It is one year into the crisis, but despite the scale of the situation, the achievements of Hassan Diab’s government remain scant. From its rescue plan to canceling contracts with the forensic auditor Alvarez & Marsal, here is a look back at the government’s already lost battles in the second of a two-part series. Find part one here.
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“We defended the government’s plan, but the political and financial lobby, with its means and its media outlets, was too powerful,” says Marie-Claude Najm, justice minister in the government formed by Hassan Diab on Jan. 21 following months of street protests.
In hindsight, Najm acknowledges that her team’s project “could have been better defended,” but “the deep state,” as she defines it, eventually won over the “technocrats” after months of intense lobbying.
Act I: To default or not to default?
The first episode of confrontation began a few weeks after Diab’s government took office. As the country suffered from an unprecedented liquidity crunch, the government had to decide whether or not to repay $1.2 billion in eurobonds maturing on March 9.
“The decision was particularly difficult,” recalls Najm. The banks, the main creditors of the state, as well as Banque du Liban, were naturally opposed to defaulting, arguing that it would amount to breaking confidence in the financial system, which was already crumbling.
But according to a source close to the government who requested anonymity, central bank Gov. Riad Salameh was so confident in his ability to place the system back on track that in December 2019, he assured Ashmore Fund, run by Ashmore Group, a specialist emerging markets investment manager, that Lebanon was going to pay its debt.
“Riad Salameh publicly declared that the dollar reserves were sufficient to pay creditors, but to guarantee investors that these reserves were going to be used to pay them is something else,” the source says.
It is impossible to verify if these promises were actually made, but the Ashmore Fund bought eurobonds worth over $2 billion, which were sold off on the secondary market by local banks crippled by the liquidity crisis.
The Ashmore Fund ended up holding more than 25 percent of the series of eurobonds maturing in March, April and June.
“Riad Salameh was risking his credibility in this matter, which could explain his total lack of cooperation with the government and his refusal to communicate the audits and data on the actual state of his reserves,” says a source close to the government.
Despite the lack of information on the actual amount of reserves available, government advisers spoke in favor of defaulting on payment.
“BDL’s remaining foreign currency reserves are depositors’ money, but they were being rapidly depleted; the government had no choice. The alternative would have been a messy default, causing a rapid deterioration in the monetary and social situation,” says Talal F. Salman, then adviser to the finance minister and the main negotiator with creditors.
“The government, however, subsequently failed to put in place, with the support of the IMF and the international community, an advantageous restructuring plan for eurobonds,” Salman says.
At the time, the government stood up to BDL and the Ashmore Fund, announcing a default on its foreign currency debt on March 7.
Back then, some saw political will on the part of certain parties to force the adoption of an IMF program. But when the political class understood the implications of such a choice, it sought at all costs to reverse course.
Act II: The war of numbers
The second act took place in April with the publication of the financial recovery plan — drawn up with the help of Lazard, an investment bank — which was to play a role as the basis of negotiations with the IMF and then creditors.
The plan provided for painful reforms to clean up public finances, but it was the part on cleaning up the financial sector that was met with outcry.
The document, in fact, announced colossal losses and required financial efforts from all parties, including the banks’ owners, whose shares would be absorbed by losses; the depositors, through a haircut on large deposits and the recovery of a portion of the revenues resulting from financial engineering; and the state, to a lesser degree, as part of a fund that was briefly alluded to and in which certain state assets would be placed.
But things took a turn for the worse very quickly. “The attacks by the banking lobby, the BDL and conniving politicians began to intensify, despite the fact that the international community and the IMF validated on several occasions the plan and the figures it mentioned,” explains the source familiar with the negotiations.
Salameh has denied trying to obstruct IMF negotiations.
“The government plan could have been fine-tuned when applied, but instead, a real campaign of sapping efforts was put in place,” says Najm.
ABL criticized the government for not consulting it, and prepared to defend itself.
Economy Minister Raoul Nehme, a former banker, explained on MTV that the discussions with creditors, and therefore banks, were not expected until after the plan was finalized in the context of negotiations with the IMF.
But the banks, holding that the state is solely responsible for the crisis and should deal with the consequences, took the lead.
In mid-April, banks launched a highly promoted campaign titled “We must give back to Caesar what belongs to Caesar.”
“At $20,000 per double page in a daily newspaper, thousands of dollars were spent in the written press, not to mention television campaigns, which are even more expensive,” says a media source.
