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Where Lebanon is headed?

The explosion on 4 August in Beirut has not only caused the deaths of dozens of people but has also cast a shadow over the future of a country already strongly affected by an unprecedented economic crisis, which has been suffocating it for several months.
What was known, before the 1975 civil war, as the Switzerland of the Middle East is the country that from 2006 to 2009 despite a war and the financial crisis of Lehman Brothers had a GDP of 9% and had a kingdom of banks grinding profits on profits.
Now, a few months ago, the state in question officially went into default on 9 March.
In practice, Lebanon no longer has the money to pay Eurobonds.
It has not paid the first tranche of €1.2 billion and will almost certainly not be able to pay the remaining €90 billion.

A kingdom based exclusively on services, in particular banking, as Lebanon imports everything it consumes, has therefore entered into a phase of serious economic crisis. Phase in which there is still no agreement with the large organizations, the situation is therefore blocked.
The social and macroeconomic indicators, therefore, reveal a dramatic situation: according to data from the World Bank, the percentage of the population living below the poverty line is 45%. In the last decade, then, the unemployment rate has grown by 22 percentage points, while the youth rate has grown by almost 30%, while the public debt is at 170% of GDP.
So those who assume a scenario similar to Argentina or Venezuela cannot be accused of being excessively pessimistic.

The question, then, is: how has Lebanon come to this very serious economic situation?
Ever since the Taif Accords that ended the civil war (1975-1990), Lebanon has been a parliamentary republic of a confessional type: the major offices of the State are divided between the three major religious denominations – President of the Shiite Parliament, Sunni Prime Minister, President of the Christian-Maronite Republic.
If on the one hand, this political system has prevented new inter-community conflicts, on the other hand, it has hindered political cooperation and promoted corruption, cronyism and the defence of vested interests, thus limiting the effectiveness of policy-making.
Over the years, in fact, confessionalism has been translated into loyalty to one’s own religious confession, while loyalty to the unitary State and the common good was put in second. In this way, the “governance of public affairs” has become the instrument to allocate resources and build consensus through welfare policies, outside of any logic of inclusive and long-term growth.d place.
The weak institutional context reflects a picture of macroeconomic imbalance: large external current account deficits – 27% of GDP in 2019 – as a product of a currency, the Lebanese lira, artificially appreciated by a peg to the dollar, which favours imports of goods and inflates private consumption (83% of GDP in 2018).
To all this must be added the large fiscal deficits of the central government, financed directly or indirectly by the Lebanese banking system through a policy of raising interest rates for dollar-denominated deposits.
According to the International Monetary Fund (IMF), the reference interest rate in US dollars rose from around 7% at the beginning of 2018 to 9.7% in June 2019, while the debt to GDP ratio peaked at 170%.

What did that cause?
This has provoked massive inflows of American currency, mostly in the short term in search of financial returns, to finance the “twin” deficits.
This policy, endorsed and supported by Central Bank Governor Riad Salamé and a large part of the political and banking class, has enabled Lebanon to pay for its considerable volume of imports. In fact, as I mentioned earlier, the country is 80% dependent on imports for food and much of the oil supply, and must, therefore, attract dollars (particularly from the Gulf countries and the Lebanese diaspora) to maintain the fixed exchange rate of the local currency with the dollar 1$:1507.5 LBP.

The Lebanese system, therefore, went into crisis when the inflows of foreign currency deposits that financed the “twin” deficits fell considerably (unfavoured by the situation of political insecurity and the simultaneous collapse in oil prices, which ended up draining remittances from the Lebanese diaspora) and the economy went into a balance of payments crisis. From that moment on, therefore, with foreign currency reserves at their lowest levels and the consequent collapse of the Lebanese lira, the government found itself in a situation of insolvency and declared a default on all Eurobonds – the foreign currency debt – for a total value of 31 billion dollars.
Thus began the spiral typical of a currency crisis, with double-digit inflation, a decrease in real income, a rush to the counters and control of bank movements to contain the flight of capital (between direct and portfolio investments, almost 3 billion dollars according to the Institute of International Finance in 2019, more or less 5% of GDP).
It is therefore also important to remember that Lebanon has one of the lowest revenue to GDP ratios: 14.86%.
The subsequent resignation of Saad Hariri, December 2019, and the lack of progress in deficit reduction have therefore curbed Lebanon’s ability to attract capital, while at the same time increasing debt service costs – over 10% of annual GDP in interest just on the debt stock, almost 42% of total tax revenue.
This made it necessary to default.
In addition to this dramatic economic situation, there has also been the COVID-19 health crisis and the costs it produces, in a country marked by the weakness of automatic stabilisers and a small fiscal space, where 30% of the economy is informal and just under half of the workforce is unstable.
To this must also be added another extremely sensitive fact: the issue of Syrian war refugees. Lebanon is, in fact, the country with the highest rate of refugees per inhabitant in the world and this has a cost that should not be underestimated, especially in terms of health expenditure.

