Over the last month, Ramy Karame, the owner of a phone shop in east Beirut, has watched unofficial exchange rates climb from 1,580 Lebanese pound (LBP) to $1, up to LBP 1,600.
The pegged exchange rate, in place since the end of 1997, is LBP 1,507 to $1. But that peg is now slipping due to fears that the Lebanese banking system has a shortage of dollars. Lebanon’s residents such as Karame have been unable to access dollars through official ATMs – formerly a common practice in Lebanon – and instead have been forced to turn to exchange shops, driving the so-called “black market” exchange rate up.
In late September, the alleged dollar shortage sparked protests amid the worsening economic situation.
Two weeks earlier, gas stations had gone on strike in protest at being unable to purchase fuel at official rates, though they quickly came to an agreement with Prime Minister Saad Hariri to end the strike. Millers, unable to buy flour at the higher rates, also warned that supplies in the country were slipping to dangerously low levels.
Although Riad Salameh, the governor of Lebanon’s central bank (Banque du Liban), has tried to allay fears of a dollar shortage by issuing several statements claiming that there were enough dollars in the country, customers from several banks have reported recently imposed transfer limits on dollars.
What caused the crisis?
The banks must maintain a certain level of dollar liquidity because they need them to buy imports. Lebanon relies heavily on imports for a variety of goods – according to the UN’s Food and Agriculture Organization, 80 percent of the country’s food is imported.
Stockpiling reserves is “an important buffer against monetary and financial risk in Lebanon, especially in the period of uncertainty we’re going through,” said Marwan Barakat, head of research at Bank Audi.
According to Barakat, the central bank’s foreign currency reserves were at $38.7 billion as of mid-September, up $2.5 billion from June as a result of transactions that targeted deposits from abroad. The reserves are the equivalent of 24 months of imports, and cover 78 percent of pound deposits in the system, which he says is “quite good.”
The recent developments are the result of an accumulation of factors including the slowing of remittances from countries with large Lebanese diaspora populations, including Latin America and the GCC; reduced investment from international donors in the absence of reforms in the country; and US sanctions on Iranian-backed Hezbollah.
One chairman of a Lebanese commercial bank, who wished to remain anonymous due to the sensitivity of the topic, pointed to the large number of Syrian merchants doing business in the country as an added stressor.
When Syrian merchants buy from Lebanese merchants, they pay for the goods in LBP and goods are transported to Syria, but Lebanese merchants originally purchased the goods in US dollars, draining Lebanon’s dollar supply.
“You add all this together, and you get a huge amount of demand, and the supply has simply not grown or has decreased,” the chairman told Al Arabiya English.
The bank chairman said he believes that Lebanon is not in a financial crisis, but a “crisis of confidence.”
With necessary reforms and increased confidence in the banking sector, the current situation, and the market rate for LBP, will stabilize, he added.
Earlier in 2016, the central bank – also led by Salameh – began implementing a series of unprecedented, but necessary, financial engineering maneuvers.
“Had [Salameh] not done this, the problem would’ve happened in 2016,” Jamil Chaya, a doctor of finance at Lebanon’s Rafik Hariri University Al Arabiya English.
The central bank pursued this strategy because the existing fiscal policy was in shambles, and whereas the democratic process was rather slow, the central bank could act swiftly to institute new procedures to help the ailing economy.
The measures taken by the central bank in 2016 allowed banks to continue partaking in the international banking system. According to Chaya, the moves made by the central bank helped Lebanese lenders meet the international criteria for banks which use dollars, including having corresponding banks in the US and meeting certain fiscal and regulatory requirements.
However, years of financial engineering were not able to save the fractured system.
Lebanon is one of the most indebted countries in the world, with the debt burden reaching 150 percent of GDP. The country’s deficit in 2018 was 11.5 percent of gross domestic product (GDP).
“The problem is now you’ve pushed the pile under the rug, and it’s gotten so big you might trip on it,” said Chaya.
In 2018, the balance of payments, which is paid in US dollars, was $12.5 billion – and it looks to be around the same in 2019, according to Mounir Rached, president and founding member of the Lebanese Economic Association.
The depletion of foreign exchange, especially in commercial banks rather than in the central bank, has led the country to its current predicament, he said.
Now, a parallel exchange system has emerged that enables people to withdraw dollars from ATMs and sell them at exchange shops to take advantage of the higher exchange rate – pressuring commercial banks to implement limits on withdrawing dollars.
How did the central bank react?
On September 30, 2019, Lebanon’s central bank announced a new monetary mechanism aimed at ensuring the country can import medicine, fuel, and wheat at a fixed rate.
The mechanism will ensure medicine, fuel, and wheat importers pay a fixed rate of LBP 1,507 to $1 with a 0.5 percent commission to the central bank. It also requires importers to deposit 15 percent of the total import price into the central bank in USD. It leaves other goods and services subject to the market rate, which so far has been reported to fluctuate between LBP 1,530 and 1,700.
The new mechanism “had positive effects on markets” and lowered demand for dollars in the days following, said Barakat. Exchange shop rates also slightly fell to around 1530 LBP to $1.
“The circular is likely to regulate imports and fight smuggling, which could result in an improvement in trade deficit that has reached 30 percent of GDP this year,” he added.
However, by leaving other imports to the whim of market fluctuations, even if market rates stabilize, the mechanism also risks creating a de facto two-tier exchange rate and depreciating the pound.
As a result, prices of some goods, like the pre-paid phone cards at Karame’s shop, will remain marginally higher. Misuses, like the ones seen so far between the ATMs and exchange shops, will likely continue.
Implications for future market rates remain unknown, but it will most likely mean the depreciation of the Lebanese pound, Rached from the Lebanese Economic Association told Al Arabiya English.
While Lebanon risks seeing further protests, Rached added that depreciation is not necessarily a bad thing, as it may encourage people to buy locally and rely less on imported goods, but this argument remains contested as Lebanon relies heavily on imported goods, particularly food products.