Riad Salame
Lebanon’s economy has operated under sustained pressure for several years. The country has a public debt-to-gross domestic product ratio of about 160%, one of the highest in the world. Badly in need of economic reform and infrastructure investment, progress has been stymied by political paralysis and widespread corruption. The presence of up to 2 million refugees fleeing the war in neighbouring Syria, adding to a domestic population of just over 6 million, has stretched the economy to breaking point.
If such a backdrop were not bleak enough, in 2019 the country’s woes have become increasingly pronounced. Particularly alarming is a slowdown in incoming foreign deposits, traditionally the lifeblood of the economy, during the first half of the year. Tighter supplies of US dollars have put pressure on the local currency’s peg to the US dollar, with reports emerging of a rising black market in currency exchange for the first time.
Lebanon was hit with a series of crises in late-August and early September. Rating agency Fitch downgraded the country’s sovereign rating to CCC, following a similar downgrade by Moody’s in January. The US Treasury imposed sanctions on Jammal Trust Bank, accusing it of supporting the activities of Hezbollah, sealing the bank’s fate. On September 1, Hezbollah fired missiles into Israel, in retaliation for an alleged Israeli drone strike on a Hezbollah facility in Beirut the previous week, threatening a significant escalation of hostilities between the two countries for the first time since 2006.
The country’s worsening economic prospects prompted Lebanon’s prime minister, Saad Hariri, to hold a four-hour meeting with senior government officials in early September. He declared an economic emergency, and pledged to push forward with vital economic reforms, in a bid to unlock about $11bn in relief funding pledged to the country at a conference in Paris in 2011.
The Banker recently sat down with Riad Salamé, the veteran governor of Banque du Liban, the country’s central bank, to discuss the prospects for the Lebanese economy and its financial sector. In a wide-ranging interview (edited for clarity and length), Mr Salamé insisted the collapse of Jammal Trust Bank will not have an impact upon the wider financial sector, and that the Lebanese pound’s peg to the US dollar remains secure.
Q: Interest rates in Lebanon have risen dramatically since late 2017. Are rates likely to remain high?
A: The high interest rates are a consequence of the fact the political and economic situation in the country [has acted as a barrier] to bringing in investment, and as a consequence of the liquidity decline in all emerging markets.
If you look at the trend, the rate reversed and started going up in November 2017 when the prime minister, Mr Hariri, announced his resignation [while in] Saudi Arabia [which he later rescinded]. The politics played a role in decreasing confidence in the country, and therefore the reaction was higher interest rates.
You’ve also had the situation after the elections in May 2018, where it took nine months to form a government; during those nine months we saw a further increase in interest rates due to that increase in political instability. Additionally, the Syrian refugees have weighed on the finances of the government and the deficit has increased.
Today, it is liquidity and political confidence that are driving interest rates and not the opposite. [This comes] especially as Lebanon is a dollarised economy – meaning any move in the interest rates on the Lebanese pound is not going to help put more liquidity in the market, but would rather create more demand for the purchase of dollars, especially as the dollarisation of deposits has increased in the past two years from 69% to 71%.
So the economy in Lebanon is a function of the liquidity in dollars more than a function of interest rates, and that’s why interest rates are fixed by the market in a way to create and continue creating inflows in foreign currencies.
Q: How would you categorise the strength of the financial sector, particularly following the sovereign downgrade by Fitch?
A: Lebanon’s banks have a solvency ratio, according to Basel III, that is about 16% on average; this is far higher than the 10.5% level that is required. When we did the financial engineering exercise of 2016, the revenues of the banks [from that engineering] were capitalised as per the request of the central bank, which gave them a high solvency. So even if you implement the standards that are required when you have two ratings agencies that have downgraded the country, the solvency ratio will remain at 12%.
The banks are also running profitable operations, and we don’t have problems in any bank in this regard, so the central bank doesn’t have problematic banks in the system.
Q: What is the status of Jammal Trust Bank?
A: This is a designation on the US Treasury’s Office of Foreign Assets Control list that makes it difficult for the bank to have correspondent banking, and therefore the activity of the bank now is in a situation of liquidation. The central bank is backing the liquidity needed by the bank to repay all of its legitimate depositors. The bank is a small bank, in that it represents less than 1% of the total deposits of the country. We are going to make our own investigations and coordinate with the US Treasury in order to [find out the truth behind] the accusations.
Q: The designation raises questions about banks’ compliance systems. Are you happy with the controls that banks have in place?
A: Yes. Lebanon has a good compliance system that is recognised by international organisations, and also has a good network of correspondent banks that are comfortable with our compliance systems.
Q: Lebanon has 65 banks serving a population of just over 6 million. Does the central bank plan to encourage further consolidation in the sector, as was recently suggested by KPMG?
A: The central bank does not force banks to merge, except in circumstances where they can’t meet our regulatory requirements. There is a law for [bank] mergers that allows us to financially back the cost of that merger. More than 33 banks have merged in the past 20 years using that law. So ultimately, it is the market that is going to decide on the number of banks that we’ll have in the future, rather than the central bank.
Q: Foreign deposits have been crucial to Lebanon’s economy for several years, particularly for maintaining the Lebanese pound’s peg to the US dollar. Deposit growth entered negative territory in May for the first time in more than 10 years. How concerned are you about this trend?
A: If you look at the figures, you will see the deposits have declined compared with the year end. But if you look at this decline, it is about $1.5bn, while if you look at the loan portfolio it has declined by $7bn. That means a lot of deposits that used to be cash collateral for loans have been closed. And therefore if you take the difference, you would see in practice that the deposits have increased by more than $4bn over the first seven months of the year.Â
Q: There have been reports that the black market value of the Lebanese pound is rising, putting the peg with the dollar at risk. Are you planning to take action to support the peg?
A: These reports are a misrepresentation of what’s going on. [Exchange houses] cannot do parabanking operations. And therefore, there is no black market as it has been described. It is like if you go into a hotel and you see the price of sterling is 5% higher than what you see on your screen. Does that mean you’re running a black market? Of course not.
Q: So the peg is secure, and will be kept at its current level?
A: Yes.
Q: What were your takeaways from the September meeting called by Mr Hariri on the need for economic reform?
A: I think the political leaders in the country are now sensitive to the fact that they need to introduce and execute reforms that will curb the deficit, and they are also keen to have a 2020 budget on time with a lower deficit. They are looking at a three-year effort that would bring the deficit much lower – betting essentially on the electricity sector, where a lot of savings can be made. As you know, if you want to stimulate investment, you need to decrease the deficit so you don’t have a crowding out in terms of funding.
