Thursday, June 13, 2024

The Way Forward

A recent research paper by the prestigious Harvard Growth Lab, led by Prof. Ricardo Haussmann, issued on November 29, 2023, presents a rational diagnosis of Lebanon’s monetary, financial, and debt crises and offers few practical resolutions for tackling such triple disaster and the way forward for a gradual recovery.

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The insistence of the government of Lebanon (GoL) to live in total denial of its deliberate default on public debt is baffling. No country, in living memory, has ever attempted before to wash its hands from the mountain of debt it has accumulated from 1995 to 2019. We can cite Mexico, Venezuela, Argentina, Russia, Turkey, and many others. All have recognized their responsibility in borrowing beyond their means and agreed to settle debt, even at massive discounts, with their creditors both foreign and domestic. 

Over the years, the GoL borrowed both in LBP and in USD to plug chronic budget deficits, stemming largely from a bloated budget (principally civil service, and military salaries) and later, to pay the accumulated interest on the growing public debt. However, more devastating was the Central Bank’s catastrophic move in 1997, to ‘peg’ the FX rate of the LBP against the USD at c. LBP 1507, first using its foreign currency reserves -and when depleted, using USD deposits of commercial banks placed at the Central Bank. Over the years, this costly and unsustainable ‘peg’ policy wiped out the mass of USD from the system, melted banks’ deposits, and caused hyperinflation. 

There is no need to blame former or present-day governments, as the blaming game settles no debt but only political scores which, have many other fields than the economy to quarrel about. What is needed though, is a humble but clear-headed approach, to find a way out from this dark, interminable tunnel that puts the “Gaza metro” to shame in comparison of its depth and maze-like designs.

The GoL borrowed on the international markets and from domestic banks. Lebanese banks fell into the classic conundrum of greed and fear. On the one hand, clear directives from the Central Bank supposedly to limit cross-border risks limited their alternatives to diversify assets (fed largely by deposits), away from sovereign debt. On the other hand, they were willingly seduced by that same Central Bank with a scheme of easy wins and high profits through placements in sovereign securities. Surely, they could have found other avenues to diversify or simply refused to lend more money to the GoL. Back in 2014, when a leading banker voiced concerns about the GoL’s excessive indebtedness policy, he immediately became the target of political and legal retributions and; treated as a pariah by his fellow bankers who toed the line charted by the Central Bank and the GoL for the sector.

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What about depositors? Small depositors (holding up to $100K and $150K in deposits) had no means and no sophistication to divert their savings away from local banks. Larger depositors -both local and diaspora-based- seized (in full awareness) the unprecedented opportunity to make double-digit returns on their deposits in comparison to lower rates offered by banks operating in safer markets (e.g., GCC) or more stable institutions in Europe or Asia. Surely, some large depositors were incapable or unwilling to seek diversification in more regulated markets for lack of proper banking structures in their home markets (Iraq, Syria, Yemen), or for the presence of sanctions on countries where their funds were being generated or simply, for tax evasion. Thus, massive deposits that flew into the banking sector originated from different sources for a host of reasons, with a proper calculation of risks/rewards. Ultimately, the risks trumped all benefits.

The vicious circle became a closed loop whereas more deposits rewarded by high rates were channeled to local banks, who made more profits and bonuses than larger institutions in developed economies, straight to the Central Bank which, hoarded all USD deposits it could gather chiefly to preserve the indefensible ‘peg’ policy, whilst the balance finally found its way into the coffers of the GoL, which continued its borrowing and spending spree. 

The raging civil war in neighboring Syria, the lack of any modicum of reforms by an enfeebled GoL, the geopolitical risks of an ultimate clash between pro-Iranian and Israeli forces, the absence of monetary discipline by the Central Bank or fiscal conservatism by the State, all led to the logical and unavoidable results: a total meltdown of the Lebanese deposits in USD, a hyperinflation, and a halt in investment flows, save the regular remittances from the diaspora that come to feed, literally, relatives and families at home.

The recent research paper by the Harvard Growth Lab, is neither an ultimate solution nor a panacea. It should be carefully read as a sober and practical roadmap for the GoL, the Central Bank, the banking sector, and the larger Lebanese economy and citizens-depositors seeking a way forward out of this self-inflicted national calamity. The research paper should also be contrasted with all plans previously floated by the GoL, its financial advisers, the IMF, and other experts, with the objective of building a consensus approach that would lift the economy from the morass in which it finds itself.

Putting aside the ‘blame game’ and let the ‘adults’ in the room to start a rational dialogue, which would be the first step towards the salvation of the national economy.

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