Lebanon: Leaked plan sets way forward, but country's path could spell lost decade
A leaked draft economic reform plan from Lebanon includes measures to reform the country’s banking sector and gradually devalue the official exchange rate, but economists and analysts give the plan mixed reviews.
The plan, designed as a roadmap for Lebanon to climb out of its deepening economic and currency crises outlines, among other measures, plans to gradually devalue the official exchange rate, restructure the banking sector at the expense of shareholders and large depositors, and seek outside assistance from the IMF and other international funders.
"Stabilizing the economy is an immediate priority," reads the document, and says that substantial foreign financial assistance will be needed, projecting that $10-15 billion in foreign financing will be needed over the next five years. Some expect the actual needed amount to be nearly double. A portion of that financing is expected to come via emergency funding as a result of the coronavirus situation.
The plan also expresses hope that some of the funding might come via the $11 billion pledged to Lebanon at the CEDRE international donor conference in 2018. But, the money has not yet been released as Lebanon’s government failed to make the promised reforms needed to unlock it. The new draft plan promises to move ahead with some of the long-promised reforms, including anticorruption measures and overhauling the country’s electricity sector to deal with chronic shortages and budget deficits.
The plan, drafted in part to woo international funding, lacks details international funders will likely expect to see, including a “clear prioritization in terms of the actions to be taken and how quickly they will be implemented,” Jamal Saghir, a former World Bank official said
“The expectation was that we would go beyond a diagnostic...to see an implementation plan in addition to a reform plan,” he told Al Arabiya English. Saghir, also a senior fellow at the American University of Beirut’s Issam Fares Institute for Public Policy and International Affairs, said international actors will likely want to see concrete reform steps before they give any funding.
Lebanon “will need support from the international community, and to do so they will need to start showing some specific results on the ground,” Saghir said.
A representative of Lebanon’s financial adviser, US investment bank Lazard, said the firm was unable to comment on the draft economic plan, which was obtained and posted by Finance 4 Lebanon, a blog run by a group of Lebanese economists and analysts who have dubbed themselves the NERDS (Nasty Economy Requires Drastic Solutions).
The draft plan envisions a “gradual controlled devaluation” of the currency from the current official rate of 1,507 Lebanese lira to the US dollar to 3,000 lira to the dollar by 2024. Driven by a shortage of dollars in the system, the black-market exchange rate has already reached almost 3,000 and has driven widespread price inflation. The plan predicts inflation of more than 25 percent in 2020.
As for the country’s troubled banking sector, “a full bail-out of the financial sector is not an option,” the plan said.
Instead, it envisions a restructure of the central bank’s balance sheet, “voluntary or forced” bank mergers, and a full bail-in of existing bank shareholders, which would entail writing off some $20.8 billion.
Under the plan, an estimated $62.4 billion in losses on banks’ balance sheets would be covered by an “exceptional contribution from large depositors,” potentially by converting a portion of their dollars into bank shares. The plan also suggested that if the country succeeded in recovering funds that have been embezzled over the years, they might be used to repay the depositors.
Dan Azzi, a former Harvard fellow and former banker who has written extensively on the country’s currency issues, told Al Arabiya English that he thought the plan provided an “accurate analysis” of many of the problems but added that finding the political will to implement many of its more ambitious proposed solutions might unrealistic.
“For them to say that we’re going to wipe out all the shareholders of the banks, [who are] basically some of the most powerful non-political people in Lebanon, is a remarkable thing,” he said. “If they pull it off, that’s something.”
But he said in practice, “Something simple like a capital controls law – which de facto we have one already – for them to make it legal, they’ve taken months, and they haven’t been able to pull it off…so you can imagine how hard it is to implement some of this stuff.”
Azzi also said he believes the proposed currency devaluation schedule is overly conservative and that the actual sustainable level for the exchange rate is likely 5,000 lira, or more, to the dollar.
Another unrealistic aspect is the amount of foreign financing needed over the next five years. That amount would likely be at least $30 billion, twice what the plan projected, according to Mohamad Faour, a postdoctoral researcher in finance at University College Dublin. Restructuring the banking sector without foreign capital is unrealistic, he added.
“After you wipe out shareholders’ equity there is still around a $63 billion hole, and you cannot expect depositors to fill that full gap,” he said. “They will have to take part of it – that’s a given – but you cannot expect them to fill the whole thing… so there will have to be an injection of foreign capital.”
Faour also said the plan was short on proposals that would revive economic growth – i.e. things that might help attract much-needed foreign investment. The plan is further overly reliant on regressive tax measures, including an increase in taxes on “luxury goods,” which have yet to be defined, and a fuel excise, he said.
“The plan is a high-level monetary and fiscal stabilization plan rather than a comprehensive economic recovery plan,” he said. “Spending and tax reforms are needed, but where are the growth initiatives?”
Bearing the burden
Alia Moubayed, managing director at financial services company Jefferies, also said the situation calls for a comprehensive plan, which should address a range of socio-economic policy reforms. The cost of bank recapitalization and the burden of financial adjustment should be "shared equally" through the plan, she said.
“The more robust the public debt [and central bank] liabilities restructuring and banks’ recapitalization plans are, the better the chances of attracting external funding, and the smaller the deposit bail-in will be,” she said.
Moubayed added that forced conversion of dollar accounts to lira “should be the option of last resort and ideally avoided, as it will exact significant losses onto smaller deposit[ors] and will exacerbate already existing and acute inequalities and threaten the social peace.”
Even with outside support, she said, the road ahead will be difficult.
“Countries that faced a similar crisis underwent painful adjustments and socio-economic hardships for years, despite external support, strong domestic ownership of the reform plans, and robust institutional capacity,” Moubayed said.
Even if Lebanon manages to secure external support, the required adjustment in Lebanon will be more severe than other countries who have weathered similar crisis because of its weaker initial conditions and institutions, larger balance sheet losses, and fragmented political landscape, she said.
“Without a very solid, and unwavering political will to reform, Lebanon’s adjustment path could very well spell a lost decade,” she said.