Will a New Prime Minster Solve Lebanon’s Complex Financial Crises?

New Lebanese prime minister, Hassan Diab, a 60-year-old engineering professor, wants to form a government of “experts” to tackle the country’s financial crisis. Diab is also appealing for sacrifice from all, whether the leaders of Lebanon’s sect-based political parties, the protesters on the streets since mid-October, or the politically indifferent.

Diab, a Sunni Muslim, received 69 votes in parliament, against 42 abstentions. But many say he cannot succeed because he was supported by President Michel Aoun’s Free Patriotic Movement, a Christian party, and two Shia Muslim parties, Amal and Hezbollah. The prime minister is constitutionally a Sunni Muslim (the president a Christian and the parliamentary speaker a Shia), yet only five Sunni deputies backed Diab. This brought Sunnis onto the streets in protest, clashing with police in Mazraa, Beirut, and in the northern city of Tripoli.

While protestors in downtown Beirut envisage revolution (“al-thawra”) sweeping away Lebanon’s sectarian political system and its corrupt leaders, an argument is gaining traction that foreign financial assistance will not come to any government involving Hezbollah. Visiting Beirut, United States Under-Secretary of State David Hale stressed the importance of reform rather than the government’s composition, but the Trump administration has been steadily strengthening sanctions against Hezbollah and its ally, Iran.

Hezbollah long maintained distance from the state, concentrating on sustaining its militia and arsenal, with which it resisted the 2006 Israeli invasion and intervened in 2012 in support of Syrian president Bashar al-Assad. But wary of unpredictable unrest and U.S. pressures, Hezbollah leader Hassan Nasrallah has been drawn into condemning the protestors while expressing sympathy for their aims.

Blaming Hezbollah for Lebanon’s woes is easier than acknowledging the failure of an economic model born in the 1990s, when governments led by billionaire Rafik Hariri set a course of high deficits financed by borrowing from domestic banks whose deposits were buoyed by Lebanese expatriates offered high interest rates. Confidence in the Lebanese lira would be maintained by a fixed peg to the dollar, maintained by the Central Bank releasing dollars as needed. At times of crisis, like the 2006 Israeli invasion, funds from the Gulf Arab states came to the rescue.

In crude terms, Lebanon has lived beyond its means. And a fiscal crisis eventually saw the model collapse like a house of cards. Maintaining dollar parity has diminished the Central Bank’s foreign reserves, while the pattern of borrowing has enmeshed an $87 billion debt (150 percent of GDP) with a banking crisis.

“This is a cardiac arrest,” Ishac Diwan, professor at the Paris School of Economics, told a seminar in the Downtown Hilton in Beirut organized by the Carnegie Middle East Center on December 23. “There is a balance of payments crisis, a banking crisis and a fiscal crisis. We’ve seen many crises around the world — few of them are triple crises.”

Rather than impose capital controls, the Central Bank passed the buck to private banks, which in November imposed limits on withdrawals. Most Lebanese are allowed $200-$400 a week, more in Lebanese lira, although everyone believes those with connections (“wasta”) are moving their dollars abroad. The Bank maintains a nominal rate of 1,500 lira to the dollar, whereas a managed “market” rate has in a month reached 2,100, slashing the real value of lira savings and wages. A shortage of paper dollars means money-changers have few available, even at 2,100 lira.

Hotels are nearly empty, restaurants are struggling. While state workers were paid before Christmas, many private-sector businesses have put employees on half pay or just sent them home. Many Lebanese are not repaying bank loans or paying bills from the state electricity utility.

There is a gap between the expectations of protestors and the dire economic situation. “I can’t sacrifice anymore,” says one Beiruti who will not pay his electricity bill. “Let the politicians make the sacrifices.”

That would be new. Corruption in Lebanon is rampant, with a state dominated by sect leaders through a so-called “confessional” system allocating parliamentary seats and government positions to 18 recognized religions — all Lebanese must be a member of one or another. The powerful set an example by flouting laws and rules.

Despite a legal ban on permanent structures along the sea front, Lebanon’s shore is littered with resorts built by those with political connections. Downtown Beirut was handed wholesale in 1994 to a private company, Solidere, linked to then-prime minister Hariri: its master plan envisaged banks, offices, luxury housing and hotels — a playground and home-away-from-home for rich Gulf Arabs.

