Abstract:
- · Already severely affected by multiple crises (economic, health), the Lebanese economy suffered a further setback with the explosion at the port of the capital Beirut in August 2020;
- · Without reforms by the authorities, financial aid and donations are slow to reach Lebanon despite the urgency of the situation;
- · Against a backdrop of frozen bank assets, remittances from expatriates, on which the economy is heavily dependent, appear to be declining, a phenomenon that is contributing to the precariousness of the population.
- · The solvency of the Lebanese banking system is deteriorating, reinforcing the vulnerability of the sector, which is already highly exposed to sovereign risk and the deterioration in the quality of loan portfolios.
- A change of system seems necessary, and stop-and-go policies would be beneficial in helping Lebanon emerge from the economic crisis and regain some semblance of resilience.
Usefulness of the article: This article follows an initial article published on the BSI Economics website in April 2020. The situation in Lebanon over the past 14 months has been exceptional and has attracted worldwide attention. The main objective of this article is to assess the repercussions of this crisis.
Following an initial article on Lebanon in April 2020, this publication aims to examine the economic crisis in Lebanon and its impact, which has become even more intense since the double explosion at the port of Beirut on August 4, 2020.
First, the financing of the port’s restructuring will be discussed, followed by a more specific analysis of the consequences of the crisis on economic activity and the banking system, before proposing areas for improvement.
I. Financing the reconstruction of the port of Beirut
I.1. The port: a pillar of the economy
On August 4, 2020, the city of Beirut was hit by an explosion so powerful that shock waves were felt more than 200 kilometers away, as far as Cyprus. This explosion of thousands of tons of ammonium nitrate in a port warehouse killed at least 154 people, injured 5,000 others, and left approximately 300,000 residents homeless.
The port where the explosion took place was one of the most efficient in the region. In 2018, Lebanon was ranked 38th out of 171 countries in terms of maritime performance and 6th in the region. Nearly 80% of Lebanon’s imports passed through this facility, whose destruction is therefore likely to have profound consequences, particularly in terms of food security but also health (see Appendix at the end of the article).
This disaster has severely weakened the Lebanese economy, as the port is one of the main drivers of economic activity. Before the explosion, imports of goods via the port had already fallen by 50.3% year-on-year to $6.13 billion in July 2020. The country, which has a large current account deficit and whose local production is heavily dependent on imports, is therefore facing an additional source of fragility. As for port revenues, these are estimated to have reached only $61.6 million in the first six months of 2020, i.e., before the explosion, compared to $108.1 million in the same period of the previous year, representing a decline of 43.1%.
To date, there is a significant lack of funding for the reconstruction of the port and its surroundings, highlighting the fact that the future of the sector depends on the government’s action plans and policies in the coming weeks.
I.2. Donations
The first international gesture of aid to Lebanon was the international donor conference organized by French President Emmanuel Macron, which raised a total of €252.7 million in emergency aid for medicines and hospitals, schools, food, and housing.
France contributed €30 million (US$35 million). In the short term, theaid arriving in Lebanon is purely and directly intended for humanitarian emergencies without going through the government or political organizations. This is to avoid corruption. As a reminder, Lebanon ranks137th in Transparency International’s ranking. The United States, France, Great Britain, Canada, and Australia, among others, have indicated that they will go directly to trusted local aid groups, such as the Lebanese Red Cross or United Nations agencies, rather than to the government.
The European Commission has said it will give an additional €30 million on top of the €33 million already promised to the country. However, like the IMF, unfortunately no concrete aid has yet been provided, as it is conditional on reforms, the first of which is, of course, the rapid formation of a government. Moreover, the IMF has been very strict in saying « no money without change » and has warned that no funds for the reconstruction of the capital will be made available until the Lebanese authorities commit to political and economic reforms, including acoherent fiscal framework and a credible strategy to rehabilitate the banking sector.
However, on October 21, World Bank Vice President for the MENA region Farid Belhadj revealed that the bank was ready to provide USD 1 billion to support the Lebanese economy and the most priority projects, so we will have to wait and see.
According to President Macron’s latest conference on Lebanon on December 2, 2020, the head of state confirmed that the pledges made by donors on August 9 had been fulfilled and even exceeded, with more than €280 million disbursed. In particular, 12,500 tons of flour had been distributed, representing 80% of the destroyed stocks, 73,000 people had received financial aid, around 20 mobile medical teams had been deployed, 25,000 people had been provided with shelter, and 90 schools had received supplies. This is a lot, but it is not enough.
I.3. The RDNA
Immediately after the explosion, the World Bank, in cooperation with the United Nations and the European Union, launched a Rapid Damage and Needs Assessment (RDNA) to estimate the impact on the population, physical assets, infrastructure, and service delivery. The three sectors most affected were housing, transportation, and culture.
