July 27, 2020Lebanon Must Avoid Lost Decades of StagflationJean Riachi is the founder, chairman and CEO of FFA Private Bank S.A.L and the chairman of FFA Private Bank Dubai Ltd.
The objective of the government's financial rescue plan is principally to serve as the basis for discussing an IMF rescue program and, eventually, to negotiate with foreign Eurobonds holders. It was criticized by some for being short on details, notably when addressing fiscal policy, or for being too vague in citing measures aimed at funding losses, and for lacking a strategic vision for the future of the Lebanese economy.
In the plan’s own words: “The program aims to address forcefully financial and fiscal imbalances, bring down the current account deficit, put the public debt on a firm downward path, restore the stability of the financial sector and restore confidence”. The use of the word “forcefully” indicates that the government’s plan wants to cut down immediately the public debt to a level deemed sustainable, fully and immediately recognize and address losses in the financial system, and implement ambitious fiscal policies.
Many measures in the plan are key but my main concern, as a financier, is to avoid falling in the trap of “kicking the can” policies that would lead to lost decades of stagflation. The priorities of the plan are as follows:
1- Immediately reduce Lebanon’s stock of public debt, which is too high, to a sustainable level.
2- Recognize the losses in the Lebanese financial system’s books, recapitalize and downsize. Postponing the recognition of losses and keeping banks marginally functional through central bank explicit or implicit guarantee and funding will result in “zombie banks”—neither alive or dead—and unable to support long term economic growth and attract capital.
3- Define an ambitious primary surplus objective for Lebanon’s fiscal policy, which, together with the sharp reduction of the public debt interest bill that will be achieved through debt restructuring, will put the debt-to-GDP ratio on a downward trajectory.
Many groups fiercely targeted the government plan—the most vocal were the central bank (BdL) and the association of banks (ABL). BdL mainly opposes the idea that its foreign exchange negative position has to be recognized as a loss while the ABL is resisting the plan because the estimated aggregated losses exceed banks’ equity and therefore wipe out shareholders.
An alternative plan proposed by the banks includes partial recapitalization of the central bank through the transfer of state assets but ignores the impact on banks of BdL’s foreign exchange imbalances. The ABL plan also opposes any haircut on government debt denominated in the local currency. In order to gain public support for its plan, the ABL has positioned itself as an advocate of depositors’ rights while the government implicitly acknowledges that some form of haircut/bail-in is inevitable. However, it is my firm belief that the ABL plan is much more harmful to depositors as it implies an everlasting capital control and a more substantial and permanent devaluation of local dollars deposits. More importantly, it is a recipe for multiple lost decades of stagflation.
The IMF made it clear that its position was mostly aligned with the government strategy and that an IMF program will help Lebanon’s economy to recover. The path of real prosperity, however, has to start first with a deep reform of the whole financial and political system, in order to avoid the trap of simply “kicking the can” for a few more years.