Owners of the small, independent shops that filled downtown before war erupted in 1975 were expropriated and “compensated” with Solidere shares. “It was theft, they were all thieves,” says a former owner, who set up shop elsewhere but proudly keeps a photo of the old family business on his wall. “I hope one day they meet justice.” Downtown today resembles an armed camp, with many shops shut and razor wire reminiscent of the U.S. Green Zone in Baghdad after the 2003 invasion.

There are also the tents of the “revolution.” While many celebrate the protesters lacking leaders, some believe the time has come to put forward a new kind of government. Within days of protests erupting in October, Chibli Mallat, law professor and advocate of nonviolent change, suggested half the ministers should be under 30 and half women.

But whoever sits in government, there are no easy solutions. Someone will pay: the question is who, and whether any government can produce a program perceived as vaguely equitable by most Lebanese. Despite what many protesters believe, the deficit could not be bridged simply through a crackdown on “corruption,” even if this were possible without removing the entire political class.

Further devaluation of the lira is one option, given that 61 percent of the debt (equivalent to $87 billion) is in lira. But given high imports, this would devastate the living standards of most Lebanese, whose income in is lira.

Samir el-Daher, advisor to former prime minister Najib Mikati and a former senior World Bank official, has circulated a paper advocating a “National Solidarity Wealth Tax,” a one-off progressive levy on dollar holdings in Lebanese banks (as held before the current crisis) that would aim to buy back or substantially reduce the $34 billion dollar-denominated state debt. This would need to be supplemented, Daher argues, with structural reform, devaluation and stronger social safety nets.

By avoiding bank shareholders’ equity, at least immediately, Daher’s strategy would aim to restore confidence in the banks and avoid debt restructuring that would “dent Lebanon’s once stellar reputation as a creditworthy, resilient country,” while avoiding a rock-bottom sovereign rating that would preclude or make cripplingly expensive any future borrowing. Contrary to Daher’s prescription, Walid Alameddine, former chairman of Lebanon’s Banking Control Commission, has advocated the state guaranteeing bank deposits.

There is much talk of international assistance. Donors, however, have over many years grown impatient with corruption and empty promises of reform. Between 2012 and 2018, Lebanon received $8.1 billion in development assistance, according to the World Bank, but even aid for Syrian refugees was pilfered. Pledges of $11 billion, mainly loans, at a Paris conference last year have come to nothing due to the government’s failure to curb a deficit that amounts to around 50 percent of government revenue and over 10 percent of GDP.

Some regard the International Monetary Fund as the only means to genuine change. This reflects the scale of the political challenge. Reform-minded Lebanese economists at the Carnegie seminar divided into those favoring large scale political change and those arguing “muddling through” might best avoid a collapse with unpredictable results.

The politicians are in no hurry. Goldman Sachs estimates the Central Bank’s remaining foreign-currency reserves at $28 billion. Might these pay off a $1.2 billion Eurobond due in March ($10.9 billion of debt matures in 2020)? Or should they be held back to ensure the state can offer basic services for poorer citizens?

The longer change is put off, the more dollars will leave, the more the fiscal balance will deteriorate, the deeper will be recession, and the greater will be the share of the eventual “hair cut” meted out to those least able to bear it — the poor and the middle class.

“With 22 percent inflation and a contraction in GDP of 5 percent, numbers in extreme poverty would double from 10 to 20 percent,” Haneen Sayed, human development specialist for Lebanon at the World Bank, told the Carnegie seminar. “By this we mean those who can’t afford basics like food, $5 to $5.50 a day.” She added that children from poorer backgrounds were dropping out of school, either to save their parents money or to work in the informal sector.

And what are the consequences for a rentier state whose politicians are slowly losing control and influence over their followers as patronage disappears along with the dollars that fueled it? “The regime can muddle through: the risk is that it lives on these [foreign currency] reserves until they are exhausted,” Diwan told the Carnegie seminar. “It could be that a new Republic will inherit a country in ruins.”

Some groups may be less vulnerable to the collapse of patronage. Not for the first time, U.S. and Gulf Arab efforts to squeeze Hezbollah could backfire, in this case by refusing financial assistance unless Hezbollah’s influence on government is curbed. “Some parties are better placed for an economic downturn than others,” said Diwan, “especially those with arms.”

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