Normalization of Crisis is No Road to Stabilization: LEM Spring 2023

Behind a façade of normalization of crisis conditions, the Lebanese economy remains in precipitous decline, markedly distant from a stabilization path, let alone a recovery path, according to the latest World Bank Lebanon Economic Monitor released today. The systemic failure of Lebanon’s banking system and the collapse of the currency have induced a pervasive dollarized cash economy estimated at almost half of GDP in 2022. The policy-making status quo, characterized by piecemeal and inadequate crisis management decisions undermining a comprehensive and equitable plan, continues to deplete capital of all kinds, including human and social, giving way to profound social inequality with only a few winners and a large majority of losers.

The Lebanon Economic Monitor (LEM) Spring 2023 “Normalization of Crisis is No Road for Stabilization” provides an update of recent economic developments and assesses the economic outlook and risks within a continuous context of uncertainty and a political stalemate. 

The pace of Lebanon’s economic decline slowed in 2022, although the overall trend and trajectory remained fundamentally unchanged. Real GDP is estimated to have declined by 2.6% in 2022, bringing the total economic contraction since 2018 to 39.9% of GDP. Despite a slight improvement in private sector activity, the widening current account deficit -a long structural imbalance- continues to weigh down on growth prospects. On the back of higher imports and falling exports, the current account deficit which continues to be financed, for the most part, by the central bank’s usable gross foreign reserves, grew to 20.6% of GDP (similar to pre-crisis levels). The Lebanese pound continued to depreciate sharply despite the central bank’s foreign exchange interventions to attempt to stabilize the parallel market exchange rate. The currency lost more than 98 percent of its pre-crisis value by February 2023 and episodes of rapid depreciation have recently intensified. Inflation averaged 171.2% in 2022, one of the highest rates globally, predominantly driven by the rise in prices of food and non-alcoholic beverages. With an expected continued, albeit modest, pick up in private consumption and a narrowing of the current account, the LEM forecasts real GDP to contract by an additional 0.5% in 2023. 

The LEM argues that a deceleration in the contraction of economic activity does not imply a stabilization. It finds that across all economic pillars, ad-hoc crisis management decisions continue to undermine an equitable and comprehensive recovery plan. In that respect, the Sayrafa platform, BdL’s primary monetary tool for stabilizing the Lebanese pound, is no exception. In an analysis of the platform, the LEM finds that the Sayrafa platform reflects unfavorable monetary tools that led to short-lived appreciations of the LBP at the expense of dwindling reserves and a weakened BdL balance sheet, especially in the absence of a new exchange rate and monetary framework. The platform has also morphed into a mechanism to generate arbitrage profits: getting access to dollars through this window provides immediate and risk-free profits given the spread with the banknote rate, estimated at US$2.5 billion since its initiation.  

The LEM showcases what a comprehensive and equitable reform and recovery plan would have entailed and what it could have achieved. It examines the decisions made instead across several pillars: monetary and exchange rate policies, public debt sustainability policies, financial sector restructuring policies and fiscal policies, while focusing on the many losers and few winners emanating as a result.  Political paralysis has not hindered the implementation of ad-hoc crisis management decisions serving a narrow elite base. These piecemeal interventions are shifting the burden of the economic adjustment to the most vulnerable segments of the population. 

“As long as the economy is contracting and crisis conditions persist, living standards are set for further erosion, poverty will continue to spiral,” said Jean-Christophe Carret, World Bank Middle East Country Director. “Delays in the implementation of a comprehensive reform and recovery plan will only further compound human and social capital losses and render the recovery longer and more costly." 


The LEM’s Special Focus section: “Gauging the Size of the Cash Economy” examines the growing dollarized cash economy and its impact on recovery prospects. Estimated at US$9.9 billion or 45.7 percent of GDP in 2022, the dollarized cash economy reflects a rapid shift towards hard currency cash transactions following a complete loss of confidence in an impaired banking sector and in the domestic currency. The cash economy is far from a net contributor to growth. On the contrary, it threatens to compromise the effectiveness of fiscal and monetary policy, heightens the risk of money laundering, increases informality, and prompts further tax evasion. Moreover, the increasing reliance on cash transactions also threatens to completely reverse the progress that Lebanon made pre-crisis towards enhancing its financial integrity by instituting robust anti-money laundering mechanisms in its commercial banking sector.