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Lebanon’s financial meltdown

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The Lebanese pound has depreciated about 90% in the past 18 months, driving annual food inflation to 400%, erasing salaries and savings, and pushing more than half the nation into poverty. All this comes at a time when the country is battling the devastation wrought by COVID-19, as well as the ravages from the 2020 Beirut blast.

Financialization 

The economic crisis in Lebanon is closely linked to the paradigm of financialization adopted by the ruling elite. This paradigm has converted the country into a “bankers’ republic”. The country that was once known as “the Switzerland of the Middle East” based its economy on the financial sector without regard for the productive sectors. 

The beginnings of the current morass can be traced to the 1997 “peg,” which artificially fixed the Lebanese pound to the dollar at an overvalued rate, thus laying the ground for the rise of rentier capitalism. On the one hand, it became more profitable to import than to produce locally. On the other hand, investing capital in unproductive economic sectors – namely financial products and real estate – became increasingly attractive as the risk of inflation receded. 

A definite set of problems emerges when a currency is pegged at a high rate. Since the government sets the rate too high, domestic consumers will buy many imports, creating chronic trade deficits. When imports exceed exports, a country’s currency demand in terms of international trade is lower. The lower demand for currency makes it less valuable in the international markets.

In response to these devaluation pressures, the government will have to appreciate its own currency. For this, the central bank needs to buy its currency in foreign exchange markets, paying with foreign currency. Since no central bank has an infinite amount of foreign currency reserves, it cannot buy its currency indefinitely. The government’s reserves will eventually be exhausted, and the peg will collapse.

Lebanon’s central bank had to ensure a continual inflow of foreign currency, namely U.S. dollars, to maintain the peg. This was done through a national Ponzi scheme – a scam in which existing investors are paid off with funds collected from new investors while the organizers cream off a share for themselves. With the help of oil money from (Persian) Gulf Arabs and remittances from the large Lebanese diaspora (estimated at more than 12 million persons living on all continents), the bourgeoisie built the bases of domestic finance. 

To further attract money from abroad, Lebanese banks promised high-interest rates on deposits. Meanwhile, people who put money into the banks received more than 5% interest on deposits. It was a great deal for investors in the region, who piled money into Lebanese banks. The money could have been used for productive investments but stayed in the financial chamber. 

Lebanon’s commercial banks used the dollar flows from abroad to speculate on sovereign-debt instruments denominated in Lebanese pounds at interest rates significantly higher than the international market rates granted by the Lebanese central bank. In other words, the banks, flush with deposits, started lending the money to the government via the central bank. The banks had promised to pay a high interest rate on the deposits, but the central bank promised to pay an even higher interest rate to the banks. It ensured the system could keep going for a little while. The banks turned around and lent the government a lot of money, pocketing the difference between the two interest rates. 

The high-interest rates on government bonds and bank deposits strongly limited investments of capital in the productive economy. Most of the money the state collected through the bonds was, in the end, used to repay the interest rather than to fund social welfare programs or public infrastructure. While proving to be catastrophic for the working class, this profit scheme enriched bankers. 

The share of public debt held by banks reached nearly two-thirds in the 1990s, and it is estimated today to be nearly 43%. Indeed, interest rates went up to as high as 40% on untaxed treasury bills, helping the banking sector’s assets grow by 25% between 1993 and 2000 and increase nearly eightfold between 1993 and 2013. In addition, between 1993 and 2018, banks’ net profits increased from $63 million to a whopping $2 billion, representing a 3,000% increase.

It is important to note that the process of financialization was fundamentally aided by the political plutocracy. In fact, politicians in Lebanon are closely stitched with the financial magnates. Individuals closely linked to political elites control 43% of assets in Lebanon’s commercial banking sector. 18 out of 20 banks have major shareholders linked to the political elite. 

Moreover, 4 out of the top 10 banks in the country have more than 70% of their shares attributed to crony capital. Only eight families control 29% of the banking sector’s total assets, owning together more than $7.3 billion in equity. For example, one of the controlling shareholders (over 5% of shares) of Bank Audi is a company wholly owned by Fahad Al-Hariri, brother of the Prime Minister, Saad Al-Hariri. 

