Almost a year ago, a group of us wrote a “ten point action plan for avoiding a lost decade.” In that document we warned that the “current ad hoc approach to policymaking will lead Lebanon on a path of implosion and political disintegration.” A year later, alas, our worst fears are becoming a reality.
The Lebanese economic implosion was totally predictable. Policy vacuums generate insidious outcomes. An economy is a living organism. If it is not medicated, the organism’s immune system fights infections. Fevers are symptoms of this reaction. In some instances the body prevails, but in others, especially if the infection is powerful or an organism’s immunity is low, the body succumbs. It is the fever that kills the organism, not the infection.
Lebanon today is categorically in the latter camp. The shocks in the past year have been severe, the vulnerabilities are acute, but the crisis is not being properly managed. As a result, the economy is organically adjusting to the new situation. The consequences of this “endogenous” adjustment are grave. The economic collapse is already evident, and the scars will prove long-lasting.
But before delving into the economics of this automatic adjustment and hard landing, the striking anomaly is that a year into the crisis the political class has done very little to contain it. There are three possible explanations for this nonchalance. First, utter incompetence. Second, an intractable political environment that makes collective decisionmaking extremely difficult, especially given the size of the losses that need apportioning. And third, an active decision by the political class to do nothing, since implosion pushes losses onto the population thereby safeguarding the politicians’ vested interests. Regardless of what the correct explanation is, policy neglect is, paradoxically, threatening seismic political shifts that will potentially impact the political class itself. The current attempt by politicians to urgently form a cabinet may well reflect a realization that an economic collapse would undermine their own political survival.
To understand how the economy is automatically adjusting, let us recall the four elements of the economic crises. By late 2019, Lebanon was facing large U.S. dollar supply-demand imbalances; an unsustainable debt overhang; a bloated and bankrupt banking sector; and a public sector that is inefficient and generates deficits. A year into these crises, all four of those problems are being dealt with—but by stealth. However, the automatic levers allowing this adjustment are insidious and detrimental to the country’s long-term prospects.
Start first with the balance of payments. The country’s net commercial needs in U.S. dollars was $12 billion in 2019. In 2020, those needs are down to an estimated $4 billion. In and of itself this is a good thing. However, underneath the adjustment is a 50 percent collapse in the value of imports, which in turn has come about because of a massive currency collapse and a deep recession that has robbed the population of the income needed to import goods. Put differently, the balance of payments is indeed adjusting. But only because the society’s income and wealth are disappearing.
The second element of the crisis is a massive public and private debt overhang that has become impossible to finance and service. All recovery blueprints would certainly recommend bringing debt down to a level the economy can afford. However, the deleveraging was always meant to pursue an orderly approach that would balance the interests of lenders—to maximize the recovery value of their loans—against those of debtors—to reduce the debt burden sufficiently to make it sustainable. Instead, with no active crisis management, the debt overhang is being resolved “organically” through disorganized defaults and bankruptcies.
The banking sector is the third element of the economic crisis. Decades of attracting deposits and on-lending them to the state had made the banking sector gargantuan. Moreover, the debt default and deep recession have bankrupted the sector. Since then the sector has been organically shrinking and cleaning itself up. Admittedly, part of this process is healthy: borrowers are selling their real estate assets to other depositors and using those funds to extinguish debt.
However, other parts of the banking sector’s consolidation are unhealthy. First, there is the phenomenon of large deposit withdrawals in circumvention of capital controls. Those deposits are being funded by the central bank’s depleting foreign reserves. A second phenomenon is that of depositors voluntarily “haircutting” themselves by withdrawing their U.S. dollar deposits in Lebanese pounds at an artificially valued exchange rate. This de facto “poundification” is causing the value of deposits to be inflated away. Banks are indeed being cleaned up. But it is depositors and the central bank’s foreign reserves that are absorbing the losses, not bank shareholders.
The fourth element of the crisis is that of the public sector. The Lebanese state has long been unable to either generate revenues or control spending. While revenues have collapsed over the past year, the spending side of the equation has paradoxically improved. Inflation—itself reflecting irresponsibly loose monetary policy—has dramatically reduced the real value of civil servants’ wages and pensions and, more broadly, public spending on goods and services. Here again, an original sin is being dealt with by stealth, but in a way that is impoverishing the middle class and society at large.
In 2020 alone, Lebanon’s GDP is forecast to contract by 25 percent, an amount equal to that experienced by the United States during the five years of the Great Depression. When measured in dollars, the purchasing power of the Lebanese economy is set to collapse by two-thirds. Inflation, steadily eating into the society’s real income, is rising at an alarming rate of 120 percent. And poverty is rampant, with close to 2 million people unable to afford basic items.
But what these numbers don’t reveal are the structural scars whose impact will be long-lasting. Human capital is fast eroding through a massive brain drain of the young, who are leaving Lebanon or trying to. Equally worrying is the loss of physical productive capacity resulting from widespread business closures. Much more alarming is the security consequences of an economic implosion. Lebanon’s sectarian history is rife with conflict. An economic collapse provides a perfect habitat for a return of violence.
Is there a better way to deal with the crisis? There definitely is. The optimal road map to recovery is well understood and much has been written about it. However, this is not really the place to address that topic. The point, instead, is to stress that the Lebanese organism is too weak to handle the current neglect and paralysis. If the policy vacuum persists, fatal consequences surely await us.
*Amer Bisat is head of sovereign and emerging markets (alpha) at BlackRock and a former International Monetary Fund senior economist. He writes in a private capacity.