Damages were estimated at between $3.8 billion and $4.6 billion (i.e., between 7.6% and 9.2% of 2019 GDP), losses at between 5.8% and 7% of GDP, and priority reconstruction needs at between 3.6% and 4% of 2019 GDP.
According to estimates bythe Institute of International Finance in August 2020, GDP could fall to $33 billion in 2020 from $52 billion in 2019, representing a contraction in economic activity of between -15% and -24% in 2020.
II. The Economy
II.1. Extreme Poverty
Following the explosion, ESCWA estimated that more than 55% of the Lebanese population lives in poverty and struggles to meet its basic needs, compared to 28% last year. Extreme poverty has tripled, rising from 8% in 2019 to nearly 23% in 2020, with 2.7 million people in Lebanon considered poor and therefore earning less than $14 per day.
ESCWA emphasizes the importance of social solidarity in Lebanon today, given that in 2019, 70% of the country’s wealth ($232.2 billion) was held by the richest 10% of the population.
II.2. Remittances
On October 13, 2020, financial and economic expert Walid Abu Suleiman simulated the Lebanese economy’s need for remittances from expatriates to fuel the economy in dollars and thus slow the fall of the Lebanese pound (LBP) on the parallel market.
Remittances as a % of Lebanese GDP, source: World Bank Data
The Lebanese economy has always been dependent on these flows. According to the graph above, they peaked at 26.4% of GDP in 2004, but began to decline in 2008, representing 14.3% of GDP in 2019. As shown in the diagram below, 28% of remittances received by Lebanon come from Europe, 27% from the United States and Canada, and 26% from the Gulf countries.
Under the recent mechanism, the BDL freezes bank assets in order to have reserves available to pay for food imports in foreign currency at the official exchange rate. This means that funds transferred via the banking system by expatriates to their relatives in Lebanon are part of these frozen assets. This has prompted expatriates to send funds not via banks but via other methods, particularly in cash. Furthermore, transfers through the banking system or electronic transfers fell by 70% in September 2020 to just $30 million per month, compared to an average of $140 million per month previously.
II.3. Macroeconomic Indicators
The inflation rate in Lebanon reached a second record high in September, at 131% (before rising to nearly 133% in November, see table showing inflation trends at the end of the article).
Another important sector of the Lebanese economy has declined: tourism. According to Global Blue, total tourist spending in Lebanon fell by 73% in September 2020 compared to September 2019. Furthermore, according to EY, the occupancy rate of 4- and 5-star hotels in Beirut reached its lowest level ever recorded, at 13% in August 2020, compared to 72% the previous year.
According to a recent monetary report by the Banque du Liban, the balance of payments recorded a cumulative deficit of $9.61 billion in September 2020, compared to a deficit of $5.95 billion the previous year. Despite the increase in net foreign assets of $2.35 billion in Lebanese commercial banks, the BDL’s net foreign assets decreased by $11.96 billion.
According to the Ministry of Finance, Lebanon’s budget deficit decreased by approximately 13% compared to the previous year, reaching $2.09 billion in July 2020. Public revenues decreased by 21% in July 2020 ($5.49 billion) and expenditures by 19% ($7.59 billion). It should be noted that the primary balance, which excludes debt servicing (related to interest payments), posted a deficit of $706.84 million in July, compared to a surplus of $577.22 million in July 2019.
II.4. The Banking System
According to the latest report by the international agency S&P on the Lebanese banking sector dated December 14, 2020, the sector is facing losses of $102.2 billion.
The four major banks—Audi, Byblos Bank, BLOM, and Bank of Beirut—were late in releasing their earnings statements. The results suggest that the Lebanese banking sector is insolvent. Audi Bank reported that its exposure to Lebanese sovereign debt was 2.25 times its Tier 1 capital (the strongest form of equity capital). As of June 30, 2020, it held $2.2 billion in Lebanese pound-denominated treasury bills, plus $4.05 billion in central bank certificates of deposit, most of which were denominated in foreign currency.
Public debt accounts for more than half of the banks’ balance sheets, so an 80% to 85% haircut on this debt would be catastrophic, as confirmed by Khaled Abdel Majeed, director of SAM Capital Partners in London.
Blom Bank’s share price has fallen 84% since the beginning of 2018 and Bank Audi’s 78%. Byblos Bank’s half-yearly write-downs increased 28-fold to reach 701.5 billion pounds. Bank Audi’s write-downs more than doubled to reach 292.4 billion pounds, while 60% of its financial assets are underperforming or impaired.
