The clouds have been forming above Lebanon’s financial sector for years, and now the storm has come with just one silver lining: most of the debt owed to creditors is held by Lebanese. Theoretically, this means that financial institutions and Lebanese bond holders are the ones who need to sit around a financial kitchen table and discuss how we preserve the collective long-term interest of the country. But that lining is beginning to thin, and fast.
The latest discussion about whether to pay the next segment of dollar eurobonds has been sullied by Lebanese bondholders offloading their debt holdings to international hedge funds—at a significant discount. Such firms have little to no interest in Lebanon or its financial stability, evidenced by the fact that they have just bought up enough of the bonds (25 percent) to have veto power over default negotiations for all 2020-dated bonds. In other words, instead of filling the moat, manning the towers, and stocking up with provisions, local financial institutions with a stake in Lebanon’s long-term financial stability just lowered the draw bridge with financial barbarians at the gate. If Lebanon does not want to surrender then it needs to wise up, fast.
Learn from others
Fortunately, hindsight is 20/20 and offers up good lessons for the prudent. Lebanon can learn from our Mediterranean cousins in Greece, who, five years into their financial crisis, finally changed tack with the creditors that were pummeling their economy with so-called reforms. But in waiting so long before coming to the table with concrete counter proposals, Greece found its creditors were in no mood to negotiate. We all know what happened next: all reasonable counter proposals—ranging from GDP-linked debt repayments and a stimulus plan to kickstart the economy—were dismissed by the Troika of the International Monetary Fund (IMF), European Commission, and European Central Bank as unreasonable, and the eurozone almost cracked. As for Greece, the country’s debt-to-GDP ratio worsened after a 25 percent contraction, youth unemployment rose to 48 percent, 400,000 Greeks emigrated, and fascism reared its ugly head in politics.
Yet lacking a financial package would have even more devastating effects on Lebanese society, and all depositors would be punished for the mistakes of Lebanon’s irresponsible financiers and politicians. Economists at Bank of America Merrill Lynch have predicted a necessary bail-in of around 50 percent in a disorderly scenario, if spread evenly across all depositors and without taking into account further devaluation of the Lebanese lira. In effect, this would mean unfairly liquidating small and medium account holders’ deposits in an attempt to recapitalize Lebanese banks. If possible, we must avoid this scenario.
Accepting that external financial assistance is necessary to avoid social collapse and food shortages, careful attention must then be paid to the conditions imposed by the creditors. Lebanon’s options are scarce; the tantalizing $11 billion promised at CEDRE in April 2018 is unlikely to arrive any time soon given that most reforms attached to the soft loans and grants remain unimplemented, and good will from the international community has been replaced with frustration over the lack of progress. Gulf countries and the US will also be loath to fund a cabinet formed by Hezbollah and its allies, while the IMF’s second largest contributor, Japan, has its own grievances with Lebanon over its harboring of international fugitive Carlos Ghosn.
As Lebanon enters into negotiations with the IMF and other donors (namely France), it needs a negotiation strategy that can save the country from financial collapse, but also tap into the funds needed to do so. This requires different thinking.
Throw out the rule book
A typical IMF plan that increases regressive taxes, enacts fire sales of the public sector, and cuts up the public sector without careful consideration of the social effects will be neither accepted nor useful. Levying regressive point-of-consumption taxes would come down heavily on the estimated one third of the Lebanese population already in poverty, and impact those the World Bank expects to enter into poverty as a result of the ongoing crisis—in total half of the Lebanese population. To avoid impacting those most vulnerable, upper income earners would need to pay the price through a progressive haircut on the top account holders in the country and an increase in the top tax tier—currently at a ridiculous 22 percent.
In fact, the IMF estimates that improving collection in the current system could raise the tax-to-GDP ratio from around 13-16 percent to 34 percent, some $18.6 billion annually. This would be enough to pay for the electricity sector reforms proposed at CEDRE some 3.5 times over, or raise the estimated $20-25 billion we need in the form of an IMF loan in less than two years. Should there be a need for immediate tax revenue on consumption, one avenue would be to increase value-added tax on luxury products—maybe it is time to start taxing yachts.
Second, any sale of state-owned assets will need to be preceded by long-planned and legislated reforms in each sector. For instance, as the prime sector for privatization, the telecom sector would need to empower its currently toothless regulator to ensure that public monopolies do not become private ones. Same for the public electricity utility, Electricitié du Liban, for Beirut Port, and for Lebanon’s national carrier, Middle East Airlines.
Third, simply slashing and burning the public sector, which pays out more than 300,000 salaries a year, would only make poverty levels in Lebanon that much worse. No doubt the civil service needs to be at the top of the list of necessary reforms, but these need to be carried out fairly. This can start with implementing the organizational structures developed by the Office of the Minister for Administrative Development and filling empty full-time positions in the civil service with those who are currently on temporary contracts—based on merit, not religious affiliation.
Ensure fair reform
Naturally, political and business elites who have long gamed the system and built patronage structures across the public and private sectors will not like such reforms—but they have little choice. Further regressive and punitive financial measures will not be accepted by a society that has simply had enough.
A country’s bargaining power in debtor-creditor negotiations increases if it has secured other financial assistance in advance, and we need all the bargaining power we can get. But as much as we need the IMF, we also need to preserve the long-term interests of Lebanon and its financial standing. Time and again, the classic IMF package has proved ineffective in bringing financial stability to countries around the globe—quite the opposite in fact. But the IMF also knows this, and has been keen to change its stripes. Case in point, the IMF offered Argentina a package that it ostensibly knew it would default on, which it has. But Lebanon is not Argentina, we do not have the size, importance, or leverage of a large South American player. Nor are we like EU-member Greece. We must acknowledge our relative weakness on the international stage as we lower the drawbridge for the IMF. If we cannot strike a deal that will protect those most in need, however, then we must be willing to walk away, batten down the hatches, and prepare for the oncoming siege.
This commentary was originally published in Executive Magazine.
