Lebanon’s economy has collapsed. There is little confusion about why or what is needed to save it. The question is why nothing has been done.
For the last two decades, Lebanon had been living off capital inflows, averaging 20% of GDP per year. Thanks to high interest rates, deposits – largely denominated in US dollars – grew to about 400% of Lebanon’s GDP, with much of the money being lent to the state to finance large fiscal deficits. Last July, the current-account deficit was over 25% of GDP, and public debt exceeded 150% of GDP. Government securities and deposits at the central bank accounted for 14% and 55% of bank assets, respectively, for a total sovereign exposure of nearly 70% of assets. Meanwhile, GDP growth has been close to zero since 2011.
The house of cards collapsed late last year, when large withdrawals led to a run on deposits, followed by a sudden stop to capital inflows. By the beginning of this year, Lebanon was mired in a triple crisis: both the state and the banks were bankrupt, lacking liquidity and unable to borrow, and the country suffered from a yawning external deficit.
In March, the government announced that it could not meet its debt-repayment obligations. Hoping to stave off a sovereign default, it then worked with international experts to develop an economic-reform plan that would address the economy’s weaknesses, including by reducing public debt, shrinking the fiscal deficit, and devaluing the Lebanese pound. A banking-sector restructuring – with a significant share of the immense losses (about $90 billion) set to be borne by bank owners and large depositors – was also planned.
So far, not a single step has been taken to implement any of these reforms. Lebanon’s government did request some $10 billion from the International Monetary Fund, but negotiations have gone nowhere. In the meantime, the authorities have not even imposed capital controls – the most fundamental response to a financial crisis.
Progress has been made toward shrinking the external deficit, but not in a way that should be welcomed. Imports have collapsed by nearly half since 2018, owing to the currency crisis. This, together with a lack of access to credit and the COVID-19 shock, has caused many firms to shut down. Meanwhile, GDP has declined by double digits, unemployment has soared above 30%, and the poverty rate has skyrocketed to 50%, decimating the middle class. A human-capital exodus has begun.
In this context, the government’s failure to act may seem shocking. Yet torpor is in Lebanon’s political DNA. The country has a byzantine sectarian power-sharing system, often paralyzed by squabbling and corruption. Lebanon’s political elites know that the prospect of a flood of refugees is a powerful bargaining chip in international negotiations, so they are happy to subsist on foreign-exchange reserves while waiting to collect geopolitical rents.
Worse, Lebanon’s political and economic elites – there is considerable overlap between them – may be deliberately seeking to shift the losses resulting from their economic mismanagement onto the population. In May, the Association of Banks in Lebanon proposed its own economic-reform plan, which recommends using state assets to avoid damaging banks. In other words, ordinary people would bear the burden of adjustment.
Moreover, the central bank has fired up the printing press, inflating away its pound-denominated holdings in an effort to bolster its foreign-exchange reserves. The pound has lost 80% of its value in just nine months, with year-on-year inflation having reached 90% in June. At the same time, withdrawals from dollar-denominated bank accounts are being taxed at 50% or more, by converting them at the official exchange rate, rather than the much more advantageous parallel rate.
This approach – essentially an adaptation of Argentina’s “Corralito,” the deposit freeze that was enacted in 2001 to halt a bank run – pushes losses onto the middle class, whose only option is to live on what remains in their bank accounts. It is also extremely costly economically. Absorbing the losses will take years, during which Lebanon will have to cope with a lack of capital inflows, a monetary anchor, or trust in the currency and banking system.
At that point, Lebanon’s elites seem to hope, the country will have created enough fiscal space that they can secure a favorable deal with international creditors and reprise their plundering of the state. This would set the stage for a grim future, in which elites claim an even larger share of a much smaller pie.
Yet there is reason to hope that they won’t get their wish. Last October, a national protest movement emerged, fueled by years of pent-up rage. In recent months, that movement has begun to mature, with protesters organizing into groupings that aim to overhaul the country’s political system.
Of course, Lebanon’s sectarian political system will not be upended easily, not least because sectarianism feeds on fear and insecurity. But the scale of the current crisis has shattered the regime’s legitimacy. Even Iran-allied Hezbollah, which has thus far defended a political arrangement that protects its weapons, is fast losing popularity among its constituency.
It helps that the international community is, for once, standing firm in its demands for reform. Though this will probably cause the crisis to worsen in the short term, as Lebanon’s elites attempt to wait out their international interlocutors, it could ultimately force the country to enact real change.
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