Lebanon’s Economic Recovery Plan Part 1: Exchange rate

Analysis by Sandro Joseph Azzam, Staff Writer

June 13th, 2020

This article is part of a more general series discussing Lebanon’s Economic Recovery Plan. Each piece tackles a different aspect of the reality of current events, explains the economic or financial principles behind it and provides the real solutions that Lebanese citizens deserve to see implemented.

Since the very beginning of the collapse of the Lebanese banking sector, one question has been on the minds of each and every Lebanese depositor: how do we fix it?

Somewhere between the Lebanese Banks Association’s cushy headquarters in downtown Beirut and the protests taking place not more than 200 meters away, Lebanon is in dire need of help. Banks have gone bust (or so they claim), Lebanon’s uber-wealthy had either sent their money abroad or have it stuck in local banks, and the Central Bank is demanding astronomical interest rates. Despite its opponents and controversial history, the IMF emerged to be the true lender of last resort.

But first, a quick history lesson.

The IMF was created in 1945 upon the suggestion of a US Treasury Department Senior Staffer, Harry Dexter White. Its role was simple: finance temporary disequilibria in the balance of trade. Its functioning was as follows: let us assume Lebanon is running a deficit with Korea and buys Korean cars. It needs to pay Hyundai and Kia in Korean Won, not Lebanese Lira. Lebanon goes to the IMF to borrow Won. The IMF sells them Won in exchange for Lebanese Lira. But at this point it becomes too easy. Lebanon can just have Riad Salame run the printing presses and create more Lebanese Lira to pay back the IMF. The solution is for Lebanon to buy Won with the commitment of repurchasing the Lebanese Lira that it had sold the IMF with any other world currency. So, if Lebanon is exporting jewelry to Egypt, it can pay for the Won that it needed with the Egyptian Pounds that it received. 

The system seemed straightforward back then, but it relied on balanced trade. If Lebanon needed to import from Korea more than it exported to Egypt, it would no longer be able to purchase the Won it needs. In case of fundamental disequilibria, the IMF would then recommend that individual countries change their exchange rates. 

To explain, if the Lebanese Lira is devalued, then buying Korean cars becomes more expensive because in this world, prices were set in the producer’s currency. Having a devalued currency means that if you could buy a Kia with 15 million Lebanese Lira at a hypothetical 1000 LBP/KRW exchange rate, you can only buy half a Kia for that price when the exchange rate is devalued 50%. Lebanese residents thus demand less Korean cars.

Now on the opposite side, if you are willing to sell your jewelry to Egypt for a fixed price of 2 million Lebanese Lira, a devaluation of the Lebanese Lira in terms of the Egyptian Pound makes Lebanese goods cheaper, thus increasing Lebanese exports. This decrease in Lebanese imports accompanied by an increase in Lebanese exports is what leads us to a position of balanced trade. By simply changing the exchange rate, you can drastically alter a country’s balance of trade.

Accompanying the improvement in trade balance, a devaluation would also reduce the payrolls of government employees in dollar terms. This would be the right step forward in reducing Lebanon’s budget deficits. While austerity may work in some isolated cases, Lebanon needs to go on a spending spree. But a smart one. External auditors should storm the Ministry of Finance and identify all the loose ends and massive infrastructure plans should be undertaken instead of the exorbitant wastage. By simply outsourcing a trainline or electricity factory to France or Korea and offering them royalty deals on future profits, rebuilding Lebanon could come at little to no upfront cost and any possible room for corruption would be eliminated, not to mention the thousands of job creation opportunities. 

Given that the IMF’s main goal would be to improve balance of trade and push it towards a true equilibrium, it would obviously support a devaluation of Lebanon’s currency. But that doesn’t mean that fundamental issues are to be set aside… These issues will be discussed in Lebanon’s Economic Recovery Plan Part 2: Banking coming soon!