Transition scenarios and their bleak alternatives

Seeking wisdoms of ethical crowds

Photo by Greg Demarque | Executive
Reading Time: 10 minutes

For the roundtable on financial reality, monetary needs, and trade and energy issues, the discussion brief invited debate on the role and responsibility of the central bank, the banking sector, the insurance sector, and capital markets in Lebanon, coupled with exploring the country’s circumstances with regard to trade and remittances, its interdependency on international financial markets, the prospects for international participation in infrastructure investing, and the national impact of global financialization. For the initial question, Executive editors asked if Lebanon has its own capacity to devise an economic plan for near, medium, and long-term economic rescue and progress.

In the realization of the financial reality roundtable, this initial query was expanded by the moderator into four questions: namely if an economic plan could still be viable in light of the ongoing uprising and economic shocks experienced since mid-October 2019, what the best course of action was in regard to the monetary course and international financial obligations of Lebanon, how trade patterns had to be changed and interactions with international markets developed, and if resource exploitation could contribute to the rescue of the economy.

Toward light or dark

The discussion of Lebanon’s financial reality was opened with the juxtaposition of two extreme scenarios in the near term. As the scenarios were first painted and later reviewed around the table, a distinction was made between a “white” scenario and a “black” scenario, the likelihood for which was 5 percent for the former and 95 percent for the latter, according to the instigator of the comparison. 

The white scenario would unfold via the designation of a government that gains popular consent, and then would progress by recovering embezzled public funds, gaining active support from friendly governments and international agencies, and implementing investments laid out at CEDRE—and would receive a positive economic shock via a sizable offshore oil/gas discovery. Under a multi-year perspective, this scenario would incur both public-private partnerships (PPP) and private investments.

By stark contrast, the black scenario, with a horizon of unfolding on very short time frames from a few weeks to three months in the opinions of several roundtable participants, would see many families without living incomes due to full or significant partial failures in receiving their salaries, causing anger, despair, and violent conflicts on the streets of Lebanon. Bank depositors would add to the violent crowds because of the loss of their deposits from abysmally dysfunctional banks.

Under this prediction of maximum socioeconomic gloom, import capacities would be extinguished, and the banking system in near entirety would implode, resulting in an accelerated scenario of social unrest that would further be reflected in the organization of communal fiefdoms by Hezbollah, while in other parts of Lebanon only a handful of private investors with access to external banking services would be able to enact financial activities. A parallel system of finance would emerge and recovery from this systemic implosion of the Lebanese financial system would require 10 years.

Debating the probability of such a scenario, participants noted that other possible pathways would not involve a collapse of the banking system. Confidence having admittedly vanished from the system, the removal of ultra-dollarization, along with impositions of capital controls and eventually the reduction of imports related to foreign exchange controls, and action to overcome tax evasion and waste in public expenditure could function toward Lebanon’s stabilization. However, under such views, the rapid designation of a government was the precondition for a benign scenario in Lebanon’s financial reality over the coming months and improving credibility scores with the population and international partners would be a key factor.     

Another participant concurred that, at the time of the discussion, no confidence existed in the Lebanese system while the central bank was unable to meet financial needs for importation and banks were experiencing runs on deposits. Restoration of confidence was only possible on basis of a government’s appointment, proceeding from which the only path to recovery would exist through involvement of the International Monetary Fund (IMF) that would enter an agreement with Lebanon and also act as catalyst for mobilizing international support.

The rapid designation of a government was the precondition for a benign scenario in Lebanon’s financial reality over the coming months.

The Lebanese economy in this perspective should first embark on simple reform measures, such as filling the void at regulatory authorities in telecommunications and civil aviation, increasing electricity tariffs, taking one-two steps toward increasing taxes and social safety provisions for the poor, attempting to reign in the external imbalance in payments and trade, and doing what the IMF would do—even if for political reasons the direct help of the IMF was not sought. Proposals to restructure the economy from a rentier to a productive one with increasing agricultural and industrial exports were presented in this context (a concept further spelled out in the position paper by economist Marwan Mikhael, first published in full
on Executive’s website).  

Moving further into the discussion of realities and possible solution ideas, other stakeholders at the table argued that there are too many variables involved in the unfolding of the current crisis for planning efforts to be adequate at this time but expressed that things will be messy, noting that many measures should have been embarked on years ago, such as a move by the central bank to reinstitute a crawling peg of the Lebanese lira instead of applying the policy of a fixed exchange rate.  Recent decisions on monetary action in the attempt at securing imports such as fuel and medicines were, however, sharply criticized. Under the perception that a new 15-year cycle was about to unfold in the story of Lebanon, the sixth of its kind, there was, however, hope from participants that the coming cycle would induce a better Lebanon.  

