A Reading of the Preludes to the Collapse and Its Causes

At a time when the Lebanese pound is collapsing and inflation is spreading like wildfire, threatening the livelihood of the Lebanese people and devouring the purchasing power of their currency, one must ask about the causes that have plunged the national economy into this vicious circle and are preventing the formulation of appropriate solutions to emerge from this protracted crisis. This is especially true given that limiting the handling of the collapse to Banque du Liban's intervention in the foreign exchange market to rein in the pound's fall, in the absence of an accompanying government plan that addresses the causes of the collapse, renders such intervention a squandering of Banque du Liban's remaining reserves and a waste of opportunities for solutions.

The monetary policy adopted by the governorship of Banque du Liban since 1992, in the wake of the collapse of the Lebanese pound against the US dollar and what followed that period and its repercussions, played a fundamental role in the state to which financial and monetary conditions deteriorated on the eve of the pound's renewed collapse since the end of 2019. Banque du Liban pegged the exchange rate of the Lebanese pound against the US dollar from 1997 until early 2020 at a middle rate of 1,507.5 pounds to the dollar, after working to lower it gradually over five years from 2,800 pounds in 1992.

In parallel with pegging the exchange rate, Banque du Liban moved to raise interest rates in order to attract foreign deposits, which drove up the cost of public debt and plunged the public treasury into a continuous and growing deficit. This deprived the productive sectors, particularly export-oriented ones, of access to capital at reasonable interest rates that would encourage productive activities and help them grow and expand. Consequently, economic activity was confined to capital flows seeking high interest rates and quick profits in trade, financial services, and other services.

Whereas the central bank governorship should have reconsidered the adopted exchange rate so that it would keep pace with economic activity and mirror it, appreciating when economic activity improved and depreciating when it declined, the exchange rate was kept fixed for twenty-two years without any attempt to adjust it or work toward transitioning from a rigid peg to more flexible policies. Monetary policies thereby missed numerous opportunities to float the exchange rate and curb its negative effects on productive economic activities in industry and agriculture.

Meanwhile, the events that coincided with the exchange rate peg, particularly political bickering and the successive crises it caused and continues to cause, along with repeated Israeli attacks on Lebanon and its vital infrastructure, culminating in the assassination of the martyred Prime Minister Rafik Hariri, had negative repercussions on the national economy in general and the monetary situation in particular. Attracting foreign capital amid political instability, successive infrastructure losses resulting from Israeli attacks, and the shock caused by Hariri's assassination all contributed to mounting pressures on the national currency and rising interest rates.

Expansionary spending policies pursued by successive governments, junto with favoritism in public procurement and rampant corruption across public administrations and institutions, led to a surge in public debt, which grew at an accelerating pace to exceed 150% of gross domestic product in 2018, increasing the cost of maintaining the exchange rate peg and raising interest rates. At the same time, the state failed to ensure the continuity of basic public services, most notably electricity, which drained the public treasury and accounted for more than one-third of the public debt.

Since 2011, the Syrian crisis and its regional and international ramifications have exacerbated pressures on the national economy, which expanded to serve the Syrian market and its in-kind and monetary needs, while the smuggling of goods, fuel, and other commodities into Syria constituted an additional factor depleting foreign currency reserves, heightening the need for more of them at a time when foreign remittances fell to unprecedented lows.

In an attempt to offset the decline in financial inflows, Banque du Liban conducted swap operations, or what became known as "financial engineering," with commercial banks starting in August 2016, under which it initially swapped the Eurobonds held by banks for their equivalent value at the time in Lebanese pound treasury bills, and subsequently swapped their cash dollar holdings for certificates of deposit issued by Banque du Liban at high interest rates, channeling nearly 70% of bank deposits into financing the public sector.

While financial engineering allowed the money supply in circulation (especially foreign currencies) to expand until 2018, that supply shrank once again as Banque du Liban was forced to intervene in the foreign exchange market to defend the pegged exchange rate and prevent speculation against the national currency on the one hand, and to provide public finances with needed foreign currency on the other. Meanwhile, shortly before the crisis erupted in 2019 and up until very recently, those holding political and financial decision-making power (the ruling establishment) moved to smuggle their deposits abroad in collusion with the banks, causing an outflow of between $6 billion and $7 billion from bank assets and worsening the shortage of hard currency.

The outbreak of the coronavirus pandemic in 2020 constituted an additional factor intensifying pressures on Lebanon's financial and economic situation. The near-total shutdown of economic activities and the contraction of the global economy played their part in complicating the crisis and reducing the foreign remittances that Lebanon so desperately needed.

The Lebanese government's announcement in March 2020 that it was suspending payment on maturing Eurobonds without prior agreement with creditors, on the pretext of "securing the basic needs of the Lebanese people and halting the depletion of Lebanon's hard currency reserves," amounted to a declaration of bankruptcy by the Lebanese state, carrying negative repercussions for Lebanon's credit rating both today and in the future.

While the government pledged to take all measures it deemed necessary "to manage Lebanon's limited foreign currency reserves wisely and prudently," the policy of subsidizing foodstuffs, medicines, fuel, and other goods adopted by Banque du Liban starting in 2020 drained those reserves and squandered nearly $18 billion, which went into the pockets of major merchants and their political partners.

Conversely, the governorship of Banque du Liban proceeded, and continues, to print and inject massive quantities of Lebanese pounds into circulation without regard for the inflationary repercussions of the money supply, which reached 69,856 billion pounds at the end of October 2022, knowing that this supply is set to balloon further with the continuous rise in the exchange rate. Yet the direct correlation between the money supply and the exchange rate makes it imperative to stop printing more pounds and to adopt monetary policies that curb inflationary effects.

As for the state's fiscal policies, they differed little from what they were before the onset of the crisis, with the expansion of public spending remaining their defining feature amid scarce state revenues, causing gross public debt to rise by 4,941 billion pounds in the first eight months of 2022. And while good governance requires diagnosing the problems afflicting public finances and devising appropriate solutions, the vested interests of those in the legislative and executive branches have prevented agreement on a comprehensive plan setting out the remedies needed to exit the crisis.

Despite the catastrophic state of the national currency and the contraction we are witnessing in the productive sectors of the national economy, halting the collapse is not impossible, especially now that we are safe from the major crash heralded by some economic analysts.

All Lebanon needs to resume economic recovery is political stability, the election of a visionary president of the republic who enjoys credibility and stands apart from alignments and backroom deals, and the formation of a government that upholds accountability, halts the collapse, drives the wheel of the national economy forward, and broadens its horizons.

Any talk of halting the collapse and drawing up plans for economic recovery will remain mere wishful thinking unless political stability is achieved, so will the Saudi-Iranian agreement pave the way toward finding solutions to the Lebanese crisis?

Translated from Arabic with AI. Read it in Arabic