Lebanon: Financial Crisis, Diagnosis, Implications and Solutions

National Bloc, "Khalina 3a Tawasol" Series, Episode of May 28, 2020 With Dr. Henri Chaoul, a member of the Lebanese Government negotiating with IMF, and Dr. Amer Bissat, a former IMF economist, Moderated by Hala Bejjani, Managing Director of Kulluna Irada.

On Thursday May 28th, 2020, the National Bloc hosted a webinar with Drs. Amer Bissat and Henri Chaoul and moderated by Ms. Hala Bejjani to discuss the Financial Crisis, its diagnosis, implications and potential solutions. Dr. Henri Chaoul, a banker, is presently a consultant to Minister of Finance and a member of Lebanon’s negotiating team with IMF. Dr. Amer Bissat, is a former IMF economist. And Ms Hala Bejjani is the CEO of Kulluna Irada.

We will present hereafter some of the topics that were discussed and the opinions of the panelists.

Dr. Bissat who has written several pieces on the diagnosis of Lebanon’s bankruptcy which he saw happening many months ago started by saying that that contrary to the general perception, Lebanon is not unique; we are not the first country to get into trouble, nor will we be the last. In fact, what is happening in Lebanon is quite standard for emerging countries.

As to the root causes of the crisis, Dr. Bissat said that our original sin is that we borrowed too much; The government, due to the many factors we know such as corruption, waste, mismanaged expenditures… cumulated $90 Bn in debt; but the private sector also borrowed beyond its means, and the CB also played a crucial role in the debt bonanza, by borrowing from banks at very high interest rates and lending to the government at much lower rates. We therefore ended-up with a very large stock of debt that unsurprisingly became unsustainable. The problem of bad debt is that creditors who lent the money want their money back. Foreign creditors are not the major problem for Lebanon, as the country is too small, and the amounts are negligible in lenders’ portfolios. The real problem is that local banks hold the larger part of the debt. They accepted a substantial risk when lending to the Government directly or via BDL at high interest rates, and now they have to pay the price; first through their equity, and as unfortunately the losses exceed the value of their equity, deposits in banks will also be affected.

Regarding potential solutions for such crises, Dr. Bissat said that when faced with such crisis, the IMF has 6 levers to activate; 

  1. First, there is a need to wipe-out the original sin by writing-off all or part of the original debt to reduce the debt stock, through a debt restructuring process.
  2. Next, there is a need to deal with the restructuring of the Banking sector; Lebanon here does not have that many options: After wiping-out banks equity, the remaining losses are estimated at $44Bn, that will be financed by depositors; the question is which depositors will be affected, by how much and under which form?
  3. However, the losses should not be borne by banks and depositors alone, and the Government has to play a role as well. The Government cannot just achieve primary fiscal surpluses, it has to undertake structural reforms that will create some savings to repay part of its debt.
  4. The fourth lever is a deep recession where you reduce expenses to create savings to service the remaining debt. This implies much lower levels of consumption, and a shrinking economy, typically lasting for 2 years at least.
  5. The fifth lever is the devaluation of the local currency, but a real one, not the multiple rates that exist today in Lebanon. While invariably very painful for wage-earners, the devaluation will inflate Lebanon’s LBP debt away, provide the CB with opportunity to inject LBP in the market, and allow inflows of US Dollars through tourism that is more affordable.
  6. Finally, when all of the above is done, Lebanon can activate the last lever, namely asking for foreign assistance. The magnitude of the losses is so high, that Lebanon cannot solve the problem by relying only on internal resources.

This 6 levers approach is in fact a general equilibrium equation. The amplitude of one lever will impact that of the others. Mr. Bissat also stressed out the need for the Civil Society to have realistic demands that are affordable within the very limited and constrained fiscal space.

Regarding Lebanon’s government financial reform plan, Dr. Chaoul said the following: The GoL plan is recognizing that massive losses were incurred, and it indicates that everyone should contribute to the solution, which has to treat foreign and local creditors equally. Losses should be borne by all stakeholders: 1) the state, through the Public Assets Management Company; 2) the politicians through an audit of all public tenders since the 90s; 3) the banking sector whose total assets reached $200Bn and whose cumulative net profits reached $19Bn, through their equity and a clawback on distributed dividends for past 3 years; and 4) the depositors, especially those who have benefitted from excessive interest rates through some form of haircut. Mr. Chaoul added that there is no escape from a devaluation of the local currency, and that such a measure would require the GoL to provide the poorest people who will suffer most, with extended Social Safety Nets, to help them go through this period.

As for the counter plan presented by the Lebanese Banks Association, Mr. Bissat said it had both Pros and Cons. On the negative side, the plan sins by taking a “Them not Us” approach, putting all the blame on the fiscal policies of successive governments, and totally rejecting to accept any risk on their equity. It also places the largest burden of the solution on the Public Sector through cutting expenditures. On the other side, and to its advantage, the plan’s existence emphasizes that we cannot demonize banks, as we need the sector to restart the economy.

Now regarding the Government’s ability to conduct the negotiations, and to deliver all the pre-requisite reforms required to build confidence at the soonest, both panelists agreed that while the decision to default and to enter into debt restructuring negotiations were courageous, the government’s performance otherwise has been very poor: 1) It failed in filling the vacant financial positions, due to the confessional distribution of roles, which is unacceptable. 2) The Government failed in conducting negotiations and having constructive multi-disciplinary dialogues with all stakeholders simultaneously, including BDL, ABL, legal experts and the civil society to enter into negotiations with the IMF and the International Community with a unified position.

It is worth mentioning that Mr. Bissat added that after the Corona Pandemic, the IMF is currently better positioned towards poorer countries, has reduced its conditionalities, increased access rights beyond countries quotas, and wants to disburse money. Lebanon should not jeopardize this opportunity.

In addition, many questions were asked by the audience and addressed by the panelists; we highlight two of them.

  • Regarding the way to restructure the banking sector, Dr. Bissat recommended the approach presented by the former minister Mr. Adel Afiouni. In short, all impaired assets including EBs, T-Bills, Certificates of deposits, etc. are grouped in the assets of one category of banks, and financed by the large deposits on the liabilities side, until a solution to the problem is found. Group the good assets from the private sectors in clean banks that are recapitalized, and that have small and medium deposits on the liabilities side. This allows a healthy banking sector to continue to operate and help the economy restart, and that will encourage foreign deposits to come back within a 2 years framework.
  • On the usage of State Assets, that is seen as unfair by many, since around 50% of the population does not have bank accounts, and would be unfairly penalized if State assets are used to bail-out banks and depositors, Mr. Bissat again adopts a very realistic and pragmatic approach and recommends compromise. The reality is that the scale of the problem is too large, and if we do not use the State’s Assets, we will have to increase pain elsewhere… a higher devaluation, a longer recession… However, he warns that some conditions must be respected: Fairness, choosing the right modus operandi, such as privatization, monetization and most importantly the right governance, as experience in Lebanon has proven that it is very easy to steal money.

In conclusion, both panelists recommend that we face reality, accept that losses have happened, and that everybody should accept some compromises so we find the most equitable solution. They are cautiously optimistic, believe that Lebanon has a lot of potential and that if we get our act together, we may avoid decades to recovery.