A wave of antigovernment protests have been seen around the world, since the beginning of last year, and are prominent even more so now. It can be dated back to October of 2019, when we first saw protests in Lebanon breaking out with citizens demanding for better living conditions. The protests were initially instigated due to an imposition of taxes on certain goods and services, but it was quick to embody a much larger purpose when the economy proved to be stagnant, unemployment kept rising to unimaginably high levels, and sectarian rule was sparking violent acts of condemnation. As a result of the country’s questionable long running monetary policies, the Lebanese pound fluctuated throughout the past year and has currently brought its value down to the lowest it’s ever been in decades, which fuelled the fire that people of the country were already protesting with.
Lebanon has had a history of high fiscal debt and imbalances that began in the post civil-war reconstruction period of the 1990s. Coordinated by France, donor conferences were held amongst several countries pledging to offer financial aid in order to restore economic stability and sustainability. However, this was not achieved. The $30 billion of capital, which amounted to 100% of the country’s GDP at the time, that entered Lebanon, was overlooked as an opportunity to make things better. The BdL, Banque du Liban, used a minimal amount of these inflows to increase their foreign currency reserves, all the while financing the expansion of their already deep current account deficit. This expansion, or at least a major part of it, corresponded with an increase in public expenditure. Cumulatively these lead to a burst in inflation, peaking at 10% in 2008, and resulting in the increase in value of the Lebanese pound. At that time, the tremendous growth also led to an improvement in the debt to GDP ratio. While this was great for the country in the short run, they did close to nothing to establish a long term stimulation of growth with the resources and inflows they were provided with, and that was the root cause of their downfall. This is precisely because of how dependant Lebanon became on foreign currency to help them out with immediate fixes in their economy, after the capital influx during the crisis in ’08-’09. Ultimately, the country adopted a monetary policy that deemed foreign reserves to be of prime most importance, over any other approach, in keeping their economy afloat.
Over the last decade, BdL persistently hiked their interest rates for deposits in order to fund for the government’s debt issue and pay for the large volume of imports the country relies on heavily, especially for food. It was also done to attract foreign currency, most importantly dollars, which the LBP has been pegged to for a legacy of 22 years. It was one of the few countries that was offering investors attractive rates of return, in contrast to the rest of the world that cut their rates to stimulate their economy, following the financial crisis. With this, it became a hub for global investors, looking for opportunities.
However, relying on USD was a risk that the central bank of Lebanon could and possibly should have avoided. They continued to pay higher rates to attract foreign funds into their country, even though the money was insufficient in covering interest and capital payments. The IMF (international monetary fund) stated that “…...for each new deposit at the BdL in USD, a bank would earn a 6.5% interest in USD and in addition, have an opportunity to borrow a slightly larger amount in LBP at 2% and redeposit it at the BdL at 10.5% for 10 years,” implying the strategy to be a Ponzi scheme that the BdL chose to adopt. Commercial banks’ customer dollars were lent to BdL at the aforementioned high interest rates, and in return, they purchased the government debt, simultaneously making profits on such transactions. Deposits within the central bank swelled by approximately 70% in a two year time span (2017-2019). Many bank shareholders are politicians, who were incentivised to continue with the scheme as they received dividends payed out by the banks. At the same time, the government kept amassing debt through corrupt spending measures in terms of buying votes through expanded public hiring, and doomed solutions for the country’s hurt electricity sector. By 2019, about 50% of the fiscal revenue was spent in covering external and domestic debt, while the rest went in paying public sector salaries. Lebanon is now the world’s third-most indebted nation with a 152% debt-to-GDP ratio.
We cannot omit the fact that some external factors, apart from a failed monetary policy, had a role to play in this financial crisis. The ongoing war in Syria, a neighbouring country, has created an influx of refugees into the Lebanon. This has aggravated pressures on public services like water and electricity. Lower oil prices have also exacerbated the situation as payments from Lebanese citizens staying in oil rich countries have declined. Overall, the dollars that previously helped to support the pound’s peg have significantly diminished, creating a loss of value.
The Lebanese pound is under soaring pressure. While the official peg remains at 1,500 pounds, the downturn has resulted in foreign-exchange dealers trading dollars at more than 4,500 LBP recently. When the central bank stopped providing foreign currency for imports, excluding wheat, drugs, fuel, baby milk, and medical equipment in October, along with the previously mentioned taxes imposed on certain goods and services, dollar conversions were cut. This forced companies to turn to the black market, also proving to be an important factor in the depreciation of the Lebanese pound. The depreciation has caused prices to shoot up, hitting disposable incomes harshly and forcing many Lebanese to rein in the free-spending lifestyles they had become comfortable with. The IMF stated that the peg is overvalued by an estimated 50% in recent years, and has warped the economy, hollowing out manufacturing and agriculture by making Lebanese goods less competitive in the global market. Sibylle Rizk, the public policy director at lobby group Kulluna Irada, noted that despite all of the dollars that have flowed into Lebanon, “We have no infrastructure, no productive sector. We have nothing. All this money was burnt on consumption… through imports and real estate, which is a bubble, and to defend the peg.”
Unfortunately, though generally a depreciation in currency can benefit countries in global export competitiveness, Lebanon isn’t one of them. Having no export sector of its own, any currency readjustment will have to be done through a contraction in imports, which would create worse situations for most economic activity in the country as they rely heavily on imports. Additionally, depreciation deteriorates the fiscal situation further, and has a negative balance sheet effect for the private sector. In this angle, it would be wiser to impose import taxes on luxury goods. Straying away from their tradition of years, of debt and foreign currency dependence, a restructuring and reorganisation of the public debt could be a saving grace, and seems to be the optimal path to choose for the country’s long run economic sustainability. This could be in the form of a lengthening of the maturity at lower interest rates without a face value reduction.
Even though the central bank has promised an injection of dollars into the market to bring back up value of the currency, with a crackdown on the black market, not only have the ministers been unclear and vague about the decision, but it can also be speculated as to whether or not it will loop them back into the same dangerous cycle they’ve been in for years.
Though the financial crisis began much before the corona crisis, with its roots embedded in structural and monetary policies tainted with political corruption, the virus did nothing but worsen the economic situation. Unemployment levels are the highest the country has ever seen, which is disastrous when paired with diminishing purchasing power due to a fall in the value of the currency. A fix is inevitable and there is no doubt it can be done, even if it takes an upheaval of the entire system to do so. With a disreputable regime that manifested and mismanaged these failed reforms, the only question in spotlight now, is who will do it?
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