Almost everywhere in the media, criticism was hurled at the government plan, dubbed the “financial bankruptcy plan” by Nicolas Chammas, the president of Beirut Traders Association, vice president of Cedrus Bank and an unsuccessful candidate for Parliament on the Free Patriotic Movement’s list.
The government’s technocrats, on the other hand, appeared to be less and less combative.
“Our words in the media were not so audible,” says Najm.
Counterattack by parliamentary committee
At the end of April, the debate moved to Parliament. The Finance and Budget Committee announced an investigation to assess the amount of losses, which the government had, it said, poorly estimated.
“It is possible, and necessary, to reduce losses from LL240 billion to around LL80 billion,” said MP Ibrahim Kanaan, the committee’s chair. He was joined by Ferzli, the deputy speaker, who said that “the calculation of losses was inaccurate and overestimated,” and only served “to justify the bankruptcy of banks.”
The IMF confirmed the government’s diagnosis, but most members of the committee remained skeptical.
According to a government source who requested not to be named, the parliamentary counterattack was orchestrated by politicians whose interests converged with those of the banks, including “members of boards of directors, shareholders or even large depositors having received favors from certain banks.”
According to the same source, the committee was even “advised by bankers and BDL in order to minimize losses in the financial sector.”
The committee chair, however, denies any contact with bankers. “We only did our job of parliamentary scrutiny, in order to bring together two divergent positions,” Kanaan says.
Parliament had, in any case, become a de facto ally of ABL and the opponents of the IMF plan by halting the negotiations with the organization. Because even if the cabinet were to adopt the plan, it could not bypass Parliament to execute it.
In May, ABL was finally invited to the negotiating table. “When Hassan Diab, advised by three ministers, including [Finance Minister] Ghazi Wazni, agreed to include banks in the discussions, I told myself the government had given in,” the source says.
Technocrats, prisoners of the system?
How can the reversal be explained? “Some ministers had been contacted by their political parties ordering them to back off,” says a source from the Finance Ministry, a jab at Wazni, who is affiliated with Parliament Speaker Nabih Berri.
Having remained on the sidelines, Berri ended up publicly dismissing any idea of a “haircut” on deposits or capital controls.
According to a banker, this position was motivated by the speaker’s relations with the Lebanese diaspora in Africa, whose deposits are placed in Lebanon.
“Some 40 percent of large deposits in Lebanese banks belong to the Shiite community,” he says.
But Berri was not alone in his fight against capital controls. According to a Finance Ministry source, the law was attacked on multiple fronts: by Salameh and politicians, because “a law on capital controls would shift the responsibility from bankers to the central bank” and to many politicians “who have thus been able to continue to transfer their money abroad at the expense of others.”
This opposition was swiftly echoed by the cabinet. “The finance minister presented a draft law, and then ministers added their comments, but Ghazi Wazni then suddenly withdrew the bill,” recalls Najm.
“Although he was clearly in favor of the law, Wazni gave in to pressure from Nabih Berri, to whom he was the economic adviser for years,” says Michel Fayad, who in turn is adviser to the caretaker economy minister.
The BDL governor also pulled his weight. “The day we convinced Nabih Berri, Riad Salameh came to see him the same evening to talk him into changing his mind,” recalls the source at the Finance Ministry.
The result, a year and half into the crisis, Lebanon still does not have a legal framework to regulate capital movement.
The same scenario played out with the forensic audit, which would have shown how the losses were accumulated, in particular those from the financial engineering of 2016 and 2017, and shed light on potential financial misappropriation.
After naming the US firm Kroll, a top forensic auditor, and launching negotiations, the government backtracked following a General Security report on the firm’s alleged links with Israel.
“The finance minister, who was in charge of the issue, suddenly told us there was a security problem, at least according to the political camp that supported him. I saw red: for me, it was clear, we should not have given in to attempts to bury the forensic audit,” says Najm.
“I objected and clung to Kroll, but the government dug in its heels and turned to another company,” she adds.
After much procrastination, Kroll was replaced at the beginning of September with Alvarez & Marsal, although the firm does not specialize in forensic audits.
“A plan B was then put in place to undermine the audit: BDL used the banking secrecy law as a pretext for not showing its accounts,” explains another government source.
Mission accomplished: given BDL’s lack of cooperation, Alvarez & Marsal threw in the towel on Nov. 26.
Since then, the government appears to have totally given up, with the economic issue put on the shelf, pending the appointment of yet another government of “specialists.”
A year and a half into the crisis, the Lebanese still do not know how they got into this situation; nor do they know how to get out of it.