Capital controls in Lebanon likely to halt dollar flight

BANKS HAVE BEEN CLOSED SINCE THE START OF THE UPRISING TWO WEEKS AGO

Calls are mounting for Lebanon to impose formal restrictions on the movement of money to defend the country’s dollar peg and prevent a run on the banks when they open their doors after nationwide protests.

Banks have been closed since the start of the uprising two weeks ago and only plan to reopen once the political situation stabilises. The longer they remain shut, however, the more a backlog in dollar demand builds and speculation swirls about the measures the banks will need to take to avert financial collapse.

In a sign of crumbling confidence, banks have been getting calls from clients asking to move their money abroad while others are working at a frantic pace to transfer funds to Swiss accounts as soon as lenders resume operations.

As tensions intensify, influential local economists have raised the alarm — calling for limits on the transfer of funds outside the country. Two senior banking executives, speaking on condition of anonymity due to the sensitivity of the issue, have said emergency measures were the logical next step given there is no political solution to the crisis in sight.

Capital controls are again becoming the weapon of choice for embattled governments in need of some breathing room. Such a step would mark a turning point for Lebanon since it’s likely to cause a backlash among diaspora investors.

Lebanon’s central bank Governor Riad Salameh said on Monday that there would be no capital controls. But a day of violence on Tuesday, followed by the resignation of Prime Minister Saad Hariri, has added to the uncertainty among investors.

Dwindling choices

Lebanon, one of the world’s most indebted countries, has few viable options. Hundreds of thousands of Lebanese have been on the streets for two weeks, demanding the resignation of a political class they say has pillaged state coffers to the verge of bankruptcy whilst leaving the public with failing public services and daily blackouts.

The worsening sentiment is playing out in the market. The yield on Lebanon’s dollar bond due 2021 jumped 3.85 percentage points to 33.64 per cent on Tuesday. The gap between bids and offers for the security widened to the most since the 2008 financial crisis, reflecting sparse liquidity.

Charbel Cordahi, who advises the largest Christian bloc in parliament on economic issues, suggested in a tweet a series of emergency measures, including setting limits on transfers outside Lebanon at $7,500 a week and a reduction in yields to 4.5 per cent on certificates of deposit held by lenders at the central bank as well as on Treasury bills.

“This would be a solely technical arrangement until the situation stabilises and shouldn’t exceed three months,” he said.

To keep its lenders stable and defend the dollar peg, Lebanon relies on inflows from the millions of Lebanese living abroad. However, capital inflows needed to finance the large current account and fiscal deficits have slowed as confidence has dwindled. Meanwhile, outflows have gathered pace.

Currency shortage

Importers have complained for months that banks were no longer allowing them to transfer Lebanese pound holdings into dollars to pay for shipments. Instead, businesses were increasingly turning to exchange bureaus for hard currency, and paying more than the official rate of 1,507 pounds to the dollar.

For much of this year, some lenders have placed informal limits on dollars they will supply to holders of Lebanese pounds, or charged additional fees for withdrawals in foreign currency for transfers outside of Lebanon. Those measures have not been ordered by the central bank.

Bankers say a decision to set formal caps on money transfers and withdrawals — or to force banks or the central bank to take a so-called haircut on their investments in government debt — should come from the government.