A promise of competence: Lebanon’s economic crisis

‘PARIS OF THE MIDDLE EAST’ NO LONGER?

A nation of 5.4 million nestled on the Mediterranean governed by sectarian confessional politics, Lebanon — once a haven of finery, opulence and swanky nightlife — now finds itself plunged into one of its worst economic crises in decades. The middle class in particular has been hit hard by the twin crises of purchasing power depreciation and a 56% rise in inflation. The Lebanese pound (LBP) has nosedived since investors started pulling dollars out of the country last year and is now worth 8,000 LBP against the US dollar. With a virtually non-existent export sector, Lebanese banks rely heavily on dollar deposits from wealthy investors and the country’s far-reaching diaspora. Promises of higher yields based on future deposits and rising interest rates drained state coffers and damaged investor confidence. The COVID-19 pandemic has also cut off the traditional tourism boost that the northern summer brings when diasporic Lebanese travel home. Without this sorely needed influx of dollars and consumption, the economy has contracted by 12%, food prices have risen and rolling electrical grid blackouts have become the norm.

Decades of mismanagement and siphoning of public wealth by the ruling class came to the fore during 2019’s October Revolution. The Lebanese people showed up in force protesting a tax on a popular messaging service and the limiting of bank withdrawals. The general perception of corruption in the upper echelons of government led to then-prime minister Saad Hariri’s resignation. Opportunistic factions competed for control in the power vacuum that followed, delaying the formation of the successive administration, Prime Minister Hassan Diab’s supposedly technocratic cabinet. This delay in forming the new government, followed by the depreciation of the Lebanese pound, triggered another wave of protests in January that was only tempered when COVID-19 restrictions were introduced. Despite these restrictions, protestors have braved the streets once more as the economy plunged into dire straits, facilitated by years of endemic corruption, poor deficit spending principles and political inertia to deal with public dissatisfaction.

SHINING A LIGHT ON CORRUPTION

Lebanon’s principal challenge is finding the political will to create a truly independent government. The country’s political parties, many of which used to be militias, are reliant on foreign powers. Hassan Diab’s supposedly progressive administration — it has a historic number of female cabinet ministers — is backed by the March 8 Hezbollah alliance, which itself is supported by proxy by Russia and Iran. The ruling class is not seen as sovereign but instead beholden to their sectarian obligations. The perception of Hezbollah pulling the strings has made it hard for the international community to respond to calls for aid.

Therefore, Diab’s government — initially hailed as a transformative force for Lebanon but straitjacketed by sectarian ties — has been handicapped in its ability to respond to the economic crisis. Leaked documents in April revealed how banks were allegedly colluding with the ruling class to finance the growing fiscal debt with public deposits and had inappropriately distributed these funds to state-financed monopolies.

Nowhere is this clearer than in Lebanon’s power generation sector. Electricity is a heavily subsidised commodity in Lebanon; the cost is responsible for about 40% of its public debt. Yet electricity is not produced 24-hours a day, forcing many households to rely on personal generators or suffer frequent blackouts. These systemic inefficiencies are evident in the incongruous reality of street lamps being switched on during daylight hours.

Unaccountable deficit expenditure on Lebanon’s electricity sector reflects the poor fiscal management that has led to the current economic crisis. Lebanon’s electricity grids are primarily operated by its national electricity company, Electricite du Liban (EDL). The government-backed EDL has operated power generation plants and powerships at the taxpayers’ expense, facilitated by $2 billion in annual fuel and power subsidies. The powerships are floating power supply stations imported primarily from Turkey, and are responsible for 25% of Lebanon’s electricity output. The import of these fuel-intensive barges is costly and an environmental burden borne by the government.

The sector also suffers from duplication, exorbitant fuel reliance and grid leakage. For example, where Egypt only has one gas-operated powership for a country of almost 100 million, the Lebanese leadership has insisted on three gas-operated powerships for its less than 7 million citizens, apparently to appease sectarian obligations by increasing land appropriation costs. Taxpayers pay twice for the supply of fuel for the local market: once, via taxes, for the government to finance the cost of fuel to EDL, and then again for the purchase of electricity from the private sector. Furthermore, despite falling global oil prices, electricity has not switched from a fixed price model to accommodate these fluctuations.

PIVOT TO THE EAST?

To ameliorate this descent into complete economic collapse, Lebanon has requested a $10 billion bailout package from the International Monetary Fund (IMF). The IMF has laid out two preconditions. First, the government must institute strict austerity measures such as slashing electricity subsidies significantly — a move likely to hurt the public. Government discussions suggest it is amenable to reducing electricity subsidies and addressing the power outages.

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The second IMF demand reflects the institution’s exhaustion with Lebanon’s structural corruption. Without explicit political reform at the upper echelons of government, the loan is unlikely to pass. Political reforms involve a clear forensic accounting of the banking sector, exposing balance sheets and democratising the private sector, and rupturing state monopolies. With the pound’s devaluation, there will also be a need to boost domestic supply-side capacity, for example in the food production sectors — imported food has become too expensive as the purchasing power of the pound has decreased. The price of a food basket increased by 56% from September 2019 to April 2020. Yet political factions within the government — many of whom are shareholders in the banks — have stalled negotiations with the IMF, resulting in the resignation of chief negotiators.

This has prompted Beirut to China, which is more liberal in its aid provision. Indeed, Chinese delegates have stated that they are ready to “activate cooperation between the two countries.” Chinese investments are generally perceived as being sanction-proof and reports indicate that Chinese state-linked entities have expressed interest in investing up to $12 billion in ports, railroads, power generation and waste management.

Hezbollah, arguably the most powerful political entity in Lebanon, has leaned on this rhetoric heavily as the US has threatened sanctions should the militia’s proxies remain involved in politics. Hezbollah also cannot turn to its traditional benefactor in Iran, which faces its own economic crisis and unrest, prompted in part by a feeling that Tehran’s support for groups such as Hezbollah has come at the cost of the domestic economy.

Yet a pivot to China seems unlikely and may present a Faustian bargain for the Lebanese. Resource-absent Lebanon does not offer many benefits to Chinese investment and the US-imposed Caesar Act has closed the key Syrian market, reducing investor confidence. Even if Chinese investment does manifest, it is likely that future generations of Lebanese would end up financing a debt trap, a phenomenon that even stable-state Middle Eastern countries like Oman and Egypt are experiencing in their deals with Beijing. On the other side of the table, Beijing’s exit from a multi-billion-dollar deal with Tehran sets a precedent for its unwillingness to challenge US sanctions without an appropriate return on investment.

Regardless, either an IMF loan or a Chinese aid package would only be a stopgap measure if reform of traditional ruling class obligations is not achieved. The body politic is intertwined with commercial interests, making structural reforms impossible if a political overhaul is not achieved first. Stalled IMF negotiations have once again spurred fears that the absence of capital to finance growing debt and import needs will expedite the collapse of the banking sector, aggravate food insecurity and increase the likelihood of violent chaos as living conditions worsen.