BrazilOut of options, Lebanon turns to IMF to save its economy
After months of fierce debate and postponement, Lebanon’s crippled government has run out of options, pressing officials to deliver its much awaited rescue plan for its crisis-hit economy.
Lebanon’s economy is in its worse state since the fifteen year multifaceted civil war which ruptured the country in the seventies and eighties. While the country did see a period of bloom from the turn of the century onwards, in retrospect, much of it was artificial according to economists, built on techniques of financial engineering that, down the line, saddled the country with a massive public debt.
With a 152% debt to GDP ratio, Lebanon is the third most indebted country in the world after Japan and Greece. But contrary to Japan and Greece, Lebanon no longer can sustain its exorbitant spending – interest payments consume almost half of government revenues.
Most of the other half of public spending flows to the coffers of corrupt officials and inefficient sectors including electricity (Lebanon has not had stable, 24-hour electricity since 1975), transport, construction and real estate.
In March this year, Lebanon was forced to default on a debt – a $1.2 billion in foreign currency debts – for the first time in its history. Now, the country needs at least $10 billion to keep things running in the coming 3-year period, and steer the government and financial system away from defaulting entirely. With funding to secure the short term, the government will then need to overhaul its ailing economy, and implement far fetching reforms.
Huge spending in Lebanon’s post-war reconstruction era were a leading precursor to today's financial problems, but these have been hugely exacerbated by a profoundly corrupt system. According to the latest annual Global Competitiveness Report from the influential World Economic Forum, Lebanon ranks among the 20 most corrupt countries in the world.
A political divide
Meanwhile, a deep split in political ambitions – Lebanon is home to 18 religions, with its political system built on a sectarian power-sharing arrangement – means that Lebanon’s government is notorious for making slow progress. Illustrating this, between 2014 and 2016 the country spent two and a half years to elect a president, with the vacant office putting future-oriented government policy on standstill.
The self-destructive nature of the political divide and corruption is most notable in the country’s energy sector. The discovery of a large oil and gas reserve in the Mediterranean years ago has the potential to fuel a bright future. According to preliminary estimates, the country can tap natural gas reserves of some 25 trillion cubic feet, which would bring in billions into government coffers.
However, despite the promise, the country is still far behind the progress of its neighbours (Israel, Cyprus and Egypt). Instead, political paralysis on the back of quarrels on distribution of income have delayed exploration and progress, with several media reports in the country unveiling how politicians are putting their own interests above those of the people.
The culmination of a deep mistrust of politicians led to an eruption among Lebanese citizens in October last year, when people flocked to the streets to shed their anger. While the pressure on officials was mounting, the Covid-19 outbreak forced the country to impose a lockdown, curbing protests in the process and buying politicians more time to take action.
Out of options
Fast forward six months and Lebanon is in deep trouble, and in need of urgent action. With the Middle East facing its own problems due to tumbling oil prices, and the West hesitant to beef up the country’s finances (the US and France are traditionally close allies of the country for its heritage), the country is gridlocked.
Having long resisted turning to the International Monetary Fund (IMF) for support (many politicians in particular the Iran-backed Hezbollah group fear the mandatory package of reforms), the government has now realised that it has no other option.
“We will ask for a loan program from the IMF and formalise our negotiations with Eurobond holders and move forward with that.”
– Prime Minister Hassan Diab
After signing off on a rescue plan incorporating IMF support, which revolves around $10 billion of external support from the IMF and another $11 billion in loans and grants from the international community, Prime Minister Hassan Diab said in a televised speech, “We will ask for a loan program from the IMF and formalise our negotiations with Eurobond holders and move forward with that.”
President Michel Aoun welcomed the proposals as historic, since for “the first time an economic, financial plan” had been proposed to place Lebanon on the path of reform.
But within hours, the plan was widely criticised for its lack of direction and clear deadlines. In the eyes of opponents, the plan is only descriptive, omitting the long-time requested reforms, mainly in the electricity sector and the downsizing of the public sector, and details on the IMF collaboration. A plan with the objective of “buying time”, although the IMF is yet to formally respond to the roadmap put forward.
Banking reform
Part of the plan aims at restructuring the country’s large but indebted banking system. Banks are a crucial part of Lebanon’s economy, and for long, the country has prided itself on the strength of its banks. During the global financial crisis Lebanese banks provided more resilient than many of the globe’s behemoths, and up until the recent crisis they were pillars of financial strength.
Mid-2019, Lebanese banks sat on around $25 billion in shareholders’ equity and enjoyed capital adequacy levels comfortably above international standards. But their capital positions have eroded rapidly, as $10 billion flew out of banks between August and December last year due to a bank run amid a fear of a potential system collapse.
To stop the banking system from toppling, extensive capital control restrictions were unilaterally put into place, leading to public anger with some Lebanese choked to live and feed their families with as little as $100 per week.
The Lebanese central bank itself has incurred losses of more than $40 billion, mainly due to a large financial engineering strategy it began conducting in 2016 to boost its reserves and satisfy the government’s unproductive and mostly corrupted expenditure.
External expertise
In a statement released last week, the central bank confirmed it has tapped a trio of leading management consulting firms to help its officials with the overhaul. KPMG has been hired to support financial management and audit services, while Kroll, a subsidiary of Duff & Phelps, has been brought on board to advise on risk management and forensic investigations.
Speaking on the government’s desire to delve into forensics, Diab said in his speech “We want a contribution from the unrealistic interests that were paid and from those who made profits from the engineering and those who broke the law and stole public money.” Meanwhile, the public is calling for similar audits to be conducted on other governmental institutions plagued with corruption.
Consultants from Oliver Wyman have been hired to advise on financial restructuring, analysis of banking balance sheets, stress testing and drafting a future strategy for the sector. The global consulting firm brings an impressive track record to the table, having previously serving as a banking advisor in times of crisis to the governments of Greece, Saudi Arabia and the United Arab Emirates.
At present, Lebanon is facing the dilemma of having a controversial financial plan that will need time to be approved, and the mounting pressure on the street for urgent solutions to the social and economic crisis. The Lebanese Lira has lost 70% of its value and most consumer goods have quadrupled in price, plunging the country in a deep state of turmoil and triggering revolutionary protests. The days ahead will be crucial in the history of Lebanon.
