Paralyzed by protests, Lebanon's fiscal crisis worsens

Lebanese banks have been closed for the last two weeks as the government grapples with mass demonstrations that have paralyzed the country, but an even greater crisis may set in when they reopen Friday

Lebanese banks have been closed for the last two weeks as the government grapples with mass demonstrations that have paralyzed the country, but an even greater crisis may set in when they reopen Friday.

There are concerns the government may not have enough foreign reserves to defend its flagging currency, service its massive debt, and maintain the import of vital goods, particularly if there is a run on the banks.

Lebanon, one of the most heavily indebted countries in the world, already was dealing with a severe fiscal crisis before the protests began, one rooted in years of heavy borrowing and expensive patronage networks run by entrenched political parties.

A proposed tax on the WhatsApp messenger service, coming on the heels of a deeply unpopular austerity package, sent hundreds of thousands of people into the streets starting on Oct. 17 in the largest protests the country has seen in more than a decade.

Banks have remained closed since then, as protesters have packed public squares and blocked major thoroughfares, bringing the country to a halt in hopes of pressuring the government to resign.

The army reopened roads on Wednesday as the protesters stood down in the wake of their first victory, the resignation of Prime Minister Saad Hariri the night before. The Association of Banks in Lebanon said banks would reopen Friday for the first time since the protests began.

The bank closures have taken a toll on ordinary Lebanese, preventing employers from distributing salaries and making it increasingly difficult to acquire U.S. dollars, which have long been widely used as a second currency. Small businesses that need foreign currency to import products have had to do without or turn to a newly emerged black market.

Fawaz, the owner of a shop selling men's suits in Beirut's Hamra shopping district, said he hasn't had a customer since the demonstrations began.

"I had already sent an advance payment for goods from Italy, but I told them to keep it, to hold onto it for another three months until the situation is clearer," he said, asking that his last name not be used so as not to attract negative attention to his business.

"I'm buying expensive goods from Italy and the people here can't afford it," he said. "Before everything else, they have to pay rent and buy food."

Few blame the protesters, who have united Lebanese from the country's many religious sects and factions against the political class that has ruled since the 1975-1990 civil war, and which is widely seen as having tanked the economy.

"The cost the political elite have imposed on the Lebanese population is in billions of dollars of public theft and mismanagement of the economy," said Sami Atallah, an economist who heads the Lebanese Center for Policy Studies.

"So to me, whatever the cost of stopping the country from functioning over the last 12 days is peanuts compared to the mismanagement and the theft that the political parties have inflicted on us."

The sectarian political system put in place after the civil war distributes political power and high offices to Lebanon's various religious sects.

While it has kept the country from slipping back into armed conflict, it has transformed parties into political machines that maintain loyalty by distributing government jobs, contracts and other favors to supporters. The result is a bloated and costly public sector that struggles to provide even basic services like electricity, water and trash collection.

Lebanon's national debt currently stands at $86 billion, or more than 150% of GDP, much of it tied to high-interest loans that impose additional obligations on the government. Meanwhile, inflows of foreign currency have dropped in recent years, in part because of the instability in neighboring Syria.

Even if there is no run on the banks Friday, experts say the political vacuum that is sure to follow the government's resignation is likely to delay enacting necessary reforms, worsening the situation. Forming a government typically involves weeks or even months of political wrangling.

Atallah says a lack of transparency makes it impossible to know how much foreign reserves the central bank has and whether it can meet its obligations.

"The numbers are murky," he said. "We know some things about the foreign reserves, but we don't know how much of it is usable, that can actually be used to defend the exchange rate."

The World Bank estimated that the Lebanese central bank had $39.7 billion in foreign reserves at the end of last year, saying it was equivalent to about 13½ months of imports of goods and services. The tiny country imports vital goods like wheat, oil and medicine, which requires considerable foreign exchange.

Banks may be forced to impose capital controls in order to hold onto their dollar reserves, which could deepen the uncertainty and inflict even more damage on the economy. The Lebanese pound is already said to be trading at up to 2,000 to the dollar on the black market, a devaluation of up to 30% from the official rate.

Ghazi Wazni, another economist, says people began converting pounds to dollars and spiriting them out of the country long before the protests, estimating that some $5 billion has been transferred abroad since the start of the year. He expects the banks to impose some form of controls to prevent a run on deposits.

On Tuesday, the Fitch ratings agency downgraded Byblos Bank and Bank Audi, two top lenders. It said Lebanese authorities would have a "high propensity" to support both banks, but might be unable to do so.

More than two weeks before the protests began, the Moody's ratings agency put the government "under review for downgrade" from its Caa1 issuer rating.

It said the decision reflects the "recent significant tightening in external financing conditions and the reversal in the bank deposit inflows that are essential in enabling Lebanon to meet the government's financing needs."

It said the government's increased reliance on reserves to meet payments on foreign currency bonds "risks destabilizing (its) ability to sustain the currency peg and ensure financial stability over the longer term."