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The spectre of war with Israel looming over crisis-hit Lebanon has raised doubts about the recent stability of its currency, which has plummeted in value in the past four years.
Continuing exchange of fire at the southern border with Israel, which resulted in many airlines cancelling flights to Lebanon and foreigners being urged to leave, have jeopardised projections of $9 billion from tourism for the country this year.
But the Lebanese lira, which has depreciated by 98 per cent against the US dollar in the parallel market since the crisis hit in 2019, has remained surprisingly stable, barely moving from about 90,000 against the US dollar despite the escalating attacks between Israel and the Iran-backed Lebanese group Hezbollah and allied militias.
The clashes began after the Israeli military began bombarding the Gaza Strip on October 7 following a deadly attack by the Palestinian militant group Hamas, an ally of Hezbollah.
“We find ourselves in a time of crisis: the central bank is working tirelessly to maintain the exchange rate stability. However, how long this can be maintained remains an unanswered question,” a high-ranking official at Lebanon's Central Bank (BDL) told The National.
This fragile stability in the exchange rate can be largely attributed to the near-total dollarisation of the economy – an informal shift with the lira being gradually replaced by the greenback.
“Our aim is to stabilise the situation under these difficult circumstances, even though this cannot be a permanent solution,” the BDL source said.
On one front, BDL drastically reduced the volume of Lebanese lira in circulation, which was more than halved in only four months, the source said, primarily by improving tax collection in lira.
But spending is carefully monitored. "The currency being injected into circulation is meticulously calculated, in co-ordination with the government and Ministry of Finance and other relevant ministries,” the source said.
This contrasts with BDL policy under former governor Riad Salameh, who resorted to printing money to finance the country's deficit, causing the lira to lose value.
Acting governor Wassim Mansouri, who took charge after Mr Salameh’s term ended in July, has consistently affirmed his commitment to refraining from lending to the state, whether in Lebanese lira or US dollars.
Another factor is that, in times of crisis, “people tend to reduce their expenses, resulting in a decreased demand for dollars in the market”, the BDL source said.
So far, the BDL has succeeded in its temporary fine-tuning efforts. “Right now, we are striving to remove Lebanese lira from the market while scrutinising expenses, and setting reserves aside for an emergency,” the source added.
'No easy answers'
The burning question is how long this fragile exchange rate stability can be maintained.
“Currently, it's a question with no easy answers,” a western diplomatic source said. “There are multiple variables at play.”
He said one factor would be a potential revival of tourism for Christmas, dependent on the prevailing security situation.
“The previous year saw a significant influx of cash, amounting to billions, which is considerable when considering an economy with a GDP now below $20 billion,” he said.
Another factor is the perception of stability among the Lebanese population. “Since the summer of 2023, there has been a semblance of stability regarding the exchange rate. But the continuing unrest could break this confidence and escalate to the point of creating a rush for dollars.”
A third variable, which could completely upset the balance, is the magnitude of any potential conflict.
“If the state is faced with heightened spending demands, in the context of open hostilities, this will necessarily lead to higher public spending while reducing economic activity, disrupting the current fragile equilibrium,” the diplomat said.
Lebanon’s politicians are well aware the country cannot afford another war with the current state of the economy, and have insisted it stays out of the Israel-Gaza conflict. But they hold little sway over the decision of Hezbollah and its sponsor Iran.
'We are not magicians'
“The current stability is closely tied to the fact that full dollarisation has almost become integral,” said Siham Rizkallah, a professor of economics at t Joseph University.
She said this had been an almost full-scale shift, without a national debate regarding which currency to adopt.
“Some 90 per cent of the transactions are denominated in dollars. Even public servant employees are now paid in dollars. This shift seems irreversible, with the good money, the US currency, driving out the bad, the lira,” she said.
But the challenge with full dollarisation lies in ensuring a constant influx of dollars to sustain the economy, as the BDL no longer has the possibility to print money to finance government deficit.
“What has supported the transition to full dollarisation as a stability strategy this year is the inflow of excess dollars into the market during the summer, primarily driven by the thriving tourism sector,” Ms Rizkallah said.
In May, the tourism ministry in Lebanon’s caretaker government said tourism, the “backbone of the Lebanese economy,” contributed 40 per cent to the country’s GDP.
Ms Rizkallah stressed, however, that there are “other sources of dollar inflows” to Lebanon, such as remittances, as well as money linked to the illegal economy, which go unaccounted for. This makes it more challenging to predict when, and whether, Lebanon might confront a shortage of dollars.
Many had hoped that the crisis would be the opportunity for Lebanon to rethink its economic model. Yet four years later, its ruling elite has been unable to implement the reforms called for by the international community to lift the country out of the crisis.
The BDL source admitted the situation was not sustainable in the long run and that reforms remained “the most important” component, which should not be overshadowed by the deteriorating security situation.
“It's essential that everyone should know that we are not magicians,” the BDL source said. "We're working with the resources at hand but we need assistance from the parliament and the government to finalise the required laws and reforms."
