Lebanon's Economy: To Avoid An Implosion - Emerging Market Views

Lebanon’s Economy: To Avoid An Implosion

Lebanon’s public debt now stands at 166 percent of GDP, 37 percent of which is denominated in foreign currency. The Banque du Liban is only days from having to redeem a $1.2 billion Eurobond, but even if this passes smoothly, two more Eurobonds due in April and June will only further aggravate the Central Bank’s precarious reserve position and would hardly spare the country the cascading economic crisis.

For several decades, Lebanon had demonstrated a particular skill at navigating safe passage through severe economic crises variously brought on by foreign invasions, civil war, regional tensions, political assassinations and even the absence of a government for extended periods. In this remarkable record of miracle-making, the country was always fortunate to have three firmly anchored pillars that always saved the day.

First, is a political system that even if cobbled together from different denominations and ethnicities was more or less inclusive and had been stress-tested more than once. It is still a delicately balanced construction and certainly needs reform, but in the hands of reasonable men and women, the system generally functioned satisfactorily.

Second, Lebanon is a liberal society and an open, market-driven economy underpinned by a banking system with deep roots in the country’s history. Benefiting from large and steady capital flows from a prosperous Lebanese diaspora and from nervous wealth in the less liberal neighboring economies, banks easily maintained high levels of liquidity, and this helped cushion the economic and geopolitical shocks that occasionally struck Lebanon.

Finally, Lebanon had always enjoyed powerful friends and allies in Europe and in the Gulf that came to its aid when in distress. In an earlier debt crisis in 2002, with the lead support of France and the Gulf countries, Lebanon attracted more than $4.1 billion (equivalent to nearly 20 percent of GDP then) in external aid which, together with an extraordinarily ambitious reform program, helped turn the economy around and spurred a resurgence of confidence and growth

However, in the past decade or so, all three pillars have weakened considerably, and this will make Lebanon’s ability to handle this economic crisis that much more challenging.

The rise of an assertive Hezbollah to dominate the county’s political system undermined the collaborative intent of the original national concord. Hezbollah’s entry into the civil war in Syria in alliance with non-Arab Iran further alienated powerful Sunnis in Lebanon and the region, and essentially disabled the national concord. As a result, the government barely functioned and remained unable to pass a budget since 2006.

What Lebanon needs to do now is to take the politically bitter medicine of approaching the international community, including the multilateral, and commit to the institutional and economic reforms that had long been debated but never agreed. International goodwill towards Lebanon may have diminished but it has not entirely vanished.

More significantly, the government pursued inappropriate macroeconomic policies and resisted structural reforms. These were designed to trim government spending, raise revenues, break up monopolies and privatize public assets. But to the ruling elite, this also meant a loss of patronage and reduced access to the public purse. Fiscal deficits grew persistently, the current account deficit widened (to 12 percent and 20 percent of GDP, respectively, in 2019), and the country’s debt ballooned.

With political paralysis in the face of economic deterioration, the central bank understandably chose to monetize the deficits, especially given ample liquidity in the system. But in doing so while defending the currency peg, central bank reserves dropped sharply (they may have turned negative by now) and the pound depreciated by more than 50 percent in the parallel market.

Lebanon’s total debt is both extraordinarily large and unusually complex, but in the final analysis, the critical component is the stock of Eurobonds of about $30.0 billion. And while the Central Bank has the funds for next week’s redemption, it is in urgent need of developing a comprehensive plan for the entire external public debt of $91.6 billion.

Lebanon may wish to tackle its debt problems piecemeal and on its own, but its options will quickly narrow, and the costs will inescapably rise. Moreover, paying back foreign debt now may be politically dicey, given that the country’s citizens’ access to their own foreign currency deposits is severely curtailed, a poverty rate that shot up to 40 percent and the country’s needs of essential foods and medicines becoming ever more urgent.

What Lebanon needs to do now is to take the politically bitter medicine of approaching the international community, including the multilateral, and commit to the institutional and economic reforms that had long been debated but never agreed. International goodwill towards Lebanon may have diminished but it has not entirely vanished. And it is only with the support of the international community that Lebanon can hope to achieve an equitable arrangement with its creditors, one that would secure for the country a modicum of stability and a potential for the revival of growth.

 

George T. Abed is Distinguished Fellow at the Institute for International Finance and former Director of the Middle Eastern Department at the International Monetary Fund. The views expressed are solely those of Mr. Abed and do not necessarily represent those of the IIF or any other organization.