In Lebanon, faith in national currency is slipping
A longstanding peg to the US dollar is increasingly a liability, rather than a guarantee of stability, for a Middle Eastern nation with enormous debt
Lebanese are losing faith in the stability of the national currency, the pound, despite lucrative and often dangerously high interest rates presented by banks.
Financial institutions in this small, Middle Eastern nation have offered such high rates on the national currency in the hope of dissuading investors from converting their money to the US dollar – or even worse – moving their resources out of Lebanon.
Recently, news spread that around $570 million, or approximately 855 billion LBP, were converted to dollar accounts in October. That was accompanied by a drop in the value of Lebanese eurobonds issued by the central bank, Banque du Liban (BdL).
This raised questions regarding the future of the pound’s longstanding peg to the US dollar, a policy that has been depicted by BdL as the prime index of stability for the economy as a whole. So long as the pound is pegged at 1,500 to the dollar, then a crisis can always be averted, according to this view. This has proven to be a disastrously incorrect belief.
One look at the increasing levels of unemployment, which stands just below 50% according to President Michel Aoun, the consumer price index (7.7%: Consultation and Research Institute), poverty rates (around 1/3 of the population, not including Syrian refugees: Consultation and Research Institute), and emigration (798,140 since 2015: ESCWA), in addition to the gradual collapse of the real-estate sector following the decline in foreign investments, proves otherwise. The only thing left stable is the peg, and that is increasingly becoming a liability.
In order to limit investors shifting their money from Lebanese pound accounts to US dollar accounts, banks have offered steep interest rates on the pound, rising to around 15% at times, currently 10.8%, while the average often hovers around 7% (already very high). This policy may keep the conversion from becoming a trend for now but it is unlikely that it will continue to be effective for the long term, not only due to the inevitability of an increasing distrust in the pound that accompanies the decline of foreign investments (namely coming from the Gulf and from Lebanese expatriates), but also because of BdL’s policies of hoarding liquidity.
Over the past few years, BdL has pursued the stability of the peg relentlessly through what has come to be known as “financial engineering,” which was meant to be a mechanism designed to attract hard currencies (USD, GBP, euro, etc) from the banking sector and their investments abroad to support BdL’s foreign exchange reserves, in exchange for immediate profits in pounds in the form of high interest rates on the transactions.
The banks have made billions in profits since 2016 through this mechanism, billions that have been paid for by increasing public debt.
By BdL selling Lebanese pounds essentially at a loss in exchange for US dollars, financial engineering led to an excess of pounds in the market. This prompted BdL to implement an additional set of measures to control liquidity “so that it does not turn into an additional demand for USD in the market,” as economic expert Ali Hashem wrote in the Lebanese daily Al-Akhbar. Inflation rose this year to unprecedented levels of around 7.6%, according to the Consultation and Research Institute.
The effect of both the engineering and the measures that followed was to raise interest rates on both the pound and the dollar in the market, and constrain liquidity to the central bank, making it much more profitable for the banks to invest in financial engineering with BdL than to invest in slow, profit-generating government bonds. That trend is reinforced by the lack of foreign investments and the decline of the real-estate sector, where 90% of bank investments reside. However, BdL’s strict high interest rate policy has been contributing massively to an ever-growing deficit in the BdL budget and Lebanon’s public debt, which is estimated to be around 150% of GDP.
In the current financial environment, BdL finds itself no longer capable of executing its measures to keep the pound from flooding the market
In the current financial environment, BdL finds itself no longer capable of executing its measures to keep the pound from flooding the market. With inflation rising around 4% between 2017 and 2018, BdL recently pressured the Ministry of Finance into raising interest rates on government bonds from 7.5% to 10.5% by refusing to purchase them, arguing that its monetary policy no longer allows it to do so due to their interest rate being “too low.” The banking sector has long stopped purchasing them, finding investment in BdL more profitable.
Previously BdL would buy government bonds from the Ministry of Finance, then BdL would issue CDs through the banks. BdL would then lend to the ministry, thus increasing government debt to the banks and BdL. Together, the banks and BdL own around 86% of the national debt (33.5% to the banks and 52.5% to BdL), according to the Association of Banks in Lebanon.
Since 2016, the banking sector is making almost all profits through financial engineering. BdL appears no longer capable of controlling inflation, and the Ministry of Finance has found itself stuck between a rock and a hard place with the choice of either raising the interest rate or burning through its reserves and going bankrupt.
The recent 855 billion LBP in the banks recently converted to dollar accounts indicates that faith in the peg and the pound is rapidly declining. Lebanon seems to be arriving at an inevitable crisis and no one from the government to BdL to the banking sector has a clear plan to avert it.
Goldman Sachs warned in a report earlier this month that Lebanon could be looking at a default in the coming two to three years if the country’s economic situation does not improve.
“Lebanon has been able to avoid slipping into a financial crisis thanks to the efforts of the Banque du Liban and its self-styled ‘financial engineering’ since mid-2016. The extent to which these operations can be sustained, however, is far from certain. Ultimately, we believe they are helping Lebanon to buy time, but cannot be seen as a long-term substitute for reform or a secular improvement in financing prospects, the need for which is becoming increasingly urgent,” Goldman Sachs said in its nine-page report on the performance of the Lebanese economy, quoted in Lebanon’s Daily Star.
Correction: A previous version of this article noted emigration from Lebanon at a yearly rate. The figure of 780,000 is the emigration to date since 2015.