Economic studies

Lebanon: a delayed Arab Spring

Following thirteen days of protest, massive demonstrations by Lebanese people of all faiths in the country's major cities, as well as mobilisation by the Lebanese diaspora, triggered the resignation of Lebanese Prime Minister Saad Hariri and his entire government. Political uncertainty has thus increased significantly. However, given that neither President Aoun nor the main party leaders (Berri, Nasrallah and Jumblatt) have resigned, it is possible that Hariri – one of the few politicians to be able to unite antagonistic political forces in Lebanon – could be called back to power to lead a technocratic government. Indeed, the popular uprising and its demonstrators at this stage have no leader capable of ensuring a political transition.However, let us come back to the underlying reasons for this social crisis that saw tens of thousands of Lebanese people take to the streets. The planned tax on internet communications that sparked the crisis was one of a long list of measures and events affecting citizens' day-to-day lives: power cuts that can only be overcome by buying electricity from private companies at prohibitive rates; very frequent cuts in the water supply; a household waste collection crisis; difficulties accessing hospital care; and, more recently, difficulties getting hold of US dollars, including for holders of foreign currency accounts. Given all these problems, the people's patience with its leaders' negligence finally ran out. The reforms announced last week (return to a balanced budget in 2020; an exceptional tax on banks; pay cuts for senior civil servants) – late and devoid of all credibility – exasperated the people rather than convincing them.At a deeper level, this crisis is above all the result of significant economic and financial mismanagement in a context of bad governance and far-reaching political tension dating back more than ten years. In fact, the Lebanese revolt of 2019 bears all the hallmarks of the Arab Spring of 2011:A lack of prospects for young people, with more than 30% of under-25s unemployed.Endemic corruption ingrained in Lebanese society, itself already traditionally prone to cronyism and favouritism. Corruption influencing government contracts and access to public services.Shortcomings in the rule of law, with over 40% of court decisions not enforced.Significant erosion of institutional authority due to the failure to disarm armed militias, including in particular Hezbollah, supported by Iran.Lastly, a glaring wealth gap between privileged political wheeler-dealers and a neglected population, resulting in feelings of inequity and a crisis of political representation. Fewer than one out of every two Lebanese people voted in the 2018 parliamentary elections, and thirteen parties are represented in Parliament.The bottom line is that all institutions analysing the situation (Transparency International, the World Bank, local institutions and field surveys) are converging on the same conclusion: in the space of a few years, Lebanon has become one of the Middle East's most poorly governed countries.Meanwhile, the economy continues to deteriorate, giving off numerous alarm signals in recent months:GDP growth, close to zero in 2018, is likely to remain below 1% this year, wiping out any chance of meeting the target – rather lax as it is – of a budget deficit of “only” 7.6% of GDP in 2019.A forecast of 10% is more realistic – and clearly too high for an already overindebted state.The drop in household savings to 2% of GDP and the decline in foreign currency deposits with commercial banks since the beginning of the year suggest that confidence is beginning to waver among not only locals but also the diaspora. This confidence is one of the pillars of Lebanon's financial stability.The decline in foreign currency deposits is now offset by liquidity support from the Bank of Lebanon, which still has substantial foreign currency reserves equating to 55% of GDP. However, the Bank of Lebanon is itself the creditor of over 30% of the country's public debt (thankfully in local currency).Excessive government borrowing (150% of GDP) and external debt are unlikely to come down, given the persistence of significant twin deficits. The balance of payments is structurally in deficit and partly dependent on transfers from abroad, which will be adversely affected by the current social instability.The probably somewhat bloated banking system has benefited massively from sovereign debt at high rates of interest in an environment of fixed exchange rates and support from the Bank of Lebanon. This situation appears to be nearing an end, which could affect banks' strength. Fearing a run on banks to withdraw foreign currency deposits, the Bank of Lebanon and commercial banks have opted to implement informal exchange controls, authorising such withdrawals on a tightly controlled case-by-case basis.Lastly, one thing is certain: if the Bank of Lebanon opts to unpeg the Lebanese pound from the dollar, we will be heading for a restructuring of sovereign debt and the potential collapse of the banking system.There have been a number of alarm signals over the past year or more exposing Lebanon's financial failings and the inability of its leaders to implement reforms to rebalance its external and public accounts and improve the day-to-day lot of its people. And yet these were the very conditions laid down by multilateral creditors (Gulf States and western countries) as prerequisites for the release over $10 billion in aid, promised a year and a half ago and withheld in the absence of reform. This failure to act is also lamented by rating agencies, which have downgraded the country's credit rating to CCC, causing the risk premium (on five-year CDS) to skyrocket to over 13%, a world record.Thanks to support from friendly countries, notably in 2002 and 2007, Lebanon has always managed to avoid sovereign default and any IMF-type bailout package with rigid, binding conditions. Will this remain the case after the current crisis, with its unexpected social twists and turns? The international environment is much less conducive to unconditional support from Beirut-friendly sponsors. Indeed, Lebanon's political and institutional balance is weakened by both Iran's growing influence in the region and conflicts between Gulf States. In addition, regional geopolitical tensions around Syria and Israel have recently intensified. A conflict similar to the 2006 war would have a devastating impact on the country's solvency: Lebanon's economic position in 2019 is much weaker than it was a dozen years ago.Can the Gulf States and western countries afford to stand back and watch Lebanon collapse? If systemic banking risk should materialise, could it spread throughout the region? These are the questions that must now be asked and the risks that must now be monitored.Olivier Le Cabellec - olivier.lecabellec@credit-agricole-sa.fr