Middle East

The Weakest Link

Lebanon's Financial Crisis: A Recipe for Disaster?

Protest Lebanon
Beirut, Feb. 28, 2002: Lebanese protesters take a page from the Argentinians' book, banging on pots and pans to demand economic reform (Photo: AFP). 

Today, a Lebanese financial crisis is no longer a probability; it is a fact. As Lebanon watches its debts mount, the conflict in the Middle East continues to rage, leading international investors, who might otherwise step in to provide the economy with a much-needed influx of cash, to remain wary of the country. If something is not done soon, analysts fear, Lebanon will sink beneath a crushing burden of foreign debt, with potentially dire political consequences for the region.

Between 1993 and 2001, Lebanon’s net debt increased by 646 percent, driving the country’s debt-to-GDP spread to 168 percent. Numbers like this have led specialists like Navaid Farooq, a credit analyst at Standard and Poor’s, to wonder whether Lebanon could pay its bills if it wanted to. The government, Farooq and his peers caution, must act quickly to reverse this trend in time. “Unless the government implements a credible fiscal program soon, an [imposed] restructuring of public debt will become increasingly likely,” Farooq warns. A public debt of just over half of GDP proved too much for Argentina to bear. Will a spread of 168 percent or more prove too much for Lebanon?

The governor of Lebanon’s Central Bank, Riyad Salameh, has sought, above all, to maintain a stable exchange rate, which has been set at 1,507.5 lira to the dollar. The prevailing wisdom among Lebanese and international analysts is that if the lira were removed from its peg, it would quickly drop to 3,000 lira to the dollar. Maintaining the peg has depleted Lebanon’s foreign reserves: Over the course of 2001, they fell by 20 percent, to US$4.9 billion.

In fairness to Salameh, the policy is not entirely unjustified: Were the lira to sink into hyperinflation, only the most drastic measures could save it. And if the Lebanese were to lose all confidence in their currency, foreign reserves would only plummet further. But many analysts have rightly observed that the Lebanese government’s current fiscal policy is untenable in the long run. As Lebanon spends its foreign reserves to keep its currency afloat, it becomes harder to pay its foreign debt. “The current policy mix of targeting the nominal exchange rate as well as nominal interest rates in the context of falling reserves and rising government debt unlikely to be sustainable,” an April 11 report by international credit agency Fitch Ratings concluded.

James McCormack, Sovereigns Director at Fitch Ratings, sees a few ways out of Lebanon’s quandary: “One solution is to increase the size of the economy, in a way that it starts growing at a faster pace than that of the debt…. In the absence of such a growth, the burden of reviving the economy becomes the responsibility of the private sector; and personally, I don’t think that the Lebanese private sector is ready to assume such a responsibility.”

Another solution entails raising taxes to raise money to pay off the debt. “The government has taken some measures in that respect,” says McCormack, “including the introduction of Value Added Tax (VAT) and the excise tax on gasoline. The two are expected to generate the sum of $533.3 million and $200 million, respectively. The problem is that the national debt is growing at such a high pace that the impact of these new measures can hardly be felt by the economy.”

“Privatization is another way out,” McCormack says, referring to a formula reminiscent of Argentina’s economic policy under President Carlos Menem. According to such a formula, McCormack postulates, “the receipts from the sale process could be used to pay off the debt principal. The government expects to be able to generate as much as US$7 billion from the sale process. But again, the issue of privatization has been on the government’s plate for several years now, and nothing has [happened],” McCormack adds.

Nor does it look like anything is likely to happen soon. Privatizing Lebanon’s state enterprises would require an elusive combination of political will and consensus. While the will may be there, as Lebanese officials cautiously insist it is, building consensus is even more difficult in Lebanon than it is elsewhere, because of the particularly delicate and intricate balance of sectarian and political forces in the country. Establishing the support necessary to privatize more of Lebanon’s economy would require time.

And all indications suggest that Lebanon does not have time. McCormack estimates that the Lebanese government can continue putting off delaying the day of reckoning until next year, when US$950 million in Eurobonds mature. “That is when things are expected to take a turning point,” he worries.

And what then? A financial collapse in Lebanon would upset the existing balance of power in the region between Syria and Israel. Since 1991, just after the close of the Lebanese Civil War, Syria has provided for Lebanon’s security. In exchange, the former has long used Lebanon as a proxy to strengthen its position against Israel. Should Lebanon’s economy collapse, Syria would likely come to see its neighbor as more of a liability than an asset. The Lebanese could easily blame Syria for their economic woes. Moreover, the myriad military factions within Lebanon, whose aims are often at odds with the Syrians’, would likely take up any ground the Lebanese government loses domestically.

If Lebanon were to fall into chaos, then the government’s control over its southern border with Israel would become even more slender. Already, Hezbullah administers many of the civil functions of daily life in southern Lebanon, and many other armed insurgents are known to be active in the region. As Israeli tanks rolled into the West Bank this past spring, Hezbullah traded fire with Israeli forces along Lebanon’s border with Israel. Other Palestinian factions are eager to re-open the “Southern Front,” as it has become known in the Arab press, but have shied away from doing so out of deference to Hezbullah. But there is no guarantee that this status quo can be maintained in the long run.

Others argue that Lebanon’s financial collapse might not be as catastrophic after all; it is just a means for changing the power structure in the country. They add that once this happens, the International Monetary Fund (IMF) will step in to extend a rescue package that will put the country on the road to recovery. The end of Syrian influence would be a good thing, they argue, and would herald a new chapter in the history of postwar Lebanon. But IMF remedies often prove unpopular. An economic collapse followed by unpopular measures from the IMF might prove to be the shock that upsets Lebanon’s fragile internal stability, and its stability as a frontline state in the Arab-Israeli conflict. Such a shock, there is ample reason to fear, could lead the region into war.