The economy is de-dollarized and the Lebanese pound is gradually floated

Limit the role of Government to efficient policy making and regulation in order to improve the performance of Lebanon’s main macroeconomic indicators

A Prosperous Economy That Creates Jobs For All and Reduces Inequalities

1.A currency peg is a country or government's exchange rate policy whereby it attaches the central bank's rate of exchange to another country's currency

2.Doing so provides long-term predictability of exchange rates for business planning and can anchor rates at advantageous levels for large importers

3.Currency pegs create stability and can remain in place for decades, provided Central Banks hold the foreign currency of the peg in sufficient amounts to support the local currency

4.Broken pegs are usually followed by major currency fluctuations e.g. the British pound in 1992, the Russian ruble in 1997 and the Argentinean corralito in 2002

1.Money in circulation

2.LBP/USD Exchange rate

3.Banks Net Foreign Assets Position

4.BDL Net Foreign Asset Position

5.Capital outflows

6.Consumer Price Index (CPI) inflation

1.Lebanon’s “currency crisis” onset can be divided into a period of decline (2011-2019) predating the full-on currency collapse (2019-present)

2.The economic collapse has vindicated in dramatic fashion Robert Mundell’s theory of the “impossible trinity,” which states that you cannot have a fixed foreign exchange rate, free capital movement and an independent monetary policy at the same time

3.It highlighted the costs of a reckless monetary policy, which depleted foreign exchange (FX) reserves accumulated at a monumental cost to try to maintain a fixed exchange rate and free capital flows. The most visible aspect of this policy was the Central Bank’s (BdL) “financial engineering” operations based on accumulating foreign currencies through borrowing FX funds from local banks at unusually high interest rates compared to international rates. The policy that started in 2012 as a one-off, small scale operation quickly ballooned to unsustainable levels, as the BdL and political class desperately attempted to fund the state (and their clientelist networks) and keep the currency peg, in place since 1997

4.Meanwhile, an overvalued exchange rate hurt all forms of local production, including agriculture and manufacturing, and led to an over-reliance on imports and chronic deficits in Lebanon’s trade balance. It eroded Lebanon’s competitiveness, increased unemployment, and even worse down productive machinery. This political-economic model turned Lebanon into a rentier economy that relied primarily on a highly vulnerable set-up based on limited services, constant financial inflows from expatriates, illusory profits of banks from financial engineering operations, and returns from over-inflated often unoccupied real estate

5.In September 2019 the fixed exchange rate regime, which has nominally held at Lebanese lira (LL) 1,507.5 to the US dollar ($) from 1997 to 2019, is broken for the first time in more than two decades when the LL began to depreciate from its official rate and is de-facto dislodged in favor of a system of multiple exchange rates:

• The official exchange rate—LL 1507.5 per US$—which remains an anchor to many contracted prices in the economy and at which BdL is backing up the importation of highly critical goods, namely, fuel, medicines and wheat
• The “Sayrafa” electronic platform, created in June 2020 with the purpose of organizing the erratic currency exchange market and allow the rate to be determined by market forces, has kept its rate arbitrarily fixed at 3,900 LL since its inception. The e-board exchange rate—LL 3,900 per US$— is used for the importation of essential goods identified in the list of (FX-backed) items issued by Ministry of Economy and Trade (MoET) as well as the rate at which lirafication is taking place. Its level is administratively determined
• At the end of the first quarter of 2021, BdL announced another attempt to launch Sayrafa, a new electronic currency exchange platform that aims to begin the process of eliminating black market currency exchange businesses by becoming the official reference point for the Lebanese lira’s market value. The platformed launched on May 17, 2021, with no impact yet on the black-market rate
• The more volatile, market-determined, black-market exchange rate

6.Acute exchange market pressures in Lebanese markets are reflected by heavy fluctuations in the black-market exchange rate. The lira has since depreciated by 90% of its market exchange value, reaching an all-time low of 15,000 LL to USD in the parallel market in March 2021, before going down again, but with extremely volatile periods along the way

7.Subsequently, exchange rate pass through effects on prices have resulted in surging inflation; the 12-month inflation rate has risen steadily and sharply from 10 % in January 2020, to 46.6 % in April, 89.7 % in June, and most recently in August, 120 %. In fact, the average year on year (yoy) inflation rate over the first 8 months of 2020 (8M-2020) for food and non-alcoholic beverages was 170.3 %, while that for clothing and footwear was 195.4 %

8.As of February 2021, BdL’s foreign currencies reserves (excluding Gold, Eurobonds and Foreign Securities) decreased by USD 14 billion

1.Lebanon’s currency peg, unlike those of oil-rich Gulf states, is not backed by FX financial resources; instead, the country relies on deposit inflows to Lebanese banks from its diaspora

2.Devaluation would be painful for a country that imports so heavily and would send foreign debt ratios through the roof

3.Although BdL publishes its balance sheet regularly, it has not published its profit and loss statements for over 15 years, and has used creative accounting to conceal the true position of its Net FX reserves

4.Despite the unsustainable situation, the monetary and fiscal policies enjoyed consistent political backing, as parties used their access to state resources to fund their clientele networks

5.Formal capital control laws were not endorsed and enacted to prevent capital flight

6.A maximum of 25% of imported essential goods subsidized by BdL reaches the most vulnerable, with the balance profiting to more affluent citizens and importers or being smuggled across borders

7.High volatility in the black-market rate in current panic conditions implies very high uncertainty

• Importers from across the economy compete for access to these FX-backed facilities
• However, less transparent demand is also well-documented in countries with capital controls and multiple exchange rate systems; specifically, corruption and misclassification of imports, to benefit from cheap foreign exchange. As importers adapt to capital controls and more depreciated black-market rates, this incentive will grow
• Lifting subsidies on essential goods’ imports will increase the demand for dollars. As long as demand for dollars exceed supply, the value of LL will continue to depreciate
• Demand for lira compared to dollars is not only low because it is not being used in the economy, but also because of a loss of trust in the currency, which is perceived as a failed currency

8.There were no serious attempts to control the foreign exchange market, which led to the unregulated multiple exchange rate system.

