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The harsh realities facing Lebanon as it approaches a moment of truth

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08 May 2022 12:05:45 GMT9
08 May 2022 12:05:45 GMT9

Nearly three years of political, economic and social conflagrations in Lebanon have upended life in what was once the “Paris of the Middle East,” transforming a land of promise into an encyclopedia of state failures.

At fault for this is a failed political system designed to seek out consensus among confessional elites, eschewing competence and expertise to secure tenuous compromises in a region that historically has struggled with democratization.

In the absence of any competent leadership, Lebanon’s economy is teetering on the verge of total collapse as various sectors continue to experience deeper and more serious deficits, exacerbated by a currency in free fall, flawed policies, inflation and a misguided ruling elite, to list but a few.

The imminent collapse has already precipitated a multisector deterioration, as indicated by unprecedented levels of unemployment, poverty and crime, increasing the prospects of frayed social relations and an imminent, irreversible decline.

Beyond the dizzying list of political and socioeconomic woes, the country’s relationships with regional Arab states, which are central to its political and economic stability, remain weak, further undermined by an out-of-touch elite and the deliberate depression they have caused.

A window of opportunity will open up two weeks from now when Lebanon conducts a long overdue parliamentary election that could reinvigorate attempts at renewing its democratic institutions.

Both domestic and external actors insist on the necessity of these elections proceeding without a hitch, given that external economic assistance is riding on it. Most Lebanese are betting on the prospect of the upcoming polls bringing newcomers into a parliament known more for squabbling than solving the country’s intractable woes.

What awaits any fresh crop of leaders is a troubled landscape that will demand unprecedented efforts to create and nourish a new political dynamic and a social contract to help counter a notorious culture of corruption, impunity and lack of accountability.

Aspiring lawmakers should not underestimate the difficult task that lies ahead, which involves more than just cleaning up the mess of the past two years. For Lebanon to successfully reemerge, there must be a full reckoning with the decades-long malfeasance that reached an inflection point nearly nine years ago.

The deteriorating political situation since 2020 continues to contribute to Lebanon’s catalog of crises. First, politicians bickered over the formation of a caretaker government, followed by a suspension of Cabinet-level proceedings and more bickering afterwards. Without competent leadership, Lebanon simply went further adrift, with much of the resulting socioeconomic pressure falling on households.

Close to 80 percent of Lebanese households now subsist below the poverty line, compared with 28 percent globally, and nearly half are living below the extreme poverty line, a figure four times the global average. Overall, the nation’s economy has contracted by more than 60 percent in two years, one of the sharpest declines in per capita gross domestic product in the world.

Prior to Lebanon’s default in early 2020, the country was living way beyond its means, having created a cumulative deficit of $82 billion since 2014. Worse yet, misguided policies that sought to maintain currency stability and rein in inflation wiped out billions in foreign currency reserves while funding unproductive priorities. Coupled with the state’s failure to highlight productive sectors and infrastructure needs, and an illogical public sector wage increase, it was only a matter of time before this fiscal and monetary house of cards collapsed.

What was once the ‘Paris of the Middle East’ is now an encyclopedia of state failures. 

Hafed Al-Ghwell

Lebanon’s central bank is currently burning through its remaining foreign currency reserves of about $12 billion at a rate of $500 million a month — and this is after some subsidies were lifted. It is a startling but predictable situation in which the ruling elite have grown accustomed to merely taping up the leaks, while causing new leaks to spring up elsewhere.

There is simply no appetite to underwrite a comprehensive restructuring of Lebanon’s banking sector or to introduce serious reforms, implement new policies and legislate rational “fixes” to put the beleaguered country firmly on track to recovery.

Unsurprisingly, Lebanon’s capacity to inject fresh foreign currency into the economy is shrinking in real time and in scope as those in power continue to delay structural reforms. Much of that hesitancy, or unwillingness, stems from the fact that the current malaise actually benefits at least three known stakeholders: The government, borrowers, and traders.

The decline in the market value of Lebanese debt, for instance, has reduced public debt from $92 billion to $10 billion, while borrowers only need to pay back about $15 billion despite borrowing nearly $40 billion prior to the collapse.

Meanwhile, traders have continued to benefit from generous subsidy schemes that hamper domestic productivity, drive up imports and increase the external deficit.

All of this has not come without cost and the ramifications are well documented, even as they worsen with each passing day. For example, the banking sector, which had become the main anchor of economic activity in Lebanon over three decades, is hobbled by the deteriorating conditions. Apart from the local and international concern surrounding the fate of about $85 billion in foreign currency and consumer deposits, bank assets have shrunk by $40 billion, resulting in a cumulative $5 billion of sector-wide losses since 2019.

Even as most of the world is experiencing some positive growth after pandemic-induced contractions, Lebanon’s economy remains trapped in a contractionary spiral. There is very little appetite for investment and the catastrophic decline in real household incomes has decreased consumption considerably. The government cannot afford expansionary interventions to create some momentum in the shrinking economy, given fiscal consolidation requirements and the corollary restrictions resulting from austerity measures.

Any potential solutions must be credible and fall in line with the International Monetary Fund’s recommendations, which include appointing or empowering a watchdog to supervise the implementation of reforms and ensure that such a vital, long-delayed intervention is not corrupted by malign politicking.

Should Lebanon succeed at this, it could be the beginning of an overdue turnaround and help to boost its lagging economy by about 5 percent, driven by private consumption, rising foreign currency inflows and renewed investments.
Absent an agreement, the Lebanese economy is projected to contract yet again, which would make it the longest contraction in recorded history. The cost of delay will also balloon to astronomical levels, since the expected financial sector losses are nearly $70 billion.

Had the government moved swiftly and decisively to deal with the crisis two years ago, expected losses could have been held under $31 billion, a figure that amounts to roughly a quarter of Lebanon’s remaining foreign currency deposits.
Going forward, the situation in the country could go one of two ways. The first is a “soft landing” that would come from a comprehensive agreement with the IMF, followed soon after by capital controls and budget laws ahead of structural reforms with maximum oversight, inclusivity, transparency and accountability. If managed properly, it would unlock a tide of international financial assistance and help Lebanon halt its free fall into economic oblivion.

Alternatively, a “hard landing” in which IMF-mandated programs, reforms and agreements fail to materialize would result in the Lebanese pound plummeting irreversibly. The only resort would be to print more money, causing hyperinflation while unmanaged external deficits wipe out what remains of the country’s foreign reserves.
Of paramount importance is a restructuring of the banking sector to bolster Lebanon’s financial standing, governance and proof of resilience. What concerns most observers, and even some stakeholders, is the sheer size of the financial sector, which is roughly three times larger than Lebanon’s GDP. This indicates an overcrowded sector that is bigger than the country needs to adequately finance a productive economy.

Beyond banking sector reforms, Lebanon also needs comprehensive macroeconomic and financial stabilization, including a restructuring of public debt and the shrinking of a bloated, inefficient public sector.

The government must also initiate inclusive, bottom-up and top-down, expansionary reforms to unleash the untapped potential and opportunities in the domestic economy. The country will also need sustainable social safety-net programs to reduce socioeconomic pressures on over-burned Lebanese households.

  • Hafed Al-Ghwell is a senior fellow with the Foreign Policy Institute at the John Hopkins University School of Advanced International Studies. Twitter: @HafedAlGhwell
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