Lebanon’s fall from grace has been nothing short of dramatic. Not so long ago, Lebanon was an upper-middle income country with a highly skilled work-force, first-world educational and health institutions, a vibrant and entrepreneurial private sector, a thriving cultural and tourist scene, and a large and engaged diaspora. In less than three years, Lebanon became unrecognizable: the government defaulted,the country’s economic activity shrunk by 35%, the currency lost 90% of its value, and a severe banking crisis resulted in wealth destruction equivalent to at least three times the country’s GDP. The crisis’ long-term implications are insured to be severe. The State, as an institution, has imploded, the judiciary is paralyzed, the educational and health systems are teetering, power blackouts are the norm, and enterprise closures are accelerating daily. In the meantime, unemployment reached 40%; a third of society cannot access adequate health care; and 41% of the population is finding it hard to access food and other basic needs. The young and skilled are immigrating en masse, leaving behind a nation increasingly polarized by sectarian tensions of the kind that, historically, led to organized forms of violence and civil wars.
How did Lebanon get here? In hindsight, the crisis was predictable. By the time the collapse started (October 2019), the economy was already facing four extraordinary challenges. First, public sector debt had reached such elevated levels, that a default had become a question of when, not if. Second, the banking sector, having lent three-quarters of deposits to the government, had become functionally bankrupt and increasingly illiquid. Third, the productive economy had experienced virtually no growth for almost an entire decade — a development with acute socio-political implications. Finally, and perhaps most importantly, the country was politically rudderless: there was no President between 2014 and 2016. Rather, there were multiple and lengthy delays in cabinet formation, and while the 2018 parliamentary elections did take place, they only happened after a five-year delay.
Is there a way out? Technically, the recipe for exiting the crisis, while certainly not easy, is at least, well understood. Lebanon urgently needs a banking sector restructuring that would distribute losses among depositors, a debt restructuring to bring back solvency and creditworthiness to the public sector, a monetary overhaul to stabilize the exchange rate and controls inflation, as well as a public sector overhaul that would raise revenues and stop wasteful spending. In parallel, there is also the need for sectoral reforms that are both short-term in nature (especially in the power sector) and longer-term (anti-monopoly laws, judicial reform, regulatory overhaul, etc.).
The key to such a program would be an IMF program—something that has become a consensus view even domestically. An IMF arrangement provides an internally consistent and rigorous economic framework guided by conditionality. Furthermore, such a program unlocks significant and much needed funding—both from the IMF itself and, through it, from other official and bilateral sources. Against all odds, and to its credit, the current cabinet (headed by Najib Mikati) reached a “Staff Level Agreement” (SLA) with the IMF. That said, turning the SLA into actual funding will not be easy and will depend on the government’s implementation of a set of stringent “prior actions”. Given the political calendar (and the complexity of the needed steps), chances of finalizing the agreement anytime soon are slim. Nonetheless, one must admit that the SLA is a reasonable framework that, at the very least, sets out a road map that will be very useful when the political landscape becomes more favorable to reforms.
The reality though is that focusing on the technical framework embedded in the SLA misses an obvious point: the magnitude of the reform and adjustment required by the IMF requires a political backdropconducive for implementation. Sadly, Lebanon is also facing a political crisis that is as severe as the economic one. Four dynamics are worth stressing. First, the domestic political calendar is treacherous. The parliamentary elections (scheduled for May 2022) are unlikely to lead to the radical political transformation many hoped for, after the mass demonstration held in October 2019. In the meantime, there are strong reasons to believe the presidential elections (scheduled for the fall of 2022) will likely be postponed, leading to the kind of political vacuum Lebanon has become accustomed to. Second, the pre-crisis political class remains powerful and supported by sectarian affiliations and allegiances that empowers it to block reforms that, by definition, will be detrimental to its economic and political interests. Within that, and this is the third political dynamic, one particularly powerful group (Hizbollah) dominates political decision making and consistently subordinates national interests to its own ideological (and externally dictated) priorities. Finally, and relatedly, the regional environment, always crucial to Lebanon’s stability, continues to be extremely unsettled and far from conducive to agreement by the domestic Lebanese stakeholders on basic economic measures.
So where do we go from here? Unfortunately, prospects for a speedy recovery or crisis-resolution are dim. Currently, a “bad equilibrium” has set in. Consumption and imports have collapsed to such an extent that the country’s needs have become manageable and financeable solely by remittances and humanitarian grants. But, of course, this “bad equilibrium” came at the cost of massive poverty and implosion. Can a “muddle through” scenario persist? Not impossible to foresee, as there are many international examples of countries imploding but never recovering. Sadly, there is an extreme version of this scenario: one where the crisis leads to a political and security implosion, similar to ones Lebanon has historically experienced.
The above two scenarios (muddle through or implosion) are painful to contemplate. A more positive scenario would require a regional settlement permitting, in turn, the polarized political system to coalesce around the difficult reform measures desperately needed to get the country from its morass. Unfortunately, it is tough to ascribe too high a probability for this scenario.
The Lebanese crisis is a tragedy in the making. It is a result of decades of bad management, waste, corruption—all within a political system fueled by sectarian and feudal dynamics. The country is at a tipping point. If no reforms are implemented, Lebanon could see decades of stagnation and a risk of a security implosion. If the political will exists, a V-shaped recovery is eminently feasible. The country deserves nothing short of that.
Disclaimer: Amer Bisat is Managing Director and Global Head of Emerging Markets Fixed Income at BlackRock. He writes in a personal capacity.
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