Lebanon – Long in the making, a financial crisis has struck

Tuesday, November 12, 2019
Samir El Daher

Diagnosis – How Did we get Here

1. A steadily deteriorating balance of payments over the past years has drastically squeezed, if not largely depleted, Central bank reserves. As a result, the fixed exchange rate regime, prevailing since 1997, had de facto to be abandoned. On September 30th, 2019, a two-tier exchange rate system was ushered in under Central bank Circular number 530. The circular guarantees the availability of foreign exchange (at the official rate) exclusively for the imports of three strategic commodities: petroleum derivatives, wheat, and medicines. Hard currency for all other imports or services can hence only be procured on a “parallel” market through authorized money exchangers at rates reflecting supply/demand balances.

2. In essence, the insufficient foreign exchange “reserves” held by the Central Bank (BdL), and the waning outlook for their replenishment no longer allow BdL to maintain the peg regime, or in more precise terms, subsidize an overvalued Lebanese pound (LBP).

3. Serene economic analysis is not about shedding tears and agonizing over past misguided policies. It became however clear that the peg regime was at the end of its ropes in 2016, when BdL engaged in its so-called “financial engineering” schemes. These futile and costly attempts at rebuilding reserves aimed at prodding commercial banks into bringing home, and depositing at BdL, their dollar-denominated assets held at foreign financial institutions. These operations may have provided a three-year lifeline to the ill-fated, unstainable currency peg. In the process, the already high exposure of commercial banks to sovereign risk (Treasury and BdL) further increased, to reach two-thirds of total bank portfolios. In this perilous “Treasury – BdL – Commercial banks” entanglement, bank depositors have become pawns and hostages. Lending by commercial banks to the Treasury and BdL has largely funded runaway unproductive current expenditures of an excessive government apparatus, power sector subsidies, and graft – a lending with a low probability of recovery as there are hardly physical or productive assets to recoup*.

Foreign currency lent by banks to BdL kept feeding and replenishing the arsenal of reserves consumed in supporting the ruinous currency peg regime that fueled unsustainable trade deficits. To prevent a banking crisis, de facto capital controls are now in place, though not officially declared. This is a dramatic development that has dented Lebanon’s banking sector position and image as safe haven for external inflows. Now however that controls are in effect, they should be enacted through a legal fiat, and not left to the discretion of bankers who might then differentiate between clients. Bank balance sheets are further weakened by the poor quality of their private sector loan portfolio with a level of arrears well above 15%.


The precarious financial situation must be urgently addressed. Restoring basic budgetary equilibria should start by curbing the growth of the public debt in order to stabilize it over the medium-term. To do so requires a massive fiscal effort in slashing expenditures and boosting revenues to generate substantial primary surpluses (estimated at some 4 to 5% of GDP) in the next five years. Such a massive fiscal effort, if feasible, would have drastic social implications in a dollarized economy under considerable pressure, as well as the potential of a depreciating domestic currency that reduces the purchasing power of the bulk of the population whose income and savings are largely denominated in LBP, and whose liabilities (car loans, mortgages, etc.) might be in dollars. Thus, the primary condition of any adjustment program should be a considerable strengthening of the social safety nets. The program should move along three parallel tracks.

a) Fiscal adjustments – costs control and revenue generating measures

(i) – Pursue reform towards a more efficient and fair tax regime, while ensuring an adequate revenues stream. To be acceptable, the burden of adjustment must be distributed fairly on all segments of society with the more affluent bearing the largest share so as to limit its impact on the middle class and the poor.

(ii) – Enact in the 2020 budget law the “progressive tax on aggregated income” with marginal income tax rates from 5% to 45% which are well within the norms in many countries. Income below the minimum wage would be tax exempt. These rates could be for a transitional period over a number of years until specific targets have been reached.

(iii) – Restructure the public debt with due concern to the rights of depositors.

(iv) – Consider opportunistic sale of selected public assets – starting with idle assets, and excluding currently operating entities yielding returns to the Treasury.

(v) – Control and reduce public expenditures, with all new capital investments to be financed by private capital (or grants when available).

(vi) – Combat illegal customs transactions through immediate measures (scanners, private auditing agencies, etc.).

(vii) – Combat tax evasion and avoidance.

(viii) – Address, through an act of parliament, and settle the file of illegal occupation and use of public property.

(b) – Strengthening the social safety nets

(i) – Introduce programs targeting the poor and the disenfranchised, that entail cash transfers, food stamps, subsidized shelter, basis health coverage, heating, transport assistance, etc.

(ii) – Refrain from public sector layoffs or salary reduction which cannot be contemplated at this point, as the depreciating currency will de facto erode the real value of salaries, yet eliminate all excesses from cumulative salaries/pensions, and excessive compensations.

(iii) – Protect the value of the CNSS, the funds such as end of service indemnities and health coverage) that are invested in LBP-denominated Treasury instruments.

(iv) – Raise the ceiling on bank deposit guarantee (currently LBP 5 million).

(c) – The package of overdue institutional and regulatory reforms

(i) – Disband or merge some of the 94 public enterprises and boards, that have out- lived their usefulness (e.g. Ministry of Displaced, Fund for the displaced, Council for the Development of the South, and others) and redeploy their staff to public sector entities with open vacancies.

(ii) – Amend the laws of the regulatory agencies for Petroleum, Telecommunications, and Power, which should fall under the oversight of the council of ministers, and not of the sector ministry.

(iii) – Amend the Code of Credit and Money to subject the Central bank to Parliament’s oversight (Note that the US Federal Reserve is under the oversight of the US Congress).

(iv) – Transfer oversight of the Board of Accounts (ديوان المحاسبة) to Parliament

(Note that the General Accounting Office in the USA is under the oversight of the US Congress).

(v) – Amend law of Capital Markets Authority to shield it from the dominance of the banking sector – a competitor to the bond and equity markets – and subject it to Parliament’s oversight (Note that the US Securities and Exchange Commission is under the oversight of the US Congress).

(vi) – Assert through appropriate legal means the autonomy of the “Directorate of Procurements” (دائرة المناقصات) and its exclusive role in all public sector works tendering and awards.

(vii) – Ensure that all public and private projects in infrastructure, industry, agriculture, tourism, housing, etc., are in compliance with the “National Physical Master Plan for the Lebanese Territory” approved by the government in 2009.

(viii) – Ensure that all public sector recruitment is conducted exclusively through the Civil Service Board, with the Board submitting a short list of three candidates for recruiting managers to choose from.