BEIRUT — Over the weekend, the value of the Lebanese lira descended to record lows of LL10,800 to the dollar, breaking a historic and psychological milestone in the currency’s collapse.
In response, the government introduced a crackdown on exchange shops and online platforms that display the market dollar price, a move that many economists and financial commentators say will not work and will only drive the parallel market further underground.
Transforming Lebanon’s currency and creating a sustainable foreign exchange market requires solutions that are far more complex and thought out. None of them will be easy, Mike Azar, a financial adviser and commentator, told L’Orient Today.
“You’re in a situation where all you’re facing is bad options,” he said.
Here’s a closer look at the government’s response to the lira’s unprecedented slide and some of the potential ways to redress the country’s exchange market.
How did we get here?
Under the auspices of Banque du Liban Gov. Riad Salameh, the lira was pegged to the US dollar at a rate of LL1,507.5 in December 1997, with foreign currency reserves used to maintain the peg and finance imports.
“When you have a fixed exchange rate system, the rate is only under your control due to certain tools,” said Andy Khalil, an economic researcher. “In Lebanon, that tool is BDL’s foreign currency reserves.”
However, these reserves have been all but drained — the result of an unsustainable cycle of borrowing, poor fiscal and monetary policies, and inflows of dollars from abroad drying up amid local and regional political instability.
In January, Salameh warned that the central bank only had around $17.5 billion in remaining reserves, while Lebanese banks’ foreign currency liabilities — money that is mainly owed to depositors — stand about $118 billion, according to BDL’s economic and financial data.
In other words, Lebanon’s hard currency liabilities, or debts, are substantially higher than its assets.
This means that the central bank simply no longer has enough cash to pump dollars into the market to match the increasing demand; therefore, the value of the lira has plummeted.
“There are too many lira chasing dollars, and not enough dollars,” Khalil said.
BDL is even struggling to maintain subsidies at LL1,500 to the dollar as promised to importers of basic goods such as wheat, fuel and medical supplies, many of whom have complained that their bills remain unpaid for months. Salameh himself admitted in January that the official peg is “finished.”
A transparent market
In response to the decline in the value of the lira, the country’s top politicians, bankers and financial players met at the Presidential Palace Monday to develop a plan. Rather than addressing the root of the lira’s plummet, i.e. the collapse of the economy, financial sector and banking system, they announced a crackdown on exchange shops and websites displaying the market rate.
“Instead of implementing reforms, they are trying to put a band-aid on a pipe that exploded,” Khalil said. “They are trying to restrict the market. This is very harmful because you are transforming from a transparent market between customers into a very incomplete, risky, uncertain one.”
By closing avenues through which people can trade dollars and lira, Azar said, the government’s oppressive tactics are likely to increase manipulation — the exact phenomenon it claims to be tackling — and push the market underground.
This, he continued, will have a knock-on effect on the economy, as businesses who rely on dollars to purchase goods will have a harder time finding them.
In the short term, “you may be able to control [the rate] somewhat, but at the cost of more people potentially becoming unemployed or shops shutting down,” he said.
Instead, Azar and Khalil argued, the existing market should be regulated and organized through a centralized platform where banks, licensed exchangers and BDL can monitor and operate on the same market exchange rates.
“Whoever wants to sell dollars would be able to go to a legal establishment or to a bank, and make the transaction safely, properly and fairly,” Azar said.
However, while suppressing the market has not been effective in bringing down the exchange rate, opening up in the absence of reforms and capital controls will not do this either. Instead, the rate would likely soar as “everything we have been trying to constrain for the last 30 years would erupt at once,” Khalil said.
They pegged it once, can’t they do it again?
The decision to peg the lira to the dollar, though achieved in 1997, had been in the works for a few years before that, Khalil explained.
“At the time, BDL had the necessary foreign assets to create the peg,” Khalil explained. “Now, BDL simply does not have the ammunition.”
Indeed, keeping the lira pegged to the dollar for so long was part of the reason for the country’s economic and financial collapse.
