Dubai: Despite the formation of a new government in Lebanon after 13 months of political paralysis, the recovery of its economy from total collapse will be a function of political stability and ability of the new government to introduce bold and sustainable reforms, according to Institute of International Finance (IIF).
“It is hoped that the new cabinet, headed by Najib Mikati and apparently supported by more than 70 per cent of lawmakers in the parliament, will arrest further deterioration in the economy and lay the foundation for economic recovery,” said Garbis Iradian, Chief Economist MENA of IIF.
Since the announcement of the new cabinet on September 10, the Lebanese pound gained in value by more than 30 per cent against the US dollar in the parallel market. But there is much uncertainty on the possibility of an agreement with the IMF to lift the economy out of its current crisis.
Need for bold reforms
The new cabinet is expected to resume negotiations with the IMF soon. To get out of the current crisis a comprehensive reform programme is needed to address macroeconomic imbalances and structural bottlenecks. Such an economic programme was prepared by the previous government (the Financial Recovery Plan (FRP), dated April 2020), which was well received by the IMF and the international community. However, the macroeconomic framework included in the FRP and the proposed restructuring of the balance sheets of commercial banks and Bank du Liban (BdL, the central bank) including the allocation of losses, need to be reexamined and an agreement needs to be reached on the figures between the financial sector, as represented by BdL, and the new government before resuming negotiations with the IMF.
It is hoped that the new cabinet, headed by Najib Mikati and apparently supported by more than 70 per cent of lawmakers in the parliament, will arrest further deterioration in the economy and lay the foundation for economic recovery.
The projections in the FRP were based on an average exchange rate of LBP 3,400 per US dollar. According to Iradian, assuming that the current multiple exchange rates are unified at around LBP 12,000 by end-2021, then the projected government debt will surge to about 300 per cent of GDP. Moreover, the CPI inflation for 2020 and 2021 far exceeds the projections in FRP. These would change the estimated GDP in Lebanese pounds and in US dollars, and thus most macroeconomic indicators in terms of GDP need to be revised.
The foreign currency debt situation is unlikely to be addressed only by rescheduling. Some form of restructuring and forgiveness will be needed to bring the debt to more sustainable levels.
Banks have imposed informal capital controls on withdrawals, limiting access to savings.
The banking sector has faced a crisis in risk management. They took provisions on the Eurobonds in their portfolios following BdL requirements, and several banks now exceed the threshold. They also took provisions on their portfolio of private sector loans, with a few banks covering almost the entire portfolio.
As such, banks have used their income to cover their operating expenditures and the provisions on the Eurobonds, private sector portfolios, and the CDs [certificate of deposits] issued by the BdL on their books. Also, the banking sector has been experiencing an “internal’ consolidation, with the merger of branches, cost containment measures, and shrinkage of their balance sheets. Nonetheless, it seems likely that several banks will need to be liquidated, followed by the consolidation of a few solvent but illiquid banks.
50 per cent chance
The IIF expects only a 50 per cent chance for the new government to pull-off the wide-ranging economic reforms to save the economy from total collapse.
Despite a difficult political, social, and economic context, Iradian expects the new cabinet to start soon implementing the re-forms, including bold steps to eliminate a wide range of distortions in the economy, while at the same time managing public anger and tensions resulting from the lifting of subsidies by end- September.
“We see a 50 per cent chance that the new cabinet will be able to carry out the economic and institutional reforms to achieve macroeconomic stability and start tackling the solvency of public finance and banking soundness, which would facilitate an agreement with the IMF and unlock adequate financial support from the international community.
While negotiation with the IMF may prove to be a difficult and lengthy process, the new government would be able to tap around $560 million in World Bank loans ($235 million allocated for an emergency social safety net for the poor, and $325 million in humanitarian aid) agreed at the August 4 do-nor conference in Paris.
The IIF project the economy to contract by about 8 per cent in 2021, on top of a contraction of 26 per cent in 2020. Such contraction, combined with 90 per cent depreciation of the exchange rate on the parallel market, has shrunk the nominal GDP by more than half in US dollars.
Wages fell sharply as pass-through from the parallel ex-change rate depreciation caused inflation to accelerate to 123 per cent in July, and the IIF expects further acceleration in the inflation rate to 204 per cent year on year by end 2021.
The key reforms expected by the IMF and the international community include the following:
• Conduct a full audit of the central bank’s accounts and public institutions to improve transparency and accountability.
• Adopt legislation to formalize capital controls.
• Guarantee the independence of the Judiciary Body to reduce corruption and improve accountability.
• Unify the multiple exchange rates
• Reform the electricity company (EdL) and eliminate losses.
• Achieve sizable primary fiscal surplus starting in 2022 to put government debt on a firm downward path.
• Restructure the financial system, which will involve recapitalization and bank mergers.
• Set up an expanded social safety net to protect the most vulnerable people.