Explaining Lebanon’s financial crisis and how it happened By Reuters
© Reuters. A damaged ATM is pictured in Beirut, Lebanon March 17, 2021. REUTERS/Mohamed Azakir/File Photo
By Edmond Blair
(Reuters) – Lebanon is in the grip of a deep economic crisis after successive governments racked up debt following the 1975-1990 civil war, with nothing to show for their spending spree.
Banks, at the heart of the service economy, are paralyzed. Savers were denied access to dollar accounts or told that the funds they had access to were now worth a fraction of their original value. The currency collapsed, plunging part of the population into poverty.
WHERE IS IT WRONG?
Lebanon’s financial collapse since 2019 is the story of how a vision of rebuilding a nation once known as the Switzerland of the Middle East was derailed by mismanagement as a borrowed sectarian elite with few constraints.
Downtown Beirut, leveled during the civil war, rose, with skyscrapers built by international architects and chic shopping malls filled with designer boutiques that accepted payment in dollars or Lebanese pounds.
But Lebanon had nothing else to show for a mountain of debt equivalent at the time to 150% of national production, one of the highest burdens in the world. Its power plants cannot supply electricity 24 hours a day and Lebanon’s only reliable export is its human capital.
HOW DID HE BORROW ALSO?
Some economists have described the Lebanese financial system as a nationally regulated Ponzi scheme, where new money is borrowed to pay off existing creditors. It works until the fresh money runs out. But how did the nation of around 6.5 million people come to this?
After the civil war, Lebanon balanced its books with tourism receipts, foreign aid, income from its financial industry and largesse from the Gulf Arab states, which funded the state by bolstering the bank’s reserves. central.
One of its most reliable sources of dollars was remittances from millions of Lebanese who went abroad to find work. Even during the global financial crash of 2008, they sent money home.
But remittances began to slow from 2011 as Lebanon’s sectarian infighting led to greater political sclerosis and much of the Middle East, including neighboring Syria, descended into chaos. .
Sunni Muslim states in the Gulf, once reliable supporters, have begun to turn away due to Iran’s growing influence in Lebanon, via Hezbollah, a heavily armed Lebanese Shiite group whose political power has grown.
The budget deficit soared and the balance of payments sank deeper into the red as transfers failed to match imports of everything from basic foods to flashy cars.
That was until 2016, when banks started offering remarkable interest rates for new deposits in dollars – a currency officially accepted in the dollarized economy – and even more extraordinary rates for deposits in Lebanese pounds. .
Elsewhere in the world, savers got tiny returns.
Given that the Lebanese pound had been pegged to the dollar at 1,500 for more than two decades and could be freely exchanged at a bank or by a supermarket cashier, what was there to lose?
The dollars flowed again and the banks were able to continue financing the expenses.
HOW CAN BANKS OFFER SUCH HIGH RETURNS?
Lebanon was still politically dysfunctional and rivalries had left it without a president for most of 2016.
But the central bank, the Banque du Liban, headed by former Merrill Lynch banker Riad Salameh since 1993, introduced “financial engineering”, a range of mechanisms that amounted to offering banks lavish returns for new dollars. . According to the bankers, it was a tactic that might have been appropriate if followed quickly by reforms – but not if, as it was, not enough happened.
The improvement in dollar flows translated into an increase in foreign exchange reserves. What was less obvious – and is now a point of contention – was an increase in passives. By some accounts, the central bank’s assets are more than wiped out by what it owes, so it can be sitting on big losses.
Meanwhile, the cost of servicing Lebanon’s debt has soared to around a third or more of budget outlays.
WHAT TRIGGERED THE COLLAPSE?
When the state needed to limit spending, politicians splurged on a public sector wage increase ahead of the 2018 elections. And the government’s failure to implement reforms meant foreign donors held back billions of dollars in aid they had promised.
The latest spark of unrest came in October 2019 with a plan to tax WhatsApp calls. With a large diaspora and Lebanon’s low tax regime skewed in favor of the wealthy, imposing a fee on how many Lebanese stayed in touch was disastrous.
Mass protests, led by a disenchanted youth demanding sweeping change, erupted against a political elite, including aging militia leaders who thrived while others struggled.
Currency inflows dried up and dollars left Lebanon. Banks ran out of dollars to pay depositors queuing outside, so they closed. The government also defaulted on its external debt.
The currency collapsed, slipping from 1,500 to the dollar before the crisis, to an exchange rate of around 23,000 at the end of January 2022, after hitting 34,000 earlier in the month.
To compound the problems, an explosion in August 2020 in the port of Beirut killed 215 people and caused billions of dollars in damage.
After a rapid economic contraction, public debt, by some estimates, was 495% of gross domestic product in 2021 – far higher than the levels that crippled some European states a decade ago.
WHAT HAPPENS NOW?
France has led international efforts to push Lebanon to fight corruption and implement the reforms demanded by donors. A new government was formed at the end of 2021, promising to relaunch talks with the International Monetary Fund. It has not yet implemented any significant reform policy.
Basically, politicians and bankers need to agree on the magnitude of the huge losses and what went wrong, so that Lebanon can change direction and stop living beyond its means.