lebanon pound

Despite banking reforms, an end to the country’s economic trauma remains a distant prospect, writes John Everington.

Three years ago, the Lebanese pound, pegged at around 1507.5 to the US dollar since 1997, began to wobble. Concerns about the declining value of the currency were dismissed by Riad Salamé, the veteran governor of the Banque du Liban (BdL), who told The Banker that the peg was secure, and that reports of a divergent black-market rate were a “misrepresentation” of the true situation.

Today, Lebanon’s economy lies in ruins. Following the 2019 collapse of BdL’s controversial “financial engineering” programme — which offered the country’s lenders high interest rates to attract dollar deposits to support the currency peg — and the country’s first-ever sovereign debt default the following year, Lebanon is enduring what the World Bank describes as a financial and economic crisis “likely to rank in the top 10, possibly top three, most severe crises episodes globally since the mid-19th century”.

With the crisis about to enter its fourth year, there are finally some faint grounds for optimism. After a protracted series of negotiations, the Lebanese government reached a long-anticipated staff-level agreement with the International Monetary Fund (IMF) for a $3bn loan facility in April, contingent on far-reaching reforms to the country’s ailing banking sector and the wider economy.

Parliamentary elections held in May, meanwhile, brought in an unprecedented 13 new independent lawmakers that had run on reformist agendas, representing a growing clamour for change among the country’s increasingly impoverished population.

Yet observers remain sceptical about the prospects for reforms for the country’s beleaguered banking sector or the wider economy. May’s parliamentary elections yielded no clear winner among the country’s many political parties, with protracted coalition talks — and the prospect of a separate presidential election in October — likely to slow the impetus for significant reform.

The banking sector, itself dominated by the country’s established political elite, remains resistant to government reform plans. And serious questions surround the future of the BdL and its increasingly controversial governor, who finds himself at the centre of a series of investigations both at home and abroad.

Deep-rooted crisis

Lebanon’s economy was in a precarious state ahead of the collapse of the BdL’s financial engineering programme. The debt-to-gross domestic product (GDP) ratio stood at around 150%, the world’s third-highest debt burden behind Greece and Japan, while Transparency International ranked the country as the world’s 137th most corrupt nation out of 180. The country’s infrastructure — in particular its transport system and ailing electricity network — was in desperate need of investment. And as early as 2015, the IMF had uncovered a $4.7bn hole in the central bank’s reserves.

“The roots of [the crisis] can be traced to years of large fiscal deficits (current wasteful spending without any build-up of infrastructure or real public assets), leading to a growing debt burden, [and] an increasingly overvalued Lebanese pound generating persistent current account deficits,” Nasser Saidi, Lebanon’s former minister of economy and trade and a former BdL vice-governor, told The Banker.

“Malgovernance, endemic corruption, incompetence, failed policies and dysfunctional politics have tipped Lebanon from being a fragile state into a failed state.”

Lebanon’s peg to the dollar had been maintained for several years thanks to dollar remittances to the country from expatriate Lebanese, which accounted for as much as 26.4% of GDP in 2004. Yet as remittances fell in 2018-19, the pound’s dollar peg became increasingly unsustainable.

Against such a backdrop, the impact of the 2019 collapse — exacerbated in subsequent years by the sovereign default, political turmoil, the Covid-19 pandemic and the Port of Beirut explosion in August 2020 — has been utterly devastating.

Lebanon’s economy has shrunk for five consecutive years, with GDP shrinking by a quarter in 2020 alone, according to Fitch Ratings estimates (see below). The Lebanese pound has subsequently lost more than 90% of its value. While still nominally pegged at about 1507.5 to the dollar, the black-market value of the pound fell to an all-time low of 33,600 in late May. The debt-to-GDP ratio has subsequently risen to more than 500%, by some estimates. Foreign currency reserves, which stood at more than $30bn on the eve of the crisis, stood at around $11bn in mid-June, having fallen by $2.2bn since end-2021.

Sporadic relief measures introduced by the government in the past three years have done little to protect the population from the impact of the collapse. Inflation has soared, rising from just 4.0% in April 2019 to 222.9% as of the end of April 2022, according to Blominvest, the investment banking arm of Blom Bank.

Food and fuel prices rose 400% in the year to April 2022, due to the impact of the war in Ukraine and the removal of fuel subsidies by the government in August 2021. Higher fuel costs and a shortage of medical supplies have pushed the country’s health system to the brink of collapse. Around 80% of the population currently live below the poverty line.

Banks share the blame

While the actions of successive governments and the BdL have been criticised for the collapse of the economy and the financial system, the banks themselves — which participated fully in the BdL’s financial engineering programme — have come under severe criticism.

“Lifetime savings have been wiped out by a reckless banking sector lured by a monetary policy favourable to their interests,” stated Olivier De Schutter, the UN’s special rapporteur on extreme poverty and human rights, in a damning assessment of the economic situation issued in April.

“The government and the broader political establishment, the BdL and the banking sector are jointly and severally responsible for the human rights violations that have resulted from the manufactured crisis Lebanon is experiencing today.”

There has been little meaningful coordination between the authorities and the banking sector throughout the crisis, with depositors paying the price. Attempts to solve the crisis have been hampered by factors including political instability, (the country has had three prime ministers since the start of the crisis, with a fourth due to be elected as The Banker went to press); opaque practices at the BdL (auditors in 2018 described its accounting practices as “differing from international reporting standards”); and a banking secrecy law (temporarily lifted only at the end of 2020) that has hampered effective audits.

Agreement between the government and the banks over the sector’s true losses was only achieved in December 2021, with estimates at around $69bn.

While political paralysis prevented the passage of capital control laws at the beginning of the crisis, banks applied sporadic controls from early to late 2019, tightening them further as time went on.

