Lebanon’s dollar reserves critically low: Economists

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Lebanon may not have been facing a dire choice between paying its foreign creditors and buying bread as suggested by Prime Minister Hassan Diab, but the country’s dollar reserves are indeed critically low, economists tell Al Arabiya English.

In electing not to pay the $1.2 billion Eurobond installment due on March 9, Lebanon’s Prime Minister Hassan Diab said dollar reserves had hit a “critical and dangerous” low level and the money was needed to pay for imports of basic goods.

“How can we make outside payments when there are people who cannot even afford bread,” Prime Minister Hassan Diab said following a Cabinet session held at the presidential palace.

As of January, the Central Bank of Lebanon listed its foreign currency holdings as about $29 billion. However, following Monday’s default announcement, Finance Minister Ghazi Wazni told news station LBCI that $7 billion had been given to local banks to help them cope with their liquidity issues.

Of the remaining amount, $18 billion is set aside as an emergency reserve.

“So, in effect, you have $4 billion left -- that is very, very low, so you could say if you use the $4 billion to pay back the debt, then we have nothing,” Nafez Zouk, emerging market strategist and economist at Oxford Economics, told Al Arabiya English.

“Some people say in times of crisis you do dip into your reserve requirements – that’s what they’re there for,” he said. “It’s not an immediate liquidity problem, but it was a moral or ethical problem in the sense that the Central Bank should not be using its reserves to pay government debt, period, especially that the remaining reserves were essentially (depositors’) money.”

However if the amount the Central Bank owes in liabilities to commercial banks is taken into account, the foreign currency reserve number turns negative. In downgrading Lebanon’s credit rating to ‘CC’ in December, Fitch Ratings noted that the Central Bank’s net foreign currency position is negative “because it has large (foreign currency) liabilities to Lebanese banks, which we estimate at USD 67 billion in September.”

Former Harvard fellow and banker Dan Azzi, who was among the first to sound the alarm on the country’s currency crisis, told Al Arabiya, “the fact that the net reserves were negative was being hidden for a long time – the fact that the deposits were being consumed to back the lira was being hidden for a long time.”

An anti-government protester destroys an ATM machine during ongoing protests against the Lebanese central bank's governor on Jan. 14, 2020 in Beirut. (AP)
An anti-government protester destroys an ATM machine during ongoing protests against the Lebanese central bank's governor on Jan. 14, 2020 in Beirut. (AP)

For many years, the Central Bank had subsidized the official peg locking in the exchange rate at 1507 Lebanese lira to the dollar, but in recent months, with the supply of dollars dwindling to critical levels, the peg has slipped, with the unofficial exchange rate rising to more than 2500 lira to the dollar. The dollar shortage has caused problems, in particular, for importers, who must pay for their supplies in dollars.

Still, Azzi said, “the argument that if we pay (the Eurobonds) we’re going to go hungry is really a populist argument.”

While Azzi said he did not believe making the Eurobonds payment would have cut into the ability to import basic necessities, he acknowledged that Lebanon’s highly import-based economy is going to suffer from the ongoing currency crisis.

“Somewhere between Beverly Hills and Venezuela, there’s a whole bunch of shades of gray,” he said. “There’s no question that our standard of living is going to go down. Unnecessary purchases, the whole conspicuous consumption lifestyle is going to be shifted, and once that happens, the bleeding stops. Once the lira reaches its natural level rather than its fake level backed by reserves, that’s when the bleeding stops.”

Zouk agreed that the decision not to pay the Eurobonds may not have been directly tied to the need to pay for basic necessities, although – unlike Azzi – he said he believes nonpayment was the right decision.

“I don’t buy the argument that we were facing a choice between importing food, fuel, medicine and paying off the debt, no, but I think doing this restructuring now was the right call, in the sense that if we know the country has run out of the capacity to repay foreign debt and has got too high of a debt burden, why not do it now while you still have the reserves?” he said.

Lebanon's Prime Minister Hassan Diab speaks during a televised address to the the nation at the governmental palace in Beirut, Lebanon March 7, 2020. (Reuters)
Lebanon's Prime Minister Hassan Diab speaks during a televised address to the the nation at the governmental palace in Beirut, Lebanon March 7, 2020. (Reuters)

Zouk agreed that the next stages will likely involve a painful rebalancing of the economy.

“Lebanon lives beyond its means, it imports things that are way too much for a small, low to middle income, country,” he said.

“So, that correction should be beneficial from an external accounts perspective, but since 40 percent of our economy is imports, it does kill the economy.”

Lebanon’s Cabinet met Tuesday afternoon to discuss next steps, with President Michael Aoun saying in a statement, “In conjunction with negotiations with bond holders, the government should develop a debt restructuring plan, plans to restructure the banks and the Central Bank, and for financial and administrative reforms and (reforms to) economic and social affairs.”

Azzi said he expects that the next step will involve a “haircut” on depositors in some form, but that based on Diab’s recent statements, it would likely target the largest depositors, rather than small and medium depositors, in the form of a bail-in, or conversion to bank shares..

“You cannot tell people that you’re going to devalue their currency and reduce their standard of living before you show that you’ve hit the 1 percent,” he said.

Zouk, meanwhile, said that the next steps will almost certainly involve an International Monetary Fund (IMF) bailout, despite the fact that some political players – notably Lebanese Hezbollah – have publicly opposed the idea.

“The next steps will require external funding, and that will most likely have to be tied to the IMF if creditors are to accept the restructuring plan,” he said.

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