With ATMs and bank facades being smashed, employees being taken as hostages, pressure and terror have become the ultimate weapon for the Lebanese citizens to withdraw their money. There have been long ques outside the banks, people waiting with uncertainty whether they will gain access to their money or return home empty handed. The Central Bank of Lebanon (Banque de Liban) and local lenders have been rationing dollars, pushing up demand for the foreign currency but that has given rise to a parallel black-market rate for the local currency (Lebanese Pound -Lbp) that’s currently 30% higher than the fixed rate. The Lebanese pound has been diverging from its current peg to the US dollars due to its worst economic and financial crisis since 1975-90 civil war. It currently stands at 1507.5 to one US dollar in the official market and 2600 in the black market. Recently the government has capped the dollar exchange rate at 2000 lbp in a bid to prevent further devaluation.
Curious as to what led to this economic meltdown and liquidity crunch? Let’s take a look at the factors which triggered this crisis in detail.
Factors Leading Up to the Crisis
Before going further into the problem, it is imperative to understand Lebanon’s economic and political structure and its background so that the factors responsible for the crisis can be understood in their entirety.
Lebanon has a very long history of huge public debt and external imbalances that goes back to the period of post-civil war reconstruction in the 1990s. What’s more disappointing from retrospect is the period immediately following the Global financial crisis of 2008, which saw a huge inflow of capital from all over the world into Lebanon ($30bn) due the dull market conditions. These inflows were made a lost opportunity in turning things around. This resulted in a huge increase in inflation owing to the capital inflows and led to the real appreciation of the Lebanese pound. Though it paved way for the decline in debt-to-GDP ratio, much more could have been done to boost long-term economic growth and to improve Lebanon’s financial position.
1. Fixed Exchange Rate and Twin Deficits
Since the government was following a fixed exchange rate system it was anxious in maintaining high levels of foreign currency reserves to defend its peg. Lebanon has also been suffering from its twin deficit – current account deficit and budget deficit since 1990’s. This resulted in the total public debt to rise to a humongous 145% of GDP in 2013, culminating in the implementation of unconventional financial engineering policies which resembled a Ponzi scheme in the making.
In order to finance the deficit and maintain high reserves the Central Bank (BdL) borrowed from the commercial banks at a high rate. This was like a pyramid scheme, in which the commercial banks received deposits from its large diaspora living in abroad as well as from the locals and in turn investing them in the BdL for a much higher rate. A side effect of this was that the local banks made money through the favourable interest rates and kept on buying up government debt as opposed to investing in productive industries. At one point about 57% of the banking sector’s assets was with the Central Bank.Paradoxically, the attempt to protect gross foreign reserves then led to a large reduction of the central bank’s net reserves and the credit ratings decreased drastically. Lebanon declared an economic emergency Sept. 2 following a downgrade from two of the three major credit rating agencies and slowed GDP growth — 0% according to the credit rating agency Fitch.
2. Political Unsettlement and Corruption
More likely, the trigger for the current crisis can be related to the mysterious resignation and disappearance of the Prime Minister Hariri following the claim of him fleeing to Saudi Arabia in 2017 and later coming back to claim his power only to resign along with his cabinet on 29th October, 2019.
This instability caused outflow of investments. It was after this series of events the resident bank deposits truly collapsed, interest rates spiked, bank lending to the private sector declined and GDP growth dropped to 0.25 per cent. The situation was critical and intense so that even the IMF financial report was never released, fearing it could instil a negative sentiment among the public.
Another vital factor responsible for this crisis was the corruption that was so dominant partly due to political instability and inefficiency of the government. The country has never shown signs of political uprightness nor the will to fight against corruption.
Impact of the Crisis
The above factors led to a cash crunch. Since all the cash was either deposited in the central bank’s reserve or in their treasury bill, commercial banks didn’t have enough money for everyone who came for cash withdrawals or transfers. The worst hit were the people at the bottom of the economic ladder – the Syrian refugees.
This crisis created high tension among the public and shook the nation for the past few months and amidst this, Hasan Diab sworn in as the new Prime Minister on 22nd January, 2020. Though the formation of the new government was meant to give greater stability for the economy, it has had a major drawback – this newly formed government is said to lack international support and holds hardly any funds from the Gulf nations as it is being backed by Hezbollah (Iran-backed terror group), and its allies.
With everything that was going on, $1.2 billion Eurobonds are set to mature this March 2020, while the nation is facing a major debt crisis. Also, the recent demotion of the credit ratings to a CC by Fitch (Rating Agency) has added fuel to the flame. The Central bank doesn’t want to bring any structural reform (Float the Lbp) to its fixed exchange system as it doesn’t see any immediate benefits that the move might bring about.
What lies ahead?
As uncertainty compels individuals from the middle to wealthier classes to convert their savings accounts from Lebanese pounds to dollars, the need of the hour is a more transparent and stable government that can win back the lost trust. With a new stable government in place and a cabinet filled with technocrats, the nation could move on to secure an IMF programme since there are no other viable sources of funds.
The bottom line is that Lebanon needs a strong government to bring in the much needed economic and political reset through structural reforms, if its economy is to be pulled out of chaos.
WRITTEN BY:
Pavithran M.
Yorumlar