9.Authorities so far implemented bad initiatives to control the black-market rate, for e.g., by enforcing a crackdown on exchange shops and websites displaying the market rate: “Instead of implementing reforms, they are trying to put a band-aid on a pipe that exploded”

• “They are trying to restrict the market. This is very harmful because you are transforming from a transparent market between customers into a very incomplete, risky, uncertain one.” By closing avenues through which people can trade dollars and lira, the government’s oppressive tactics are likely to increase manipulation — the exact phenomenon it claims to be tackling — and push the market underground
• This, will have a knock-on effect on the economy, as businesses who rely on $ to purchase goods will have a harder time finding them
• In the short term, “you may be able to control the rate somewhat, but at the cost of more people potentially becoming unemployed or shops shutting down”
• As for the new e-board exchange platform, BdL said in a circular addressing commercial banks on May 10, 2021 that it will intervene in the market to absorb liquidity to support the market value of the lira “if it deems [this] appropriate and within its capabilities,”. However, BDL’s ability to inject hard currencies into the market is questionable given its dwindling hard currency reserves. The finance minister has warned that the country may run out of money to cover imports of basic necessities by the end of May
• In the absence of foreign inflows of US dollars, any intervention by BDL will be financed through the legally required bank reserves held at BDL, which equates practically to what is left of clients’ deposits
• Many banks have refused to register in Sayrafa

1.The Code of money and credit promulgated by decree n13513 of 8/1/1963

2.Circular 536 (December 4, 2019): New regulation on local and forex currency interest rates ceilings

3.circular 149 (April 3, 2020), BdL established a special unit that exchanges foreign currencies comprising BdL, banks and exchange bureaus

4.2020: Circulars 148, 151, 549, 565 allow the withdrawal of pre-crisis deposits at exchange rates higher than the official rate, but lower than the black-market

5.Circular 568 (August 26) instructs banks to accept repayments by resident clients of their dollar retail loans—with limits of $US 800,000 for housing loans and $US 100,000 for retail loans— in LL at the official exchange rate

6.In circular 535 (November 26, 2019) and 561 (July 8 2020), BdL formalized its backup of critical imports; specifically, BdL’s provision of foreign currency at the official exchange rate for 90 percent of the import bill for fuel products and 85 percent for wheat, medicine, medical equipment and baby milk imports

7.Circular 556 (May 27, 2020): banks allowed to solicit foreign currency from BdL for 90 % of the value of raw materials imported by the industrial sector

8.Circular 557 (May 27) further targeted this scheme to agribusinesses, removing the limits

9.Circular 564 (July 8, 2020) allowed for foreign currency back up at the e-board rate for another list of essential goods’ imports identified by the Ministry of Economy and Trade (MoET)

Policy Action

1.The only way to slow the LL depreciation is to enter into an IMF program, after preparing a credible reform plan, in order to introduce foreign currency liquidity to absorb some of the market demand, restore confidence, and create the necessary conditions for economic revival

2.The government should also to undertake a huge number of radical reforms, including debt restructuring, taking care of insolvent banks and creating a more productive economy (Cf Issue. Economic Growth O13a, Public Debt O13b and Money and Banking O13h)

3.Unify the multiple foreign exchange rates now in place under one aggressively weaker rate, with the technical assistance of the IMF, by eliminating regulations and barriers to foreign exchange market operations and establish a transparent foreign exchange platform liquid and efficient enough to allow the rate to respond to market forces. The market making role of the BdL should be reduced and limited to managing volatility

4.After the unification, consider an eventual floatation of the foreign exchange regime while adopting very tight monetary policies to maintain LBP stability

5.Reduce inefficient use of foreign currency reserves through:

• Introduction of a capital control law in line with IMF recommendations to limit the flow of foreign capital outflow while ensuring equal depositor treatment and an end to the ongoing abuses
• Implement a gradual shift away from the current FX subsidy program, towards direct cash transfers to households as a first step. A study prepared by the World Bank found that shifting to a broad coverage (80% of the population) cash Transfer program will be more effective and efficient. Such a program would improve Lebanon’s balance of payments, meaningfully extend the time-till-exhaustion of remaining BdL reserves, and help cushion the impact on Lebanon’s poor and middle class. In addition, it would help reduce by more than 50% the cost on BdL’s FX reserve. Afterwards, any new subsidy programs should be included in a comprehensive social protection scheme included in the annual fiscal budgets.
• Regain swift control over the money supply and reduce money printing by:

1.Repealing BdL’s circular 151, which redeems the Lebanese dollars (Lollars) by printing more money in LL. To successfully do so, Lebanon’s government, the BdL, and banks must, through negotiations, agree on a clear and fair distribution of the LL241trillion7 ) in aggregate losses incurred by Lebanese entities, with an underlying policy of protecting depositors as much as possible

2.Improve public spending efficiency and fiscal revenue collection, as well as fiscal space for an adequate social protection scheme. Lowering the fiscal deficit is crucial since the only way to finance it and continue paying wages of the public sector personnel is through money printing. To do so, clear targets in reducing the size of the public sector and increasing its productivity should be introduced, including through a review of the civil service by an independent international institution and a comprehensive tax reform plan