The Lebanon poses a problem for central banks and the belief they cannot fail

by Shaun Richards

There is a lot going on in the Lebanon to say the least so let me open by offering my sympathy to those suffering there. My beat is economics where there is an enormous amount happening too and it links into the role of the new overlords of our time which is,of course, the central banking fraternity. They have intervened on an enormous scale and we are regularly told nothing can go wrong rather like in the way that The Titanic was supposed to be indestructible. If you like me watched Thunderbirds as a child you will know that there were few worse portents than being told nothing can go wrong.

The State of Play

The central bank summed things up in its 2019 review like this.

The Lebanese economy has moved into a state of recession in 2019 with GDP growth touching the negative territory. The International Monetary Fund projected Lebanon’s real GDP to shrink by 12% in 2020, a new double-digit contraction not seen in more than 30 years. In comparison, the IMF forecasted real GDP to contract by 3.3% in the MENA region and by 3% globally in 2020. Inflation in Lebanon recorded 2.9% in 2019, and it is expected to reach 17% in 2020, according to the IMF.

As you can see we have two double-digit measures as output falls by that as we note that the ordinary person will be hurt by double-digit inflation. This poses yet another question for output gap theory. I have to confess I am a little surprised to note that the IMF has not updated the forecasts unlike the government. From the Financial Times.

The government says the economy shrank by 6.9 per cent of GDP last year and expects a further contraction this year of 13.8 per cent — a full-blown depression with an estimated 48 per cent of people already below the poverty line.

The next feature is a currency peg to the US Dollar as we return to the Banque Du Liban.

At the monetary level, the year was marked by noticeable net conversions in favor of foreign currencies, a decline in deposit inflows, a shortage of US dollars and a lack of local currency liquidity. As a result, BDL’s assets in foreign currencies witnessed a contraction of 6% to reach $37.3 billion at end December 2019.

Troubling and a signal that if you control the price via a currency peg the risk is that you have a quantity problem which is always likely to be a shortage of US Dollars.

Well I need a dollar dollar, a dollar is what I need
Hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me ( Aloe Blacc)

This led to what Taylor Swift would call “trouble,trouble,trouble”

It is worth mentioning that in the last quarter of 2019, the Lebanese pound has plunged on a parallel market by nearly 50% versus an official rate of 1507.5 pounds to the dollar. The Central Bank is still maintaining the official peg in bank transactions and for critical imports such as medicine, fuel and wheat.

This leads to the sort of dual currency environment we have looked at elsewhere with Ukraine coming to mind particularly.

The present position is that the official peg is “Under Pressure” as Queen and David Bowie would say as it has been above 1500 for the whole of the last year. There was particular pressure on the 4th of May when it went to 1522. Switching to the unofficial exchange rate then Lira Rate have it at 3890/3940. I think that speaks for itself.

The official Repo rate is 10% and rise as we move away from overnight to 13.46% for three-year paper. Just as a reminder the United States has near zero interest-rates so this is another way of looking at pressure on the currency peg and invites all sorts of problems.For example the forward rate for the official Lebanese Pound will be around 10% lower for a year ahead due to the interest-rate gap. So more pressure on a rate which is from an alternative universe.

It looks like there has been some currency intervention as in the fortnight to the end of May foreign currency assets fell from 51.6 trillion Lebanese Pounds to 50.5 trillion.


We start with the Financial Times bigging up the banking sector but even it cannot avoid the consequences of what has happened.

The banks, long the jewel in Lebanon’s economic crown, and the central bank, the Banque du Liban, are at the heart of this crisis. The banks long offered high interest rates to attract dollar deposits, especially from the far-flung Lebanese diaspora. But Riad Salameh, BdL governor since 1993, began from 2016 offering unsustainable interest returns to the banks to lend on these dollars to the government, through the central bank.

That has led to a type of economic dependency.

In sum, 70 per cent of total assets in the banking system were lent to an insolvent state. The recovery programme estimates bank losses at $83bn and “embedded losses” at the BdL at $44bn (subject to audit). Together that is well over twice the size of the shrinking economy.

One of the worst forms of corruption is where government and the banks get together. For them it is symbiotic and both have lived high on the hog but they have a parasitical relationship with the ordinary Lebanese who now find the price is inflation and an economic depression.

Bankers are protesting at government plans to force mergers and recapitalisation, through a mix of wiping out existing shareholdings; fresh capital investment for banks that wish to stay in business, especially by repatriating dividends and interest earnings; recovered illicit assets; and “haircuts” on wealthy depositors.

Or as Reuters put it.

But the banks were not responsible for the devastating waste, pillage and payroll padding in the public sector – about which this plan has little detailed to say.


We find that this sort of situation involves both war and corruption. Big business, the banks and government getting to close is another warning sign and one we see all around us. But as we review a parallel currency, an economic depression and upcoming high inflation there is also this.

The sources say the plan focuses overwhelmingly on the banks and the central bank, which together lent more than 70% of total deposits in the banking system to an insolvent state at increasingly inflated interest rates put in place by central bank governor Riad Salameh. ( Reuters)

Ordinarily we assume that a central bank cannot fold as the stereotype is of one backed by the national treasury to deal with losses. There is a nuance with the Euro area where the fact there are 19 national treasuries adds not only nuance but risk for the ECB. But in general if you control the currency you can just supply more to settle any debts.the catch is its overseas value or exchange rate as we note that Mr and Mrs Market have already voted on the Lebanese Pound. But there is more as I noted on Twitter last week.

Auditors are asking banks to take a provision of ~40% against exposure to its central bank. This has to be a first in history. ( @dan_azzi)

We have become used to that being the other way around. The next bit is rather mind boggling as we mull the moral hazard at play here.

Even funnier is that BDL is about to send a circular asking banks to take a 30% provision on their exposure to BDL.

Frankly both look too low which means for the ordinary person that there is a risk of bail ins.