Defaults on personal and corporate loans are likely to increase, with the Lebanese economy expected to contract by 25% in 2020 amid high inflation (131% at the end of the year). Most car and real estate loans are denominated in USD. The Lebanese pound (LBP) has long been pegged to the US dollar at 1,507.5 LBP, but the parallel market exchange rate ended the year at over 8,000 LBP/USD since mid-November. For now, borrowers can still make repayments in Lebanese pounds at the official exchange rate. But this is not sustainable. If the currency is allowed to float and find its real rate, there is no way for people to settle these loans in dollars. People are trying to repay their loans, but their salaries have steadily declining purchasing power.
Between early 2019 and June 30, 2020, the banking sector’s combined loan portfolio declined by $16.5 billion, according to Bank Audi. Its own loan-to-deposit ratio in the domestic market fell to 20%, a « historic low. » Banks also suffered significant declines in their deposit base despite strict central bank restrictions on withdrawals.
III. Potential Collapse of the Lebanese Economy
Despite deteriorating economic conditions and contrary to forecasts, the Lebanese economy has shown some resilience over many years. For example, during the period 2007-2012, the debt-to-GDP ratio fell from a peak of 183% to 131%, while real GDP averaged 6.7% over the period 2007-2012, and the trade deficit improved from 43% to 31% of GDP. This progress indicated that an economic rebound was possible and that, without a highly unfavorable political context, both domestically and externally, Lebanon’s public debt and budget deficit could potentially have been maintained at a more sustainable level. However, the lack of fiscal discipline is mainly attributed to the composition of the creditor base. As this consisted mainly of resident lenders, it provided an opportunity for the government to « take charge » of managing this debt, without much transparency and without external intervention or supervision.
As economist Kassim Dakhlallah of the Economic Research Forum points out in a recent article, a procyclical fiscal policy in the form of tax increases or wage cuts will have devastating consequences for the Lebanese economy in its current situation. Indeed, procyclical fiscal policies, i.e., expansionary policies during periods of expansion and contraction during periods of recession, are generally considered harmful to the well-being of society. They increase macroeconomic volatility, reduce investment in real and human capital, hamper growth, and harm the poor (Serven, 1998).
One solution proposed to counter countercyclicality is the triggering of automatic stabilizers. As a reminder, automatic stabilizers are a type of fiscal policy designed to offset fluctuations in a nation’s economic activity through their normal functioning without additional and timely authorization from the government or policymakers. These stabilizers are in principle countercyclical and have the potential to decelerate the budget deficit and thus promote a budget surplus in the long term. For example, Lebanon’s primary public balance recorded a surplus of 1.8 trillion pounds in fiscal year 2014, with automatic stabilizers improving the balance by 5.5% and reducing the deficit by 3.9% of GDP.
Furthermore, social protection programs are absolutely necessary to stabilize the economy, particularly in the context of Covid-19. Unemployment insurance, tax cuts, and compensation for public and private sector employees are needed to combat the recession and reduce social unrest. Indeed, this situation will lead to a further deterioration in the budget balance, which is obviously not the objective. On the other hand, this transfer of income from the state to households and businesses will automatically offset the negative effects of the economic slowdown. Individuals will receive additional income, part of which will fuel consumption and investment and stimulate job creation. Given that the budget continues to run a deficit, better use of spending to finance productive activities would be necessary and effective.
Conclusion
In conclusion, Lebanon is experiencing an extremely deep crisis and the priority is to maintain the bank’s dollar reserves in order to import essential goods. Capital controls should also be adjusted, as capital outflows would put further downward pressure on the Lebanese pound.
A recovery plan should be put in place to support small and medium-sized enterprises in order to encourage exports, particularly in the agriculture and small manufacturing sectors.
References
http://www.cas.gov.lb/index.php
https://www.arabianbusiness.com/
https://blog.blominvestbank.com/
https://unsplash.com/s/photos/beirut-explosion
https://www.lorientlejour.com/
S&P
ESCWA
APPENDIX
Drug shortage
For months, Lebanon has been experiencing a shortage of medicines, particularly those used to treat chronic and neurological diseases. Lebanon has recently been hampered by the smuggling of medicines abroad. The Ministry of Health has also closed a number of pharmacies and prosecuted warehouses storing medicines in order to smuggle them or sell them at double the price.
What is interesting is that these drugs are inexpensive, which means they are easier for importing companies to obtain than others. If the reason for their loss is the difficulty in obtaining US dollars, it is necessary for importers to prioritize one drug over another. The loss of these drugs, in particular, has prompted some doctors and observers to talk about an intentional halt by certain importers to importing them because they are cheap; that is, they are not profitable for traders.
The head of the pharmacists’ union has cited several reasons for the interruption in the supply of drugs: a) delays in the approval of credits by the Central Bank; b) the scarcity of the dollar; c) the desire of citizens in recent months to stockpile drugs for fear of the removal of subsidies; d) smuggling has contributed to the fact that the price of drugs in Lebanon, which are sold in Lebanese pounds, has become the cheapest in the region, after the pound lost more than 70% of its value against the dollar.
