The Signs Were Clear – Lebanon’s Dysfunctional Government was a Heavy Burden on the People

When discussing Lebanon with those who only follow the general contours of what’s going on, you often hear the questions: what went wrong, how long have there been problems, and why weren’t they resolved before? In light of the weeks of demonstrations, now turning violent; the inability of President and Parliament to name a new Prime Minister; and the continued lack of a meaningful dialogue to repair Lebanon’s dislocated economy and political system, recent statements and reports clearly point out additional support for the negative public perceptions of the government held by the Lebanese people, well in advance of the October 17 people’s revolution.

The statement by the International Support Group for Lebanon reinforced messages that have been evident since the Arab Barometer reflected dissatisfaction with the political, economic, and social services fabric of the country. It expressed the need to install a competent, reform-minded government that would implement immediate and medium-term restructuring of the economic and political regime that has brought Lebanon to its status as a fragile state.

The statement recognized the “aspirations expressed by the Lebanese people,” the need for projects “in line with the people’s needs and expectations,” and that “the right to peaceful protest must continue to be respected.” If the state’s failures were so endemic and generational in the making, what was the fuse that set off the people? Some point to the inadequate response to wildfires in the summer; and others add the tax proposed on WhatsApp, without considering the inadequate tax regime that exempted the wealthy from their share of responsibility.

Two other documents are worth reviewing for a deeper appreciation of Lebanese perceptions of their government. The first profiles their quality of life as reported in the UN Human Development Index for 2019, which uses longevity, education, and income to assess the level of human development in a country. Lebanon is barely in the top half, at 93rd out of 189 countries overall. The same position is reflected in the Gender Inequality Index where it is 79th out of 162 countries in terms of reproductive health, empowerment, and women in the workplace. Lebanon’s mean years of schooling at 8.7 barely exceeds the world average of 8.4 years, while it is below the world and Arab countries average in purchasing power and expected years of schooling. At the same time, Lebanon, at 91.7%, has one of the highest literacy rates in the world…so you have an educated, literate, unemployed, functioning society that has not met the needs of its people.

The extent of the deficit between the political system and the people was tallied in Transparency International’s report on the Middle East and North Africa, which interviewed 1,000 Lebanese citizens in the summer of 2019. The results point to the powder keg that exploded in October. In this survey, while the questions were comparable, it

was not a comparison among the six countries: Lebanon, Jordan, Palestine, Tunisia, Morocco, and Sudan. The data speaks for itself and paints stark realities that frame the current demonstrations.

  • 89% think that corruption in government is a big problem.

  • 87% believe that the government is doing badly at tackling corruption.

  • 80% have little or not trust in their government.

  • 68% responded that corruption has increased since the summer of 2018.

  • 68% said that most or all government officials are involved in corruption.

  • 65% are not satisfied with how well their democracy works.

  • 65% report using “wasta” to resolve issues through the courts; “wasta” being defined as influence or connections of third parties.

  • 54% said that wasta was needed to access public services.

  • 51% said that wasta was necessary to secure access to utilities.

  • 47% were offered a bribe for their vote.

  • 39% noted that while informal payments were expected, they were not asked for.

  • 36% had paid a bribe to police.

  • 28% were threatened to vote for a specific candidate.

  • 23% had experienced or knew someone who experienced sextortion – sex demanded for favors.

Interestingly, 54% of Lebanese responded that they can report incidents of corruption without fear, the highest ranking of the six countries; while, on the other hand, they had the lowest ranking for “Can ordinary people make a difference in the fight against corruption? (39%)” This anomaly has been exploded by the widespread protests cutting across regional, sectarian, age, and gender differences.

So the steam has been building and now the people are speaking for change, for reform, for dignity, for quality of life. How long they will continue to postpone their goals will determine how challenging the long road to reconciliation and rebuilding the country will be.

Some Progress Made in Reconstructing Government – Will it be Enough?

