The glamorous rate of the Lebanese Pound, artificially indexed to the US dollar for so many years, is history now. In recent months, the pressure on Lebanon’s economy is seeing a pile-up. Not only does Lebanon have to mitigate ramifications stemming from the coronavirus-induced lockdown which is slowing down its economy, it also has to manage the political paralysis and persistent financial crunch, as well as, manage its Himalayan pile of debt, which happens to be the largest in the world.
Impact on Banking
Given this background, in a report the Bank of America Merrill Lynch said, if the policy paralysis persists, Lebanon’s Central Bank, the Banque du Liban, is likely to face a liquidity crunch in mid-2020.
“The pace of BdL (Banque du Liban) reserves loss implied by mid-November data suggests 2020 could be a crunch year. A sharp halt to the economy is likely to reduce external funding needs, but the damage done to depositor confidence may be long-lasting. The latter may fundamentally impair the country’s funding model in the absence of an urgent political settlement, comprehensive reform program and material external support,” reads the report from Bank of America Merrill Lynch.
According to its initial assessment, although the likelihood of a recovery is low, however an International Monetary Fund (IMF) program could improve its chances given the competing disorderly scenarios.
“We would expect face value cuts to total government debt to stand at 70-80 percent under a disorderly adjustment. Under a typical, hypothetical, IMF program, we would expect 50 percent face-value cuts to total government debt stock and a 50 percent cut to coupon rates, with exit government debt at 100-110 percent of GDP. Market expectations, as reflected in asset pricing, appear instead consistent with 35 percent face-value cuts to total government debt and to coupon rates,” said the report.
It goes on to read, “We quantify the impact of a potential debt restructuring on the banking sector capital position. We find that maintaining financial stability and restoring domestic confidence could depend on coherent and front-loaded economic reforms, in conjunction with large external support likely underpinned by an IMF program, in our view”.
From this broad macro perspective, let us delve into the micro, and see how this impacts Lebanon’s currency and its fallout on its citizens.
The economic implosion which began in September 2020, saw an coronavirus-induced acceleration leading to the Lebanese pound depreciating by nearly 85% against the U.S. dollar; this is despite the central bank pegging the currency at 1,500 against the greenback. The Lebanese pound now stands at almost 10,000 against the dollar, spurring a cataclysmic rise in prices for a country that imports 80% of its food.
The resulting economic shockwave has led to basic necessities becoming luxury goods for the common man.
Case in point: Hassan Bdeir, a 48-year-old trader, who is used to having meat in most of his meals has to make do with a bowl full of vegetables. “Usually I’d have meat pastries. Now? No way,” he said, pointing to a half-finished bowl of ful. “This is what we eat now. And even this, not just anyone can afford it.”
Bdeir’s meatless meal is a classic example of the calculus that most Lebanese have to face as they find ways to mitigate the effects of the crumbling economy and dip into their dwindling savings. Will the political class get serious on embracing reforms, and stop beggaring Lebanon?
Impact on the common man
The rapid depreciation of the Lebanese pound has almost removed red meat from the table for most citizens. Many restaurants have had to reduce, if not cancel, their red meat options from the menu; others have had to modify their signature dishes to use other substitutes including chicken or vegetables.
“People come in, buy five kilos [11 pounds]. That was the standard,” said Ahmad Mallaah, 42, who co-manages his family’s butcher shop in Beirut’s Msaytbeh neighborhood. “Now they barely take one, and even that they’re dividing over five meals.”
Red meat has even been taken off from the country’s menu for its armed forces, with the army eschewing meat in the food it serves to soldiers.
Demand for red meat has plunged to the point where Ahmad Mallaah does not even bother to stock it anymore. While four sheep carcasses hang from hooks from his window display his three fridges are empty. “What you see in there now costs 5 million Lebanese lira,” he said — more than $3,000 at the official exchange rate.