Collapse 

The collapse of the Ponzi pyramid constructed by the financial oligarchy began in October 2019 with the slowdown of flows of hard currencies in the context of the global crisis of capitalism, and instability in the Middle East (West Asia), particularly in Syria. The expatriation of capital organized by the wealthiest 1% of the population, who dominated the financial sector, exacerbated the lack of cash. 

The banks, having lent three-quarters of deposits to the government, had become functionally bankrupt and increasingly illiquid. Unable to contain the crisis of their own making, they passed the burden on small depositors by setting illegal and discretionary capital controls that prevented them from withdrawing their pensions and wages. 

In hindsight, the crisis of Lebanon’s economic architecture was predictable. The state was borrowing from or via the central bank at exorbitant interest rates; the central bank was borrowing from the local banks, who were lending the money of their depositors, who in turn were lured in by high-interest rates. High-interest rates of up to 15% kept this unsustainable cycle going for years. But running out of cash was inevitable. When this happened, the entire structure of accumulation broke down. 

From our partner Tehran Times

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Economy

Economy Contradicts Democracy: Russian Markets Boom Amid Political Sabotage

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The political game plan laid by the Russian premier Vladimir Putin has proven effective for the past two decades. Apart from the systemic opposition, the core critics of the Kremlin are absent from the ballot. And while a competitive pretense is skilfully maintained, frontrunners like Alexei Navalny have either been incarcerated, exiled, or pushed against the metaphorical wall. All in all, United Russia is ahead in the parliamentary polls and almost certain to gain a veto-proof majority in State Duma – the Russian parliament. Surprisingly, however, the Russian economy seems unperturbed by the active political manipulation of the Kremlin. On the contrary, the Russian markets have already established their dominance in the developing world as Putin is all set to hold his reign indefinitely.

The Russian economy is forecasted to grow by 3.9% in 2021. The pandemic seems like a pained tale of history as the markets have strongly rebounded from the slump of 2020. The rising commodity prices – despite worrisome – have edged the productivity of the Russian raw material giants. The gains in ruble have gradually inched higher since January, while the current account surplus has grown by 3.9%. Clearly, the manufacturing mechanism of Moscow has turned more robust. Primarily because the industrial sector has felt little to no jitters of both domestic and international defiance. The aftermath of the arrest of Alexei Navalny wrapped up dramatically while the international community couldn’t muster any resistance beyond a handful of sanctions. The Putin regime managed to harness criticism and allegations while deftly sketching a blueprint to extend its dominance.

The ideal ‘No Uncertainty’ situation has worked wonders for the Russian Bourse and the bond market. The benchmark MOEX index (Moscow Exchange) has rallied by 23% in 2021 – the strongest performance in the emerging markets. Moreover, the fixed income premiums have dropped to record lows; Russian treasury bonds offering the best price-to-earning ratio in the emerging markets. The main reason behind such a bustling market response could be narrowed down to one factor: growing investor confidence.

According to Bloomberg’s data, the Russian Foreign Exchange reserves are at their record high of $621 billion. And while the government bonds’ returns hover at a mere 1.48%, the foreign ownership of treasury bonds has inflated above 20% for the second time this year. The investors are confident that a significant political shuffle is not on cards as Putin maintains a tight hold over Kremlin. Furthermore, investors do not perceive the United States as an active deterrent to Russia – at least in the near term. The notion was further exacerbated when the Biden administration unilaterally dropped sanctions from the Nord Stream 2 pipeline project. And while Europe and the US remain sympathetic with the Kremlin critics, large economies like Germany have clarified their economic position by striking lucrative deals amid political pressure. It is apparent that while Europe is conflicted after Brexit, even the US faces much more pressing issues in the guise of China and Afghanistan. Thus, no active international defiance has all but bolstered the Kremlin in its drive to gain foreign investments.

Another factor at work is the overly hawkish Russian Central Bank (RCB). To tame inflation – currency raging at an annual rate of 6.7% – the RCB hiked its policy rate to 6.75% from the all-time low of 4.25%. The RCB has raised its policy rate by a cumulative 250 basis points in four consecutive hikes since January which has all but attracted the investors to jump on the bandwagon. However, inflation is proving to be sturdy in the face of intermittent rate hikes. And while Russian productivity is enjoying a smooth run, failure of monetary policy tools could just as easily backfire.

