Lebanese banks that have implemented individual capital controls will only bring temporary respite to the economic crisis in the country and the present impasse highlights the need for the formation of a new government and wider reforms to usher in long-term financial stability, the Institute of International Finance (IIF) said. “Capital controls can promote financial stability if managed effectively but are not a silver bullet,” Garbis Iradian, IIF’s chief economist wrote in a report released this week. About $3 billion (Dh11bn) left the country in the first nine months of the year, according to IIF estimates. Though the country's central bank has not imposed capital controls, Lebanese banks have capped weekly withdrawals at $1,000, restricted out of country transfers and reduced credit card lines. Lebanon has traditionally relied on remittances and capital flows attracted by high interest rates on deposits to finance its budget and trade deficits. The government in turn relied on Lebanese banks flush with liquidity from depositors to buy bonds and treasury notes. Despite the buying of government paper, Lebanon’s government has not been able to reduce the size of its public debt amassed in the post-civil war reconstruction of the country and presently stands at $86 billion, equivalent to 150 per cent of gross domestic product (GDP). The bulk of public debt is held by Lebanese lenders. Based on the terms of borrowing in the 1990s, following the end of the country's 15-year civil war, interest payments on Lebanese pound-denominated debt account for 45 per cent of total government spending, according to <a href="https://carnegie-mec.org/2019/09/17/no-country-for-poor-men-how-lebanon-s-debt-has-exacerbated-inequality-pub-79852">Nisreen Salti, an associate professor at the American University of Beirut, who published her findings this month with the Carnegie Middle East Center</a>. By 1996, interest payments represented close to 68 per cent of the budget deficit. "Two-thirds of any new debt was being issued only to finance interest payments owed on existing debt," Ms Salti wrote. The Lebanese pound, pegged to the US dollar since 1997, has lost about 20 per cent of its value against the greenback in the black market, and with the prolonging of the crisis, banks are unlikely to attract additional flows from Lebanon’s diaspora given the present restrictions. That in turn increases the pressure on the government to meet its debt obligations - $1.5bn of Eurobonds are due this month and another $2.5bn of maturing Eurobonds by June of next year. “Lebanon's ability to rely on capital controls is constrained,” Mr Iradian said. “Since the financial sector is the linchpin of the country's economy, and the sector’s reputation as an anchor of stability is deeply ingrained, the authorities probably cannot keep severe capital controls in place for long without calling the country's basic model into question.” Though the central bank governor has said there would be no capital controls imposed by the regulator, nor a haircut imposed on depositors, the country may have no option but to turn to the International Monetary Fund for a bailout package, which may require it to devalue the currency. In the event of a devaluation, the pound may fall as much as 50 per cent against the dollar, according to Jason Turvey of Capital Economics. A default on debt payments by the government would follow and the economy will slide into a recession, he said in a report this week. “A 50 per cent drop in the value of the pound would cause inflation to rise to as much as 35 per cent year on year,” Mr Turvey wrote. “Higher inflation would squeeze households’ real incomes and hit consumer spending. The economy, which already appears to be in recession, would contract at an even faster pace.”
