Lebanon’s economic crisis is almost two years old and the country has entered treacherous territory. While an ambitious economic reform plan is still the best path out of the crisis, realism is in order. Such a plan is highly unlikely before parliamentary and presidential elections scheduled for 2022. Despite an unprecedented economic and institutional collapse, the country’s political leadership has blocked any serious reforms that could have threatened its stakes in the system and, ultimately, its power. The forces of change in society, which first emerged after the popular uprising in October 2019, have yet to produce credible leaders or articulate a program that resonates. Nor are regional developments, to which Lebanon is hostage, conducive to decisive transformations anytime soon.

While a comprehensive reform plan will eventually be necessary, the country needs to immediately arrest its collapse. The nation’s fabric is effectively being torn apart. The economy is in a depression, inflation is startlingly high, the currency is imploding, there are widespread shortages in basic goods, the health system is failing, emigration is accelerating, civil disorder is rampant, and the Lebanese people are witnessing an alarming rise in sectarian tensions.

Due to all of this, it is necessary to introduce an emergency stabilization program (ESP) that seeks to achieve basic—some would say rudimentary—objectives. These include ending the economic depression and injecting much-needed capital into the economy, reducing shortages of basic goods, bringing back core government services, stabilizing the currency, and controlling inflation. For this to be successful, the ESP must be politically feasible, simple enough to be rolled out quickly—in as short a period as one hundred days—and must show immediate results. Such an ESP would neither address Lebanon’s structural economic and institutional problems nor put the country on a path toward a productive economic recovery. But the stability it would provide would give Lebanon a fighting chance to address the more profound economic problems the country has to face.

Lebanon’s Situation Is Dire and Untenable

Lebanon’s economic trouble began as a common emerging markets crisis. The country’s debt was unsustainable, the banking sector was insolvent, and the balance of payments deficit was large. The consequences, while dramatic, were expected. The government defaulted on its debt in 2020. It also abandoned the currency peg between the U.S. dollar and the national currency, the Lebanese pound. The pound immediately lost much of its value, and there was a run on banks that resulted in severe deposit-withdrawal restrictions. Economic activity came to a halt and the International Monetary Fund (IMF) estimates that GDP contracted by 34 percent in the years 2020–2021. At the same time, inflation accelerated, unemployment rose, and income and wealth destruction led to a dramatic rise in poverty.

However, the crisis should and could have been contained. Because it was left completely unattended, the results were catastrophic. The IMF’s World Economic Outlook database identifies 114 international episodes in which a country’s GDP contracted by 10 percent or more over two years. Of these, Lebanon’s contraction ranks as the tenth worst—and the very worst if one excludes war-related episodes. It took two years for Lebanon to register the kind of collapse that Venezuela—the classic example of a badly managed middle-income country in crisis—experienced over six years.

This situation need not have been so severe. Self-inflicted wounds greatly exacerbated the crash. The failure to pass the Financial Recovery Plan of then prime minister Hassan Diab’s government in April 2020 was a major shock to confidence. Lebanon’s mismanaged subsidy scheme has created shortages in energy products, which has had a negative knock-on effect on electricity, the supply of gasoline, water, the internet, and other utilities, further aggravating the breakdown. Delays in dealing with the banking sector increased depositor losses and magnified wealth destruction. The inexcusable delay in imposing capital controls led to outflows that could (and should) have been used for domestic economic activities. And irresponsible monetary policy augmented the inflation problem and the pound’s collapse.

However, the catastrophic macroeconomic outcomes don’t tell the whole story. The malign neglect has created scars that will likely be long-lasting and difficult to reverse. Chief among these is the accelerated emigration of the young and those with skills, Lebanon’s main productive assets. The disintegration of entire sectors that had helped define the country, particularly education and health, will also prove to be enduring. And most insidiously, Lebanon is witnessing a rise in sectarian tensions that, historically, has preceded periods of protracted violence.

The Aims of an Emergency Stabilization Program

An ESP is a priority to halt the severe consequences of the Lebanese crisis. In an ideal world, an ESP would be implemented by an independent cabinet that has emergency legislative powers. In Lebanon’s case, however, this is unlikely. Instead, an ESP should constitute an economic road map for the more traditional cabinet now being negotiated, even if the outcome of this discussion remains unclear. Moreover, the international community would be well advised to link assistance for any new cabinet to its implementation of an ESP.

