Feeling like indulging in a big mac? Well be prepared to pay a hefty sum of 13.64 euros when in Lebanon. But it doesn't stop there. Faced with three different rates: the official, bank, and black market rates, you'd generally be able to either pay 13.64, 5.39 or 1.66 euros for a classic big mac all depending on where you exchange your money. This is one implication of Lebanon's currency crisis among a sea of other tragic complications.
Please note that some of the views stated in our articles are those of the writers, and not necessarily those of FAECTOR.
A country that famously dons the title of resilience is once again fighting to emerge from the complications of corruption and a looming economic collapse. While the turbulent fight against coronavirus has preoccupied the rest of the world, it seems to be the least significant of Lebanon's problems. At the same time, the catastrophic explosion of August 4th left the country in an even bigger calamity.
In order to understand the complexity of the currency crisis which ties into the banking sector frenzy and overall economic distress, we must first discuss the underlying political situation along with the tragic explosion that cost more than 200 civilian lives.
Brief Background of Politics In Lebanon
The root of Lebanon’s situation can be drawn back to its alarming politics. Having gone three years without a president or prime minister elected into power and five years until the next elections, the Sectarian Lebanese government fails to settle a power sharing deal between the 18 different religious groups. The three dominating groups consist of Maronite Christians, Sunni Muslims, and Shiite Muslims. Essentially, parliament seats must be proportionally distributed among the religious groups and government posts are only assigned to devotees of a designated religion. For instance, only a Maronite Christian can become president and a Sunni as prime minister. This is due to the unwritten National Pact made in 1943 that agreed on such a sectarian distribution of power, which was generally in favor of the Maronites (the political elitists at the time). However, over time the Shia Islamist political party and militant group, Hezbollah, challenged the once prevalent western values promoted by the presiding Christian majority. Backed by funding and military provisions from Iran, Hezbollah’s military division (and in several cases the political party itself as well) is also considered a terrorist group in numerous countries, including the Netherlands. They have guaranteed a third of the cabinet seats, which essentially gives them a veto. On the other hand, while there exists a general disapproval of the political system among Lebanese citizens, many fear abolishing the system as this risks leaving behind a fragile government with the likelihood of sovereignty by a certain powerful political party, such as Hezbollah.
The Lebanese government is afflicted with constant allegations of Corruption. According to Transparency International, the global coalition for corruption, Lebanon's Corruption Perceptions Index (CPI) as of 2020 stands at a daunting low of 25. For comparison purposes, the CPI of the Netherlands stands at an exemplary rank of 82. This is what critics claim to be the consequence of adopting a Sectarian government in which religion paves the way for which things are run. This could in essence provide an element of foreshadowing for the tragedy of the Beirut port explosion to follow, where the severe mishandling and negligence of the leaders in power brought the lively city crumbling down.
Lebanon before the explosion
For years, unrest had been stirring among Lebanese citizens. A country known for its rich culture, tantalizing food, and the warmth of its people is forced to abide by harsh standards of living. Especially deprived in terms of limited daily hours of electricity and power blackouts; the country's national grid can supply merely half the electricity that the people demand. This shortage of energy is drawn back to their government's under-investment in power plants and heavily criticised budget allocations. In turn, to power their homes many are forced to turn to expensive generators, which are conveniently owned by tycoons with strong ties to leading politicians. In addition to the poor electricity affair, inequality is also a prevalent feature that torments the country. (https://theatlas.com/charts/0OsZPsVEw). Additionally, according to the World Bank, an estimated 27% of the population lives below the poverty line. Not to mention the concern following obstructed access to clean drinking water and weak public healthcare system. Lebanon also hosts the largest number of refugees per capita at an estimate of 1.5 million Syrian refugees as of 2020. A study conducted by the International Labor Organization about the impact of Syrain Refugees in Lebanon demonstrates that prices of accommodations and basic commodities have excessively inflated amidst the increased demand. Additionally, higher unemployment alongside lower wages has also been a by-product of the new pool of refugees that accept lower wages without social benefits.
October 29th of 2019 brought about the resignation of then prime minister, Saad Hariri. This was the inevitable outcome of the fervent protests that amassed an estimate of one million people. Besides all the aforementioned poor conditions that Lebanese citizens were forced to endure and a political crisis, the ultimate trigger of the protests that ensued was the announcement of the government's new lucrative tax scheme. The Lebanese people were enraged and the resignation of Hariri and his cabinet was not enough to put out the destructive flames. Many of the previous ruling figures remained in power and the newly appointed cabinet in January 2020 remained blindsighted to the needs of the people once again.
On August 4th of 2020 an even bigger tragedy struck the people of Lebanon. A staggering detonation of 2,750 tonnes of improperly stored ammonium nitrate sent shock waves throughout the city of Beirut. Equivalent to 500-1100 tonnes of TNT which is about a twentieth the size of the atomic bomb used in Hiroshima, Beirut's port explosion marked one of the largest non-nuclear blasts ever recorded in history. It had also been felt in Cyprus, almost 160 kilometers away. With an estimated 220 people dead, 6,500 injured, 300,000 displaced from their homes and a physical damage of $ 3.8- $ 4.6 billion dollars as estimated by the IMF.
