Lebanon's economy is not collapsing... but it is a 'zombie'

Last week, Lebanon's finance minister caused panic in the bond market when he suggested his heavily indebted country was planning to 'restructure' its debt, a process that usually includes debtors relinquishing part of what is owed to them in what is known as a 'haircut'. 

Lebanese dollar-denominated bonds immediately tumbled in value and Beirut's credit risk surged as investors were left feeling nervous about the status of their Lebanese holdings and the state of Lebanon's finances and the economy in general.

It didn't help that Minister Ali Hassan Khalil's disastrous remarks came on the heels of a report published by the Goldman Sachs Group forecasting a financial crisis, possible debt restructuring and the fallout from such a scenario, lending some credibility to its worst-case predictions.

And a few days earlier, he came out to issue an ominous warning that the country's chronic political crisis was turning into a financial one. 

The minister has since qualified his remarks, denying all talk of debt restructuring and instead claiming he meant 're-scheduling of the debt', a completely different and prosaic process. (The initial remarks were made in Arabic, and translated financial jargon can be confusing, to be fair to the minister). Lebanese bonds rose again as the markets accepted the minister's explanation, accepting there is no imminent financial collapse in the country....for now.

Most Lebanese banks, which hold the majority of Lebanon's debt, are owned by the country's political elites or their close associates

Explaining the 'zombie' economy

So which story do we believe: Is there imminent collapse, including a collapse of the value of the Lebanese pound that will force a restructuring of the debt, or is everything hunky dory in Lebanon? 

"There is no truth to either of these narratives," Dr Jad Chaaban, Associate Professor of Economics at the American University of Beirut, told The New Arab via telephone.

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Unlike other heavily indebted countries most notably Greece, Lebanon's public debt burden has a (parasitical) life of its own almost separate from the state of the economy. This is why the sovereign debt crisis in Lebanon does not automatically translate into a sweeping financial and currency crisis.

There are three main reasons why a financial collapse in Lebanon is unlikely in the near term, Dr Chaaban told The New Arab.

First, he says, the powerful central bank (Banque Du Liban) is heavily involved in public debt management, including by carrying out preemptive policies that exploit the country's currency peg to the dollar to carry out so-called financial engineering in collaboration with local banks. This includes offering higher interest rates on deposits in the Lebanese pound compared to the dollar, for example.

This allows the BDL to regularly increase its holdings of foreign currency reserves through soft capital controls on dollar deposits, which are increased when needed, for example during times of crisis such as the Saudi abduction of Prime Minister Saad al-Hariri in November 2017. 

The heavy intervention and massive war chest of foreign reserves buttressed by inflows from Lebanese expatriates and bonds, give Lebanon a lot of leeway to manage any financial crisis bar 'biblical scenarios'. 

Second, most Lebanese banks, which hold the majority of Lebanon's debt, are owned by the country's political elites or their close associates. As a result, they have an active stake in not only avoiding any default or restructuring, but also increasing their profits from treasury bonds by assisting the BDL manage the debt through monetary policy.

And third, according to Dr Chaaban, a lot of the talk about crisis in Lebanon is part of a deliberate game by its politicians.

As he wrote in an article this week, "while a collapse does not seem imminent, the anxiety created around a Greek-style national bankruptcy has allowed the ruling politicians and their allies to steer (again) the public debate towards a "crisis management" rhetoric, away from a real discussion on accountability and responsibility for what got us into this". 

However, the price of this buffer policy is that Lebanon's real economy is in a permanent 'zombie' state: Neither living nor dead. Or to use the economists' jargon, it is in a state of stagflation, "no growth, increase in prices, and decline in money available for economic activities" as Dr Chaaban puts it in the same article.

Heavily sensitive to geopolitical crises, Lebanon's main sectors, tourism, services and agricultural exports are muddling through but nowhere near sufficiently to boost growth

A 'tax on the future'

While the government's finances are being managed through creative monetary policy that can be sustained in the near term, Dr Chaaban told The New Arab this amounts to a "tax on future generations". 

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Indeed, Lebanon's fundamentals are not in good shape. Heavily sensitive to geopolitical crises, its main sectors, tourism, services and agricultural exports are muddling through but nowhere near sufficiently to boost growth, now standing at an anemic 1.9 percent (Lebanon needs almost 4 times that growth to sustain its deficit and start to bring down its debt in the long run).

Meanwhile, unemployment is in the double digits, driving an exodus of young people looking for work, inflation is much higher than the regional average and the government cannot afford to finance any major infrastructure projects due to high cost of debt servicing, a bloated politicised public sector and huge subsidies to the inefficient electricity sector.

A chronic political crisis that involves regional powers and even the US as well as local parties makes an adequate response and economic planning a far-fetched process for an antiquated and corrupt political system more interested in maintaining sectarian balance than decent living conditions for its citizens. 

Although Lebanon last year touted an $11 billion capital investment programme to build flagship projects and reinvigorate the real economy through soft-loans and grants, secured by reminding the world of the tiny nation's role in hosting millions of refugees, the euphoria has given way to skepticism as the country remains without a government to carry out the project despite holding elections in May.

Lebanon is also betting on making major gas discoveries during the exploration rounds scheduled in the coming years in its territorial waters and on major reconstruction contracts in neighbouring Syria. However, economists warn both prospects may turn out to be little more than mirages given political uncertainties in Syria and geopolitical risks in the Eastern Mediterranean hydrocarbon landscape.

In short, Lebanon's economic model prevents both total collapse and meaningful development. The solution?

"Substantive and fair reforms to this status-quo should start by acknowledging the real sources of the problems: Ruling politicians...have used the public sector to strengthen their grip on the country, and have covered up corruption and waste which have lead to an increasing debt and their own enrichment," Dr Chaaban wrote.

Finally, if it seems to be good news that collapse is not imminent, Dr Chaaban tells The New Arab things can still go south quickly.

"Financial collapse is still possible," he says, but only in scenarios that involve, for example, "the US slapping Iranian-style sanctions on the country's banking sector," as a way to pressure Hizballah. 

"But that's a different story."


Karim Traboulsi is a news editor at The New Arab. Follow him on Twitter: @Kareemios