Lebanon is facing a herculean task to escape its economic malaise. For decades, it has maintained a hefty current account deficit to finance substantial government spending, much of which pays for a social safety net that keeps the socio-politically diverse country from falling apart. But plummeting consumer sentiment, slowing capital inflows and the threat of more Iran-linked sanctions are deepening economic fragility and driving home the unsustainability of that kind of government spending.
A 1989 peace accord ended Lebanon's 15-year civil war but failed to solve the political issues that incited the strife in the first place. Thirty years on, Lebanon's political situation and economy remain precarious because enacting major reforms would upend the social contract that has provided a share of the country's wealth and kept a lid on hostilities.
In its recently passed 2019 budget and under-discussion 2020 budget, the government has agreed that austerity measures are the solution to trim government spending. But forcing austerity measures upon Lebanon will fundamentally disrupt the country's social safety net, thus damaging the political ties between citizens and their political patrons. As Lebanon moves forward with austerity, popular unrest and a weakened government are all but guaranteed.
Struggling to Maintain the Peg
An immediate issue driving home the need to slash government spending is the current strain on the Lebanese pound's peg to the U.S. dollar. Increasingly, Beirut must prop up the peg (roughly 1,500 Lebanese pounds per dollar) by depleting foreign currency reserves. The peg, implemented in 1997, initially helped Lebanon crawl out of an economic slump after its costly 15-year civil war. This summer, however, the black-market currency exchange rate crept swiftly beyond the official peg, raising the prospect of a devaluation down the road or the complete elimination of the fixed exchange rate.
Removing the peg would cause the pound to rapidly depreciate, seriously endangering Lebanon's postwar social contract, which guarantees that the state will take care of citizens' basic needs through hefty social spending. But today, Lebanon's economic instability is threatening its citizens' purchasing power, and thus their trust in the government and the system the country's confessional communities enacted after the civil war has eroded. Capital flight, decreased remittances and slumping consumption all illustrate the extent of the decline in consumer sentiment in the country; meanwhile, speculation on the stability of the dollar peg has already reduced capital inflows and increased capital outflows.
Anti-Iranian U.S. sanctions, too, have added another layer of economic anxiety. The United States is imposing new sanctions on Hezbollah and Iranian-linked entities in Lebanon, such as the Jamal Trust Bank. And more Lebanese banks could find themselves in the crosshairs as the United States' anti-Iran sanctions net widens. Lebanese lenders, in effect, are experiencing a double whammy: on one side, the United States is threatening to sanction them for their links to Iran or Syria, and on the other, the Lebanese central bank is demanding that they participate in reform efforts by purchasing low-cost treasury bonds to help pay off the country's debt-servicing bill.
As Lebanon moves forward with austerity, popular unrest and a weakened government are all but guaranteed.
Facing the Inevitable: Austerity
To solve the issue and court future investment, Lebanon's 2019 and 2020 budgets include unprecedented austerity measures and the promise of future labor and tax reforms. While authorities hope to solve the country's intractable deficit and debt issues by increasing capital inflows and supporting the currency peg (without relinquishing control to an outside institution like the International Monetary Fund), they will heap further economic pressure on citizens, who will respond with more pressure on the political class to draft a new social contract.
Lebanon's biggest expenses are debt servicing, public sector costs and payments to the state electricity company. To trim each of these, the government's plan involves austerity measures or pressure on the private sector. For example, Beirut hopes its subsidy reform will help reduce transfers to the state energy company, which cost $2 billion a year, but that will increase the price of electricity for Lebanese who have grown weary of daily brownouts and costly utilities. The government, meanwhile, hopes its public sector reforms will help lighten the public sector wage burden, which devours a remarkable 35 percent of the budget, but such reforms, inevitably, will allow fewer citizens to land coveted jobs in the public sector. That's a serious problem in a country whose youth unemployment rate runs 37 percent — as well as a further betrayal of the social contract that is sure to deepen discontent. There are simply no solutions to the debt issue that don't involve the government trimming its spending — and Lebanese citizens and private sector companies footing more of the bill.
Austerity measures are also more inevitable because recently promised grants and loans to Lebanon require the country to implement austerity in order to unlock the funds. Beirut praised the $11 billion in loans and grants from the 2018 Cedre Conference, an international donor summit for Lebanon, as a way to weather the crisis. But to access the funds, Lebanon must impose austerity measures that will not only hurt citizens' purchasing power but also direct them toward capital-intensive infrastructure projects that won't provide any immediate succor to struggling lower- and middle-class Lebanese struggling to buy food and keep their jobs. Furthermore, such restrictions will only increase the current account deficit. What's more, many external private investors will want to see if Lebanon will implement some structural reforms before they part with any cash.
The Aftermath of Austerity
Given that Lebanese citizens aren't used to austerity, the prospect of new taxes, more job uncertainty and higher utility prices are bound to incite unrest and raise calls for a new relationship between the governed and the governing. Recent popular protests highlight citizens' rejection of the 2019 austerity budget, which parliament finally passed seven months into the year. More austerity measures in the 2020 budget will focus additional anger on Prime Minister Saad Hariri and President Michel Aoun, potentially weakening their political standing as each struggles to deliver political patronage. Powerful political actors like Hezbollah, which keeps one foot in the government and one foot out, will also witness a decline in its political capital if it can't maintain social spending for its base. Politicians will continue to try to blame the country's economic malaise on Syrian and even Palestinian refugees (the Lebanese government estimates that Syrian refugees cost $1 billion directly and $3.5 billion indirectly), but fear-mongering about refugees has become an all-too-easy salve for politicians looking to deflect blame for Lebanon's structurally weak economy. One possible implication is that other actors, including central bank head Riad Salameh and Foreign Minister Gebran Bassil, will boost their political capital amid speculation that both could run for the presidency.
Lebanon's regional patrons cannot or will not come to its rescue as they have in the past, further forcing Lebanon to proceed down the path of austerity. As Arab Gulf economies slow amid the fall in energy prices, there are no guarantees that they can again help stabilize Lebanon by offering grants. Already, the weakening economic activity in the Arab Gulf states is affecting Lebanon because expatriate workers in each of the Gulf states are now sending home record-low remittances. Meanwhile, Saudi Arabia might not deem it politically expedient to financially aid Lebanon; it might only choose to do so if it thought Iran-backed Hezbollah would benefit from the country's economic slump. And then there's Iran, another past economic patron of Lebanon's, which can scarcely afford to help the country — even if the United States suddenly lifted sanctions.