HKS Affiliated Authors

Additional Authors:

  • Clemens Graf von Luckner
  • Jesus Daboin Pacheco

Excerpt

November 2023, Paper: "Lebanon’s current economic crisis ranks among the worst in recent history. GDP has collapsed by 38% in real terms. The Lebanese lira, which was fixed to the dollar in 1997, has lost more than 98% of its value on the parallel market. The government has defaulted on its debt, and depositors are unable to access their funds held at commercial banks. Consolidated public sector debt, including both government debt and commercial banks’ claims on the Banque du Liban (BdL), represents more than seven times the current GDP. Public services delivery has crumbled. In short, the country is undergoing a debt crisis, a banking crisis, a currency crisis, and a growth collapse. Four years into the crisis, a resolution remains elusive, and each passing day increases the economic and social burdens faced by the population.  Given the increasing cost of delaying a resolution, we propose a strategy for Lebanon’s economic recovery that addresses all the dimensions of the crisis while recognizing the need to rapidly kick-start the economic recovery. We propose transitioning as soon as practical to a monetary system based on full dollarization. In a context of weak policy credibility and recognizing that the economy and the financial system are already highly de facto dollarized, we deem official dollarization the superior alternative. A flexible exchange rate system with inflation targeting, in an already highly dollarized economy, would lead to high and volatile interest rates and an unstable and fragile macroeconomic setting, that will slow down the recovery. We suggest a bank restructuring that is informed by our understanding of the origins of the crisis. The nsolvency of the commercial banking system is caused by the fact that the main asset of banks – dollar deposits at the BdL – has lost the bulk of its value because of BdL’s own insolvency. In turn, the BdL is insolvent because its dollar liabilities, accumulated mostly in the process of funding the public sector, are multiples of its dollar assets, courtesy of a massive currency mismatch. With the depreciation of the currency, the mismatch has translated into a large negative equity position."