Qadhafi's rule that affects items including petrol, bread and airline tickets. Subsidies amounted to approximately LYD10.6bn (USD8.7bn) in Libya in 2013, equivalent to 15.9% of the total budget for the year. Expenditure from energy subsidies is equivalent to more than 11.0% of GDP, and food price subsidies are equivalent to approximately 2.8% of GDP.

Reform Much Needed...

Exports Collapsing In 2014
Libya - Oil Production, Consumption & Net Exports

Burdensome Subsidy System Exacerbating Fiscal Crisis

BMI View: Reform of Libya's subsidy system is a long way off despite recent proposals, and this will contribute to the ongoing fiscal crisis. We forecast the fiscal deficit to come in at 26.3% and 6.5% of GDP in 2014 and 2015 respectively. Although our core view is for the government to muddle through the crisis, risks to fundamental financial stability will remain significant over the coming quarters.

The Libyan government's plans to limit its costly fuel subsidies are unlikely to materialise over the coming quarters, and this will contribute to the ongoing fiscal crisis. Authorities have long recognised the need to reform the burdensome subsidy system, a legacy of Muammar Qadhafi's rule that affects items including petrol, bread and airline tickets. Subsidies amounted to approximately LYD10.6bn (USD8.7bn) in Libya in 2013, equivalent to 15.9% of the total budget for the year. Expenditure from energy subsidies is equivalent to more than 11.0% of GDP, and food price subsidies are equivalent to approximately 2.8% of GDP.

Reform Much Needed...

The need for reform has increased significantly over the past few quarters. Gasoline and diesel consumption rose by 15% between 2012 and 2013, more than the usual 3-7%, and cabinet spokesman Ahmed Lamin attributed this to an increase in smuggling, mainly to Tunisia. The subsequent uptick in the cost of subsidies is being accompanied by declining government revenues. Oil exports - which accounted for 95% of total government revenues in 2011 - have dried up as major oilfields and ports have undergone a nine-month shutdown due to political unrest and local disputes. Although federalist rebels in the Cyrenaica region of eastern Libya reached an agreement with Tripoli in April to reopen four oil ports in the region, the agreement remains prone to reversals. As an illustration, eastern federalists said that they are unwilling to negotiate with newly appointed Prime Minister Ahmed Miitig, who was confirmed by the General National Congress (GNC) - the country's parliament - on May 4. Energy production will remain volatile, in our view, and BMI's Oil & Gas research team forecasts total hydrocarbon exports to decline by 56.5% to 377,600 barrels per day (b/d) in 2014 before increasing by 117.9% in 2015 under the assumption that the political situation improves.

Exports Collapsing In 2014
Libya - Oil Production, Consumption & Net Exports

...Yet Unlikely

In the latest of several proposals designed to reduce subsidies, Lamin said on April 17 that the government was proposing to introduce a 'smart card' system through which citizens would be able to buy a limited amount of subsidised fuel and pay for any extra quantities at market price. That said, we reiterate our view that the government's ability to enact structural reform to subsidies is limited, and we do not expect to see a sizeable reduction in public spending on such items over the next few years. Indeed, the various governments that have followed one another since the deposition of Qadhafi have been reluctant to cut subsidies, as Tripoli uses current expenditure to maintain public support to its rule. Even if subsidy reform is approved by the GNC at some point, we cannot exclude the possibility of policy reversal further down the line. More importantly, perhaps, the central authorities' ability to implement reform will remain limited given their lack of effective control over the country's territory.

Fiscal Position Fragile
Libya - Fiscal Balance

Government Muddling Through Despite Risks

Despite declining revenues, we do not foresee a sharp drop in current spending this year, and we forecast the government's budget to come in at a deficit of 26.3% of GDP in 2014 and 6.5% in 2015, from our estimate of a 1.8% deficit in 2013. Our core view is for the government to muddle through the current fiscal crisis; Tripoli will resort to tapping into extra reserves from unused government spending, unused balances in several government agencies and its buoyant foreign reserves to finance its expenses. Foreign reserves amounted to USD118.6bn in November 2013, equivalent to approximately 43.2 months of imports, and represent a significant cushion against systemic risks to financial stability.

This is not to say that risks of a full-blown fiscal crisis are off the cards. Should oil exports fail to increase in H214, the government's resources might not be enough to pay salaries and maintain the subsidy system, a situation that could dramatically worsen the political crisis.

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