Trading in complexity

With a view to trade and the guidance of imports and exports, it was noted that two aspects of the negative trade balance involve the shrinking of exports over the past 20 years as well widening of the trade deficit due to increasing imports. The export capable sectors of the Lebanese economy over many years have suffered from deficient infrastructures and also lacked governmental interventions to make producers more competitive and increase exports. Private sector actors in credit insurance have a mission to support companies in building abilities to increase sales and export, but the government’s role in this context cannot be fully substituted through private initiatives, it was argued. That companies in Lebanon need more support in becoming export-ready, was raised as part of these discussions.

From the perspective of Lebanese industry, it was noted that a quick increase in export volumes was not likely to be achievable for local companies, given their high comparative costs relative to regional peers, and the fact that they were not commodity exporters but rather had their main potential in exports of complex products. In this regard, the complexity of the Lebanese economy was more on par with European countries than with regional neighbors and emerging markets producers. While this was a very positive factor offering economic gain potentials in the long term under international collaboration scenarios with higher cost developed economies, the development of such potentials required time. Therefore, a shorter term adjustment of trade imbalances of Lebanon was more readily achievable by import reductions and substitution with locally produced goods, it was argued.

On the financial side, proposals from the industry stakeholders entail conversion of bank deposits held by investors. Two special vehicles or funds were on the drawing boards in this regard, the first was a mechanism for industrial sector investments and lending that entails capital guarantees from the Lebanese central bank and also at the international level. The triangular process envisioned by industrialists would ease interest costs of industrial loans, remove part of deposit interest burdens from the books of banks as well as liberate funds that have been locked under provisioning needs, and provide long term benefits to investors who cannot access their deposits in absence of economic sanity.

A similar but somewhat simpler mechanism would, in the view of industrialists, also be enacted in the sphere of unsold property stock in Lebanon. It was noted that the envisioning of such scenarios would have room for the activation of special-purpose banks in the country. Pointing out that many banks have exhibited substandard behavior and unsatisfactory communication performance as the Lebanese economic crisis began to unfold, industry representatives at the financial reality roundtable agreed nonetheless that it would not be feasible in the short term to depart from Lebanon’s monetary policy patterns of a peg to the US dollar.

Yet another very noteworthy scenario elaboration at the sixth roundtable was presented with a baseline assumption of 80 percent agreement with the “black” scenario presented at the start of the discussion. This scenario, however, argued that the time window for embarking on a determined financial rescue operation would not close within weeks, but rather a few months. Under this variant of “black,” the rise of social tensions and job-loss related unrest in combination with investment losses would loom in the first half of 2020.

Attempts to avert this chain of events would have to include an, albeit costly, defense of the dollar peg because failure to do so would translate into a factor four exchange value deterioration of the lira. Currency support under this recipe would have to be maintained until an organic restabilization of the lira was achieved at, or near levels of, the current official exchange rate, from which point on unpegging of the currency could be implemented.

This scenario also assumed the need to have a viable departure point in an agreement on a government and a negotiated political settlement. In pursuing a rapid agreement on government formation, however, the scenario assumed that a significant share of governmental power would fall to the opposition, which would henceforth restrict the ability of establishment politicians to act with previously existing impunity. As such, incorporation of opposition in governmental functions would work toward gradual transition to an entirely new government.

Lessons learned

Part of this transition process would be the activation and continuation of economic councils within the framework of the uprising. Such agora transparency, it was argued, would prevent politicians from maintaining corrupt patterns. At the same time, recovery of embezzled funds/elimination of financial gaps in the political economy of Lebanon (in electricity, telecommunications, customs, and other realms) would work for reestablishing a rule-based and compliant political economy system. As further part of the starting setup, it was argued that authority over the Lebanese streets must be restored to the point of not allowing protesters to lock down economic activity in the country.

The rise of social tensions and job-loss related unrest in combination with investment losses would loom in the first half of 2020.

