The Lebanese public debt, which exceeded $90 billion in early 2020, has always tended towards instability, owing to both the fiscal deficit — over which successive governments failed to exert control and which has exceeded 11.5% of GDP each year since 2018 — and the ongoing deficit in the balance of payments, which reached a cumulative value of around $18 billion between 2011 and 2019. To adapt to this two-fold structural imbalance, successive governments have facilitated uncontrolled borrowing from banks, rather than implementing reforms. In turn, the banks have responded swiftly to government demands, to the point of neglecting the deposits held on behalf of Lebanese (and non-Lebanese) customers, which have experienced unprecedented profits and interest rates. Since the mid-1990s, between $80 billion and $100 billion of depositors’ cash has been spent on government consumption, unproductive public expenditure, and public debt servicing, not to mention the cost of political corruption, quotas, and the lack of competence in the management of public affairs and governance.
Challenges posed by the Lebanese public debt crisis
Around a quarter of existing GDP would be required to pay off the Lebanese public debt and the costs of servicing it within ten years, a sum that far exceeds expected government revenue, leaving no funds with which to finance any other public spending, based on current levels of spending and investment. As a result, for the first time since the establishment of the Lebanese State one hundred years ago, the Government came to a tacit understanding with the commercial banks, in the absence of legislation, that the banks would monitor bank transfers to foreign accounts and would impose discretionary caps (to be lifted over time) on withdrawals. The Government and the banks also agreed to produce two US dollar exchange rates: the official rate governed by the monetary stabilization policy in place since the 1990s and upheld by the banks, including the Banque du Liban; and a free, market-driven rate with at least a 50% higher value than the official rate. In the short term, the Government is seeking to write these arrangements into law, with some minor amendments, by pushing a bill through the House of Representatives.
The Government’s failure to pay
Given the conditions, the Government has no choice but to restructure the public debt, starting by suspending the payment of foreign debt bonds (Eurobonds), a proportion of which was due for payment on March 9 ($1.2 billion, out of a total of $5.4 billion, including interest, that would come due in 2020). One of the main reasons for this decision, which commercial banks have tried to resist in various ways, including by selling a large portion of their bonds to foreign investors, is the significant decline in assets held by the Banque du Liban in foreign currency, which currently amount to less than $30 billion, i.e. between a quarter and a third of funds deposited by commercial banks with the Banque du Liban. This sum includes the mandatory reserves that the Banque du Liban must hold for bank deposits, thereby effectively reducing the available resources to a third of that total.
Given this large hole in the Banque du Liban’s accounts, efforts to prioritize the use of the bank’s stocks of foreign currency to pay and service the foreign debt will entail many unknown risks. The continued commitment to pay off such debts would weaken, or even destroy, any chance that the banks would have of recovering at least part of the deposits held with the Banque du Liban in order to protect depositors’ rights. It would also prevent the State from continuing to meet the population’s basic needs by supporting the import of fuel, medicine, and wheat, areas in which the private sector is hard pushed to meet demand, given the controls imposed on transfers (i.e. credits) and the existence of two dollar exchange rates.
What can be done?
Restructuring public debt is a complicated and painful process that may have a negative impact on Lebanon’s reputation on the global financial markets and, consequently, its ability to borrow from those markets in future. While the process will require peer-to-peer negotiations with Eurobond investors based on the contracts for the issuance of such bonds, the Government must also take into account the risks accepted voluntarily by those investors in exchange for years of obscenely high returns, thanks to interest rates that were at times 8 to 10 times higher than those on the global markets, especially given the Banque du Liban’s “suicidal” financial engineering since 2016.
The Government’s negotiations with creditors — before they turn to the judicial system — should lead to organized, programmed understandings based on one or more approaches: debts may be rescheduled or redistributed over longer periods, agreements may be reached with creditors to reduce interest rates, and/or part of the debt may be deducted. Whatever the approach, the Government should apply the lessons learned from the sovereign debt crises and restructuring operations carried out in more than 110 countries over the past three decades. Notably, most of these countries have, to some extent, been able to return to the financial market and attract investors, depending on their success in controlling public finances and debt through transparent, discreet, and targeted economic plans and programs.
It must be acknowledged that financial default is a form of bankruptcy, involving huge, widespread losses. The greatest challenge lies in distributing such losses between the various social groups and economic sectors in a country such as Lebanon that is already characterized by great disparities between its sectors, regions, and social components.
On a financial level, a ceiling must be set for the dollar exchange rate, and the gap between the official rate and the free market rate must be narrowed, in order to protect consumers’ purchasing power, especially if the use of the Lebanese lira as a tool for pricing, trade, investment, and savings is widely expanded in a country where 75% of bank deposits are held in dollars.
On a banking level, banks must rid themselves of all losses and inflated accounts, and must work to restructure, merge, and capitalize their accounts to reduce the size of their assets as a percentage of GDP, which currently exceeds 300%. This must be accompanied by radical, comprehensive reform of the Banque du Liban’s policies.
At the level of public finance, steps need to be taken to reform the current tax system — where 1% of the population account for a quarter of national income and 45% of wealth — by applying a system of unified progressive taxation to all sources of income and increasing taxation of large financial and wealth companies, including through inheritance tax. Public spending must also be restructured, first and foremost by abolishing and merging various public funds and institutions that now serve only to legalize and facilitate corruption and clientelism among the authorities.
In addition to reforming public policy, the basic demands of the October 17 popular uprising must be met: ensuring the independence of the judiciary, removing administrative immunity and banking secrecy for all persons currently or formerly involved in public affairs, working tirelessly and in coordination to recover stolen public funds, improving living standards, particularly by providing universal health coverage and improving the quality of formal education, protecting wages, employment, and the pensions system, and excluding the deposits held by low- and middle-income groups from the impact of any financial “haircuts”.
As these trends and demands become reality, Lebanon has started to transition gradually from the current rentier economy to a productive economy with high added-value activities capable of creating jobs.
* Managing Director of the Consultation and Research Institute, Beirut.
EPC | 18 Nov 2020
Shereen Mohammed | 17 Nov 2020
EPC | 16 Nov 2020