Under siege
Lebanon needs an IMF bail-out—minus the austerity
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 if 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.
A typical IMF plan that increases regressive taxes, enacts fires 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 (see labor special report starting page 10). 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.
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.
Lebanon is concurrently being hit with multiple crises, generating the perfect economic and financial
storm. Net foreign reserves are at an all time low and hard decisions will have to be taken regarding the restructuring of the sovereign debt in all its forms. As the financial and monetary discussion is taking center stage it is crucial not to lose sight of the only way out of this crisis: a strategic vision for an economic recovery.
In order to keep hyperinflation at bay, reduce the drain of foreign reserves at the central bank, and project an aura of confidence when entering into potential negotiations to restructure Lebanon’s debt, we need to address the balance of payments conundrum.
We currently import around $20 billion a year, while exporting a little less than $3 billion. The deficit of $17 billion needs to be covered by inflows of hard currency. Lebanon enjoys a special status with an outsized diaspora that sends remittances in a systematic fashion to the tune of around $7 billion every year.
The very large remaining gap was depleting reserves at alarming rates, forcing BDL to come up with schemes to replenish them by proposing very advantageous rates to attract funds. The whole system was unsustainable and is now headed toward collapse.
We need to reduce the trade deficit to a manageable $7-8 billion, which can only be achieved by reducing imports to around $12 billion and increasing exports to around $4.5 billion. Such a drastic transformation should not cripple growth but rather set the stage for job creation and policies that promote environmental sustainability.
A quick look at our annual imports yields some clear targets for import reduction: Fuel: Lebanon needs approximately $3.8 billion of imports every year (at current oil prices). In 2019 the country imported closer to $6 billion. There is a general consensus across all stakeholders—BDL, importers, and customs—that around $2 billion worth of fuel was being smuggled to Syria, hence the discrepancy. Gold and rough precious
stones: At roughly $1.6 billion, these are overwhelmingly transiting through Lebanon with very few used in manufacturing.
Cars and trucks: A gradual return to pre-2008 levels of imports can be achieved over the next three years. The current approximately $1.7 billion in imported vehicles will have to be forgone and local stocks used in the meantime.
Luxury items: A repositioning of the shopping habits toward a slightly lower price segment will induce a ticket reduction (the average ticket is what is being paid at the cash register in shops). An estimate based on private sector figures across the various sectors shows that we will witness a reduction of around $450 million for 2020.
Another approximately $2.5 billion would still be required to bring the deficit to a manageable level. This could only be achieved by import substitution.
The manufacturing sector generally runs at 60 percent production capacity and no capital expenditure would be required to increase production to the required target. An increase of 50,000 jobs would be required to fulfill this uptick in production, and another 100,000 jobs would be created in the other economic sectors (per UNIDO, every manufacturing job created would generate another 2.2 jobs in other sectors).
The sector currently employs around 150,000 Lebanese employees and another 50,000 to 60,000 foreign workers. The difficulty in accessing hard currency is inducing a rapid replacement of the foreign workforce with a more willing local one. A total of 200,000 jobs would not be hard to achieve should we provide the manufacturing sector with the basis for success.
A selective access to officially priced hard currency is central to the success of such an endeavor, it would give the manufacturers the opportunity to keep all costs in the local currency, greatly reducing the effect of inflation and rebuilding part of the purchasing power that has been lost.
A review of the tariff code needs to be taken to reduce under invoicing and protect eventual foreign direct investments in the manufacturing sector.
It is also crucial to crackdown on smuggling—the informal economy has crippled all the sectors and drained the public finances. The World Bank estimates the informal economy at 40 percent of GDP.
The manufacturing sector is also the easiest to audit and increasing its share of GDP to 25 percent will disproportionately increase tax collection.
The economy is in a dire state, but we can jolt it back to growth. We need to prioritize our efforts and make sure any use of the remaining resources we still have are invested in productive, job-creating, deficit reducing sectors— and manufacturing will be central to such a strategic vision.
To overcome the current crisis, the new Lebanese government will need to develop innovative poli
cies—quickly. Currently, authorities are following a conventional model by seeking ideas from a bureaucracy of civil servants and consulting agencies. Perhaps a more effective way for the government to find solutions is to engage citizens directly via a digital crowdsourcing campaign.
Crowdsourcing is obtaining information and ideas by asking for input from a large group of people, often sourced via the internet. It is based around the theory of collective intelligence, where Swiss researchers estimate that a million individuals working independently have a 97.7 percent likelihood for solving any problem.
The most basic form of crowdsourcing is to run an open online contest for solutions to specific challenges. The relevant ministry drafts and posts a challenge for citizens to respond to with ideas. The proposals can either be voted upon online by peers or judged by a selected committee of specialists. A successful example of this model is challenge.gov, a platform developed by the United States for members of the public to compete to help the government solve public problems. Since 2010, the site has run nearly 1,000 challenges to find solutions for more than 100 federal agencies.
This competitive crowdsourcing process is simple, cheap, and effective—but it limits innovation. By competing, citizens are not incentivized to work together and build upon each other’s proposals.
A more complex, collaborative model could yield better results. In 2013, the Finnish environment ministry invited 700 citizens to participate online to reform the off-road traffic law. Using a blend of online engagement platforms, citizens shared around 500 ideas, 4,000 comments, and 19,000 votes throughout the process. A Finnish Parliament review of the exercise found it beneficial to democracy by 1) providing access to a large pool of knowledge for policy-makers, 2) opening an avenue for civic participation with the potential to increase citizen engagement, and 3) providing a point of contact between citizens and lawmakers that was likely to increase trust—if done well. The paper did caution, however, that crowdsourcing was not an end within itself and would need to be directed toward a specific goal or policy target.
More complex and collaborative crowdsourcing models are more difficult to run and more susceptible to design flaws. How decisions are made, who gets to participate, and how participants contribute could improve or hamper the process. Online crowdsourcing could also marginalize those who are not digitally literate or have no access to the internet.
As a result, a Lebanese model should follow a merged online and offline concept. A platform where citizens can submit ideas should be developed, with the ideas voted upon publicly and filtered. In parallel, specialists across the Lebanese community, both locally and globally, could be invited to form large, digitally-enabled panels to develop expert proposals informed by citizens’ proposals. Ultimately, these proposals would be submitted to government actors as prospective policy solutions to be debated internally, and implemented.
A 2017 paper, published in the bimonthly journal the Public Administration Review, found that “properly designed crowdsourcing platforms can empower citizens, create legitimacy for the government with the people, and enhance the effectiveness of public services and goods.” Applying crowdsourcing solutions for Lebanon could yield multiple benefits. First, Lebanon has exceptional talent. Whether locally or abroad, members of the Lebanese community are innovating and pushing the boundaries of science, technology, and the arts worldwide. The caliber of solutions they submit could be much better than those proposed by a government committee or consulting firm. A digital, open approach would bring the estimated 8 million-strong Lebanese diaspora directly into the governance process, allowing the crowdsourcing campaign to leverage expats’ knowledge about successful solutions implemented abroad.
Second, crowdsourcing innovation could increase faith in the new government from a skeptical public. By providing citizens with an open, transparent space to discuss problems and contribute solutions, the Lebanese have an alternative means to express themselves beyond protesting. Such a move would shift the conversation from what is wrong and who is to blame to how to solve our problems.
Finally, a progressive digital crowdsourcing campaign would send a positive signal to the international community. It would position Lebanon as a pioneer in digital governance, willing to try innovative new ways to overcome its crisis, as well as highlight a real commitment toward democratic inclusion in regulatory reform.