Lebanon has been facing a severe liquidity crisis since August 2019, which was further exacerbated by the COVID-19 pandemic and the 2020 Beirut port explosion. In this article, we delve into the root causes of the crisis and examine how it has unfolded.
Lebanon, a small Middle Eastern country with a population of around 6 million, has been grappling with a severe liquidity crisis since August 2019. This crisis has had far-reaching implications, with the country experiencing hyperinflation, a collapsing currency, and widespread food and fuel shortages. While the COVID-19 pandemic and the 2020 Beirut port explosion have exacerbated the situation, the root causes of the crisis are complex and have been building for years. It started with a vision for rebuilding a nation once known as the Switzerland of the Middle East which saw downtown Beirut level in the civil war. With rising skyscrapers built by international architects and swanky shopping malls, the capital began to be filled with designer boutiques that took payment in dollars or Lebanese pounds. But Lebanon had little else to show for a debt mountain equivalent at the time to 150% of national output, one of the world’s highest burdens.
PROBLEMS BEGAN TO PILE UP
After the civil war, Lebanon balanced its books through tourism, foreign aid, financial industry earnings, and Gulf Arab states, all of which boosted central bank reserves. It relied on remittances from millions of Lebanese who worked overseas. They sent money home during the 2008 financial crisis. However, remittance inflow began to slow in 2011 as Lebanon’s sectarian fighting slowed politics, and the Middle East, notably Syria, fell into instability. Because of Iran’s growing influence in Lebanon through Hezbollah, a strongly armed Shi’ite militia, the Sunni Muslim Gulf powers began to withdraw. Transfers fell short of imports of staple commodities and luxury autos, increasing the budget deficit and balance of payments imbalance.
A NATIONALLY REGULATED PONZI SCHEME
One of the main factors behind the crisis is the country’s high level of debt. Lebanon has one of the highest levels of debt relative to its GDP in the world, with a debt-to-GDP ratio of around 150%. This is primarily due to decades of mismanagement and corruption. It all can be traced back to a dubious monetary policy seven years back. In 2016, banks began providing incredible interest rates for new deposits of dollars, an officially accepted currency in the dollarized economy, and even more for Lebanese pound deposits. Savers elsewhere received small returns. The perpetrators of the plan seemingly appear to have gambled on the value of the Lebanese pound not deteriorating from a fixed rate. It had been tied to the dollar at 1,500 for almost two decades and could be freely swapped at banks or supermarket cashiers at the time. Therefore, dollar inflow increased foreign reserves, and liabilities rose simultaneously as deposits were subjected to high-interest payments. As the country went through several political turmoils over the following years, Lebanon’s debt rose to a third or more of budget spending without anyone taking notice.
A TICKING TIME BOMB
For decades, the Central Bank of Lebanon has pegged the value of the Lebanese pound to the US dollar at a rate of 1,507.5 pounds to one dollar. However, this fixed exchange rate regime became unsustainable as the country’s foreign exchange reserves dwindled, and the demand for dollars soared. This has led to a black market for dollars, with the exchange rate reaching as high as 8,000 pounds to one dollar at its peak. The Lebanese government attempted to address the shortage of dollars by imposing capital controls, but these measures only exacerbated the crisis by further restricting the flow of dollars into the country.
OUT OF THE FRYING PAN…
The COVID-19 pandemic has also played a role in exacerbating the crisis, as the country’s already struggling economy has been hit hard by lockdowns and restrictions on international travel. The 2020 Beirut port explosion, which devastated the city and caused billions of dollars in damages, has only added to the country’s economic woes. The crisis has had severe consequences for the population of Lebanon, with widespread food and fuel shortages and skyrocketing prices.
WHAT BROKE THE CAMEL’S BACK?
A few concurrent events led to the total meltdown of Lebanon’s socioeconomic collapse. Before the 2018 election, legislators lavished a wage raise on the public sector when the state needed to curb spending. Due to the government’s failure to implement promised changes, foreign donors withheld billions of dollars in funding. However, the ultimate cause for unrest was a plan to tax WhatsApp calls in October 2019. With a large diaspora and a tax system favouring the wealthy, it was terrible to impose such a fee considering how many Lebanese relied on WhatsApp to stay in touch. Protests against a political elite, particularly ageing militia leaders who prospered while others struggled, were sparked by disgruntled youngsters who demanded sweeping reform. At the same time, foreign currency inflows ceased, and dollars left Lebanon. Banks lacked sufficient funds to pay depositors waiting outside, so they closed their doors. Concurrently, the government defaulted on its international debt. To sum it up, a dubious banking policy fueled by mismanagement, corruption and lack of effective oversight snowballed into yet another country being bankrupt.
EPILOGUE
Reuters summarised Lebanon’s financial collapse since 2019 as “A story of how a vision for rebuilding a nation once known as the Switzerland of the Middle East was derailed by mismanagement as a sectarian elite borrowed with few restraints”. Does that ring a bell? We will leave it up to the readers to draw their conclusions. However, it’s hard to miss a similar pattern when we look closely at countries that have gone bankrupt, playing the smoke-and-mirrors game of unsustainable debt and development. For obvious reasons, most of these nations are desperately seeking bailouts and implementing a series of economic reforms. In the case of Lebanon, they are yet to restore faith in the economy. The government has attempted to address the crisis through several measures, including negotiating a loan with the International Monetary Fund (IMF). However, these measures have been met with resistance, and the government has been unable to implement them effectively. The situation in Lebanon remains dire, and it is uncertain how the country will be able to resolve the crisis. It is clear that a comprehensive solution is needed that addresses the root causes of the problem, including the high level of debt, the fixed exchange rate regime, and the lack of economic reform. Without addressing these underlying issues, it is unlikely we will see an end to the commotion, and the population of Lebanon will continue to suffer the consequences.
