On The Brink Of Collapse – Lebanon Approaches The IMF

Anti-corruption protests, which rocked Lebanon late last year, have sparked again as the country’s dollar pegged currency, the Lebanese Pound, lost more than 60% of its value in recent weeks. The country hovers on the brink of total economic collapse with a debt to GDP ratio of 175%.  Across the nation, protestors have taken to the streets in response to what has been perceived as a complete failure to address corruption and  institute meaningful economic reform; protestors’ anger is pointed at the state bureaucracy, the Central Bank, Banque du Liban (BdL), and the private banks, which used to be regarded as stable institutions weathering decades of volatility in the country’s history.

 
In October 2019, Lebanon instituted wildly unpopular capital controls as banks rationed dollars for essential imports; this largely barred USD withdrawals and has even converted some small USD accounts into LBP.  For years, Lebanon has operated as a dollarized economy taking in billions of US dollars  per year in the form of remittances from the Lebanese diaspora across the world; in 2017 and 2018, Lebanon saw $7.1bn and $7.2bn in USD remittances.  The sharp dry up in dollar liquidity has sparked rampant inflation, with CPI inflation soaring to 25%, and left ordinary citizens barely able to meet basic bills and put food on the table.  In the course of this, roughly $2bn of non-resident deposits flowed out of the country and $12bn of total deposit outflows left by year end 2019.  This has led to the angry speculation that insiders have been able to withdraw while the average man on the street has been restricted.  Hezbollah has taken advantage of this situation by pushing forward al-Qard al-Hassan, Hezbollah’s key money exchanger and a bank replacement for the Shia community in Lebanon, as an alternative to the traditional banks; this entity was sanctioned some years back by the US government.

Thursday morning,  Lebanon’s  Prime Minister, Hassan Diab, and his cabinet, approved an economic and financial reform package; they are now formally seeking to open talks with the IMF on an aid package. This comes as some surprise as Lebanon has often sought technical aid from the IMF but never financial aid and direct involvement. Till now, such moves have been rebuffed by Hezbollah leadership and Hezbollah backed politicians as it would require complete transparency  from Lebanon’s banking and governmental institutions.  With Lebanon’s March 2020 default to global institutional investors on $1.2bn of Eurobonds and approximately $19bn to $20bn in Eurobond payments coming due over the next five years, Lebanon has little choice but to turn to the IMF. Hezbollah has thus far agreed after objections earlier this year.  Hassan Diab, who came to power in January, is well liked and backed by Hezbollah leadership; his own Sunni constituency failed to back his election.

 
The draft version of the reform plan passed on Thursday has been well received by financial investors. The BdL and the private banks have been less receptive as it has placed a large amount of the reform and restructuring on the shoulders of the banks and depositors versus imposing more dire financial austerity at the governmental level. The plan has ambitious targets with an aim to lower Lebanon’s debt to GDP ratio to 103% by 2024 and to have a fiscal surplus of 1.6% in the same year. The plan also lays out a move away from a LBP USD peg, which historically has been LBP1500 to $1; it plans for a transition to  what is called a “crawling peg” ultimately taking the exchange rate to LBP3000 to $1.  The plan does not include any bank bailouts and from a state perspective holds long overdue electricity reforms as key.  

The economic and financial reform plans bear a striking similarity to the reforms enacted in Cyprus and Greece during the Euro crisis; proposals place the heaviest burden on the banking systems and its so-called “large” depositors versus harsh fiscal austerity, deep government restructuring and severe anti-corruption measures.  The current plan envisions the banks absorbing up to an $83bn loss.  As the banks’ capital base is approximately $20bn, this means the remaining $63bn will be absorbed by depositors; it is being termed as a “contribution” from depositors. Accounts with deposits at $100,000 and below, 90% of total depositors, will be safeguarded.  Large depositors, receiving a “haircut”, will be compensated by a fund, which could contain bank equity or perhaps a government backed fund.  It remains to be seen how this will play out; however, one thing is clear, the Lebanese banking system, after this crisis, will no longer be considered a safe place to keep money and large remittances are unlikely to flow back into the banks. 

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