Lebanon's Profligate Factions Gamble on a Foreign Rescue

7 MINS READJun 5, 2019 | 10:00 GMT
A protester passes a burning tire during a demonstration over feared pension cuts May 20, 2019, near the government's headquarters in Beirut.

A protester passes a burning tire during a demonstration over feared pension cuts May 20, 2019, near the government's headquarters in Beirut.

  • As a result of unsustainable subsidies, youth unemployment, a refugee influx, the economic effects of the Syrian civil war and the strings attached to foreign aid, Lebanon could face an economic crisis if it does not pursue austerity measures.
  • But because there is no leader strong enough to impose austerity, Lebanon's factions are more likely to risk an economic crisis than a political one, meaning they will wait for critical foreign aid from powers who wish to prevent another civil war.
  • Such a calculation, however, depends on continued regional stability, meaning that a deeper conflict between the United States and Iran could have profound knock-on effects on the Lebanese economy.

Since Lebanon's elections in May 2018, the country's big political factions — the largely Sunni Future Movement of Prime Minister Saad al-Hariri, the Free Patriotic Movement of Foreign Minister Gebran Bassil, of which President Michel Aoun is part, the generally Christian-dominated Lebanese Forces, and the Shiite bloc of Amal and Hezbollah — have agreed on one thing: the country's finances are unsustainable. With a debt-to-GDP ratio of 152 percent and a banking sector filled with depositors who readily withdraw their cash come any crisis, Beirut's politicians know that reform and austerity are a must if Lebanon is to maintain its budget and wider economy.

The Big Picture

Over the years, Lebanon's sectarian politics have produced an unwieldy system that perpetually teeters on the edge of chaos. Now, however, its political actors must face a new challenge: a looming economic crisis. But even if the country's diverse factions manage to preserve their respective interests in the sectarian system while staving off the fiscal crisis, they might be powerless to stop the machinations of greater powers, especially the United States, Israel and Iran.

Beyond that, though, they don't agree on much. Lebanon lacks a unified national social contract. Instead, each sect and political party grabs spoils from the weak central state for their favored supporters; Hezbollah, for example, now controls the Health Ministry, from which it's able to dole out jobs and offer better services to its supporters. Asking any single faction to agree to austerity, accordingly, is akin to asking that it topple its own pillar of power, making reforms slow — if not completely unlikely.

And just below the surface are the unhealed wounds from the 1975-1990 civil war. While such memories perpetuate mistrust among communities, everyone is wary of pushing the line too far out of fears of rekindling violence, especially as Hezbollah remains well-armed — as well as battle-hardened from its 2006 war with Israel, its 2008 clashes with its rivals in Beirut itself and its participation as a major force in Syria's civil war.

This does not negate the potential of reform: Lebanon's politicians will at least pay lip service to reform to buy time. Nevertheless, their underlying calculation will be that they can risk an economic crisis over a political one in the expectation that outside powers, from France to the United States to the Gulf states, will intercede to prop up their precarious finances. But such hopes may yet fall victim to the escalating U.S.-Iran confrontation, a possible Israeli-Hezbollah conflict or even increasing donor fatigue among Beirut's sponsors.  

Lebanon's Wobbly Economy

Lebanon is not in the same perilous financial state as Jordan, where donor aid underpins national stability. It enjoys stable (if shrinking) foreign exchange reserves and an influential banking system thanks to both remittances from the Lebanese diaspora and investment from countries such as Turkey, the United States and Saudi Arabia. Its gross domestic product has maintained robust growth since the Great Recession, although that has also been reliant on injections of foreign aid — the most recent round of which came in 2014-15 — and overseas remittances. Nevertheless, the country struggles with high youth unemployment (17 percent) and has barely improved its wider joblessness figures since the Great Recession (rising slightly from 7.67 percent in 2008 to 6.69 percent in 2018). Moreover, its exports have taken a hit because of the civil war in Syria, a major former trade partner. (In total, Lebanon's exports to its war-torn neighbor have fallen from 35.79 percent of GDP in 2011 to 23.93 percent in 2017.) 

