Dec 29, 2020
Lebanon’s Financial Crisis – Policy inaction at its worst

Lebanon is facing a financial crisis of unprecedented proportions. After piling-up unsustainable levels of debt (equivalent to circa 180% of its GDP today) to prop-up its rentier and consumerist economy from the early 1990’s to 2018, its day of reckoning has come. Being a heavily import-dependent nation with rapidly depleting foreign currency reserves, Lebanon has defaulted on its sovereign debt. Its 30-year currency peg of 1507.5 Lebanese Lira to the dollar has broken, nosediving the exchange rate to over 8000 LBP to the USD in the parallel market, thereby leading to a collapse of purchasing power in this import-dependent nation by north of 60%. The country has entered a hyperinflationary phase, with year-on-year inflation levels approaching 130%. One third of the working population is now unemployed, and over half of the population is living in poverty. The banking sector is insolvent, with people’s lifelong savings worth and aggregate of $180bln stuck in the banking sector due to the de-facto capital controls, with little to no prospects of deposit recovery in sight. GDP is expected to contract from $58bln in 2018 to $18bln in 2020; a real contraction of 25% in one year.

What has the ruling class done to tackle this crisis? Absolutely nothing. The only shy attempt to tackle this crisis took the form of a financial plan that was suggested by the government in April 2020, which would form the basis of negotiations for an IMF package. This plan however was derailed by the ruling elite and the banking sector, who were unhappy with the losses that they were expected to absorb as part of the financial plan. Workable alternatives to the now defunct plan were not suggested.

The political decision therefore was policy inaction; leaving the economy to naturally adjust without any stabilizers. The system is currently cleaning itself up, albeit in a socially costly and economically inefficient way. Consumption has nosedived due to the defacto devaluation of the Lebanese Lira by 80% and the resultant impoverishment of the Lebanese population, bringing imports down from $17bln in 2018 to an estimated $4bln in 2020. Diaspora will continue to send foreign currency through banking and non-banking channels to their family members. Those who can emigrate will likely do so, and like most of the diaspora will likely send money to their now poorer family members. In the medium-term, the balance of payments will rebalance at a huge societal cost through impoverishment and emigration.

The economy will eventually stabilize at a certain equilibrium. However, that equilibrium is far from being optimal, and Lebanon under that equilibrium will struggle to realize its true long-term potential. Odds are that post-stabilization economic growth would be sluggish, and poverty would be at record-high levels. Some people have termed what Lebanon is going through as a “lost decade”. Unfortunately, under this do-nothing status-quo, we are talking about a lost generation rather than merely a lost decade.

Of current immediate interest is the issue of subsidies in Lebanon. The current subsidies system is centred around BDL guaranteeing to import wheat, fuel, medication, and medical appliances by providing 85% of the costs at the exchange rate of 1507.5, when the de facto exchange rate is in excess of 8000. This subsidies system was expanded a few months ago to include 200 consumables guaranteed at the 3900 rate. This is burning through the ever so dwindling reserves, which have reached $17.8B, of which $17B are obligatory reserves that the central bank argues cannot be touched due to them being 15% of customers’ deposits.

It does not take much hindsight to claim that providing blanket subsidies to certain goods is bad economics. Global evidence shows that such subsidies mostly benefit the top 20% of the population. Successful welfare states tend to provide a comprehensive means-tested social protection and safety nets, in addition to the provision of health care and education across the board. One can argue that in hindsight, the cost of providing such a comprehensive social safety net may have been lower and more welfare-maximizing than subsidizing certain goods.

However, the cost of the current subsidies is assumed by the central bank through its dwindling reserves, and not through the government’s budget. Moving to a more comprehensive means-tested social protection would move the cost of subsidies from the central bank’s reserves to the government’s budget, which runs double-digit deficits (around 12% as of 2018). Absent fiscal reform, moving the cost to the budget would widen the deficit substantially. A deficit that will only be financed through central bank financing, currency printing and subsequently even higher inflation levels that will hit the poorest of society.


It is therefore necessary not to look at the subsidies issue in isolation, but rather look at it within a broader political, socio-economic, and macro-financial framework, as piece-wise measures will be futile and will, at best, only buy time. Subsidy reform should be placed in the context of overhauling Lebanon’s almost non-existent welfare system to provide a comprehensive and means-tested social protection. The provision of social protection and safety nets should be placed in the context of fiscal reform that frees much-needed fiscal space for social spending without imposing an inflation tax on the population through large deficit financing. Fiscal reform should be anchored against a broader macro-financial framework that restabilizes the economy, halts the economic collapse and places the economy back on track towards a sustainable and equitable growth trajectory that delivers the prosperity the Lebanese people very-well deserve. All these require bold and difficult political decisions on societal burden-sharing. There will be winners and losers in this process, and unfortunately, no one can get out of this unscathed.
 
 
Mohammad Faour
 
 
References:

1-World Economic Outlook, October 2020: A Long and Difficult Ascent:
https://bit.ly/3aRpL1M

2- http://www.annd.org/english/itemId.php?itemId=878#sthash.v1X3RuMP.DcRO8S2q.dpbs
 
3- Central Administration of Statistics: http://www.cas.gov.lb/index.php/economic-statistics-en




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