Dubai: Despite the formation of a new government in Lebanon after 13 months of political paralysis, the recovery of its economy after a total collapse will depend on political stability and the ability of the new government to introduce bold and lasting reforms, according to the Institute of International Finance (IIF).
“It is hoped that the new cabinet, led by Najib Mikati and apparently supported by more than 70% of legislators in parliament, will stop further deterioration of the economy and lay the groundwork for an economic recovery,” said Garbis Iradian, economist chief. MENA of IIR.
Since the announcement of the new government on September 10, the Lebanese pound has appreciated more than 30% against the US dollar in the parallel market. But there is a lot of uncertainty about the possibility of a deal with the IMF to pull the economy out of its current crisis.
Need bold reforms
The new cabinet is expected to resume negotiations with the IMF soon. To emerge from the current crisis, a comprehensive reform program is needed to address macroeconomic imbalances and structural bottlenecks. Such an economic program was prepared by the previous government (the Financial Stimulus Plan (PRF), dated April 2020), which was welcomed by the IMF and the international community. However, the macroeconomic framework included in the PRF and the proposed restructuring of the balance sheets of the commercial banks and the Banque du Liban (BdL, the central bank), including the allocation of losses, must be reviewed and agreement must be reached on the figures between the financial sector, represented by the BdL, and the new government before resuming negotiations with the IMF.
It is hoped that the new cabinet, led by Najib Mikati and apparently supported by more than 70 percent of parliament’s lawmakers, will stop further deterioration in the economy and lay the groundwork for economic recovery.
– Garbis Iradian, MENA Chief Economist of IIR
Mountain of debt
The PRF projections were based on an average exchange rate of LBP 3,400 per US dollar. According to Iradian, assuming the current multiple exchange rates unified at around 12,000 LBP by the end of 2021, the projected public debt will reach around 300% of GDP. In addition, CPI inflation for 2020 and 2021 far exceeds PRF projections. These would change the estimated GDP in Lebanese pounds and US dollars, and therefore most macroeconomic indicators in terms of GDP need to be revised.
The foreign currency debt situation is unlikely to be resolved only through rescheduling. Some form of restructuring and cancellation will be necessary to bring the debt down to more sustainable levels.
Crisis of confidence in the banking system
Confidence in the banking system has been severely affected and may take time to recover. The financial crisis that began in October 2019 reduced the savings of most Lebanese in the banking system.
Banks have imposed informal capital controls on withdrawals, limiting access to savings.
The banking sector is facing a risk management crisis. They have taken provisions on Eurobonds in their portfolios following the BdL’s demands, and several banks are now exceeding the threshold. They have also taken provisions on their portfolio of loans to the private sector, with a few banks covering almost the entire portfolio.
As such, banks used their income to cover operating expenses and provisions on Eurobonds, private sector portfolios and CDs. [certificate of deposits] issued by the BdL in their books. In addition, the banking sector is experiencing “internal” consolidation, with the merger of agencies, cost control measures and the contraction of their balance sheets. Nevertheless, it seems likely that several banks will have to be liquidated, followed by the consolidation of a few solvent but illiquid banks.
50 percent chance
The IIR expects the new government to have only a 50% chance of implementing sweeping economic reforms to save the economy from total collapse.
Despite a difficult political, social and economic context, Iradian expects the new cabinet to begin implementing reforms soon, including bold steps to eliminate a wide range of distortions in the economy, while managing in at the same time, public anger and tensions resulting from the lifting of subsidies by the end of September.
“We see a 50% probability that the new government will be able to carry out economic and institutional reforms to achieve macroeconomic stability and start tackling fiscal solvency and banking soundness, which facilitate an agreement with the IMF and unlock financial support from the international community.
While negotiations with the IMF can prove to be a long and difficult process, the new government could get around $ 560 million in loans from the World Bank ($ 235 million allocated to an emergency social safety net for poor and $ 325 million in humanitarian aid) agreed at the August 4 donors’ conference in Paris.
The IIR projects that the economy will contract by around 8% in 2021, in addition to a 26% contraction in 2020. This contraction, combined with a 90% depreciation of the exchange rate in the parallel market, has reduces nominal GDP. more than half in US dollars.
Wages fell sharply as the pass-through of the parallel exchange rate depreciation caused inflation to accelerate to 123% in July, and the IIR expects the inflation rate to accelerate again to 204% in July. one year by the end of 2021.
What do the IMF and the World Bank want from the government?
The IMF, the World Bank and other official donors have suspended their financial support mainly due to the repeated failure of the Lebanese political class to implement crucial reforms.
The main reforms expected by the IMF and the international community are as follows:
• Conduct a comprehensive audit of the accounts of the central bank and public institutions to improve transparency and accountability.
• Adopt legislation to formalize capital controls.
• Guarantee the independence of the judiciary to reduce corruption and improve accountability.
• Unify multiple exchange rates
• Reform the electricity company (EdL) and eliminate losses.
• Achieve a large primary budget surplus from 2022 to put public debt on a firm downward path.
• Restructure the financial system, which will involve recapitalizations and bank mergers.
• Establish an expanded social safety net to protect the most vulnerable people.