“In order to maintain it, they amassed debt, rather than creating an incentive to buy lira,” Khalil said. “The maintenance led us to where we are today.”
Creating a transparent, fair and regulated exchange market must come alongside other measures to regain a level of control over the rate and, ultimately, overhaul the economy and financial system.
In the short term, BDL could implement “stop-gap measures” to temporarily ease pressure on the exchange rate, including by limiting the amount of lira in circulation.
In April 2020, as banks continued to prevent customers from withdrawing from their accounts in cash dollars, BDL introduced a policy that increased lira in the market.
Circular 151 allowed depositors to withdraw up to $5,000 per month from their US dollar deposits at BDL’s platform rate — currently set at LL3,900 — though limits vary according to account size and between banks.
To support the increased lira outflows, the bank printed increasing volumes of lira banknotes, further skewing the imbalance between dollars and lira available on the market.
“Every day that people withdraw from banks, the supply of lira in the market is chasing after a smaller supply of dollars,” Azar said.
Putting further restrictions on the amount of money people can withdraw in lira or only allowing withdrawals at the LL1,500 rate could reduce the lira in circulation. This would increase demand for the lira and decrease it for the dollar, bringing down the exchange rate.
However, this move would be “artificial,” and would harm the economy and people’s livelihoods, as with fewer lira available, people can consume less and become poorer, Azar said.
Khalil argued that introducing controls on lira could have another consequence — the creation of a new market for lira stuck in banks, which would reduce its value.
“The money is technically imprisoned and wants to escape in any way possible,” he said.
Former banker Dan Azzi coined the term “bira” to refer to Lebanese liras that are held inside banks, and therefore are worth less than lira in circulation, just as “lollars” are worth less than cash dollars.
Azar agreed that the stop-gap measures would be “painful” and a “trade-off in this situation where all the choices are bad decisions.”
“But there are also a million other things that would need to be done,” he continued, such as limiting the smuggling of subsidized goods abroad and drawing up a plan to retarget subsidies in a sustainable and just way.
“These short stop-gap measures need to happen while doing reforms.”
Reforms to attract dollars
In order to begin to improve things, the government would have to undertake a huge number of radical reforms, Khalil said, including debt restructuring, taking care of insolvent banks and creating a more productive economy.
“That’s the only way to get things a bit under control,” Azar said.
Lebanon has long been dependent on imports, with products from abroad supplying the market and neglected and under-incentivized local industry unable to compete.
“We need to create demand for local goods so that dollars come in,” Khalil said.
Demand for lira compared to dollars is not only low because it is not being used in the economy, but also because of a loss of trust in the currency, he continued. “It’s a failed currency.”
Once there is an overhaul of the financial system, there must then be concerted efforts to redevelop the lira.
“We need to reform the currency and give it a new face — but this must come after financial reforms,” Khalil said.
These reforms are not only needed to create a sustainable economy, financial sector and exchange market, but they are also a prerequisite for international donors — the only real hope for a significant inflow of dollars.
Successive governments have failed to enact key reforms to secure loans and grants pledged at donor conferences, such as the CEDRE conference in 2018 and French President Emmanuel Macron’s aid conference that followed the Aug. 4 Beirut port explosion.
After defaulting on sovereign debt last year for the first time in its history, the Lebanese government turned to the International Monetary Fund as a final hope for salvation, asking for $10 billion in aid and promising to implement a “rescue plan.”
However, discussions with the IMF collapsed over disagreement on the extent of the losses in Lebanon’s banking sector. The prospect of an IMF intervention appeared less likely after consultants Alvarez & Marsal withdrew from conducting a forensic audit of BDL to identify poor, and potentially criminal, policy after the firm was not provided with essential information from state institutions.
Any hope for reforms now seems even further off, as Lebanon enters its eighth month without a government and the Prime Minister-designate Saad Hariri and President Michel Aoun continue to squabble over the makeup of a new Cabinet.
“Without the reforms, it will get worse,” Khalil said. “The amount of real assets is reducing by the day, as the real issues have not been tackled.”
Additional reporting by Omar Tamo.