Economically speaking, Lebanon is an interesting case study in many respects. Like several Mediterranean countries such as Italy or Greece, it is characterized by huge public debt (151% of GDP). At the same time, like several northern liberal and service-based economies – and unlike most Mediterranean economies except for Turkey – it shows low levels of household savings. Something that does not come as a surprise to people familiar with the high prices for basic commodities that characterize Lebanon’s domestic market, especially if compared to average incomes. Together with public debt, its large current-account deficit (-27% of GDP) is another background character of a drama that over the last decades have been displaying subplots about inequality, corruption and productive sector suffocation, and that since last October took a sudden twist towards a new phase. A drama that has only one real protagonist: the banks.
Of course, not all banks were created equal. The Lebanese Central Bank is the absolute protagonist of this story, with the fundamental support of crucial secondary protagonists: Lebanon’s private commercial banks.
Our story starts in the 1990s, just after the end of the country’s long civil war. By that time, Lebanon was in desperate need of money to reconstruct the war-torn country. The state started borrowing money from the local market, issuing bonds in local currency. To fight the mistrust that people had in the Lebanese lira due to the dramatic devaluation spiral that occurred during the war – which contributed to destroy entire fortunes – the interest rates of state bonds immediately skyrocketed, reaching levels still unmatched today, even in the developing world. Rather soon, local banks lost their appetite for private and corporate lending strategies – which yielded far less – and channeled most of the little savings people still had after the war towards the much more profitable public bonds.
This had three direct effects on the economy: first, it caused a dramatic increase in public debt, which reached the record peak of 183% of GDP in 2006; second, local banks stopped looking for other investment opportunities as long as public bonds’ interest rates largely surpassed the interest rates they had to pay on their depositors’ saving accounts. This led to a significant increase in public bonds’ weight on their balance sheets, which between 1993 and 2000 amounted to 27% of the banks’ asset base (against 5.4% constituted by loans to the commercial private sector). Third, it dramatically expanded the share of the public budget necessary every year for debt-servicing payments. By the end of the 1990s, local private banks owned two-thirds of the (increasing) public debt. This meant that every year a growing share of government revenues was channeled towards a small group of private entities. By 1998, debt-servicing payments surpassed the state’s budget deficit. The government had to start borrowing money and widening the tax base just to repay previous debts.
Of course, the first effect of this scheme was inequality: over the years the government especially increased consumption taxes – which hit all citizens equally, regardless of income differences – to repay the debt. That meant that a large share of the tax revenues paid by all citizens were pocketed by a small group of private lenders.
The second important effect was that the public and private financial sectors became increasingly interdependent: banks attracted new deposits from the local economy and from abroad thanks to the high interest rates they could offer; in turn, the state could borrow fresh resources from the banks to finance its budget. Of course, the continuation of such a scheme – which, quite accurately, many called a Ponzi scheme – was made possible by the deep connection between the banking sector and the Lebanese political scene. Most private banks are connected to national party leaderships which, in turn, base their political activities on systems of local patronage structured on sectarian basis.
The possibility to cash in on high interest rates simply by lending to the state made the local banking sector reluctant to invest in local productive enterprises. The dollar peg imposed by the Central Bank, crucially important to attract financial inflows, made local exports increasingly uncompetitive on the international market, deepening the country’s current account deficit. The real estate sector, boosted by the post-war reconstruction effort, became the main economic sector after banking.
Over the last two decades, the continuous inflow of fresh money from abroad became crucial to stabilizing the balance of payment and, thus, to survival of the system. This scheme was initially shaken by the sudden dramatic decrease of investments from the Gulf monarchies. Gulf leaderships in the last years “strongly advised” their citizens against traveling to and investing in Lebanon after it had become clear that the party-militia Hezbollah, a close Iran ally, had gained the upper hand in local politics. The conflict in neighboring Syria and the refugee crisis it sparked – Lebanon today hosts over 1 million Syrian refugees – also contributed to harming investors’ confidence in the country’s stability.
Riad Salameh, the Central Bank’s governor since the 1990s, became the symbol of the system’s survival capabilities. He used all possible tools of “creative finance” in order to maintain the stability of the system and the peg in the face of decreasing foreign financial inflows. He even managed to increase, on paper, the country’s currency reserves in a period of growing mismatch between the total stock of financial inflows and the current account deficit. However, even the most skilled illusionist cannot perform miracles in front of a country-wide upheaval, such as the one we have seen enfolding since last October.
While the Lebanese people were flooding the country’s streets and squares, financial assets began being rapidly moved away from the country’s banks. Sometimes, when their owners enjoyed sufficiently good connections with key decision makers, such transfers have continued even after the banking sector introduced harsh measures to limit cash withdrawals and financial movements.
Any Ponzi scheme illusion has its moment of reckoning. The Lebanese financial system’s came on 9 March, with official declaration of the country’s default. Especially now, no leader has sufficient political capital to further procrastinate the end of the current system as we know it.
Hence, the drama told in this article is now entering a new chapter. Over the next weeks its protagonists will have to show the world, and especially the Lebanese people, whether they are ready to dramatically change course and radically restructure an unsustainable system. Lebanon has all the resources, especially human ones, the build a new, sustainable course. But old habits a die hard, especially when those in charge of crucial decisions are those who profited the most from them.