Lebanon's Debt Crisis: A Man-Made Catastrophe and the Path to Recovery - Dr. Khalil Gebara
Lebanon's Debt Crisis: A Man-Made Catastrophe and the Path to Recovery - Dr. Khalil
Gebara
Lebanon has been navigating an economic and financial collapse
recognized globally as one of the most severe since the mid-nineteenth century.
Since 2019, the country's real GDP has contracted by approximately 40%, the
Lebanese lira has lost over 98% of its value against the dollar, and more than
half the population has fallen into poverty. The government's March 2020
default on its Eurobond debt—Lebanon's first sovereign default in history—was
not a sudden shock but the inevitable result of decades of systematic policy
failures.
My recent report, "The Political Economy of Debt Accumulation in
Lebanon," prepared for the Arab NGO Network for Development (ANND),
analyzes the deep-seated structural problems that created this crisis and maps
a comprehensive path toward sustainable recovery.
The Root Causes of Lebanon's Debt Spiral
Lebanon's debt crisis stems from three interconnected failures that
compounded over nearly three decades.
1. A Fundamentally Flawed Economic Model
The roots of Lebanon's sovereign debt crisis are firmly embedded in the
policy choices and economic model adopted after the end of the civil war.
During the 1990s, the country embarked on an ambitious reconstruction program,
primarily financed through extensive borrowing. This approach led to massive
budget deficits and a rapid accumulation of public debt. Between 1992 and 1997,
the fiscal deficit averaged around 20.7% of GDP, with a primary deficit of
approximately 10.7%. In this period, public debt surged from $2.9 billion to
$16.5 billion, exceeding 100% of GDP by 1997.
This model created structural dependency on foreign capital inflows to
finance chronic twin deficits—both fiscal and current account. By 2019, Lebanon's
current account deficit exceeded 20% of GDP, among the highest globally, while
the country imported over 80% of its consumption needs. The economy became a
consumption machine sustained by external financing rather than productive
investment.
2. Catastrophic Fiscal and Monetary Mismanagement
Fiscal policy failures were systematic and persistent. Public spending
became dominated by rigid expenditures: public sector wages, debt service, and
massive subsidies, especially to cover the deficit of Electricité du Liban,
which consumed over 75% of the budget. These subsidies alone absorbed 3-4% of
GDP annually—more than the combined spending on health and education.
Revenue collection was both inefficient and deeply regressive, relying
heavily on indirect taxes like VAT while suffering from widespread evasion.
Most damaging was the complete breakdown of fiscal governance: Lebanon operated
without an official budget for over a decade (2005-2016), relying instead on
extra-budgetary spending that destroyed any pretense of financial planning or
accountability.
Monetary policy compounded these problems. The 1997 decision to peg the
Lebanese lira to the U.S. dollar at LL 1,507.5 initially provided stability but
became increasingly unsustainable. To defend the peg, the Banque du Liban (BdL)
offered artificially high interest rates to attract dollar deposits. When
capital inflows slowed after 2011 due to regional instability, BdL resorted to "financial
engineering" operations that functioned essentially as a Ponzi
scheme—requiring ever-increasing new deposits to pay existing obligations while
accumulating massive hidden losses estimated at $50-60 billion.
3. Institutional Collapse and Governance Failures
Underlying these economic distortions is a profoundly dysfunctional
governance system rooted in sectarian power-sharing arrangements. Political
elites have systematically captured state institutions, treating ministries and
public agencies as political spoils rather than instruments of public service.
This has prevented coherent national development strategies while blocking
essential reforms at every turn.
Key oversight institutions—the Court of Accounts, Central Inspection
Board, and Civil Service Board—have been rendered ineffective through political
interference and resource starvation. Lebanon ranks among the worst globally in
transparency and governance indicators, with over 85% of citizens believing
corruption is widespread in public institutions, according to recent surveys.
A Comprehensive Recovery Strategy
Addressing this crisis requires moving beyond piecemeal measures toward
an integrated reform framework built on five essential pillars.
Rebuilding Fiscal Credibility
Recovery begins with establishing credible fiscal frameworks anchored in
realistic budgets with transparent revenue and expenditure forecasts. This
requires comprehensive tax reform to enhance domestic revenue mobilization
while reducing reliance on regressive indirect taxes. Modern public financial
management practices—linking spending to cash flows, enforcing procurement
laws, eliminating off-budget expenditures—are essential for rebuilding public
trust.
Comprehensive Financial Sector Restructuring
The banking crisis requires a transparent, equitable resolution
addressing the interconnected balance sheets of the sovereign, central bank,
and commercial banks. A critical complexity is that domestic institutions held
approximately 37% of Lebanon's "foreign" Eurobond debt as of 2019,
blurring traditional distinctions between domestic and external creditors. Debt
restructuring must simultaneously address external bondholders and domestic
financial institutions while ensuring equitable burden-sharing that protects
small depositors.
Strengthening Social Protection
Economic adjustment cannot disproportionately burden the most vulnerable
populations. Lebanon must scale up poverty-targeted cash transfer programs
while safeguarding essential public spending on health, education, and food
security. Subsidy reforms must include compensation mechanisms for vulnerable
groups to prevent deepening inequality during adjustment.
Revitalizing Productive Sectors
Lebanon must transition from consumption-led to export-oriented
development. This requires streamlining bureaucratic procedures, reducing
regulatory barriers, and expanding access to finance for small and medium
enterprises in agriculture, manufacturing, and technology sectors. Engaging Lebanon's
diaspora in productive investment—rather than speculative flows—is crucial for
sustainable recovery.
Institutional Reform and Governance Restoration
Sustainable recovery requires deep institutional reform to restore state
legitimacy. This includes implementing judicial and administrative reforms that
ensure accountability and reduce political interference. The national
anti-corruption strategy must be enforced through empowered, independent
oversight bodies with adequate resources and legal authority.
The Political Economy of Debt: A System's Survival Strategy
The post-war
reconstruction of the 1990s was deliberately financed through borrowing rather
than taxation, allowing political elites to distribute the spoils of
reconstruction through their networks.
This behavior continued after the prolonged political stalemate
following 2005, when the political elite persisted in borrowing to preserve
their patronage networks. However, the problem with this approach was that the
road ahead was not linear—it was a steep downward slope. Each delay made the
eventual crash more severe, and each financial engineering scheme required
ever-larger amounts of money to sustain. The banking elite played along,
prioritizing short-term profits over the sustainability of the banking sector.
By 2019, when the system finally collapsed, the accumulated distortions had
become so massive that they devastated Lebanese society.
The collapse of 2019 did not alter the preferences of the political
elite. Preserving their clientelist networks remained their overriding
objective, outweighing any concern for protecting depositors' money or
preventing a significant portion of the Lebanese population from falling into
poverty. They opted instead to preserve their interests by tapping into
required reserves and what remained of depositors' money. Unfortunately, the
results of the 2022 parliamentary elections showed that their strategy succeeded.
To conclude, Lebanon's debt crisis represents the ultimate failure of a
political economy designed to serve elite interests rather than national
development. Recovery requires not just technical economic reforms led by
technocratic ministers, but a fundamental transformation of the political
system that created this man-made catastrophe.
Recent publications
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