Depreciating Lebanese pound fuels inflation as country's financial losses mount

Lebanon's financial sector is 'too big to bail', with financial losses exceeding $72 billion, or more than three times the GDP in 2021, lender says

The weak Lebanese pound has led to enormous increases in the prices of goods and services, as companies seek to pass costs on to their customers. AP
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The Lebanese pound's continued sharp depreciation is stoking triple-digit inflation, while the country's financial sector is too big to be bailed out amid mounting losses, the World Bank has said.

The country's financial losses exceeded $72 billion, the equivalent of more than three times its gross domestic product in 2021, the Washington-based lender said in its Lebanon Economic Monitor.

Inflation in Lebanon is expected to average 186 per cent this year, among the highest globally, up from an average 150 per cent in 2021.

The crisis is hitting poor and vulnerable groups the hardest, the World Bank warned.

Lebanon's pound depreciated 137 per cent in 2020, 219 per cent in 2021, and was already down an additional 145 per cent in the first 10 months of this year, according to the bank.

"The size of the balance sheet and associated losses make Lebanon’s financial sector, too big to bail," the World Bank said. "The magnitude of the holes in the intertwined balances sheets of the Central Bank, the banking sector and the sovereign, dwarfs the current and future assets that the sovereign could realistically mobilise for a bailout."

The Mediterranean country is in the grip of the worst economic and financial crisis in its modern history. Three-quarters of its population have plunged into poverty after the economy collapsed, following the country's default on about $31 billion of Eurobonds in March 2020.

That led its currency to sink more than 90 per cent against the dollar on the parallel market and caused the country to experience one of the world's worst food price inflation rates.

The pound's unfavourable exchange rate against the US dollar continues to exacerbate inflationary pressures. This has led to an increase in the prices of goods and services, as companies seek to pass costs on to their customers.

Earlier this week, in an interview with Al Hurra television, Central Bank Governor Riad Salameh said the exchange rate would change as of next February. The authority plans to devalue the pound officially to 15,000 to the US dollar, as part of steps to unify the country's multiple exchange rates and abandon the 25-year peg of 1,507 pounds to the greenback.

Lebanon's real gross domestic product is expected to contract by a further 5.4 per cent in 2022, assuming continued "political paralysis" and no implementation of an economic recovery strategy, the World Bank said.

Its economy contracted about 58 per cent between 2019 and 2021, with GDP falling to $21.8 billion in 2021, from about $52 billion in 2019 — the largest contraction on a list of 193 countries, the World Bank said in a report in January 2022.

Lebanon’s four-year contraction in real GDP has already wiped out 15 years of economic growth and is scarring the country’s potential for recovery, the World Bank said in its latest report.

The depth of the cumulative economic contraction ranks Lebanon’s continuing crisis among the worst since the 1850s, it reiterated.

"Divergent views among key stakeholders on how to distribute the financial losses remains the main bottleneck for reaching an agreement on a comprehensive reform agenda," the lender said.

"Such discord prevents banking sector resolution, which is critical for restoring financial sector stability and economic recovery."

The World Bank recommended a "bail-in solution", based on a creditors’ hierarchy, along with comprehensive reforms as the only realistic option for Lebanon to turn the page on its "flawed development model".

A bail-in makes large creditors and shareholders bear the main cost of bank restructuring, by writing down, cancelling or converting liabilities into equity, which allows viable banks to regain solvency and ensures the protection of small depositors.

"Lebanon must now move to a new sustainable development model. Delays in the day of reckoning with the magnitude and viable distribution of financial losses will only compound human and social capital losses," the World Bank said.

Lebanon needs to urgently adopt a domestic, equitable, and comprehensive solution that is based on addressing upfront the balance sheet impairments, restoring liquidity and adhering to sound global practices of bail-in solutions based on a hierarchy of creditors (starting with banks’ shareholders) that protects small depositors, it concluded.

The International Monetary Fund has repeatedly called on Lebanese authorities to introduce critical structural and financial reforms, a prerequisite to securing $3 billion of assistance from the lender to help the country emerge from its crisis.

Lebanese politicians are deadlocked over the formation of a new cabinet nearly six months after parliamentary elections. The country's political elite have also yet to agree on a new president after the six-year term of Michel Aoun expired on October 31.

Updated: November 24, 2022, 1:58 PM