The saga of Lebanon’s economic derailment is well known, having achieved global prominence both because of the extent and quality of the national demonstrations and intense expressions of concern from the international community. A recent policy paper called the government’s policy of financial engineering a “Ponzi scheme,” and critics are now focusing much of their ire on the Central Bank as access to their accounts are severely constrained and businesses are closing because they cannot secure enough US dollars to keep operating.

Word came yesterday that some progress is being made on the issue of a “clean” government, one that does not include political figures. According to a Reuters story, the caretaker Prime Minister Saad Hariri has nominated Lebanese businessman Samir al-Khatib to head the next cabinet, which, in Hariri’s preferred scenario, would feature only technocrats as ministers. The announcement was made with the ominous caveat that “some details” still had to be hashed out. What does this mean? Two bits of reality…any “experts” would have to be approved by the major political parties, and nothing has been heard from Hezbollah and Amal. Caretaker Foreign Minister Gebran Bassil said there was agreement on a majority of “competent” specialists from each side, without indicating if “majority” means all the ministers, including him, and who makes up the “sides” that will nominate the cabinet ministers. Any new government would still have to be approved by the Parliament where Hezbollah can obstruct any forward momentum.

A painful exposé on the spoils system that passes for government contracts was the subject of an article in the New York Times that gave examples of how the system of awarding contracts reflects the agreement at the end of the civil war in 1990 to divide up the spoils. “Hospitals, roads, schools, and other projects are distributed to favored contractors according to sectarian quotas that ensure every group benefits, regardless of necessity,” was the conclusion. Given that the vast majority of these contracts lack any serious oversight and there are no independent regulatory bodies to ensure transparency and effectiveness, the contracting office will be one of the top spots for action by any reform-minded government.

Delay in constructing a new government can only deepen Lebanon’s fiscal crisis. The Institute of International Finance (IIF) noted that the continued delay only aggravates the country’s economic misery. Addressing the banking situation, it noted that “deposits had dropped by more than $10 billion since the end of August. An important part of this money was sent abroad, while more than $4 billion of it is being kept in people’s homes. This shortage of capital makes loans for any purposes almost non-existent, although dollar financing is available from banks for a reported 20% interest!

An article in the Arab News said that immediate and medium-term steps should include “the careful management of Lebanon’s rapidly dwindling foreign currency reserves; defending the value of the Lebanese pound, including tighter measures of capital control; a deep fiscal plan to fight corruption; new social policies to protect those most affected by the current crisis; a negotiated debt reduction plan with a fair sharing of the burden across society; and a monitoring mechanism that allows the people to put pressure on their leaders to implement these reforms while state oversight mechanisms are reinforced.”

Recent statements from the CEDRE donors in a meeting called by France indicated that some of the funding may be repurposed to provide short-term capital infusion to support the Lebanese currency, if a new government of technocrats was put in place with a clear reform program approved by the Parliament, under international monitoring. Lebanon has now entered a vicious cycle being driven by the rising burden of servicing and refinancing the public debt and the sharp fall of capital inflows, which can only be staunched by reducing the debt and rebuilding investor confidence. Both are long-term propositions.

With the onset of winter and the impact on energy prices, the all but certain disappearance of any significant tourism to bring in valuable foreign currencies, and rising discontent among demonstrators and citizens of all persuasions, Lebanon may indeed be facing a decade-long decline.

Lebanon – A fiscal solution to the problem of the public debt – A one-time “National Solidarity Weal

Although Lebanon was able to meet its November $1.5 billion Eurobond payment, there is a general consensus that Lebanon’s public debt has spiraled out of control. It needs to be reduced both as a share of GDP and in absolute amount. There is a great deal of apprehension that Lebanon may not be able to meet the next bond payment of $1.2 billion due in March 2020. It is evident that the public debt cannot be put on a sustainable path without a major policy adjustment in parallel with a massive, if at all bearable, fiscal effort.

