A tangled web of financial misdeeds, shaky banks, and questionable central bank practices has plunged Lebanon’s economy into a crisis with no end in sight

Lebanon once hailed as the “Switzerland of the Middle East,” now stands as a cautionary tale of economic mismanagement and systemic failure. At the core of this crisis lies a staggering $100 billion outflow that has crippled the Levantine nation’s economy, leading to what the World Bank has described as one of the worst economic crises globally since the mid-19^th century.

The roots of Lebanon’s economic collapse run deep, intertwining decades of fiscal mismanagement, a banking sector teetering on the edge, and a central bank engaged in what many experts now characterise as a Ponzi scheme. This perfect storm has not only decimated the country’s GDP but has also pushed 80 percent of its population below the poverty line.

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“A close look over the 2003-2019 period suggests that outflows from Lebanon exceeded inflows to Lebanon by $100 billion, exerting pressure on the net foreign assets of the financial system composed of banks and the Central Bank and depleting liquidity within the system,” Dr. Marwan Barakat, Group Chief Economist and Head of Research at Bank Audi, told Arabian Business.

This massive outflow, occurring over just 16 years, raises critical questions about the sustainability of Lebanon’s economic model and the role of various actors in precipitating the crisis.

Where it all went wrong

Lebanon’s economic woes didn’t materialise overnight. The country has long lived beyond its means, maintaining an illusion of stability through a complex web of financial manoeuvres. The central bank, Banque du Liban (BDL), played a pivotal role in this scheme by offering high interest rates to commercial banks to attract deposits, which were then used to finance the government’s ballooning deficit and maintain an overvalued exchange rate.

“The central bank did the Ponzi scheme in the sense that he offered them high interest rates in order to attract new deposits, and those new deposits were actually used to pay off outflows of funds, so going out of Lebanon, right? So the money was not invested to yield a return similar to the interest paid by the central bank,” said Dr. Patrick Mardini, CEO of the Lebanese Institute for Market Studies (LIMS).

This system worked as long as fresh dollars kept flowing into the country. However, as regional instability grew and remittances slowed, the house of cards began to crumble.

Barakat elaborated on the scale of the problem. “The excess of outflows over inflows over the 2003-2019 period was financed by banks and Central Bank foreign liquidity. BDL that had its gross FX reserves exceeding its FX liabilities by $4 billion in 2003, saw its net FX reserves declining drastically to form a – $47 billion gap at end-2019 and to approach – $73 billion as of today.”

Lebanon’s economic challenges

While the central bank’s policies were at the heart of the crisis, commercial banks and the government share significant responsibility. Lebanese banks, enticed by high interest rates and the perceived safety of government debt, placed substantial amounts of their clients’ funds with the central bank.

“Lebanese banks contributed to the collapse by placing a substantial amount of their clients’ funds at the central bank,” Mardini said. This concentration of risk in the public sector left banks dangerously exposed when the music stopped.

The government’s role in the crisis cannot be overstated. Years of fiscal mismanagement, characterised by bloated public sector spending and rampant corruption, created an insatiable appetite for financing.

“The political class that has expanded tremendously the inefficient and bloated public sector… successive governments that have spent aggressively with no checks and controls while neglecting fiscal adjustment,” said Barakat.

In 2020, Lebanon faced significant challenges. The total public debt-to-GDP ratio reached a record 237.8 percent due to the economic downturn, low growth rate, and a 4.3 percent increase in public debt. As of early 2023, the country’s gross public debt stood at $102.47 billion, reflecting a yearly increase of 3.2 percent which was primarily driven by foreign currency debt (especially in USD) which reached $41.57 billion.

The public sector’s external debt increased from LBP 50,486 billion in 2018 to LBP 62,315 billion in 2022. This growth indicated Lebanon’s reliance on external borrowing denominated in foreign currencies.

The devastating impact

The consequences of this economic meltdown have been severe and far-reaching. Since October 21019, GDP has contracted by 60 percent, the Lebanese Pound has depreciated by 98 percent, inflation has reported a cumulative 6,000 percent, and unemployment has peaked at 30 percent.

These figures paint a picture of an economy in free fall. The human cost is immeasurable, with millions of Lebanese citizens seeing their life savings evaporate and their futures become uncertain.

Lebanese expat Jad Younis, 37, lost his life’s savings in the crisis and is still feeling the pinch almost 5 years later.

“I lost $168,700, which represented my entire savings accumulated over 10 years of working in a GCC city — my life savings. When the crisis hit Lebanon in October 2019, I was outside the country and unable to return to withdraw my money. Wire transfers were blocked, so I couldn’t transfer funds to my bank account abroad either,” he shared.

Following this, the situation worsened with the onset of the global pandemic, which made it impossible for him to travel to Lebanon.

“After several months, I managed to deposit some cheques, which was a tactic many Lebanese used to increase their balances in exchange for some dollars banknotes. At the time, the currency was fluctuating, and no one knew how bad things would get,” Younis added.

He only managed to secure $3,000, withdrawing it from the bank (not devalued) and exchanging it for some Lebanese pounds and cheques worth $15,000. “On subsequent visits to Lebanon, I saw that banks had replaced glass facades with steel, and with the worsening situation on the news, I realised it was hopeless to claim my money. At some point, I had to give up.”

Now, with “low expectations,” Younis is hoping that he will one day be able to recover the rest of his money. His story is just one among many Lebanese citizens who are grappling with the personal toll of the crisis.

The path forward: reform or further decline?

As Lebanon stands at a crossroads, the path to recovery remains unclear. Barakat outlined three potential scenarios for the coming year, ranging from a positive outlook with significant reforms and international support to a negative scenario involving further conflict and economic deterioration.

Mardini, however, emphasised the need for structural reforms, particularly in dismantling monopolies in key sectors such as electricity and telecommunications. “Dismantling monopolies is very, very important, especially that today, the government cannot spend money on those sectors anymore,” he said.

According to the experts, other essential reforms include: implementing a stable monetary policy to control inflation, restructuring the banking sector to restore financial intermediation, fiscal discipline and debt reduction, and attracting foreign investment and encouraging private sector growth.

Lebanon’s crisis has not gone unnoticed by the international community. The International Monetary Fund (IMF) has been in discussions with Lebanese authorities about a potential support programme, but progress has been slow due to political gridlock and resistance to necessary reforms.

The IMF concluded its latest visit to Lebanon in May 2023. At the time, Ernesto Ramirez Rigo, who led the team’s visit, said that while some progress was made on monetary and fiscal reforms, these measures fell short of addressing the banking crisis and enabling economic recovery.

“The Fund remains committed to supporting Lebanon, and we expect the Article IV discussions to take place in September 2024 to assess progress on critical economic and financial reforms,” he said in a statement at the time.

Lebanon’s economic implosion serves as a stark warning about the dangers of unsustainable economic models and the importance of fiscal responsibility. As the country grapples with the aftermath of its $100 billion outflow crisis, the lessons learned here will resonate far beyond its borders.

“I think in 2015 we should have had a crisis, a collapse. And the crisis would have been way smaller… The government and the central bank tried to extend the party, basically doing what they called financial engineering operation, which basically meant that they attracted more deposits into the banking system through offering banks higher interest rates in order to keep the money flowing in and financing the whole party,” Mardini said.

The road to recovery will be long and challenging, requiring not only economic reforms but also a fundamental shift in governance and accountability.