STUCK ON STABLE

The Lebanese pound's peg to the US dollar, along with the wide circulation of dollars in the economy, has helped to keep the economy stable.

There is something INTERESTING about Lebanon's finances that has been the subject of study for academics and international financial institutions alike: no matter how bad the panorama turns for this tiny nation, how sluggish its economic growth can be, or how punitive the evaluations of credit rating agencies are, Lebanon remains a financially stable and liquid market. Pointing at a single accountable factor for this odd scenario is not only reductive but it can also leave out important elements from the broader picture. However, it is undeniable that the peg of the Lebanese pound (LBP) to the US dollar has played a protagonist's role in the Lebanese financial scenario.

After the Civil War and the reconstruction process that took a visible toll on the local economy in the mid-1990s, Lebanon's Central Bank introduced a fixed exchange rate of LBP1,507.5 to USD1 in 1998. The formula proved successful, with capital continuously coming into the country, and the peg has remained unmovable ever since. Moreover, the peg has allowed large influxes of capital during Lebanon's many challenging times and far from ever being threatened, the dollarization process has hardened over time, with a current deposit split of 65% in US dollars against 35% in Lebanese pounds.

The dollarization has helped to attract depositors that flood Lebanese banks with capital to finance the country's account deficit through an environment of confidence despite Lebanon's adverse ratings (S&P's: B with a negative outlook; Moody's: B2). It has allowed the banking sector to stay profitable and retain positive growth even through adverse times, and has helped to maintain lucrative operations abroad. According to the Association of Banks in Lebanon (ABL), at the end of 2015 the sector had amounted $186 billion in assets and $155 billion in deposits, tripling the $45.7 billion of the country's GDP. Dr. Makram Sader, the Secretary General of ABL, said that, “the high dollarization in Lebanon can be viewed as one of the elements of the resilience of the banking sector."

As if keeping speculators out and capital in was not enough, Lebanon's peg to the dollar has had another major benefit: the country has never defaulted. This effect is unique in light of the fact that Lebanon has the third largest debt-to-GDP ratio in the world (133%) just behind Greece and Japan, its industrial and exporting base is rather limited, and its annual GDP growth rate has fallen sharply in the past five years (from 8% in 2010 to 1% at the end of 2015). Yet, the alarming state of the sovereign debt has not deterred investors from coming nor has it been close to putting the country's financial system against the ropes. Furthermore, Lebanon continues to have successful bond issues with recent evidence in the $1.3 billion Eurobond issued in October 2015 and the $1 billion issued in April 2016. The equation becomes complete with the enormous amount of remittances the Lebanese diaspora sends annually, which represents figures as high as 19% of the total GDP. Remittances have traditionally invigorated the country's finances since they inject capital inflows in parallel to the country's situation—the more uncertainty in the economy, the larger the remittances and the stronger their effect on banking capitalization and debt financing.

The Central Bank's conservativeness in managing the country's monetary policy has been in favor of the currency peg by ensuring that banks offer attractive spreads to finance the current account, thus keeping deposits coming into commercial banks even in the midst of economic pressure. It is common knowledge in Lebanon that Banque du Liban's guidance goes further than structuring monetary policy or regulating private demand; the institution also serves as a stabilizer of last resort, ensures that the public sector's economic needs are met, and stimulates the overall economy through the proper allocation of funds into those sector experiencing slowdowns. The currency peg has even allowed the Central Bank to inject capital into a series of innovative projects aimed at boosting the economy, and industries as varied as solar energy, real estate, telecoms, and startups have all benefited from these inflows.

The unique nature of Lebanon's dollarized economy has not been free of complexities, however. Despite the large amount of capital inflow and the expansionary monetary policy Banque du Liban has led in recent years, Lebanon has become over-dependent on the cash lines that flow freely and willingly across its banking sector. As Dr. Freddi Baz, Vice President and Strategy Director of Bank Audi, told TBY, “Lebanon has suffered from the Dutch Disease, caused by the big brain drain the country faces and the short-term FDI the Lebanese diaspora sends back to their homeland." This is an effect that has hampered the country from developing an industry of its own as a way to reverse the historic trend of being an import-driven economy. “The drivers of growth in Lebanon should shift from domestic demand to foreign demand, from consumption to exports, because this is what would generate higher quality growth rates," Baz said.