Leb Lira

One of the lessons of the currency crisis is that if you’re going to peg your currency, you need to structure your economy in such a way to (nearly) guarantee that you have net positive inflows of foreign currency into the country year on year in order to have a long-term sustainable economic system. To be clear, this is true even if Lebanon wasn’t running a “Ponzi-like” scheme, where new $ from overseas are needed to continuously meet old $ liabilities (in order to, for e.g., meet growth in $ deposits because of interest on them; see previous post on Lebanon currency crisis).

Why is this true? It’s true because in the opposite scenario (where you have net positive outflows, because, for example, of a large structural deficit in your balance of trade), you end up drawing down your foreign reserves continuously, which leads to your eventual inability to defend the peg and therefore, a forced devaluation of the currency.

You can try maintaining positive $ inflows by a combination of:

(1) Reducing imports
(2) Increasing exports
(3) Attracting foreign currency via alternative means (e.g. foreign investment, tourism, remittances).

For the longest time, Lebanon relied on (3) to make the “system work”, given that it maintained a large structural trade deficit (i.e. more imports than exports). And for two decades, it worked. Until now. The big problem with relying on (3) is the large exogenous risk (i.e. risk from outside your system) you take since something outside your system can topple your system by significantly reducing these alternative inflows. In the case of Lebanon, the Syria War in 2011 and the Oil Crisis in 2016 significantly reduced alternative foreign currency inflow by reducing tourism, investments and remittances, which precipitated the $ crisis.

So perhaps the right focus then is on (1) and/or (2) if we want to try and minimize some of that exposure. To be clear, that would not completely eliminate exogenous risk since you would still be relying on others to buy your exports, but with enough diversification and trade partners, coupled with a reduction of imports, you would be able to mitigate against a large chunk of that risk. Now can the peg be maintained while nurturing a robust export economy and/or a structural reduction in imports (via for e.g. self-sufficiency) to maintain a trade surplus? Perhaps, but the peg is currently artificially inflating the value of the LL against the $, which hurts the country’s ability to develop an export economy and encourages excess imports. Why? Because suppose, based on fundamentals, that the “true” conversion rate is 1 $ = 3000 LL. Given that we pay for imports in $ and foreigners pay us for our exports in LL, and given that the pegged conversion is 1 $ = 1500 LL, imports are currently costing us half as many LL to buy as they should (based on the “true” conversion rate, thus encouraging excess imports and increasing $ out of country), and exports are currently costing foreigners twice as many $ as they should, making us less competitive (thus decreasing the amount of $ into the country). So maintaining the current peg while trying to develop a robust export economy and/or reducing our imports is like running into a head-wind.

It should be noted that we may be able to develop an export economy and reduce imports while maintaining the current peg if we, for example, ever discover commercially viable quantities of natural gas offshore, which would in theory (1) increase our $ via our government take (from, for e.g. taxes and royalties on the produced gas that the International Oil Companies (IOCs) would have to pay us) (2) replace at least some of our imports like heavy fuel oil for power generation (thus reducing $ exiting country to buy fuel) (3) potentially generate export revenues (thus increasing $ entering country), depending on how our contracts with the IOCs are structured. However, there are significant hurdles to “get there” in the near to medium term for a variety of reasons that I won’t get into right now, which means this will not solve the problem any time soon (I may address this in a separate post).

So maybe we should think about giving up on the peg, and letting the currency float? On the plus side, this would set the value of the LL to its appropriate value based on the country’s fundamentals, which, based on today’s Lebanese economy, would weaken the LL versus the $ compared to today. This, in turn, would stimulate the export economy over time and naturally limit imports, since our products would be cheaper to buy for foreigners, and their products would be more expensive for us to buy. On the downside, this would cause significant short term pain as the purchasing power of the average Lebanese citizen decreases, and measures would need to be put in place to mitigate against that, especially for the most vulnerable among the population. This is, no doubt, a very sensitive subject that would require careful management, but devaluation seems to be happening already in parallel exchange markets at your local money changer (~2000 LL per $ now), except that it’s being done haphazardly while Riad Salameh pretends all is fine and the peg is intact.

These are just some tentative thoughts, but we need to have these types of conversations to be able to participate in shaping the future economy of the country.