Image Credits to Rodolph Ghousoub
Besides the massive blow to GDP forecasts for 2021, the social impacts of the explosion are beyond compare. An estimated $555 million of damage is incurred in the form of displaced families seeking shelter, destruction of the food supply, damage to pivotal education facilities, and a severely threatening exposure of the healthcare sector. Additionally, as the country heavily relies on imports to supply most basic necessities such as food and medicine, the damage to its Port of Beirut incurred a heavy blow to their provision of resources. It also severely harmed the port's main grain silos which contained roughly 80% of Lebanon's total imported grain provision. This is detrimental to their food security as merely 10% of grain consumption is provided locally.
Image Credits to Rodolph Ghousoub
What had caused this devastating blow?
There still remains a lot of speculation as to what exactly caused the disastrous event. A swarm of controversy also exists surrounding a possibly intentional trigger. However, what is known so far is that the ammonium nitrate that exploded had actually been offloaded due to technical problems from a Russian-leased vessel that was sailing from Georgia to Mozambique in 2013. Now what exactly was done to this abandoned ammonium nitrate? Skeptically stored in a dangerous warehouse for six years without any proper safety measures. Once again, the disastrous effects of government corruption and negligence comes into play. Hassan Diab, prime minister at the time, resigned six days after the explosion alongside a wave of other resignations from other ministers. A port general manager, Hassan Koraytem spoke of previous multiple requests for the ammonium nitrate to be re-exported or sold. However, left to no avail. It still remains obscure as to how the fire had erupted and there are still ongoing investigations. A leading force behind the plethora of controversy is that the Hezbollah trial verdict was due three days after the explosion, which led many to speculate the involvement of Hezbollah in triggering the detonation.
Trade Deficit and Public Sector Debt
To make matters worse, Lebanon has one of the highest levels of government debt as a share of economic output and ranks third as the most indebted country in the world. What started out as a source of financing after the gruesome civil war has made them obliged to lose a large percentage of their revenue towards debt financing every year. At the same time, Lebanon's economy remained stagnant with very little growth, which in turn aggravated the debt-to-GDP ratio reaching a worrying high of 174.5. The ramifications of the port explosion has also hurled Lebanon into even deeper financial distress. Eventually, being obliged to succumb to defaulting on a $1.2 billion eurobond payment. Furthermore, Lebanon relies very heavily on imports (around 39.61% of their GDP) which prompts a negative trade balance.
Currency & Banking Sector Crisis
Lebanon has followed a questionable fixed currency scheme in which it pegged the Lebenase pound against the dollar at 1,500 for decades following the civil war. This was set in order to stabilize the inflation which was then soaring at rates above 400%. However, in order to maintain a fixed rate, it must be secured with steady revenue from exports, which Lebanon lacks in this case. To illustrate, the highest their revenue for exports had been $4.4bn against $21.1bn in imports during 2018. This large discrepancy between export revenues and import costs indicates an insufficient backing of a fixed currency scheme which is doomed for inevitable collapse.
In order to simply explain the banking sector crisis, the ponzi-like scheme of the financial sector which eventually left 80% of the local-currency debt, to be owned by the commercial banks and Banque du Liban (BdL), the Central Bank of Lebanon, must be touched upon.
Recall now that Lebanon follows a fixed currency exchange rate which implies a strong need for a large stock of foreign reserves, a foundation for the Lebanese Pound's Stability. In order to preserve this, in 2016 the BdL presented a “financial engineering” plan that exchanges local-currency debt from the finance ministry with dollar-denominated bonds financed by Eurobonds. These bonds in turn were sold to the commercial banks of Lebanon with extraordinary rates of return on the dollar deposits. Alongside this, the BdL also issued USD-denominated long-term Certificates of Deposits (CDs) to commercial banks which allowed commercial banks to exchange their dollar reserves for Lebanese pounds. As a result, the BdL was able to secure higher foreign exchange reserves to support the currency peg and commercial banks could earn an effective interest rate of 15%. Many critics of the financial engineering plan assert that it's a very risky short-term fix and poses a load of financial burden on the IMF. Infamously referred to as a Ponzi Scheme as it relies on “fresh borrowing”, money sourced from the later investors (commercial banks), to pay back the existing debt.
Sustaining this scheme requires a consistent large supply of dollars; however, due to a decrease in income from remittances due to low oil prices in Gulf countries in late 2018, dollar deposits decreased. The country also slid into an economic crisis (as discussed in previous sections) causing the currency to sharply lose value on the open market while the official rate remains pegged at the initial rate of 1 dollar against 1,500 pounds. The same Eurobond used to finance the dollar-denominated bonds, issued for the BdL and sold to commercial banks, was defaulted as discussed previously. This led banks to eventually prevent dollar withdrawals but as of April 2020, the BdL has allowed the withdrawals of dollar savings at an above-market exchange rate in local currency. However, this rate is still 55% below the black market exchange rate. This has debilitating effects on the depositors especially. It is understood that the BdL allows people to trade at numerous unofficial exchange rates to discourage and prevent dollars being withdrawn from banks, keeping them safe.
How much Lebanon's currency is exactly worth remains ambiguous. As of now, four different foreign exchange rates are recognized on the black market, even reaching rates as low as 15,000 pounds per dollar. The political unrest alongside an economic frenzy has left Lebanese citizens in distrust and ultimately faced with crippling inflation which has plunged the population into even deeper poverty. Food prices, for example, have increased by 400%.
The fate of Lebanon lies hidden beneath the thickets of political instability, economic disaster and collapse. Faced with an ultimate economic collapse characterized by an utterly illiquid banking sector, abolished and absent government, and a raging foreign exchange black market that is spiraling out of control; Lebanon is in dire trouble.