Several experts have mentioned the inevitability of “Debt restructuring,” the conventional approach advocated to address the debt overhang. Restructuring entails: rescheduling, i.e. postponing, debt payment installments; lowering interest payments; and most distressingly, reducing the due principal amounts. In legal terms, failure to make timely repayment (compared to the original contractual terms) of principal and interest is construed as a default. A default on a specific debt issue, or a specific borrower, may trigger cross default clauses on all debts outstanding.

As has become increasingly clear, in Lebanon, the main creditor of the Lebanese state is the banking sector – commercial banks and Central Bank of Lebanon (CdL). A public debt restructuring would thus affect bank balance sheets through a write-off of shareholder equity and, if insufficient, through a “haircut” on some, or all of the deposits.

Whichever option or options are exercised, a debt restructuring will dent Lebanon’s once stellar image as a creditworthy, resilient country that never failed its financial obligations, even at its darkest hours. It will ineluctably translate into a sovereign rating downgrade to the lowest rung, and impede the country’s future ability to access international and domestic debt markets other than at forbidding costs, if at all.

An alternative solution to debt restructuring. Just as there is a debate in the US over the so-called “wealth tax” as a tool to address fiscal needs, a similar concept for putting Lebanon’s finances on the right path is using fiscal policy initiatives. Fiscal policy is the undisputed domain of the sovereign state that can adjust its tax code at will. Altering the tax policy is not construed as a default even if the change is enacted in the context of debt resolution. The fiscal approach to the debt problem will have the same parties – bank depositors and the commercial banks in this instance – shouldering the cost of adjustment.

The proposed fiscal approach will seek to buy back the US$34 billion foreign currency denominated debt[1], or a substantial part thereof, by levying a one-time “national solidarity” tax, in the form of a wealth tax. For that purpose, wealth will be narrowly defined as foreign currency deposits in Lebanese banks at the exclusion of all other assets. To ensure fairness between depositors who kept their funds in Lebanese banks and those (notably insiders) who transferred them overseas, the measure could bear retroactively on the value of deposits present in Lebanon on a certain date, say January 1st, 2019. Were it to be applied, this tax will have the same effect of a haircut without triggering a default on the debt with a subsequent sovereign downgrade.

One may argue, correctly, that this approach would exonerate and keep whole the bank shareholders whose equity, to the contrary, is meant to take the first loss under any debt resolution program. Yet, given the deleterious condition of the banking system, this proposed fiscal solution might spare banks, for the time being, the further loss of scarce capital when measured against their hollowed assets base, although this doesn’t preclude that some measures of restitution be later applied to shareholders.

A number of scenarios could be envisaged taking into account the distribution and size of bank accounts. Were this tax to be levied on all US$120 billion foreign currency deposits, it would yield: US$12 billion for a 10% tax rate; US$24 billion for a 20% tax rate; and US$30 billion for a 25% tax rate.

For the measure to be socially fair and acceptable, it should rather target larger accounts, i.e. those of the more affluent. Here too, various scenarios may also be considered. For instance, applying a 20%, 25%, or 30% tax rate on the 1% of the largest accounts (about US$80 billion in total) would yield respectively US$16 billion, US$20 billion, or US$24 billion. The same analysis can be done in applying various tax rates on the largest 10%, 20%, or 30% of the accounts. Measuring comparative yields across specific timelines will both enable Lebanon the time to develop a more comprehensive strategic approach of reforms and help reduce anxiety among international investors.

NOTE. This proposed one-time national solidarity wealth tax should not be viewed as retaliatory against the wealthy. Antagonizing and demonizing the affluent has deleterious, irreversible long-term economic costs such as driving investors, entrepreneurs, job and wealth creators out of the domestic economy. In this consideration, it would be useful that the real wealth effect on those affected by this tax be assessed by comparing, over relevant periods, the after-wealth tax returns on bank deposits in Lebanon against such benchmarks as: the return on US dollar-denominated treasury instruments of comparable maturities; or the returns that would have accrued to bank depositors in other markets where interest rates are markedly lower.


[1]The problem of the Lebanese pound denominated debt, major as it is, can be addressed separately, as in terms of priority it is less critical than the external debt, especially in the context of a depreciating national currency.