People in Lebanon lost their incomes, jobs, and life savings due to a massive economic slowdown coupled with high inflation and a devaluation of the currency. The Lebanese government suspended the payment of a $90 billion debt, mostly held by the domestic banking system. The central bank accumulated losses on foreign exchange operations as well.Banks became insolvent, froze deposits and requested the establishment of official capital controls. The “Lebanese Government’s Reform Draft” proposes a way out of the crisis. This blueprint builds on that document and aims to complement it. The key components of our proposal are:

Growth-driven reforms: The crisis calls for a new approach to fiscal policy. In current circumstances, tax increases will lead to lower revenues and public monopolies will keep on spending borrowed money on useless projects. High debt burdens and debt haircuts on future generations will follow. We recommend replacing current taxes with a single, simple flat tax, similar to what many former communist countries have done. We also recommend dismantling monopolies and opening markets to competition. Competition would reduce the need for government to borrow and spend. It will substantially improve the quality of infrastructure and reduce the cost, while setting the base for sound economic growth.

 

Currency board: We expect the suggested dirty float of the exchange rate to lead to recurrent devaluations, further impoverishing the population because of the central bank’s tendency to finance fiscal deficits. To solve the currency crisis, we argue for replacing Banque du Liban (BdL) with a currency board. Unlike the dirty float, a currency board would ensure a sound, stable, and fully convertible Lebanese pound. A currency board would also deprive the monetary authorities of the ability to finance the government and thus would impose monetary discipline that Lebanon has clearly lost since at least 2015.

 

Cumulative interest: The costs of government debt and BdL’s mismanagement should not be entirely borne by depositors. Both entities need to dismantle monopolies, liquidate their assets, and cover a part of their losses. Furthermore, rather than imposing an unfair haircut on depositors above a certain threshold, we recommend revealing cumulative interest paid by Lebanese banks to their depositors since the 2015 Ponzi scheme, including depositors who already transferred their money outside Lebanon. Cumulative interest should be the second source of a bail-in, after banks’ shareholder equity. This process, used in the Bernie Madoff fraud case, allowed the conservators to preserve the initial principal invested.

 

Our suggested reforms would enable the government to raise more income without increasing taxes, to cut spending without discouraging investment, to stabilize the Lebanese pound without making losses on foreign exchange operations, and to restructure banks without shifting the entire burden onto depositors.

Click Here to Download BELIEF as PDF