While political dissent or international sanctions remain futile, inflation is the prime enemy which could detract the Russian economy. For years Russia has faced a sharp decline in living standards, and despite commendable fiscal management of the Kremlin, such a steep rise in prices is an omen of a financial crisis. Moreover, the unemployment rates have dropped to record low levels. However, the labor shortage is emerging as another facet that could plausibly ignite the wage-price spiral. Further exacerbating the threat of inflation are the $9.6 billion pre-election giveaways orchestrated by President Putin to garner more support for his United Russia party. Such a tremendous demand pressure could presumably neutralize the aggressive tightening of the monetary policy by the RCB. Thus, while President Putin sure is on a definitive path of immortality on the throne of the Kremlin, surging inflation could mark a return of uncertainty, chip away investors’ confidence: eventually putting a brake on the economic streak.

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Synchronicity in Economic Policy amid the Pandemic

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business-economy

Synchronicity is an ever present reality for those who have eyes to see.Carl Jung

The Covid pandemic has elicited a number of deficiencies in the current global governance framework, most notably its weaknesses in mustering a coordinated response to the global economic downturn. A global economy is not fully “global” if it is devoid of the capability to conduct coordinated and effective responses to a global economic crisis. What may be needed is a more flexible governance structure in the world economy that is capable of exhibiting greater synchronicity in economic policies across countries and regions. Such a governance structure should accord greater weight to regional integration arrangements and their development institutions at the level of key G20 decisions concerning international economic policy coordination.

The need for greater synchronicity in the global economy arises across several trajectories:

· Greater synchronicity in the anti-crisis response across countries and regions – according to the IMF it is a coordinated response that renders economic stimulus more efficacious in countering the global downturn

· Synchronicity in the withdrawal of stimulus across the largest economies – absent such coordination the timing of policy normalization could be postponed with negative implications for macroeconomic stability

· Greater synchronicity in opening borders, lifting lockdowns and other policy measures related to responding to the pandemic: such synchronicity provides more scope for cross-country and cross-regional value-added chains to boost production

· Greater synchronicity in ensuring a recovery in migration and the movement of people across borders.

Of course such greater synchronicity in economic policy should not undermine the autonomy of national economic policy – it is rather about the capability of national and regional economies to exhibit greater coordination during downturns rather than a progression towards a uniform pattern of economic policy across countries. Synchronicity is not only about policy coordination per se, but also about creating the infrastructure that facilitates such joint actions. This includes the conclusion of digital accords/agreements that raise significantly the potential for economic policy coordination. Another area is the development of physical infrastructure, most notably in the transportation sphere. Such measures serve to improve regional and inter-regional connectivity and provide a firmer foundation for regional economic integration.

The paradox in which the world economy finds itself is that even as the current crisis is leading to fragmentation and isolationism there is a greater need for more policy coordination and synchronicity to overcome the economic downturn. This need for synchronicity may well increase in the future given the widening array of global risks such as risks to cyber-security as well as energy security and climate change. There is also the risk of the depletion of reserves to counter the Covid crisis that has been accompanied by a rise in debt levels across developed and developing economies. Also, the speed of the propagation of crisis impulses (that effectively increases with technological advances and globalization) is not matched by the capability of economic policy coordination and efficiency of anti-crisis policies.

There may be several modes of advancing greater synchronicity across borders in international relations. One possible option is a major superpower using its clout in a largely unipolar setting to facilitate greater policy coordination. Another possibility is for such coordination to be supported by global international institutions such as the UN, the WTO, Bretton Woods institutions, etc. Other options include coordination across the multiplicity of all countries of the global economy as well as across regional integration arrangements and institutions.

Attaining greater synchronicity across countries will necessitate changes in the global governance framework, which currently is characterized by weak multilateral institutions at the top level and a fragmented framework of governance at the level of countries. What may be needed is a greater scope accorded to regional integration arrangements that may facilitate greater coordination of synchronicity at the regional level as well as across regions. The advantage of providing greater weight to the regional institutions in dealing with global economic downturns emanates from their greater efficiency in coordinating an anti-crisis response at the regional level via investment/infrastructure projects as well as macroeconomic policy coordination. Regional development institutions also have a comparative advantage in leveraging regional interdependencies to promote economic recovery.

In conclusion, the global economy has arguably become more fragmented as a result of the Covid pandemic. The multiplicity of country models of dealing with the pandemic, the “vaccine competition”, the breaking up of global value chains and their nationalization and regionalization all point in the direction of greater localization and self-sufficiency. At the same time there is a need from greater synchronicity across countries particularly in the context of the current pandemic crisis. Regional integration arrangements and institutions could serve to facilitate such coordination in economic policy within and across the major regions of the world economy.

