38 Middle East & Africa The EconomistMarch 14th 2020
A
currency crisishas done what years
of sectarian bloodletting could not. On
March 9th Lebanon did not repay a $1.2bn
Eurobond, the first sovereign default in the
country’s history. Even during the darkest
days of its civil war in the 1980s, the state
met its obligations. But Lebanon must now
choose between honouring its debts and
providing the most basic services to its citi-
zens. “How can we pay the creditors while
there are people in the streets without the
money to buy a loaf of bread?” said Hassan
Diab, the prime minister.
Lebanon has spent months slipping to-
wards an economic abyss. Its currency, the
pound, is officially pegged to the dollar, but
has lost more than 40% of its value on the
black market. Banks are imposing ever-
stricter capital controls because they lack
the hard currency to repay depositors. Big
protests in October, against the corruption
and incompetence that led Lebanon to cri-
sis, brought down the previous govern-
ment. Mr Diab, an academic, inherited a
mess when he took over in January. Many
Lebanese support his decision to default.
But it is only a first step—and it is not clear
that his government has a plan.
Start with restructuring. About two-
thirds of government debt (which, in total,
is more than 150% of gdp) is held by local
banks. They argued for months against a
default, because they fear even a modest
haircut would wreck their balance-sheets.
As default grew more likely, the banks
dumped some of their holdings to outside
investors that were willing to gamble. Offi-
cials believe foreigners now hold more
than 25% of some bond issues—enough to
block any restructuring deal.
The problems do not end there. For
years the central bank, the Banque du Liban
(bdl), borrowed dollars from commercial
banks to sustain the currency peg and cov-
er big fiscal and current-account deficits
(in 2018 they were 11% and 26% of gdp, re-
spectively). In return, the banks received
above-market interest rates on what
seemed like a risk-free investment.
But this state-sanctioned pyramid
scheme no longer has enough new money
to sustain itself. Bank deposits, which grew
at a healthy clip for years, levelled off in
2018 and have started to decline. Commer-
cial banks had 247trn pounds ($160bn, at
the official rate) in deposits in December,
an 8% drop from a year earlier. The central
bank does not have enough dollars to repaywhat it owes. At the end of January it had a
healthy $37bn in gross foreign-currency re-
serves—but an eye-watering $52.5bn in li-
abilities, mostly owed to local banks, esti-
mates Fitch, a ratings firm.
Lebanon may thus have to negotiate a
deal not only on its bonds, but also on de-
posits held by the bdl. If the central bank
defaulted on deposits, it would be a death
blow to the financial sector, which has 55%
of its assets tied up there. A haircut of just
18% would leave commercial banks insol-
vent and require a recapitalisation worth at
least 25% of gdp, estimates ihsMarkit, a
research firm.The dollar shortage has sent the pound
into a spiral. On March 6th the central bank
told money-changers not to buy dollars for
more than 30% above the official rate. But
supply and demand dictate that the edict
will merely create a new black market.
Money has become a daily fixation for
many Lebanese. atms no longer spit out
dollars. To obtain them, customers trudge
to the bank each week, often queuing for
hours, to withdraw whatever pittance their
branch allows, sometimes just $50 a week.
Paying with plastic is also fraught—some
businesses have stopped accepting cards.
Banks still honour cheques, which has
led to an odd boomlet in luxury goods as
clients snap up tangible assets. Khoury
Home, a household-goods store, advertises
new washing machines as a way to “survive
the haircut”. But cheques simply move in-
accessible money from one account to an-
other. Sellers have begun to demand at
least partial payment in cash.
On February 15th the national carrier,
Middle East Airlines, announced that it
would stop accepting Lebanese pounds the
next day. The decision, later reversed, was
striking, because the airline is majority-
owned by the bdl. Such is the state of Leba-
non’s economy: a firm controlled by the
central bank no longer wants to accept the
currency issued by the central bank.
With money scarce, the economy is fro-
zen. Even before the crisis, unemployment
was thought to be as high as 25%. Perhaps
40% of Lebanese are now poor, and the
number could soon rise to 50%, according
to the World Bank.
No one is lining up to help Lebanon:
neither its Western partners nor the Gulf
states that have bailed it out in the past. It
will probably have no choice but to seek an
imfloan. The fund will insist on painful re-
forms. There is already talk of raising the
value-added tax and fuel prices. Lebanon
will also have to find a new economic mod-
el. Mr Diab rightly points out that it is a ren-
tier state, too reliant on finance and in-
flows from a sprawling diaspora. “We don’t
need a banking sector four times the size of
our economy,” he said. Last year Lebanon
exported just $3.7bn-worth of goods.
Though it will never be an industrial
powerhouse, businessmen point to oppor-
tunities for growth. With an educated,
multilingual workforce, Lebanon could be
a hub for tech companies and high-end
manufacturing. Agriculture has room to
grow. So does tourism, which already con-
tributes 19% of gdp. All these, however,
need big investment in new infrastructure.
Electricity is spotty, internet speeds are
glacial and roads are clogged. The country’s
natural beauty has been spoiled by heed-
less development. But the coffers are bare.
Restructuring the debt will be easier than
restructuring a country blighted by de-
cades of bad government. 7BEIRUT
For the first time, Lebanon defaults on its debtsLebanonResilient no more
Piles of debt
Lebanon,dollar-bondrepayments schedule, $bnSource:Bloomberg *DefaultedonMarch9thpayment3210
25242322212020*Principal InterestRage against the machine