An ESP would not address Lebanon’s structural economic and institutional problems. Nor would it achieve debt sustainability, restructure the banking sector, overhaul the fiscal regime, or fix the hole in the balance sheet of the Banque du Liban, the country’s central bank. Crucially, it would not engage in desperately needed regulatory, governance, and sectoral reforms. Whether an ESP serves as a launchpad for such transformative reforms would depend on other factors, including Lebanon’s elections and regional developments.

Ending the Subsidy Regime and Organizing Cash Transfers

The ESP’s starting point should be ending the chaotic and unsustainable subsidy system. Except for certain items, such as bread and medicine, domestic prices should reflect the actual cost of importation. The current scheme is regressive in the extreme, with a disproportionate share of the benefit accruing to the rich rather than to those who really need assistance. It has also resulted in an alarming loss of foreign currency reserves that will, at the very least, complicate the eventual effort to restructure the banking sector. The system has also led to persistent smuggling, hoarding, and rent-seeking activities that, together, have produced the severe shortages presently debilitating the economy.

While ending subsidies is imperative, it is critical that the move be immediately followed by a cash transfer system to help the most vulnerable. Allowing import prices to reflect prices in foreign exchange will lead to an inflationary shock that hits the purchasing power of a society already reeling from the ongoing crisis. The ESP should immediately compensate those affected with a total of $1–1.5 billion in cash transfers. Such transfers have become a standard demand-management lever that has been used during the novel coronavirus crisis in both rich and emerging economies, including those of Argentina, Brazil, and South Africa.

The cash transfer scheme can be rolled out in as little as three months. If it is well targeted, it will cover most of the consumption basket of those who legitimately need aid. Inevitably, there will be attempts to corrupt the plan and transform it into an instrument of patronage for election purposes. As such, following a successful COVID-19 vaccination campaign in which the World Bank was involved, the institution must also play a key role in implementing and monitoring the cash transfer.

A cash transfer scheme of this magnitude is affordable without resorting to Lebanon’s foreign currency reserves. There are significant external funds already available for rapid disbursement. Lebanon can access $546 million in World Bank loans, including the already approved $246 million loan for an Emergency Social Safety Net (ESSN), as well as a repurposing of other approved loans. But to access those funds, the government must first implement the ESSN, which has been languishing in a surreal bureaucratic maze. Also available is the $370 million in humanitarian support committed at the French-sponsored international donor conference for Lebanon held on August 4, 2021. Finally, a credible cabinet implementing the ESP should reasonably be able to raise an additional $300–$500 million in humanitarian grants from governmental and nongovernmental agencies in Gulf Cooperation Council countries and Europe.

Most significantly, as part of the global effort to help countries deal with the coronavirus pandemic, the IMF is about to distribute a one-off Special Drawing Rights (SDR) allocation to all its members. This allocation is an unconditional gift that governments can use for any purpose they choose. Lebanon’s share will amount to 607.2 SDR (the equivalent of $860 million)—a massive and unexpected boon for a country that is desperate for financial oxygen.

The SDR funds should be immediately invested into the economy. A reasonable argument could be made that the funds are best directed to help productive sectors. However, recent international experience, including during the coronavirus pandemic, demonstrates that grants that directly support consumption can also be potent. Moreover, resentment is at a dangerous peak in Lebanon, and Lebanese society deserves immediate compensation for the massive pain it has so far incurred unjustly.

Reviving Government Operations

Reviving government operations should be another prime objective of the ESP. According to author calculations, noninterest government spending, when adjusted for inflation, fell by 60 percent between 2019 and 2020. To give a sense of the collapse, spending in 2019 stood at the equivalent of $9 billion. In 2020, it fell to $2.5 billion. While data are not yet available for 2021, there are indications of an even sharper decline.

The colossal deterioration in inflation-adjusted government spending is the mirror image of the erosion in the purchasing power of government employees’ wages and the virtual disappearance of basic government services, whether education, health, maintenance of infrastructure and utilities, or even national security. To resuscitate government functions without delay, the ESP must allocate a bare minimum of $3 billion (on top of the cash transfer program) to funding a wage increase for civil servants, social security, and a reactivation of basic education and health services.

