In the vortex of currency depreciation, Lebanon's economic outlet is difficult to find

Contributing writer Lee Zhenjie

Since breaking through 100,000:1 on March 14, the decline of Lebanon's local currency, the Lebanese pound, against the US dollar parallel market exchange rate has not only not slowed down, but has broken through the 110,000 mark in just four days like a "brake failure", causing widespread attention from the international community and strong concern from emerging market countries. Lebanon is experiencing the most serious economic crisis in the country's history, due to multiple factors such as the impasse in the formation of the government, the disruption of the new crown epidemic, the spillover effect of the Russian-Ukrainian conflict, and the explosion in the port of Beirut. The collapse of the Lebanese pound not only means that the fixed exchange rate reintroduced by the Lebanese government in early February has become useless, but also means that the confidence of market players and the household sector in Lebanon's financial system has also fallen to the bottom.

The protracted economic crisis stemmed from the collapse of Lebanon's financial system in the fall of 2019, but it was no coincidence. Observers generally believe that the bankruptcy of the Lebanese government and central bank in 2022, and the economic tragedy with no end in sight, are not so much a change of direction under the hammer of multiple "black swan events" as an inevitable outcome of long-standing policy shortcomings.

First, the deepening currency collapse is the most direct reflection of Lebanon's overall economic turmoil, illustrating that the country's once-proud financial sector, which has given it the title "Switzerland of the Middle East," has become the most vulnerable Achilles heel in its internal economic landscape.

The Central Bank of Lebanon has consistently refused to formally acknowledge the actual collapse of fixed exchange rates, instead introducing multiple exchange rate regimes "specific to the type of transaction", with the result that markets have completely lost trust in the official financial system, the original payment system has largely failed, and many international banks have begun to restrict remittances to and from Lebanon. Under multiple pressures, Lebanon's central bank had to monetize its deficits and debt, while massive currency overruns further eroded the value of the currency, and the ensuing hyperinflation put its domestic market and ordinary consumers under enormous pressure.

Second, the deformed rentier economic model has long eroded Lebanon's economic and financial stability, with eventual catastrophic consequences.

This rentier characteristic is reflected in two points: First, the service sector accounts for up to 70% of Lebanon's gross domestic product (GDP), and the four pillars of the economy, finance, tourism, trade, and remittances, are all highly susceptible to changes in their availability and conditions for continuous capital inflows. Second, more than one-third of government spending is spent on servicing ballooning debt and snowballing interest, nearly 25 percent on public sector salaries and nearly 40 percent on subsidies. At the same time, Lebanon's tax revenues are at a low level worldwide, tax contributions to GDP are even lower than in many high-welfare developed countries, and the cash economy makes it harder for governments to collect taxes. Excessively high unproductive budget spending and irresponsible tax policies led to the government's inability to service its debts, triggering a total collapse of the financial system.

Third, the profitability of commercial banks meant that they were difficult to take into account before the crisis.

Over the years, attracted by high interest rates and a fixed exchange rate linked to the US dollar, many diasporas and foreign elite groups have continued to invest in Lebanon, and external capital inflows have become an important dependence on Lebanon's economic development. Foreign capital inflows have begun to slow against the backdrop of the global economic downturn, but Lebanon's major banks remain committed to prioritizing the accumulation of strategically important foreign currency deposits, thus seeking to keep foreign reserves and balance sheets safe – albeit at the expense of the domestic economy and employment. In fact, Lebanon has never established a sound capital management system within the legal framework, and when the financial crisis hit, elite depositors still had the means to move their assets overseas as quickly as possible, but ordinary depositors encountered withdrawal restrictions. As real wage incomes plummeted, wealth in bank accounts shrank rapidly, large numbers of the Lebanese middle class fell into poverty, and many highly educated young talents were forced to flee abroad in search of a more decent life, which led to the loss of vitality and vitality of Lebanon's economic development. Against this backdrop, Lebanon's battered economy is highly vulnerable in the event of an emergency, and social pessimism is particularly violent.

For Lebanon today, when the price of assets in the whole society has plunged sharply and the price of basic living materials has soared, market participants naturally tend to choose more stable and safe currencies for trading. Due to Lebanon's implementation of the Lebanese pound-dollar dual currency system, the rise in risk aversion will lead to the rapid emergence and spread of the phenomenon of "dollarization" of the economy, and the current round of the collapse of the Lebanese pound will further expand the scope of influence of "dollarization".

Although "dollarization" has played a role in stabilizing Lebanon's economy, it will also have an inevitable negative impact on society. Since this dollarization does not come from government-led alternatives, but is based on market choices that arise as businesses and individuals refuse to accept payments in Lebanese pounds, this sudden and intensifying change will inevitably put enormous pressure on the survival of ordinary residents who have only Liberian pounds in their income structure and do not have the ability and stable access to sufficient amounts of dollars. Indeed, since the beginning of the year, the phenomenon of denominated and settled in United States dollars in Lebanon has gradually spread from luxury stores to a growing number of supermarkets and grocery stores.

According to a survey conducted last year by the International Labour Organization and the Government of Lebanon, more than 90 per cent of Lebanon's population still earns their income mainly in Lebanese pounds, so that under the current circumstances, groups without foreign exchange relief from relatives abroad find it difficult to pay even the most basic living and medical expenses. In theory, dollarization on the consumer side can be solved by matching simultaneous dollarization on the income side, but the Lebanese government and most businesses and employers clearly do not have the capacity to solve this problem.

Some analysts believe that in the current context, the assistance of the International Monetary Fund (IMF) is the only way out of Lebanon's financial crisis. However, according to the agreement, Lebanon should implement five key reforms, including restructuring the financial system, reforming the fiscal system, restructuring external public debt, and introducing strong anti-corruption and anti-money laundering measures, otherwise the IMF will not disburse loans.

Fulfilling the provisions of the agreement means that the Lebanese government needs to address structural economic problems in one fell swoop, based on the recognition that the current national economic model is broken and irreparable. Thorough economic and financial reform is highly complex, and the road to achieving an ideal state is long, and the Lebanese government, enterprises and citizens need to maintain sufficient strategic focus to this end. The current initiatives of the Lebanese government and the central bank fall far short of the reforms required by the IMF. On the contrary, the country's central bank's governor has recently been accused of money laundering and has begun an investigation, proving that the economic management ability of the top levels of the government is also worrying.

In the future, as the first step in a long reform journey, Lebanon may reach a minimum acceptable agreement with the IMF to secure financial support from other international financial institutions or GCC countries. In anticipation of a sharp slowdown in the global economy, although this will have a certain positive impact on the Lebanese economy, it is still difficult to solve the problem fundamentally.

Recently, as the crisis of market confidence in the European and American banking sectors continues to ferment, concerns about the evolution of financial risks beyond expectations have gradually spread to the world. Whether emerging market countries, including Lebanon, will again become "pressure exports" is unknown, but the ironic remark circulating on major social media in Lebanon that "the central bank has begun printing 1 million Lebanese pounds" has shown the public's concern about the country's economic future. Whether Lebanon ultimately emerges from the crisis or embarks on a Zimbabwe-style path of compromise depends on the determination and ability of the Lebanese government to address structural challenges. (About author:Li Zhenjie, Associate Researcher, Research Center, Economic, Trade, Industry and Investment Research Center, Mediterranean Research Institute, Zhejiang University of Foreign Chinese)

Source: China Youth Daily client