An Economic Flashpoint: How did Lebanon get here?

By Dhruv Shah

With its snow-capped mountains and robust banking system, Lebanon, a small country bordering Syria, was once considered to be the Switzerland of the Middle East. Yet today, this comparison is far from reality: Lebanon is on the verge of economic and political collapse.

Since October 2019, Lebanon’s economic crisis has been almost archetypal, as efforts to rebuild the state have been compromised by the financial mismanagement of its political elites. Yet, Lebanon’s collapse does not come as a surprise. Prior to the start of the crisis in October 2019, Lebanon was facing several critical challenges to its economy. The biggest issue facing the country concerned its history of high public debt – so elevated that many economists posited when, not if, Lebanon would default. Some have even compared Lebanon’s financial system to a regulated, national Ponzi scheme – “fraud which pays existing investors with new funds obtained from new investors.” Ponzi schemes require constant credit to be sustained: in the case of Lebanon, out of control spending was largely financed by borrowing further from creditors, which eventually dried up. 

On the political stage, some of Lebanon’s problems can be traced to the aftermath of its civil war. The Civil War of 1990 culminated in Lebanon’s warring parties signing a deal to end the fighting which had killed more than 100,000 people; laying ruin to much of the country. The Taif Accords institutionalised a system of sharing power within parliament which was highly reliant on sectarian splits. For the separate factions, Taif “promised a division of influence in return for laying down their arms.” Consequently, Lebanon’s political system is largely reliant on peace between different groups to run the country – cultivating a battleground for ideological conflict. 

Lebanon’s post war reconstruction witnessed its politicians borrowing vast amounts of money in an attempt to resettle thousands of displaced citizens and bolster central banking reserves. To service its debt, Lebanon decided to peg its currency, the Lira, against the US dollar. Tethering exchange rates had one key benefit; allowing the country to effectively subsidize imports such as wheat, fuel and luxury goods, that would otherwise have been beyond the means of many citizens. This provided much needed stability, attracting global investors and encouraging remittances – a critical source of government funding – from the several million Lebanese workers working abroad. 

Yet, the short lived prosperity proved to be double-edged. Lebanon’s central bank, the Banque du Liban, has long sustained the peg by borrowing lots of dollars to cover the huge deficit spending within the country (in 2018 this was 11% and 26% of GDP, respectively). In order to keep up the illusion of stability, interest rates have been as high as 14% for individuals and private banks to encourage more investment. This in turn requires more central bank deposits to service such high interest rates. Moreover, the peg has ensured Lebanon exports little and relies mostly on imports. Consequently, much of the economy has been hollowed out, with Bloomberg estimating that the economy has been overvalued by 50%, as important sectors such as manufacturing and agriculture goods were rendered less competitive abroad. 

Economic challenges have gradually compounded alongside political problems. Lebanon’s bureaucracy is highly ineffective: a 2005 World Bank study found that Lebanon required 25% more funds within the health sector to achieve similar results as other countries. The country continues to payroll hundreds of staff working for the national trainline despite the fact that it has not functioned in several decades – “laying off staff could be too sensitive.” The country’s sectarian system has encouraged rampant nepotism and corruption. The Financial Times estimates that to the present day, over $6bn of funds have been siphoned out of the country to offshore bank accounts. 

As political divisions grow, fewer workers are now sending remittances home, while even fewer international investors are considering investment into the country. Many Sunni Gulf states have turned support away from the country and withdrawn vital funding to Lebanon’s banking sector, after the Iranian-backed Hezbollah began increasing its political voice within the government. Lebanon today has a  budget deficit which has skyrocketed at over $80bn in debt leaving Lebanon with the world’s highest debt to GDP ratio at 150%.

In October 2019, the population erupted into protest in response to a new plan to tax calls on WhatsApp. For many Lebanese people, this was ‘the straw that broke the camel’s back,’ with the protests calling out decades of corruption and sectarian politics. 

As the Lira continues to collapse, and citizens rush to hold onto dollars, the country now faces a currency shortage of USD, devaluing the currency by 85%. A country already badly hit by the pandemic, Lebanon now faces food shortages and hyperinflation, leaving many unable to afford basic necessities. It has been estimated that half of the population are currently living in poverty. Frequent blackouts and endless queues for fuel along with dwindling medicine stocks have exacerbated economic and political collapse, prompting the UN warning that Lebanon will become the next humanitarian crisis if something is not done soon. 

Currently, Lebanon remains in talks with the IMF for a bailout of $20bn. The bailout, however, seems unlikely to materialise. The IMF has demanded significant reform of the financial system in return for financial assistance but IMF sources argue that Lebanon’s elites are more interested in protecting their narrow financial interests than reforming the country. This inherent corruption is coupled with wider political implications. Lebanon also faces the challenge of controlling Hezbollah, who have taken control over large parts of the government; exacerbated by the domestic instability and lack of leadership. Further, with repeated crises pushing Lebanon into Iran’s embrace; there is a greater likelihood that Lebanon will be “drawn into Iran’s list of protected satellites.” This will pose significant problems for the US and Gulf states who will try and undermine Iranian influence within the country. 

At the heart of these endless cycles of crises are Lebanon’s innocent people, who are yet again rendered the victims of economic and political collapse. In attempting to contain these crises, Lebanon appears to have very little room left to reform the county. The Lebanon of today is far removed from its former image as the Switzerland of the Middle East, closer instead to its Syrian neighbour, a failed state.  

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