Published: June 13th, 2020
Lebanon's economy is reeling from a decades-old decision to peg the Lebanese Pound (LBP) to the U.S. dollar, sparking protests over the government’s response to an intensifying economic crisis that pre-dates the COVID-19 pandemic and has cost thousands of jobs.
Depreciation is pushing up prices, blasting disposable incomes and forcing many people to cease spending on non-essentials.
By tying its exchange rate to the U.S. dollar for more than twenty years, Lebanon created a hidden subsidy for imports. Prices for everything from fuel to cars and luxury goods have been lower than they otherwise would have been, arguably enabling Lebanese consumers to live lifestyles that would have been beyond their means.
That, combined with high-interest rates paid to depositors, attracted remittances from the large population of Lebanese people living abroad and became a vital source of state funding.
Prosperity, however, has come at a cost. Analysts say the central bank’s peg has been overvalued by an estimated 50 per cent in recent years. That’s created a pear-shaped economy that hollowed out the agriculture and manufacturing sectors by making exports of Lebanese products less competitive. With easy access to imports, Lebanon’s service sector grew to account for 76 per cent of jobs.
Reality began to bite in October 2019, when the central bank’s dollar reserves began to dry up, and it stopped providing greenbacks to importers of non-essential goods. Only companies bringing in fuel, grains, baby milk and medicines could access dollars. As the country’s banks cut back their dollar conversions, Lebanese companies began turning turn to the black market, driving the pound over a depreciation cliff.
In March Lebanon halted payment on a USD 1.2 billion Eurobond, the first sovereign default in the country’s history, and went on to default on $30 billion. Even in the 1980s, when its civil war was raging, the state met its obligations. Politicians are now weighing the impact of honouring government debts against the provision of essential services to citizens.
LBP has been scraping lows of around 4,500 per dollar, versus the official peg of 1,500. In practical terms, that means it only applies now to essential goods. Overseas money transfers are setting the real market exchange rate.
Lebanon was already in crisis when coronavirus arrived. Sports clubs and schools have since been closed along with Beirut’s bustling nightlife, as people worried that an underfunded healthcare system might break under the strain of pandemic.
In response to the March default, Charbel Nahas, Lebanon's former labour minister, tweeted that the action amounted to an admission by the state that the country’s financial system is ‘bankrupt.’
The dollar peg has survived numerous crises, from the 2014 crash in oil prices to nearly a decade of war in neighbouring Syria. But as risks grew and deposits stopped flowing in from abroad, the system collapsed under the strain.
Three months after its default, the government is attempting a bailout deal with the International Monetary Fund (IMF). Banks are pushing back, however, on a rescue plan approved by the government in April, and any short-term relief will only halt or slow the pace of declining output.
Though growth stagnated years ago, a group of senior economists has forecast that the economy could shrink by 10 per cent or more this year—similar to what the U.S. experienced during the Great Depression.
Unemployment touched 20 per cent in 2018, and that number is expected to rise as more companies shut their doors. Government figures show inflation is on-track to hit 25 per cent – a 10-fold spike over last year. Half the country’s population could be pushed into penury.
When the global financial crisis landed in 2008, Lebanon was seen as a go-to destination for investors. High returns and a stable banking sector fuelled a property boom and the arrival of expensive high-rise flats beyond the means of most locals. Confidence began to ebb in 2011, however, with the outbreak of Syria’s civil war.
When economic conditions forced the government’s hand in October, Lebanon’s central took steps to push up interest rates and attract liquidity from abroad, sustaining the dollar peg with high interest rates. A complex series of swap operations meant a growing proportion of private-sector bank deposits relied on the central bank, which used them to fund a state that was increasingly unable to sustain its economy. As systemic risks rose, investors sought safety and growth staggered.
Since then, a government agency found that prices for some food items have risen by more than 200 per cent, and the prime minister has warned that Lebanon faces a food crisis.
Fluctuations in the exchange rate and confusion between the official and unofficial rates have forced many shops and small businesses to cease purchases of certain items completely. In April only 200 vehicles arrived at the Port of Beirut, compared to more than 3,000 in April 2019.
While the crashing currency obliterates household finances, the government says tax revenue this year will fall by 30 per cent. IMF estimates show the deficit will touch above 15 per cent of Lebanese GDP.
Central bank foreign reserves are down 10 per cent for the year to date. Its stockpile of greenbacks declined by more than $900 million between April and May, depleted to finance imports of essential goods.
While devaluation might be expected to make Lebanese-made products and services more attractive, so far, the benefits have been hard to find. Exports have gone up but only by 7 per cent in Q1 – even as imports dropped by over 40 per cent.
After hobbling along for years, the economy will contract by more than 12 per cent in 2020, the worst drop in output since the end of the civil war in 1990.