From our partner RIAC

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Economy

A New Strategy for Ukraine

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Authors: Anna Bjerde and Novoye Vremia

Four years ago, the World Bank prepared a multi-year strategy to support Ukraine’s development goals. This was a period of recovery from the economic crisis of 2014-2015, when GDP declined by a cumulative 16 percentage points, the banking sector collapsed, and poverty and other measures of insecurity spiked. Indeed, we noted at the time that Ukraine was at a turning point.

Four years later, despite daunting internal and external challenges, including an ongoing pandemic, Ukraine is a stronger country. It has proved more resilient to unpredictable challenges and is better positioned to achieve its long-term development vision. This increased capacity is first and foremost the result of the determination of the Ukrainian people.

The World Bank is proud to have joined the international community in supporting Ukraine during this period. I am here in Kyiv this week to launch a new program of assistance. In doing this, we look back to what worked and how to apply those lessons going forward. In Ukraine—as in many countries—the chief lesson is that development assistance is most effective when it supports policies and projects which the government and citizens really want.

This doesn’t mean only easy or even non-controversial measures; rather, it means we engage closely with government authorities, business, local leaders, and civil society to understand where policy reforms may be most effective in removing obstacles to growth and human development and where specific projects can be most successful in delivering social services, particularly to the poorest.

Looking back over the past four years in Ukraine, a few examples stand out. First, agricultural land reform. For the past two decades, Ukraine was one of the few countries in the world where farmers were not free to sell their land.

The prohibition on allowing farmers to leverage their most valuable asset contributed to underinvestment in one of Ukraine’s most important sources of growth, hurt individual landowners, led to high levels of rural unemployment and poverty, and undermined the country’s long-term competitiveness.

The determination by the President and the actions by the government to open the market on July 1 required courage. This was not an easy decision. Powerful and well-connected interests benefited from the status quo; but it was the right one for Ukrainian citizens.

A second area where we have been closely involved is governance, both with respect to public institutions and the rule of law, as well as the corporate governance of state-owned banks and enterprises. Poll after poll in Ukraine going back more than a decade revealed that strengthening public institutions and creating a level playing field for business was a top priority.

World Bank technical assistance and policy financing have supported measures to restore liability for illicit enrichment of public officials, to strengthen existing anticorruption agencies such as NABU and NACP, and to create new institutions, including the independent High-Anticorruption Court.

We are also working with government to ensure the integrity of state-owned enterprises. Our support to the government’s unbundling of Naftogaz is a good example; assistance in establishing supervisory boards in state-owned banks is another. We hope our early dialogue on modernizing the operations of Ukrzaliznytsia will be equally beneficial.

As we begin preparation of a new strategy, the issues which have guided our ongoing work—strengthening markets, stabilizing Ukraine’s fiscal and financial accounts; and providing inclusive social services more efficiently—remain as pressing today as they were in 2017. Indeed, the progress which has been achieved needs to continue to be supported as they frequently come under assault from powerful interests.

At the same time, recent years have highlighted emerging challenges where we hope to deepen and expand our engagement. First, COVID-19 has underscored the importance of our long partnership in health reform and strengthening social protection programs.

The changes to the provision of health care in Ukraine over recent years has helped mitigate the effects of COVID-19 and will continue to make Ukrainians healthier. Government efforts to better target social spending to the poor has also made a difference. We look forward to continuing our support in both areas, including over the near term through further support to purchase COVID-19 vaccines.

Looking ahead, the challenge confronting us all is climate change. Here again, our dialogue with the government has positioned us to help, including to achieve Ukraine’s ambitious commitment to reduce carbon emissions. During President Zelenskyy’s visit to Washington in early September we discussed operations to strengthen the electricity sector; a program to transition from coal power to renewables; municipal energy efficiency investments; and how to tap into Ukraine’s unique capacity to produce and store hydrogen energy. This is a bold agenda, but one that can be realized.

I have been gratified by my visit to Kyiv to see first-hand what has been achieved in recent years. I look forward to our partnership with Ukraine to help realize this courageous vision of the future.

Originally published in Ukrainian language in Novoye Vremia, via World Bank

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