Did you know that 3 Lebanese Pounds were equal to a dollar before the Lebanese civil war?
A Cola cost 0.25 Lira, 2kg of Bread cost 0.5 Lira, and a full tank of fuel cost 7 Liras. Can you imagine the effect of such a rate today? Chart 1 illustrates the Lebanese Lira exchange rate with the U.S. Dollar from January 1964 to May 2011. This historical illustration describes the volatile exchange rate with the USD and the inflationary effect of the civil war. The “Loubnani” card, launched by Bank Audi in August 2010, is surely contributing to the comeback of the Lebanese Lira, but how? This issue, RAGMAG looks at our national currency and what measure can be taken to really bring back the value of our greenback.
Hit the Books
The Lebanese Lira (also known as Lebanese pound) was first issued in 1939, and consisted of 100 “Korch”. During the Lebanese civil war from 1975 to 1990, the Lebanese Central Bank did not take decisive actions to halt the depreciation of the Lebanese Lira. Commercial banks and politicians contributed to this depreciation by speculating against the Lebanese Pound. Many Lebanese families lost their wealth because their lifesavings were deposited in Lebanese Lira. As a result, the government had to introduce new banknotes gradually: 500 LBP, 1,000 LBP, 5,000 LBP, 10,000 LBP, 20,000 LBP, 50,000 LBP and finally 100,000 LBP. Even after the civil war, the bad monetary policies contributed to a loss of trust in the Lebanese currency. This is why, today, most of us use the Lebanese Lira for our daily transactions but use the U.S. Dollar for larger transactions such as purchasing a house or land, a car, international trade and the like. This also reinforces the dollarization of our economy.
Backtrack
It was in 1999 that the Lebanese Lira was first pegged to the U.S. Dollar. At the time, the major concerns were to restore the Lebanese Lira’s stability and political support so the Lebanese Lira was pegged to the U.S. Dollar, since the majority of the Lebanese exports were to the United States. The dollarization rate of the economy increased to half, and the Dollar was accepted as a legal tender alongside the Lebanese Lira.
The exchange rate policy of a country is set by the Central Bank based on factors such as economic and financial integration, economic diversification and monetary stabilization. Exchange rates affect the attractiveness of the domestic products in international trade and the government’s budget by setting the price at which it purchases foreign currency. A fixed exchange rate has positive and negative effects on an economy. On the positive side, investors will find it very difficult to rush in the acquisition of the currency causing speculative attacks since the fixed exchange rate will protect the currency making its price more transparent, its value more credible and secure. Furthermore, financial markets will become more stable, inflation will decrease and growth will improve. However, the other side of the coin can be drastic, including a risk of currency crisis when foreign reserves are low, the monetary policy (an important macroeconomic tool) is abandoned. At the time when the peg was enforced, Lebanon’s major trading partner was Europe. Pegging the Lebanese Lira to the U.S. Dollar won’t help decrease of transaction costs with the largest trading partner. The peg was expected to improve economic growth and limit inflationary pressures, which was not to be the case.
Repeat After Me
The United States is characterized by a floating exchange rate regime where the U.S. Dollar value is allowed to fluctuate according to the foreign exchange market. The financial crisis in 2008 represents a clear example of such risks. A floating exchange rate regime exposes the economy to many risks, such as anxiety about the present and future, lack of investment due to unstable prices, large interest in purchasing and selling the floating currency for higher profits, lack of discipline in economic management and last but not least inflation. In addition to all these factors Americans are nowadays doubting the ability of their currency in regulating country deficit especially after the successive problems their economy is facing; recession, housing crisis, financial crisis, the persistently high unemployment rate, and now the debt tragedy. The American economy is currently struggling to restore its vital signs back to normal.
What is the repercussion of such risks on the dollarized Lebanese economy? The Lebanese economy is benefiting from the weak value of the U.S. Dollar by having more attractive exports when sold in U.S. Dollars but these exports do not outweigh the large imports of the service-based country. Another benefit is becoming a cheaper country for tourists, which did not positively affect the number of tourists, due to the political instability of the country itself and the region from a larger perspective in addition to the continuous Israeli threat. Lebanon can also benefit in the decreasing value of its public debt denominated in U.S. Dollars. But are all these benefits enough to offset the negative effects of the increasingly weak Dollar?
Don’t Put All Your Eggs In One Basket
The recently sinking Dollar was first noticed in Lebanon by the increasing inflation. The largest trading partners, Gulf Cooperation Council (GCC) and Syria are reconsidering their peg with the U.S. Dollar, in the favor of pegging their currency to a basket of currencies. Our highly dollarized economy will have to finance more expensive imports, priced in stronger foreign currencies. A large share of the Lebanese imports were from the Eurozone, after the weakening of the U.S. Dollar, Lebanese importers had to look at the United States as their main import source, but is this really a solution when transportation costs are higher, delivery time has increased, and the majority of the Lebanese imports consist of raw material? Investment has sharply decreased due to the weak U.S. Dollar and low interest rates in Lebanon.
Action Plan
Is Lebanon facing the same fate as Mexico in the mid-1990’s or Argentina in the late 1990’s? No answer is clear yet as the swift changes in the region increase uncertainty. It is undeniable that the Lebanese economy isn’t benefiting from the peg and possible flotation aid solutions can be considered.
1- One of the options would be for Lebanon to peg its currency to another strong currency such as the Euro. Another option would be to freely float its currency. Investments will climb as a result, as the decrease in foreign exchange reserves previously accumulated in the central bank to defend the peg will be free and used in the economy, in turn leading to higher growth if used with the proper uncorrupt economic policies. This option will also reflect in an automatic adjustment of the balance of payments as banks will not interfere on the market to buy or sell the national currency and defend the peg. Furthermore, the government will free a previously imprisoned macroeconomic tool, the monetary policy, which can prove to be a regulating tool when necessary. The economy will not be prone to crisis as it is the case in the fixed exchange rate regimes as it will be more flexible to external shocks (such as volatile oil prices). This still represents high risks to the service dominated Lebanese economy.
2- Another option looks more promising- Pegging the Lebanese Lira to a basket of currencies (Dollar, Euro, and Yen) to foster stability, and provide investors with a less volatile environment especially after S&P’s unprecedented and unexpected downgrading of the U.S. long-term credit rating. Gulf countries such as Oman and UAE announced that the peg to the US dollar will not be reconsidered at the current times regardless of the S&P cut and the slump in the financial market indexes of the Arab countries. Which is the best exchange rate policy? That is the question that is agonizing emerging countries policymakers.