Charts showing external debt vs. capital reserves and budgetary expenses

The internal dysfunctions obstructing Lebanon's budget and economy have, moreover, not changed. Hefty food, water and electricity subsidies are all hurting the country's bottom line, while debt used to bolster these perks has grown precipitously. (Debt servicing totaled 70 percent of Lebanon's GDP in 2017.) Meanwhile, widespread tax evasion, combined with the presence of ghost workers in various government ministries, has further drained the budget. All of these inefficiencies, however, are key to maintaining the political legitimacy of Lebanon's main factions: In exchange for spoils from the country's coffers, voters remain loyal to the established sectarian parties. Given such a situation, Hezbollah's control of the Health Ministry, for instance, has become even more important for the group, as the institution helps boost the organization's internal finances at a time when U.S. sanctions are squeezing its main patron, Iran.

The international community, led by former colonizer France, has offered a new round of $11 billion in aid (through last year's CEDRE II conference to assist Lebanon) — albeit with strings attached: The latest tranche is offering soft loans that Beirut can only unlock after it actually makes structural reform part of the national budget. That places the country's factions in a tricky position: while the main stressors of its macroeconomic situation have not changed, thereby requiring foreign money to prevent a fiscal crisis, few of the factions want to alienate their own supporters by imposing genuine austerity. What's more, Hezbollah, the often-called state-within-a-state, bears the arms to force the issue.

As a result, Beirut only has the incentive to do the bare minimum to try to unlock the CEDRE II aid while avoiding painful reforms that might destabilize its political system. Moreover, recent historical experience demonstrates that Beirut's politicians can still rely on an outside world interested in avoiding yet more regional instability — cash-strapped Jordan obtained a Gulf Arab bailout in 2018, as did Bahrain. Already, Qatar and Saudi Arabia have stepped up to either buy Lebanese bonds (in Doha's case) or provide broad, unspecified assurances of financial backing (as in Riyadh's).

Beirut only has the incentive to do the bare minimum to unlock foreign aid while avoiding painful reforms that might destabilize its political system.

What a U.S.-Iran Conflict Could Mean for Beirut

But an escalating U.S.-Iran confrontation this summer, as well as the potential that such a conflict could spark a Hezbollah-Israel conflict, means that Beirut's calculations may be far off target. Because the United States has historically sought to drive a wedge between Lebanon's Shiites and Hezbollah, it has resisted the impulse to impose broad sanctions that might push the Shiite community into the arms of the militant group or hurt Lebanon's broader macroeconomic situation. But America's robust anti-Iran strategy suggests that Washington's sanctions strategy might well expand to Lebanon's banking sector in an effort to squeeze Hezbollah. Naturally, such a move could prove ruinous to a sensitive sector susceptible to capital outflows, thereby rapidly worsening the fiscal situation.

And in the unlikely event that the U.S.-Iran struggle moves into a military phase, Lebanon's austerity drive could be upended. Not only would such a conflict result in capital flight (even in the absence of sanctions), Hezbollah may intervene in an effort to deter or retaliate against Israel or the United States. That would introduce a chaotic unknown into Lebanon's politics, as factions would find themselves in an awkward position as Hezbollah invokes Lebanese nationalism against foreign aggressors like the United States and Israel, which would threaten retaliation against Lebanon's economy, if not military action on the country's soil. And when the dust settles, Lebanon would ultimately have to contend with reconstruction costs (for which the international community would inevitably have to pick up the bill) that would compound its economic woes.

But even if the U.S.-Iranian conflict doesn't come to actual military blows, Lebanon's economy is running out of time, meaning any sort of diplomatic or security troubles — whether in the region or right at home — could be just enough to touch off a run on deposits and reduce remittances to a trickle. That, naturally, would rapidly move forward the fiscal deadline Beirut is facing. Lebanon has long relied on bailouts to preserve its economy, but donor fatigue and the machinations of the powers that want to make use of Lebanon as part of their wider regional strategies mean that such aid will not be as forthcoming as in the past.

Editor's Note: This piece has been amended to correct the political affiliation of President Michel Aoun.

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