Yet the patchwork system of the initial restrictions “allowed politicians and cronies, bank shareholders and bankers, the ‘privileged and connected’ to transfer over $10bn at the expense of continued depletion of international reserves and destruction of confidence in the banking system,” Mr Saidi told The Banker.

Depositors withdrew around $11.3bn from the banking system between the fourth quarter of 2019 and the same period in 2020, according to an analysis by Bank of America (BofA).

Faced with a chronic shortage of US dollars and the collapse of the pound, Lebanon’s banking system, once the most prominent in the Middle East, has effectively ceased functioning.

“Those that have [Lebanese pound] accounts have had 90% of their savings effectively wiped out since 2019,” Hassan Moughnieh, who leads the Association of Depositors in Lebanon, told The Banker.

“For dollar-account holders, if you want to withdraw $1000, you’re given L£8m, which has a black-market value of less than $300. And if you want to close your account, you’re given a banker’s cheque that is impossible to cash, apart from on the black market at a fraction of its value.”

While court cases filed by depositors against banks in Lebanon have had little success, the UK high court in March ordered Lebanese lenders Société Générale de Banque au Liban and Bank Audi to transfer $4m to a UK-based depositor, months after a similar ruling in France.

Following the rulings, Bank Audi in March shut several UK accounts held by British citizens or residents. Depositors told Al Jazeera that they were offered a chance to reopen their accounts if they waived their rights to sue the bank or make foreign transfers.

Many Lebanon-based depositors have tried more drastic measures to access funds, according to the Association of Depositors in Lebanon, with several incidents of threats made to bank staff in an attempt to access dollar deposits.

Several Lebanese banks did not respond to requests for interviews for this article.

Recovery plan

Authorities began discussions with the IMF shortly after the crisis began. Yet initial progress was slow, with the fund arguing for far-reaching economic reforms in return for financial assistance.

The government and the IMF finally reached a preliminary agreement in April for a $3bn loan facility, with prime minister Najib Mikati promising the implementation of such reforms. In late May, the Lebanese cabinet approved the country’s Financial Sector Recovery Strategy (FSRS), days before it went into caretaker mode following parliamentary elections earlier that month.

Included in the plan, according to a Reuters report, is a full audit of the BdL’s foreign exchange standing, to be conducted by the end of July, to be followed by the cancellation “at the outset, [of] a large part of the central bank’s foreign currency obligations to banks in order to reduce the deficit in BdL’s capital”.

An audit of the country’s largest 14 banks, representing a total of 83% of total assets, will be undertaken. While viable banks would be recapitalised with ‘significant contributions’ from bank shareholders and large depositors, non-viable banks would be dissolved by as early as this November, according to the plan.

Small depositors would be protected “to the maximum extent possible”, according to the plan, without spelling out minimum protection levels. The government has previously indicated it will guarantee accounts with balances below $100,000, but that depositors will have to wait several years to fully access their money.

Despite being passed by the cabinet, it remains to be seen whether the country’s newly elected parliament will approve the new deal. While May’s parliamentary ballot saw the election of 13 new reform-minded candidates, it is likely to be weeks if not months before a coalition government is formed. Meanwhile, the country is set to hold elections to elect a new president in October.

“Given that presidential elections are just around the corner, it’s going to be tough to conclude everything in the short-term, so things may need to be dragged out into 2023,” Jean-Michel Saliba, a Middle East and north Africa economist at BofA, told The Banker.

“Lebanon’s political class has not closed the door on the FSRS reforms, but by the same token they haven’t rushed to conclude them. Once the presidential elections are out of the way, we’re likely to see whether the political class will go for it or not.”

Banking blowback

Perhaps more significantly, the influential Association of Banks in Lebanon (ABL) has already opposed the plan, stating that it places the main burden on the banks and their depositors. The ABL has previously proposed the establishment of a “government debt defeasance fund” to include state assets, which would settle state debts via a long-term and low-interest bond.

The ABL’s position towards the FSRS may translate to a lack of clear parliamentary support for the deal, given the body’s links to the country’s traditional political class, notes Mr Saliba.

The UN estimates that as of 2014, individuals closely linked to political elites controlled 43% of the assets in the commercial banking sector; 18 out of 20 banks had major shareholders linked to political elite; and eight families controlled 29% of the sector’s total assets, owning more than $7.3bn in equity when combined.

“There is no hope for accountability in Lebanon until the banking sector is reformed and such conflicts of interests prohibited,” said the UN’s Mr De Schutter.

The ABL did not respond to requests for interviews for this article.

The governor’s fate

Questions also surround the future of BdL governor Mr Salamé, whose current term in office comes to an end next year.

“The governance of the BdL is going to be a very important factor going forward,” says BofA’s Mr Saliba. “If Riad Salamé leaves his position, it’s going to be a complicated process to find someone to replace him that is acceptable, both locally and internationally. It’s a position that holds a lot of power.”

The governor, who has served in the role since 2003, has come in for severe criticism both at home and abroad for the BdL’s alleged role in triggering the crisis, and faces several probes into his finances — again, both in Lebanon and abroad.

France, Germany and Luxembourg have seized properties and frozen assets worth €120m in March, as part of an investigation into Mr Salamé’s finances by French investigators. Mr Salamé and four other suspects — which include members of his family — are suspected of embezzling more than $330m between 2002 and 2021.

That same month a judge in Lebanon’s district court charged Mr Salamé and his brother Raja (who was subsequently taken into custody) with money laundering via several companies that they own.

Mr Salamé has denied all charges against him. He and his brother launched legal action against the state in June, claiming that the country’s public prosecutor made “grave mistakes” through the course of his probe, according to a copy of the lawsuit seen by Reuters.


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