The Beirut port blast that claimed 178 lives, left over 6,500 injured and 300,000 homeless last August –the largest non-nuclear deflagration in history- was an avoidable tragedy. It was also virtually impossible to hide. The collapse of the Lebanese financial system could have also been avoided. It was, however, less visible. A series of measures set by the Lebanese Central Bank (Banque du Liban, BDL) and the government swept the inevitable default under a rug of financial engineering and the lira-to-dollar peg. While all solutions to end the crisis will be painful, reforming the system is a feasible feat, as the current situation is not the result of external factors but rather of a poorly-functioning (and endemically corrupt) political and economic system of governance. How did the country reach this point?
When, in October 2019, Lebanese civil society started protesting all over the country demanding political reform, the economy had already reached stagnation. At the time the debt-to-GDP ratio was projected to be at 155 %, making Lebanon one of the most indebted countries in the world. Despite Prime Minister Saad Hariri’s resignation on October 29, the lack of confidence in the economy and banking system resulted in the capital flight of between 3 to 4 billion USD. This amount was withdrawn while banks were officially closed to (most) customers following the October Uprising. When the banks did re-open, the regular and not ’connected ’ customers found it increasingly difficult to withdraw cash from their US dollar accounts. This, in turn, resulted in the black market rate of the USD to skyrocket. The Lebanese pound has lost around 90% of its value since late 2019. From its fixed official banking rate of 1,507 lira per USD, it reached 13, 125 lira. This coincided with the term ’lollar’ appearing on social media. A play on words of the term ‘dollar’ and the acronym ‘lol’, namely a Lebanese dollar, or a US dollar stuck in the Lebanese banking system, a computer entry with no corresponding currency. The banks lacked sufficient liquidity: were no longer able to pay customers’ deposits back because they were no longer there. This lack of accountability, which adds insult to injury, is also enabled by the fact that customers have no legal recourse, they can go to Court but they will lose as there is no law to protect them in this situation.
A Flawed System
Dan Azzi, economics analyst and former Lebanese bank executive, who came up with the term lollar, breaks down the causes of the crisis highlighting three points. Lebanese expats who live abroad would send their remittances in USD back to the country for their retirement. These deposits were then used to back the lira peg. This allowed for the peg – introduced in 1997 – to be stable for the past 20 years while, at the same time, it overvalued the Lebanese currency, resulting in the Lebanese people living above their means. Once Lebanese bankers were able to attract expats’ investments through financial engineering they would lend the money to the BDL at very high interest rates and the BDL would use these funds on imports.
The current reported amount of reserves in Lebanon is estimated to be roughly 15 billion dollars in cash, and another 15 billion in gold, which accounts for approximately one and a half of GDP, which stands at 20 billion. In theory, the country is rich: the reason for shortages is because the numberof claims against this amount is too high. According to Azzi, the only solution, albeit painful, is to reduce the claims implementing a ’haircut ’. The analyst explains that the reserves are either being wasted on subsidies such as fuel or the funds leave the country through a system favouring powerful and well-connected people. At this rate, he adds, in about 15 to 18 months, the remaining deposits will be gone and gold alone will be left. The next stop, if nothing is done to prevent it, will be to enter a scenario that resembles Mogadischu in 1993.
For the Lebanese economy, one of the consequences of having the Lebanese currency pegged to the USD - at an inflated rate - was that Lebanon was no longer competitive compared to its neighbours and, as such, it grew reliant on imports.
Mike Azar, a debt finance advisor and former Professorial Lecturer of International Economics at the Johns Hopkins School of Advanced International Studies in Washington, D.C, explains that he believes the crisis could have been avoided and highlights the need for political governance reform. One of the tools he deems necessary is the creation of an economic crisis steering committee to analyse the complexity of the issues holistically by qualified experts and without any conflicts of interest.
Essentially, the peg is unsustainable and does not incentivise reforms. Furthermore, because of the way the current system functions, foreign aid money contributes to the devaluation of the currency, which ultimately hurts everyone. According to Professor Azar, "The international community still thinks they are dealing with a government [in Lebanon], but there is no government: it is pure anarchy".
He explains that the social safety net that is being created only serves the purpose of keeping the streets calm for future elections; it lacks any planning, oversight, or sustainability.
The $246 million World Bank loan, whose conditions were agreed upon last January, offers an example of the malfunctioning of the system. The loan was meant to support more than 150,000 of Lebanon’s poorest families with monthly cash handouts: however, it was put on hold by the World Bank at the end of May. The international financial institution asked the government to clarify the reasons behind the Social Affairs Minister’s modifications on the $246 million loan destined to the families who are most in need in Lebanon before releasing the funds. At this point, Professor Azar believes the loan is unlikely to come through.
The Shared Responsibility and Accountability That No Institution Accepts
Following street protests on Wednesday, the BDL Governor Riad Salameh reassured depositors yesterday that the Central Bank is not bankrupt and that people's deposits are safe and will be returned soon, reversing a decision to halt withdrawals from dollar deposits at a higher rate than the official peg but a much lower one than the informal market rate. This effectively puts it at roughly one third of the black market’s value of the USD- hard to consider it a good deal - though it remains the only way for many to access their funds. Lebanese banks have locked depositors out of their dollar accounts and blocked transfers abroad. But since Circular 151 was issued last year, depositors have been allowed to withdraw dollars, with the funds paid in the local currency at a rate of 3,900 pounds.
In a video published months ago, Governor Salameh stated that the funds the BDL lent to the Government were in Lebanese pounds not in dollars, clarifying that the funds used for imports are the reason for the diminished bank liquidity. He also added that the BDL is aware depositors’ dollars went to fund imports, citing the lack of any responsibility in the matter by the Central bank. The Governor’s office was contacted but was unavailable for a comment at the time of writing.
To understand how the crisis has affected the daily lives of the Lebanese, it is sufficient to see the long queues at the petrol stations, ATMs, the longer than usual power cuts or the price of food items that has risen by 400 %. Luna Safwan – a Lebanese journalist and human rights activist – notes "We have four hours of electricity per day, generators work 24/7, hospitals cannot afford to function, it is impossible to make a trip to the supermarket without spending 1,000,000 lira for basic goods…not to mention the current political fraction, and politicians acting like teenagers".
Indeed the current government in Lebanon is acting in a caretaker capacity. Political paralysis and lack of accountability have complicated an already disastrous economic crisis with fractious political leaders unable to form a new cabinet and implement the reforms required to unlock foreign aid.
Lebanon has lacked a government since the massive blast in Beirut's port last August wrecked swathes of the capital. Prime Minister-designate Saad al-Hariri (the same one who resigned in 2019, a scenario resembling a sort of political musical chairs) - and President Michel Aoun have been unable to agree on the naming of ministers for months.
In its recent report, the World Bank ranked the Lebanon financial and economic crisis in the top ten, possibly the top three, most severe crises worldwide since the mid-nineteenth century. In March 2020, Lebanon did not repay a $1.2bn Eurobond, the first sovereign default in the country’s history. It had never happened before, not even during the 15 year-long civil war. The country’s future cannot afford any more inaction.