Lebanon’s short-term priority in addressing its economic crisis should be to enact measures that restore confidence in the banking system and the exchange rate, according to Sarah Hadchiti, a research analyst at Blominvest Bank.

The banking system, paralysed by the worst financial crisis in Lebanon’s history, faces major structural and operational challenges.

Lebanon central bank governor Riad Salameh warned on August 27 that banks that cannot increase their capital by 20 percent by the end of February 2021 will have to get out of the market.

Speaking to Arabian Business, Hadchiti (pictured below) said: "It’s wise to recall that, based on various country experiences, exchange rate crises don’t necessarily lead to banking crises, but all banking crises lead to exchange rate crises.”

Lebanese banks have frozen savers out of their dollar deposits and largely blocked transfers abroad as the country sinks into a financial meltdown on a scale it has never seen.

“The year 2020 proved to be an economic disaster for Lebanon. The country is suffering from a triple whammy – an exchange rate crisis, a banking crisis and a debt crisis – with no end in sight in the near future. And most analysts agree that it was the debt crisis – coupled with a corrupt public sector - that sparked two other crises," Hadchiti said.

“But, surprisingly, the debt crisis has receded in relative significance these days, partly because it’s not as 'sexy or juicy' as the other two, but mostly because domestic debt which constitutes nearly 64 percent of total debt (with total debt reaching $93.5 billion in June) is losing its real value with rising inflation," she added.

She said the foreign currency debt which the government has defaulted on, represents a "real concern especially that almost 50 percent of it is held by foreigners".

Lebanon witnessed another dramatic inflation surge in August as consumer prices rose an annual 120 percent, compared to 112.4 percent in July and just under 90 percent in June, according to new data released by the official Central Administration of Statistics.

At the end of March, inflation was only 16 percent on an annual basis and the exchange rate stood at about LBP2,800 LBP to the US dollar but a severe spiral of exchange rate depreciations saw the exchange rate shoot to LBP8,600 to the US dollar at end-June and fed into an inflation rate of 90 percent year-on-year.

So what caused inflation to rocket and exchange rate depreciations?

“The upshot of the above discussion is that reservations about the health of the banking system and more so the exchange rate regime – coupled with BDL’s policies to contain their implications – are what ignited the rise in cash liquidity and its vicious cycle effects on currency depreciations and inflation. In other words, it wasn’t so much deficit monetisation that did that,” Hadchiti said.

She added: "There are two important conclusions that can be drawn. First, with nearly two thirds of the debt in domestic debt that is losing its real value, the debt crisis is perhaps becoming increasingly less so. That’s not to say that debt shouldn’t be taken seriously: it should, especially when it comes to restructuring foreign debt payments. But what should be taken most seriously are the recurring budget deficits because they reflect a structural problem in Lebanese public finances that has less to do with fiscal matters and more to do with governance matters.

"So, fundamentally, what should underly fiscal reforms in Lebanon are governance reforms that aim at reducing waste, corruption, nepotism, and at increasing efficiency, in public administrations and enterprises.”

"Second, public sector governance reforms take time and are usually medium- to long-term projects. Reform of the banking system should therefore be a short-term priority," Hadchiti concluded.