Lebanese politicians must agree a new government that can stabilize the economy and attract international support if the country is to stave off even deeper economic crisis.
Assuming such a government can be formed, there is still no easy way forward for a country driven toward economic collapse by years of bad governance, corruption and waste.
The least damaging scenario would be a “soft landing” guided by the International Monetary Fund (IMF), economists say, though IMF support has not been broached in public by Lebanese leaders. The economic crisis is the worst since the 1975-90 civil war.
The following scenarios sketch out what might happen in a situation where Lebanon gets a government with international backing, and in a scenario where deadlock continues.
New government agreed, emergency plan drawn up
Caretaker Prime Minister Saad Hariri and his political foes including the Iran-backed Hezbollah party agree on a government that is either led by Hariri or has his blessing.
The government would engage with Western and Gulf Arab states over emergency support. A donor meeting could be convened, probably by France. The response may well include an injection of billions of dollars into the financial system by wealthy donors.
But given the scale of the crisis, Lebanon would also need an IMF program, economists say. Aid would be tied to implementation of reforms.
“We have to bring in the IMF,” said Marwan Mikhael, head of research at Blominvest Bank. IMF support would be vital to ensuring “an orderly adjustment”, added Capital Economics Senior Economist Jason Tuvey. “At least you would ensure the banking system would not collapse and protect the poorest in society.”
“The IMF would not be able to lend to Lebanese without a debt restructuring, so that would have to happen one way or another. I suspect the IMF would also push for a currency devaluation. They estimate it (is) 50% over-valued,” he said, according to Reuters.
A negotiated debt restructuring could include “a haircut” on large bank deposits, Tuvey said. This would reduce their value while leaving the accounts of smaller depositors untouched so the wealthy would carry the burden.
A senior banker said a deposit haircut could be avoided if a stability strategy was enacted now, but could not rule it in a worst-case scenario. “You have to do a debt restructuring and the sooner the better,” the banker said.
Mikhael said a debt restructuring would lengthen maturities and reduce interest rates but not reduce the debt value.
“In the positive scenario, you might have a parallel market for a few months because the capital controls will remain in place until you see things have started to work,” added Mikhael, who believed the pound’s official value would be maintained.
Political crisis continues
Lebanon remains without a new government.
Dollars continue to leave the banks despite controls. In the near term, this leads banks to block all dollar withdrawals, Mikhael said. “The parallel market will flourish more, you will have higher inflation,” he said.
Starved of capital inflows, a sovereign debt default would become inevitable sooner or later. Tuvey said this could happen as early as March. Mikhael said the central bank had enough reserves to cover maturities for a year. “It can be more but then the forex of the central would be very thin,” he said.
The drain on currency reserves would leave the government with no choice but to devalue the pound, Tuvey said. “In this scenario it could be much messier and the currency could overshoot its fair value,” Tuvey said.
Sovereign debt default “runs the risk of banks suffering large write-downs on their balance sheets”, he said. “This is where you run a risk of the collapse in the banking sector.”
The senior banker said the banks’ fixed assets including property would help to shield them from collapse.
“If you put in place the stability strategy today, you surely don’t have to go into a deposit haircut. But the more you wait, the more painful it will be.”