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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a professor at Harvard’s John F Kennedy School of Government and director of the Harvard Growth Lab
With the tragic events unleashed by Hamas on October 7, and global focus on the region dominated by the subsequent conflict in Gaza, it is easy to lose sight of the fact that Lebanon is in a catastrophic economic situation, one which is a source of serious and avoidable human suffering. In 2019, the country fell into a triple crisis, involving the downfall of its currency, its banks and its public debt. GDP has collapsed by close to 40 per cent. Although lira-denominated debts have been wiped out by inflation and depreciation, government and central bank dollar-denominated debts represent seven times current GDP.
Four years has not been long enough to find a path out of the crisis. In September, an IMF mission visited Beirut once again to advance a resolution, without tangible results. While political gridlock is the main problem, sometimes stalemates can be broken with a solution that generates enough winners. That is the spirit in which Ugo Panizza, Carmen Reinhart and I, together with a team at the Harvard Growth Lab, propose a plan to quickly resolve the crisis.
First, to restore economic stability, we advocate for full dollarisation. In an already de facto dollarised economy, and given the country’s troubled political economy, a domestic currency with a flexible exchange rate and inflation targeting would lack credibility and lead to very high interest rates. Dollarisation is a good fit because Lebanon’s goods and labour markets are already deeply integrated with countries, mostly in the Gulf, that peg to the US currency.
Second, we propose an innovative solution to the debt overhang. All crises are caused by an unsustainable accumulation of debt, but what makes the Lebanese one different is the role of Banque du Liban, the country’s central bank. Pre-crisis deficits were funded through the BdL which offered dollar-denominated deposits to commercial banks. The BdL in turn financed the government in local currency. When the crisis hit, the currency mismatch broke the BdL and, with it, the banks. That is why Lebanese citizens cannot access their own bank deposits.
We propose tackling this by converting $76bn of commercial banks’ dollar claims on the central bank into interim government certificates. Ninety per cent of these will be given to large depositors for their balances in excess of a threshold that we estimate at $100,000 to $150,000. The remaining 10 per cent will be absorbed by the banks. This operation will move the insolvency to the government and leave the country with a solvent, although much smaller BdL and banking system.
Third, public debt, including the newly issued certificates, will be renegotiated with creditors at a later date, in the context of an IMF-supported programme. Given what we estimate as $8bn in additional financing needed until 2030 to support the recovery, a haircut upwards of 80 per cent on these debts will be necessary. The government will need to chart a credible fiscal path, achieving a 3 per cent primary surplus by 2030 and a 6 per cent of GDP adjustment in six years. This will have to be gradual to prioritise the recuperation of infrastructure required for the economy to recover. We believe the first two steps can be done swiftly and unilaterally before an IMF-led debt deal, allowing for a quick bank reopening and economic recovery.
Fourth, the country will need export-oriented growth drivers. We see opportunities in quality agro-processed products, increased tourism and the expansion of high-skill business services including through remote work. Recently discovered offshore natural gas resources may also help.
So far, Lebanese policymakers have been unable to find enough common ground to tackle the crisis. Economic recovery is impossible without much-needed consensus — this sequence of building blocks could help them achieve it.