Economic issues have returned to the spotlight in Lebanon, with prospects of a financial collapse taking center stage as the country reels from its more than one-year war with Israel.

Lebanon’s economic crisis has long been in the making and necessitates a comprehensive recovery plan and a clear agreement with the International Monetary Fund (IMF)—which to date has been severely lacking due to the influence of Hezbollah on the country’s affairs.

As several economic experts have noted, achieving any semblance of normal economic conditions in the small Eastern Mediterranean country requires fundamental changes in governmental approaches, especially considering the international community’s firm stance on Lebanon's factional disagreements with Hezbollah blocking any form of investment due to sanctions on the group.

Lebanon's economic crisis requires new intervention from financial institutions to stabilise the Lebanese pound after years of fiscal mismanagement. Previous attempts at economic reforms have failed, prompting calls for a new approach to negotiations. A key obstacle remains Washington's opposition to creating a deposit recovery fund, even as Lebanese officials maintain that protecting depositors' assets is crucial for the nation's recovery.

National recovery on horizon

Lebanon needs swift domestic economic reforms rather than waiting for international aid. A key initiative from Central Bank Governor Wassim Mansouri proposes leveraging bank lending to stimulate recovery, similar to how reconstruction funds are managed under donor supervision. The proposal now requires parliamentary action to establish the necessary legislative framework for implementation.

While the policy of pegging the Lebanese pound was essential during the financial collapse, the revival phase necessitated a more flexible exchange rate determined by natural economic indicators. The exchange rate of the dollar against the pound is expected to undergo gradual fluctuations over the next three years, rising or falling based on economic developments. With the successful implementation of a recovery plan, the dollar’s exchange rate could decrease to approximately LBP50,000 within two to three years.  

The Lebanese pound has held steady at LBP90,000 to the dollar, but Standard & Poor's forecasts potential sharp currency devaluation ahead. The rating agency cites mounting public debt and economic disruption from the Israel-Hezbollah war as major impediments to Lebanon's recovery efforts.

The International Monetary Fund's May assessment found Lebanon's government reforms inadequate to address the economic crisis. The country's recovery prospects face additional pressure from ongoing challenges, including the refugee situation, heightened tensions along its borders, and spillover effects from the Gaza conflict. Similarly, the IMF’s May report highlighted the insufficiency of governmental reforms in addressing the crisis. 

Fiscal realities and exchange rate challenges  

Former Central Bank Vice Governor Dr. Ghassan Ayache (1990-1993) outlined measures needed for Lebanon's economic stabilization amid mounting pressures from regional conflicts and institutional gaps.

Pre-war recovery plans focused heavily on technical reforms to restore confidence in Lebanon's financial system, particularly in revitalising the banking sector's role as an economic intermediary. "The anticipated pre-war measures revolved around establishing a comprehensive programme to bridge the financial system's gap, particularly to recover bank deposits," Ayache explains. However, he added that post-war conditions demand more comprehensive reforms, starting with political reconstruction as a starting point.

"The need has emerged to rebuild confidence in the political system as a whole by reconstituting state institutions, beginning with the election of a president and forming a competent government capable of addressing these significant challenges," he states.

On monetary policy, Ayache notes that while Governor Wassim Mansouri's leadership has maintained exchange rate stability, unprecedented challenges loom. "The greatest risk facing the Central Bank lies in preventing a dramatic devaluation of the currency, particularly as the state's public finances risk further deterioration due to an unprecedented rise in the fiscal deficit," he warns.

Next year's budget precarious

The 2025 budget outlook appears increasingly precarious, with war-related expenditures straining fiscal planning. Since July 2023, the Central Bank has maintained stability by avoiding government lending. However, Ayache cautions that mounting spending pressures might force policy changes, describing potential increased state lending as "swallowing a poisoned chalice."

Regarding deposit protection, Ayache challenges the IMF's stance against state intervention. "This stance is far from convincing, as the state shares partial responsibility for bridging the financial sector's losses and recovering deposits," he argues, citing Lebanon's monetary laws that mandate state coverage of Central Bank losses.

The Central Bank has built foreign currency reserves to $10.388bn, but Standard & Poor's warns this stability remains fragile without immediate reforms. According to Ayache, resolving the crisis requires "fairly distributing the financial gap, including deposits, among the state, banks, and depositors" to achieve a sustainable solution.