In last year’s final issue, MEES asked whether the ‘music would stop’ for Lebanon’s economy in 2019 (MEES, 21 December 2018). One year on, and the fat lady is close to bringing the house down.
The writing, after all, has been on the wall for years. Lebanon has failed to record 3% GDP growth since 2010 (see chart 1), all the while racking up enough debt to give it the third highest debt-to-GDP ratio globally at 150%. The suggestion that Lebanon’s economy would take a turn for the worse in 2019 looks like a massive understatement.
The Lebanese government – practically paralyzed from infighting throughout the last decade – did little to help the low growth climate, which in fairness was partly due to the war in neighboring Syria. A whopping 77% of government spending since 2011 has gone toward three items (see chart 2): government salaries (33%), payments on the interest of the government’s now $91bn debt (32%), and subsidizing fuel imports for power generation (12%). Hardly a recipe for economic growth.
Despite routine ratings agency downgrades (MEES, 8 March) and pressure from the IMF (MEES, 6 September), a political class rich enough from corruption and powerful enough from political patronage had long appeared able to withstand the pressure.
And to its credit, the political oligarchy (headed by Western friendly Prime Minister Saad al-Hariri) even managed to bag $12bn in aid pledges from the international community (MEES, 13 April 2018), promising only vague platitudes of fiscal reform in return.
Behind the veneer of big debts and big reform plans, Lebanon’s economy has been slowly rotting from the inside, and perhaps most surprisingly, from arguably its most respected institutions – the central bank (Banque du Liban; BDL) and its robust retail banking sector.
For all the country’s political problems, it had somehow managed a clever balancing act to keep it afloat, and even fund a remarkably lavish lifestyle for a country with $10,000 per capita GDP. The Lebanese Pound (LBP) had remained pegged to the US dollar at 1,500 LBP to $1 since 1998, providing the economy with stability, increasing purchasing power, limited inflation and an overvalued workforce.
And although Lebanon’s non-existent industrial or agricultural exports coupled with a love for foreign imports meant dollars were constantly flowing overseas, the country had some unique things going for it.
For one, the Lebanese are a famously successful diaspora with an estimated 2-3 times more living abroad than in Lebanon with its population of six million. This meant a healthy flow of remittances (a 15% GDP injection, in US dollars to boot), deposits in Lebanese banks to capitalize on fantastic interest rates, and a robust tourism industry (mostly from foreign visitors). The constant influx of dollars kept the dollar peg – and the security it provided – firmly in place.
But in the last couple of years, inflows have flatlined whilst imports have continued to rise, leading the country’s current account deficit to soar. Lebanon for 2018 had the world’s worst current account deficit – a whopping 23.7% of GDP (see chart 3). The 2014 crash in oil prices and subsequent effect on the GCC economies (where many Lebanese work) was a major factor.
To compensate, Banque du Liban continued to raise interest rates (which have routinely exceeded 10-15% in recent years) on bank deposits to attract foreign dollars, in addition to several other obscure ‘swaps’ arrangements dubbed by the central bank’s long-time honcho Riad Salameh as “financial engineering” (MEES, 25 May 2018).
This year, the complex weave between the central bank, finance ministry and banking sector began to come apart at the seams. It’s become abundantly clear that the central bank has nowhere near enough liquidity to back the billions in dollar denominated bank accounts (let alone the accumulated interest) of Lebanon’s retail banks – essentially triggering an end to the peg, a massive run on the banks, a prolonged shutdown of the banking sector, and now cruel informal capital controls depriving depositors of their access to dollars and to a lesser extent Lebanese pounds sitting in their own accounts.
The Banque du Liban maintains the 1,500 LBP official rate for a few key imports (like medical supplies), but with dollars no longer easily accessible and a peg for non-essential items no longer in place, the currency has now begun to float, and with it much of the country’s personal savings (see chart 4).
Whilst nobody knows where the situation is headed, both Lebanese citizens and analysts mostly believe the crisis is only in its early stages. On the banking front, something must give. Some have called for a haircut on the largest accounts, whilst others have speculated that all current and savings accounts – the majority of which are denominated in dollars – will be forcibly converted into Lebanese Pounds.
The situation has given rise to a particularly odd phenomenon known as the “Lebanese Dollar” (or “Loller”), which are US dollars ‘stuck’ in Lebanon, since they cannot be used outside the country. Whilst still technically belonging to the depositors, few actually think these dollars will ever be returned at the 1,500 LBP rate, or even at a slightly discounted rate. Others suggest the banks may compensate through lowering interest rates, but such a solution is unlikely to address the depth of the problem.
The situation is looking increasingly dire. This week Fitch lowered Lebanon’s credit rating to CC, a whopping 10 notches below investment grade, and just one notch above C, which signals “default imminent.” And this is where Lebanon’s current monetary/banking crisis combines with the aforementioned fiscal problems to paint an even darker picture of the situation.
Most of Lebanon’s debt, around 62%, is held in domestic banks, which has long been given as a reason why a default is unlikely. After all, local banks live off government borrowing and would easily refinance to avoid mutually assured destruction (not to mention the political ties between the banks and governing elites).
But if the central bank cannot back deposits in commercial banks, it means the government cannot rely on in-country institutions for help, and at the same time would have no chance of borrowing internationally given its current fiscal state.
Furthermore, the current crisis has removed any semblance of prestige that the Lebanese banks once had, and 10%+ interest rates are likely a thing of the past. So with little incentive to bank in Lebanon, foreign deposits will dry up further. A perfect storm looks to be brewing, with Beirut lying right in its path.
THE UPRISING CONTINUES
For any government to navigate such disturbing problems, strong cooperation and public backing would be essential to righting the ship. And Lebanon currently has neither. Anti-government protests erupted on 17 October, essentially shutting down the small Mediterranean country (MEES, 1 November) and subsequently costing Mr Hariri his job (MEES, 1 November).
The demonstrations’ momentum has eased slightly in recent weeks, but the public nonetheless appears keen to call for a new leadership regardless of the severity of the economic crisis and calls from the international community to form an immediate government.
Progress on government formation appears to finally be pushing forward, with some of Lebanon’s major political parties (but not Mr Hariri’s key Sunni party, the Future Movement) coming together on 19 December in favor of Hassan Diab as prime minister designate. Lacking a support base of his own, the American University of Beirut professor and former Education Minister is likely doomed from the outset – even if he manages to form a government.
It is difficult imagining Mr Diab succeeding as a ‘consensus’ candidate, indeed he to an extent is representative of the very elite ‘consensus’ system the protests are targeting. If Mr Diab even manages to make it into the new year, he will find himself dealing with the worst situation the country has faced since its 15-year civil war. The fact that the same power brokers are now tasked with handling the tempest of their own creation hardly strikes confidence – domestically or abroad.