Government revenues have also sharply contracted—falling from the equivalent of $9.5 billion in 2019 to a mere $2.3 billion in 2020, according to author calculations. To fund the spending outlays discussed earlier, the ESP must strive to enhance revenues. Increasing tax rates on personal income or raising the value-added tax in Lebanon’s existing economic and political environment is extremely difficult, but there are other relatively easier ways to generate revenues. Revaluing customs and property tax bases to reflect real prices would generate a significant amount of government receipts. In addition to this, adjusting the prices of utilities to reflect actual costs should also raise revenues. Realistically, though, those new sources of income would not be enough to pay for the extra spending. As such, the ESP should foresee a new international conference on Lebanon that aims to fill the gap between needed spending and available revenues.

Stabilizing the Currency

A key objective of the ESP must also be to stabilize the value of the foreign exchange rate of the pound and control inflation. The good news is that if the government indeed mobilizes and spends all the foreign assistance discussed earlier—including World Bank loans and SDRs—the resultant supply of U.S. dollars would help stabilize the pound and conceivably lead to a moderate currency appreciation. However, that won’t be enough to restore monetary stability.

There are three other crucial measures the ESP must undertake. First, it is high time for a serious effort to put in place measures to control capital outflows. Second, Lebanon receives a significant amount of capital inflows, such as remittances and humanitarian funds. The ESP could introduce a scheme that centralizes these inflows and prioritizes how they are spent. This is a common crisis measure that has been pursued in other emerging economies in the past, including those in Argentina, Chile, and South Korea. Finally, and perhaps most importantly, the explosive rise in money supply since early 2020 must be radically brought under control.

Managing International Relations

A final point pertains to the way the ESP will affect Lebanon’s engagement with foreign donors and multilateral institutions. Reaching an agreement with the World Bank on the ESSN, repurposing the other approved loans, and releasing the monies committed at the recent Lebanon aid conference should be an immediate priority. It is also recommended that another Lebanon conference be scheduled in three months, at which point the achievements under the ESP could be showcased to raise money for general budgetary purposes.

The IMF negotiations are a more complicated story and one needs to be clear-eyed about their chances of success. While technical discussions must start immediately, the ESP should not be hostage to an agreement between Lebanon and the IMF. The negotiations will be difficult and the IMF will ask for measures that are well beyond the scope of the ESP. The global financial institution will insist on debt sustainability, which in turn will require restructuring the banking sector and recapitalizing the central bank, not just reaching a deal with debt holders. The IMF will also demand an ambitious structural overhaul of the fiscal regime and sectoral, governance, and regulatory reforms that are likely to be impossible before elections next year. Ideally, after the ESP is successfully implemented and those policymakers implementing the ESP gain credibility, the government could potentially secure a smaller IMF agreement based on post-election reform promises. But it is best not to count on that outcome.

Conclusion

An ESP will have immediate and measurable positive effects. The cash transfer program, equivalent to 3 to 5 percent of Lebanon’s GDP, will represent a massive economic shot in the arm. The return of basic government services, even if they are paid for through higher taxes, will also greatly help economic recovery. The introduction of pricing that is more reflective of costs will lessen shortages of basic items such as gasoline and medicine as well as reduce smuggling and hoarding. U.S. dollar liquidity will rise in the system and banks may be able to release limited amounts of deposits. The central bank will no longer hemorrhage reserves and the now-undervalued pound may also modestly recover. While inflation will rise initially because of the removal of subsidies, it should fall sharply in a few months as monetary policy is tightened and the foreign exchange rate stabilizes.

Even though the ESP may not be the ambitious program that Lebanon needs to emerge from its economic predicament, stemming the country’s economic collapse has to be the main priority today. The ominous path Lebanon is taking may mean there will soon be no country to rebuild and transform. There will be a time for a more far-reaching program down the road, but the priority now is to keep the nation afloat for long enough that it can reach that stage.

About the Author

Amer Bisat is a senior portfolio manager and Head of Sovereign and Emerging Markets (alpha) at BlackRock and a former International Monetary Fund senior economist. He writes in a private capacity.