Revenue streams drying up
While earlier authorities managed to maintain a-more-or-less static exchange rate against the dollar using incoming revenue streams, which included tourism, remittances from abroad, foreign aid as well as debt instruments which made Lebanon the third-most indebted country in the world. However with revenue streams drying up, and with neighboring Syria seeings years of continued economic instability and wars, authorities have had to do some “financial engineering”: they tried to attract U.S. dollar deposits by offering stratospheric interest rates, but these in turn required more deposits to pay off. According to critics, this essentially was a giant Ponzi scheme.
In September 2019, matters came to rest when Lebanon faced a serious shortage of dollars, with banks imposing capital flight norms to contain withdrawals which in turn resulted in massive protests across the country which toppled the government. Although a new cabinet was formed on the back of promised reforms, the crisis has in fact deepened with the political class continuing to bicker among themselves. The lack of much-needed urgent economic reform has fueled inflation, among other factors. According to Steve Hanke, an expert in troubled currencies at Johns Hopkins University, Lebanon’s inflation has reached a monthly rate of 135%, with the lira on the way to hyper-inflation.
Inflation-fueled price hikes, which led to protests and demonstrations, which had stopped because of COVID-19 lockdowns, could potentially once again return in full force.
The upside to this disaster, it that it provides political leaders an opportunity to take the bull by its horms and pin down and mitigates long pending issues in Lebanon’s economy. Essentially, this is an opportunity for Lebanon to take charge of its food supply and develop its agricultural industry. Naturally, there will be hurdles since this is a systemic issues which affects the entire population, including farmers. Lebanon will have to cling on to its much vaunted resilience; a begining could be made where there was abject desolation.
Need for monetary reforms
Much of this crisis can be boiled down to the inaccuracies in circulating figures of the Lebanese pound exchange rate against the greenback.
In an insightful report, Bank of America stated, according to estimates of the IMF, the U.S. dollar is likely to touch the 46,500 lira by the end of 2020 with the main driver of this deterioration being the inaccurate circulating figures for the exchange rate of the Lebanese pound against the US dollar on the black market.
According to this report, the trend of the Lebanese pound vis-a-vis the U.S. dollar for the rest of 2020 is that it is set to depreciate by around 2223% given the central bank’s continued printing of the currency until the exchange rate touches 46,500 pounds.
Thus Lebanon is likelly to witness hyperinflation which will continue to ravage the economy and the test Lebanon’s resilience. It will not bode well for the common man since international banks, including the IMF will step in only if they are convinced that Lebanon’s politicians are serious on introducing the following through with much need economic and financial reforms.
Given that a monetary system is the backbone of an economy, Lebanon’s politicians need a systemic and fundamental change in their attitude and approach towards bringing about financial and economic reforms. Rather than wait for the political class to get their act together, enterprising-minded Lebanese could fall back on the barter system, as a fall back option.
Post-WWII, Germany had briefly defaulted to using cigarettes as money for trade of basic necessities within communities, given that cigarettes always have a predictable value. For Lebanese, this could be gold, grain or even cigarettes. A stable unit allows members of the community to at least trade in basic commodities for their families; retailers could to receive a fair price for goods, and workers to earn a stable wage.
Another option is to adopt dollarisation. In 2009, following a hyperinflation in Zimbabwe, the country had essentially abandoned its currency and had adopted the U.S. dollar as its main currency. The measure was in effect up to 2019, when it reintroduced a new Zimbabwean dollar.
This is a tried-and-tested method, and is especially effective for countries which have a significant dollar-based debts and imports.
One of the downsides of this option is that, it essentially hands over control of the country’s currency and links it to the economic stability of the United States. Further, the coronavirus pandemic has created a shortage for U.S. dollars, globally. With the price of the greenback already sky rocketing in Lebanon’s black market, selecting this option is likely to send dollar prices to stratospheric levels.
A third option before Lebanon is Bitcoin. Proponents of the digital currency have long advocated that Bitcoin is tailor-made for such types of economic scenarios. There are precedences for states adopting cryptocurrency with Venezuela being the latest case in point.
Venezuela has widely adopted cryptocurrency and routinely accepts the digital currency in more than 20,000 large and small businesses.
Cryptocurrency though requires a significantly higher level of education across the population.