The IMF: the negotiations
In the meantime, the former Prime Minister Hassan Diab and the Monetary Fund were, therefore, trying to negotiate, between pauses and postponements, so far 16 meetings.
These meetings, in essence, revolved around a series of standard macroeconomic measures.
● A devaluation of the Lebanese lira followed by a semi-flexible exchange rate aimed to rebuild foreign exchange reserves and restore economic competitiveness.
● A drastic reduction in the current account deficit accompanied by aggressive fiscal consolidation. This through an increase in the progressiveness of the tax system and indirect taxes (increase in VAT) and a reduction in part of the “unproductive” public expenditure (i.e. cuts in subsidies to the electricity sector, cost: between 3. 5 and 5% of annual GDP; liberalisation of the energy market with the appointment of the Electricity Regulatory Authority and the Board of Directors of Electricité du Liban; new law on public procurement, etc.), with the aim of generating a primary surplus that will stabilize the trajectory of the debt-to-GDP ratio (from >170% currently to 95% in 2024) and allow more fiscal space for social spending and capital investment.
In this sense, for over two decades, the budget has been directed instead: to raising public sector wages (30%), debt servicing (29%), current budget transfers to the state-owned company Energié de Liban (12%). While only 7% of the public budget was spent on social services, 5% on investments, 0.09% on tourism, 0.03% on industry and 0.34% on agriculture.
● Recapitalisation of the banking system, probably through external deleveraging of assets to the government (60% of sovereign bonds are on the balance sheets of Lebanese banks) to a purpose-built bad bank and a restructuring, both in terms of balance sheet and governance, of the Banque du Liban (BdL, the central bank of Lebanon), often used for creative accounting to hide losses.
● Finally, there is also a very difficult debt restructuring plan that includes arrears of $31.3 billion of Eurobonds plus $57 billion of domestic T-Bills and T-Bonds as of 31 January 2020. Estimates speak of a bail-in for depositors of nearly 34% of all bank deposits to cover the nominal value of Eurobonds, while the remaining debt of nearly USD 60 billion, in a local currency, could be converted into longer-term securities with lower interest rates.

However, the latest developments do not bode well.
In fact, before the government resigned, there were disputes between the government and the IMF about the real size of the “holes” in the public finances regarding the losses recorded in the balance sheets of the Central Bank of Lebanon. Not to mention the bargaining power of some hedge funds, including London-based Ashmore Group Plc, which has recently accumulated over 25% of Eurobonds and thus has veto power to block the terms of debt restructuring.

Notwithstanding the possible “green light” of the powerful Shiite party-military Hezbollah to an IMF aid, the lack of unity of intent on the Lebanese side due to the resistance of the interest groups complicates the situation. These are, in fact, afraid of losing acquired positions of power, also given the complex interconnection between the boards of the banks, BdL and the Ministry of Finance.

In conclusion, the IMF’s Extended Fund Facility (EFF) access programme (calibrated in the range of $3 to $5 billion) – until a few weeks ago could have helped to return to sustainable public finances by pooling financial support from other international donors around a coherent, long-term programme. The figures in question speak of $8 billion from the IMF, plus $11 billion from international donors present at the “Conférence économique pour le développement, par les réformes et avec les entreprises” (CEDRE) in April 2018.

However, the EFF would probably not change the structure of the economy either by reducing the size of the banking sector (today’s assets far exceed GDP by +450%), or by limiting the real estate sector (an outlet for banks’ easy access to credit policies since the Solidere project), or by strengthening the primary and secondary sectors. The latter two sectors are in fact highly dependent on tourism. Moreover, it should be added to the big problem that the country has a poorly developed productive structure.
For Lebanon, therefore, the road is long and painful and given the premises, there is no reason to believe that things can turn out in the best possible way.

By; Michele Brunori

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