Lebanon: From the penthouse to the outhouse

When the financial crisis swept through the world in 2007, the Lebanese economy hardly felt a thing. During the four worst years of the Great Recession, Lebanon saw gross domestic product (GDP) grow at an average of 9.15% — on a par with China. That inverse relationship with the rest of the world has continued but to the Middle East country's detriment. While growth in other nations was restored in 2011, Lebanon saw anemic growth of just 0.9% and spent most of the following eight years sliding into its own financial mess.

Fast-forward to last Saturday, when Lebanese Prime Minister Hassan Diab confirmed rumors that the country would — for the first time — default on its debt. Diab suspended the payment of a $1.2 billion (€1.06 billion) Eurobond, which came due on Monday, because of plummeting foreign reserves. Behind the onerous decision is a country that now has one of the largest debt burdens in the world, equivalent to nearly 170% of GDP.

"This is just the tip of the iceberg," Sami Atallah, executive director of the Lebanese Center for Policy Studies, told DW. "There is more debt due, some $4-5 billion this year alone, so this is going to be quite a huge crisis." The Reuters news agency last week cited sources in the Lebanese government as saying they would seek restructuring on a total of about $31 billion in dollar bonds.

Protests drew the world's attention

Lebanon's problems came to a head in October when hundreds of thousands of people rallied in several cities demanding an end to years of corruption and economic mismanagement by the ruling elite. Their protests, which started over a now-shelved tax on WhatsApp messaging, have continued for several months over worsening living standards in one of the most unequal countries in the world. 

Many of the issues are a result of the sect-based political system introduced at the end of the country's 1975-1990 civil war. Fiscal and trade deficits built up over several years that were masked by high capital inflows chasing high interest rates. The inward investment helped the country repay its debts while maintaining the Lebanese pound's peg to the US dollar.

"Instead of having a productive economy, we have a rentier economy [an elite group living off income from property and investments] in a sectarian/feudal system that breeds widespread corruption," said Mohamad Faour, a postdoctoral finance researcher at University College Dublin. "And rather than introducing much-needed structural reforms years ago, the government decided to kick the can down the road."

Read more: 'People in Lebanon want to live in dignity'

What default means

After announcing the default, Lebanon's leaders called for "fair" restructuring talks with creditors, who now face significant losses. Raoul Nehme, Lebanon's economy minister, told Reuters on Monday that he did not yet know whether investors would cooperate in the restructuring or sue the government. As Lebanon has few assets outside of the country, legal action would be unlikely to recoup any significant part of the amount owed.

Faour told DW that burned creditors may be asked to take a 50% write-off, which is a somewhat "sweeter deal" than implied by current bond prices. "They won't be happy with a haircut of that size, so they'll be expecting some kind of credible economic plan to ensure that — post-restructuring — Lebanon will be able to repay the remaining debt."

Faour and Atallah think investors will demand that any restructuring plan is frontloaded by a program from the International Monetary Fund (IMF). But talk of involving the IMF has already sparked fierce political resistance, particularly from the powerful Iran-backed group Hezbollah, who say the conditions imposed would likely spark a "revolution." 

The Washington-based IMF is well known for demanding deep austerity and harsh tax reforms as part of its stabilization programs. Several emerging market economies have complained that the measures led to several years of economic contraction and higher unemployment. Lebanese protest groups insist they won't bear the brunt of the necessary cuts.

Can Lebanon take the strain?

Atallah told DW that Lebanon now faces a "very delicate and intense moment" as it sits on the brink of collapse. "The IMF may well be inevitable, but the real test will be whether the government can put together a credible plan that distributes the losses fairly and does not further impoverish the country." He said the IMF will likely demand regressive measures, including hikes to VAT (sales tax), fuel tax and the privatization of state-run companies.

Faour agrees that regressive measures will "backfire" on Diab, who took over as prime minister of a government of technocrats in January with a promise that it would be run for the people by the people. 

"The emphasis should instead be on imposing a progressive taxation system, a luxury tax, import taxes, and a higher income tax bracket — right now it's 22% which is ridiculous," he told DW, adding that a recent report showed that Lebanon loses out on $5 billion a year, or about 10% of GDP, from poor tax collection.

He hopes that, like Iceland, which called in the IMF during the 2008 financial crisis, Lebanon will be able to avoid the same austerity measures seen in southern Europe. Iceland developed its own progressive reform program which quickly won credibility with creditors.

Even with the IMF's support, Lebanon may struggle to attract the same regional backers who lent to the country following the civil war. Atallah thinks Persian Gulf Arab countries will now be less interested, especially due to the drop in oil prices, which has reduced their fiscal reserves.

"You need capital coming in, real capital in dollars, to reboot the system and fix it. The question is, who's going to give you the money?"

Reuters contributed to this report