Efforts to recover looted funds would have to follow but were likely to be of limited effect under this scenario’s assumptions, the reason being that most of the funds that were diverted from serving public interests were “stolen in lawful ways,” i.e. under imposition of legislation that was permissive of politicians’ self-interests. However, once a new government has reclaimed partial trust of citizens and partial trust of the old political stakeholders, it would become possible to approach the international community with a request to disburse a first tranche of money allocated under the CEDRE framework and Lebanon could then begin to implement a reexamined and eventually improved Lebanon Economic Vision, the plan devised in 2018 by the McKinsey consultancy firm.

Even as the proponent of this scenario noted that reliance on CEDRE lending would not have been advisable just one year ago, the participant pointed out that such inflows would be needed under the rescue scenario in addition to inflows from Lebanese diaspora sources that would be contingent upon implementation of
a good government.  

Despite the need for external funding, a pivot of the system away from seeking to attract deposits and financial inflows into an economy that prioritizes venturing into industrial and agricultural production activities was embedded in this rescue scenario. The argument in this regard was that the country must be equipped with an economic policy by the government and a monetary policy by the central bank. The central bank would decrease interest rates in 2020 (note: a circular to that extent was released a few days after) and stepwise governmental easing of tax burdens on companies then would support industry and agriculture in conjunction with the implementation of an inter-ministerial initiative labor market initiative. The former needed to entail guidance for youth into constructive employment. Industrial and economic growth would subsequently cause confidence in the Lebanese economy and currency to improve.

No savior in oil

Included within the financial reality theme of the sixth roundtable were perspectives on the energy sector, with an opening comment that painting Lebanese oil exploration as the solution to the country’s economic problems was not reflective of reality. Oil cannot save a country, it was emphasized. The ongoing process of development of regional infrastructures without current Lebanese participation was noted, as well as the need for a clear vision on the domestic or export usage of an
eventual discovery.

However, it was further emphasized that the chances of a commercially usable discovery at the speculated size of 1.7 trillion cubic feet gas was at 25 percent and that revenues from exploitation could not be expected before eight to nine years. In the intermediate time, no more than necessary expenditure was warranted, for example in tendering for a single floating storage regasification unit (FSRU) that would be employed until a gas discovery transitions into commercial use. Besides the need to allocate funding to an FSRU unit, challenges for implementing new energy infrastructures for natural gas usage in electricity generation were the need for civil works and the acquisition of the liquefied gas. A review and revision of energy exploitation policy and eventual gas purchasing contracts was also required.

With regard to electricity provision by the state utility Electricité du Liban (EDL), better planning and tariff setting were required in order to tackle unsustainable electricity subsidies. However, current plans would increase the price of electricity for end uses and need examination, otherwise the risk of a vicious cost cycle at levels of end users exists.

From an industrialist’s perspective, a participant added that some solutions could be implemented immediately, due to economic opportunities—such as decentralization of electricity production—created by cost differentials. Also it could be advantageous for a company to have reliable electricity supply from EDL, even if prices are hiked significantly, because reliable supply would allow manufacturing plants to avoid allocating three electricity budgets: one for state electricity, one for private generation, and a third for costly backup batteries to keep things running during the switch. Thus, even at double the current rates for industrial usage of state electricity, removing inefficiencies from the EDL system would suffice to make it operationally viable, although not thriving, as a starting line for a privatization process, it
was argued.

Also critically mentioned were legal barriers that prevented private sector producers from selling electricity into the national grid as well as undesirable behavioral effects on end users by having introduced generator metering at the wrong time. A proposal for immediate substitution of state subsidies for electricity provision at the private household level would be to hike tariffs and effectively institute a redistributive levy in the area where households have the least need to buy additional generator services, namely in the Beirut area, because residents there benefit from low cost provision of power at rates not hiked in over
20 years.  

Discussions at roundtable six, which like the other events in the series deliberately did not involve politically-entwined individuals nor the “1 percent,” reflected the presence of “leftwing” and “rightwing” perspectives in the current search for a better economic and fiscal direction. In agreements across such barriers, however, all participants concurred that it was paramount to continue dedicating time and energy to emancipation of Lebanon from paradigms of a society with a weak state, widespread corruption, a large and expansive public sector with entrenched social entitlement niches but poor economic efficiency, and sub-standard social justice and safety nets. Empowering Lebanon will require many interrelated efforts and have to show measurable results as far as monetary stability at emergency speed and structural reforms in the near term, but also produce determined and conciliatory economic mindsets for liberating a country that for many years was frozen in socioeconomic immobility with growing economic informality
and unmitigated poverty.

Thomas Schellen

Thomas Schellen is Executive's editor-at-large. He has been reporting on Middle Eastern business and economy for over 20 years. Send mail

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