Economic crisis and challenges in Lebanon

By Ishac Diwan Economy October 23, 2021

Themes

The collapse: current economic situation
Where do we stand on adjusting to the triple crisis?
Mikati and the IMF: Subsidies, Energy sector, K-control, Banking reforms?

Diagnostic: an exaggerated collapse

The initial shock is a sudden of external flows
But aggregate spending decreased by much more
Because GDP collapse as well, bringing poverty and misery
Exacerbating elements: fiscal crisis and inflation; banking crisis
Policies that help fasten a recovery – Fiscal, Credit, devalution, external support – did not follow.
What resulted is an exaggerated adjustment

In shares of 2018 GDP (except last column)

“Ajustement par le bas”

National accounts 2018 to 2021: percentage change

Adjustment of the External Accounts

Lots of capital flight, competing with imports, leading to an enormous real devaluation

Source: BdL last bulletin

Understanding the triple crisis

Capital inflows: ~20% GDP, ~ $10 bil./year, into bank accounts
Banks mainly deposit at BdL ($CDs about $80bn)
- High Interest Rate and fixed XR keep the money coming
BdL sells a lot of the $ (at LBP1505) to importers
- This finances the trade deficit
- If IR was lower, flow would stop, and a devaluation needed
BdL lends much of the LBP to the Gov.
- At lower IR – explains some of the losses of BdL
- The rest of the losses is “cost of carry” for the “Reserves”
Government finances its deficit
- But primary deficit about balanced -> most of the funds back to depositors
- Rise of “paper wealth” pushes consumption and import
Overvalued XR and high IR tax domestic production and exports

How did we get there? Debt dynamics

Source: IMF art 4, 2019

Early height in debt ratio did not trigger crisis – deficit was falling, and GCC/West supportive
In past decade, primary in balance-> deficit was financing debt service

Debt ratio deterioration ajer 2011 largely due to growth collapse and rising interest rates

10 points action plan and achievements

1 Empowered economic emergency steering committee

2 Government imposed capital and banking controls

3 Decisively deal with public sector debt

4 Embark on a credible fiscal reform

5 Deal with private sector debt

6 Repair BdL’s balance sheet

7 Bring the banking sector back to health

8 Preserve social peace through a focus on social justice

9 Re-think the FX/monetary policy mix

10 Stabilization and Structural Reform Facility

Dec 2019. Firas Abi Nassif, Edward Asseily, Bilal Bazzy, Hala Bejani, Amer Bisat, Henri Chaoul, Ishac Diwan, Haneen el Sayed, Ali El Reda Youssef, Saeb el Zein, Nabil Fahed, Philippe Jabr, Sami Nader, May Nasrallah, Paul Raphael, Jean Riachi, Nisreen Salti, Nasser Saidi, Kamal Shehadi, Maha Yahya, Bassam Yammine, Gerard Zouein.

IMF requirements

PM: “some things we can, others we cannot do”
- Seems focused on energy, subsidies/SSN
IMF main “prior action”: at minima, start process to reduce public debts so that IMF loans can be reimbursed in future with a high enough probability
- Also, capital control (so new $$ do not leak out)
- Safety net (reputational)
Negotiable time-table and “effort” for:
- XR unification
- Plan for fiscal adjustment
- Banking reforms

Subsidies and Safety Net

Unsustainable
- Draining national assets(~$5bil/y)
- More than total fiscal expenditures!
Regressive and full of leakages
- Less than 20% of “subsidy goes needy
- A good share goes in contraband
Generates corruption and inefficiency
- High incentives for speculative storage
- Support over-consumption, esp. of energy

To be replaced by a SN
- WB 200-300 mil project
- Government has a~1 bil. Plan wt no financing plan yet
- Discussions on going on modalities

Energy sector

Goal: lower production cost (from c27 to 17/KW) AND increase EDL supply to 24h (1500MW), AND full cost recovery (from c10 to ~c20).
This eliminates private generators (~c35/KW), saves the Gvt $1-2 bil in subsidies (EDL + mazout), reduces pollution (shij to gas)
The plan requires time/money: to fix generators, add capacity, improve governance
Regional help: Iraq. Egypt/Jordan: $400 mil. Each (about 800MW)

Distributing the losses

Highly imbricated balance sheets. Losses are:

Government debt = $90 bil (LBP + Eurobonds) [BdL, Banks, Eurobonds]
BdL’s own losses, $35 bil+ ? [Bank deposits]
Bank losses loans to private sector ($15bn?)
Total losses to digest: $50-90bn??

Note: figures in table from Sep 2019, later figures include lots of netting out

Debates on Banking sector reforms

All choices distributive as Debt (mainly) internal. To repay is take from Fadi to give to Nabil, and to default is to take from Nabil to give to Fadi.

Banks equity (first line of defense) – but resisting
Haircuts [plain/reprofiling/good-bad banks] – Distributive fight
State assets (incl. gold, privatize, put in a fund) – Distribution? State revenues?

Differences in plans

Government/Lazard: all of 1 (22bn), a bit of 3 (not gold, “corruption refunds”), 2 paid by large depositors, new banks
ABL: default only on Eurobonds; lots of 3 ($40bn, incl. gold), some bank capital preserved
(Salame: leave BdL debt out of the mix)
Status quo: the small depositors taxed heavily through Lirification