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Macro focus Lebanon’s debt mechanics backfire (Interview)

Economist Alexandre Kateb explains how the state has had to go into debt over the last thirty years, via its central bank, to attract foreign capital. Since trust has been broken, the banking system has been beset by numerous requests to withdraw money.
Consultant and specialist in the Arab world, Alexandre Kateb is a lecturer at Sciences-Po.

Economist Alexandre Kateb explains how the state has had to go into debt over the last thirty years, via its central bank, to attract foreign capital. Since trust has been broken, the banking system has been beset by numerous requests to withdraw money. Co
nsultant and specialist in the Arab world, Alexandre Kateb is a lecturer at Sciences-Po. He is the author of Arab Economies in Motion

In an attempt to avoid financial bankruptcy, the new Lebanese government of Prime Minister Hassan Diab has just asked the IMF for help. What are the roots of this political-financial debacle?

It is almost impossible to understand the political, economic, financial and social crisis that is affecting Lebanon today without going back to the early 1990s, when the country emerged from fifteen years of civil war. At the time, under the governance of Rafik Hariri, Lebanon began a phase of reconstruction. The new ruling team decided to reconnect with the pre-civil war assets, to ensure that the country regained its leadership as a regional financial centre. To achieve this, the government of Rafik Hariri will strengthen ties with the Petromonarchies of the Gulf and, above all, with the Lebanese diaspora.

Is this the beginning of what some have described as “a very advantageous monetary policy for Lebanese and foreign depositors?

Yes. Very quickly Lebanon put in place a very advantageous monetary policy for depositors. In other words, bank interest rates were above 15%. Suffice to say that wealthy investors from Saudi Arabia, Kuwait and other Gulf countries who deposited petrodollars in Lebanese banks received returns that were out of step with those of other countries. Moreover, as early as 1997, the monetary and political authorities decided to tie the value of the Lebanese pound to that of the dollar. This is enough to build some confidence in the value of the local currency. This monetary link between the two currencies has remained fixed until today.

Hasn’t this system been pushed to its excess?

Definitely. But, more generally, it must be understood that in order to make Lebanon’s economy work, the state has been in debt since the end of the civil war. For years, neither the monetary authorities nor the various governments could fault it. No one to sound the alarm and say that the country was sitting on a financial volcano. No one to warn that a country cannot forever depend on foreign capital inflows to run its economic machine. However, the workings of this mechanism began to stop at the beginning of the Arab Spring, in 2011.

What are the consequences?

Lebanon suffered a sharp drop in dollar capital inflows. This is the moment when the economic crisis is regional… Where neighbouring Syria is sinking into war, Syrian refugees are flocking to Lebanon in numbers. And where the Lebanese diaspora reduces its transfers of money to the accounts of Lebanese banks.

But what are the links between Lebanese banks that are threatening to collapse and the state?

Lebanon has adopted a debt-based mechanism that is now turning against it. For years, the savings of the diaspora and wealthy investors in the Gulf countries were first deposited in Lebanese banks. And for good reason: these banks promised high returns to depositors. But how could they promise a salary of 7% or 10%? Well just by redirecting these deposits to the Lebanese central bank

And this is precisely the peculiarity of the Lebanese system …

Indeed, in a context of scarcity of savings, the Bank of Lebanon has subscribed massively to the issuance of government debt by then selling them to Lebanese banks for rates of return of more than 15%. Banks have therefore not hesitated to direct their depositors’ savings towards the redemption of sovereign debt from the central bank. They paid 5% interest to their clients and pocketed the remaining 10%.

Did everyone win?

As long as the system holds, everything’s fine. But when public debt reaches 180% of GDP, the highest in the world in relative terms (relative to the country’s GDP), when the country produces nothing, when everything is imported and billed in dollars and when the economy is totally dollarized, then there is the risk from a shift from recklessness to widespread distrust. And today, distrust spares no one. The protests at the end of 2019 revealed all the fragilities of this casino economy.


Faced with the fall in capital inflows essential to its expenditure, the State had no choice but to raise interest rates in the hope of attracting the missing capital to it. The consequent increase in bank rates has deterred Lebanese entrepreneurs from borrowing to invest. In the end, the rise in rates and the flight forward of public debt linked to the remuneration of foreign capital resulted in an asphyxiation of public finances. The Lebanese state is in debt to pay its debts. This vicious circle has reached its limits.

But how can we explain the blockage of the banking system?

Against the background of the political and social crisis, the Lebanese realize that the banking system is extremely fragile. Those who can decide to withdraw their savings in dollars before it is too late, before the bank failure. This panic has only precipitated the crisis. However, in Lebanon as in Argentina in the early 2000s, banks have not been able to cope with the influx of requests to withdraw savings. Keep in mind that deposits from banks were directed to the central bank to buy highly profitable government bonds. However, it is precisely this central bank that is not in a position to insure repayments of government bonds purchased by most banks.


Because the state itself is hyper-indebted and has absolutely no means to pay down its debt. No taxes, no taxes, low growth, falling due to distrust of capital inflows, the noose is tightening dangerously on the new government of Hassan Diab. Hence his intention to seek help from the International Monetary Fund (IMF)…

Were the Lebanese aware of these fragilities?

They probably were, but they took the risks. Until the day they thought, let’s get our marbles back before the cata. Therefore, and to guard against the loss of value of the Lebanese pound, the Lebanese seek to obtain dollars whose parallel price continues to appreciate.

But the central bank has $37 billion…

It’s true. But it owes $60 billion to the banks. As long as these banks do not all ask for that money at the same time, everything is fine. But here we are, customers who fear the worst are queuing outside bank counters. Everyone wants their savings back. So, in turn, the banks go to the central bank to ask for repayment of the bonds they have taken out. And there everything hangs, since the central bank does not have that 60 billion …

What would be the external effects of a Lebanese banking crash?

We are in a situation where the Lebanese banking authorities have decided to limit the withdrawals of savers. But if the central bank, which cannot cope with the banks’ cash demands, decides in the coming days to put a discount on the repayments it owes to lebanese banks, then it would not only be a save-who-can Lebanon, but with regional tensions with depositors from Kuwait, Saudi Arabia and a large part of the Lebanese diaspora.

So the state has no choice but to go into debt?

To avoid collapse, yes. But he needs to build trust, end the panic. This is an extremely critical moment, as poverty affects one in two Lebanese. It is all the more so since the country produces almost nothing, since almost a third of jobs depend on the state. Only foreign partners can stabilize the country by providing funds.

(1) Ed. De Baeck Superior, 2019, €19.90.

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