In November 2019, Lebanese banks imposed severe restrictions on the ability of local depositors to make cash withdrawals and international transfers from their dollar accounts. As of February 2020, Lebanese banks doubled down on their “capital control” policies, transforming their weekly limits into bi-weekly limits as low as two hundred US dollars ($). Depositors could withdraw additional amounts from dollar accounts so long as they were converted to Lebanese liras (LL) at the official exchange rate of approximately 1508 liras per dollar, while the market rate rose to well over 2000 liras per dollar. As March 2020 enters its final week, expectations are that the banking sector will completely halt withdrawals and international transfers from depositors’ dollar accounts.
These ad-hoc and illegal measures by the banking sector have become one of the most salient markers of Lebanon’s economic crisis. Executives and government officials claimed these policies were a necessary response to any combination of factors, including regional instability, the drying up of foreign aid, and the Lebanese uprising—boiling down to what they claimed was an unnecessary and avoidable loss of faith in the Lebanese banking sector and in the Lebanese economy more generally.
More recently, on 7 March 2020, Prime Minister Hassan Diab announced that Lebanon would not repay the eurobond debt due on 9 March 2020. In other words, the Lebanese government for the first time in history was going to miss a repayment on its public debt. Then, on 23 March 2020, the Ministry of Finance announced it will "discontinue payment on all of its outstanding US dollar-denominated eurobonds." For most protesters, both decisions were an important development: they served as official recognition by the government that there was indeed an economic crisis in Lebanon—something officials had denied for years and more recently tried to blame on the uprising. For others, particularly those more aligned with the status quo in Lebanon, the announcement to not make due payments for outstanding eurobonds was the real marker of crisis.
This article takes up the matter of eurobonds repayment to argue that the problem in Lebanon is structural rather than contingent, and begins three decades ago with the political economy of postwar Lebanon. As the title suggests, this is an explanatory piece. Various practitioners and others active in the uprising, not all of whom are known, should get the credit for the data and analysis collated and interpreted below. The author was exposed to this knowledge through her engagement in the drafting of a monetary policy solution adopted by seventeen groups and parties active in the uprising. All the mistakes remain her own.
What are Eurobonds?
A bond is a written commitment by the bond issuer (a government or company) to pay the bondholder a specified amount (interchangeably referred to as the face or par value) at a specified date (referred to as the maturity). When a government or company issues a bond, investors buy that bond and thus the two parties enter into a contract with certain terms and conditions embedded in the bond. This contract governs what is effectively a loan by the bondholder to the bond issuer, since the bondholder will be repaid in time.
Generally, investors pay less than the face value of the bond when purchasing it. This is because, as an investment, buying the bond means passing on the opportunity of lending the amount paid on the broader market and earning interest accordingly. The amount paid at the time of bond purchase is called the market value of the bond.
For example, let us assume that there is a bond with a face value of one thousand dollars and a maturity of thirty years. This means the bond issuer is promising to pay the potential investor one thousand dollars after thirty years. How much the investor pays for that one thousand dollars promise depends on a number of variables. Two important factors are the interest rates prevailing on the broader market and risk assessments of the country or company for which the bond is being issued.
- If the investor expects that lending seven hundred dollars for thirty years on the broader market will result in a return of one thousand dollars, an investor might pay up to seven hundred dollars for the bond.
- If an investor thinks there is a risk that the bond issuer might go bankrupt, they would be willing to pay much less than were the bond issuer projecting an economically sound future. The market value of the bond would thus be lower, and the investor’s return higher. However, if the investor views a particular economy at risk of crisis or collapse but possessing a strong state, they are likely to prefer to invest in government bonds than lending the amount in the open market. In this instance, the investor might be willing to pay more than the seven hundred dollars for a thousand-dollar bond issued by that state. In this case, the market value of the bond will be higher, and the investor’s return here will be lower.
The difference between the face value and the market value is effectively profit that the bondholder earns on the effective loan she makes to the bond issuer. This profit may be expressed as an annual rate of return (even when the bond does not actually make annual payments).
In addition to the face value of the bond at its maturity date, bond contracts might also commit the bond issuer to pay an annual amount specified as a fixed percentage of the bond’s face value. This fixed percentage is called a coupon rate, because back in the day when bonds were actual pieces of paper, they did come with a number of detachable coupons that the bondholder presented annually to the bond issuer to redeem the owed payment. Whether the bond comes with coupons or not also affects the rate of return on the loan and therefore the price an investor is willing to pay for the bond. For example, she would be willing to pay more for a six-percent coupon bond than for a zero-coupon with the same face value and maturity.
This brings us to the matter of eurobonds, which are bonds denominated in dollars floated anywhere outside of the United States. They are called eurobonds because the dollars that sit anywhere outside of the US financial system, which are raised in these bond issues, are called Eurodollars. This is the case because the first dollars to sit permanently outside of the US financial system were the Marshall Plan dollars that flooded Europe in the aftermath of World War II. These came to be called Eurodollars much like the dollars that sit in the oil-producing Gulf are called petrodollars.
What Does This Have to Do with Lebanon?
Since 1993, the Lebanese state significantly increased its public debt, first by issuing lira-denominated treasury bonds and later by issuing eurobonds on various occasions for various maturities and amounts. Public debt is money owed by the government to bondholders as well as bilateral and multilateral lenders. Today, total public debt in Lebanon stands at approximately ninety billion US dollars, some thirty-three billion (thirty-seven percent) of which consists of eurobonds. Adding what the government owes in financial commitments to social groups and suppliers who work on credit (e.g., contractors, hospitals, and the National Social Security Fund) raises the amount owed by the Lebanese government to well over ninety billion dollars.
One way of assessing the significance of a country’s public debt is to compare it with the country’s total economic output, typically measured as Gross Domestic Product (GDP)—which is the total value of goods produced and services provided in a country in one year. Lebanon’s debt-to-GDP ratio was 155 percent by the end of 2019 (up from 141 percent in 2016). The ratio is projected to shoot to 185 percent by 2024. This is an enormous debt relative to Lebanon’s GDP.
The only two countries to surpass Lebanon on this measure are Greece and Japan. Greece’s debt-to-GDP ratio today stands at 174 percent, but it stood somewhere in the range of 100–105 percent on the eve of the 2008–2010 Greek debt crisis. Japan has the highest national debt in the world at 234 percent of its GDP, but with the crucial difference from Greece and Lebanon in that the debt is almost entirely denominated in the national currency. The Japanese government is therefore technically able to print its way out of any default, notwithstanding the accompanying social costs in terms of inflation that would erode the purchasing power of incomes and savings.
In Lebanon too, the lira-denominated debt (approximately sixty-three percent of public debt) is more manageable than the public debt denominated in foreign currency (the eurobonds). The central bank (Banque du Liban, BdL) can always print enough liras to pay offer the former, but it is unable to print dollars to pay the latter. In fact, at the base of the current crisis in Lebanon is the fact that the Lebanese state can no longer repay the eurobonds it has issued over the years and which are now maturing.
A critical component of Lebanon’s public debt is the fact that most of the treasury bonds and eurobonds are held by local banks, constituting a sizeable share of their assets. In the typical business model, banks keep some of the deposits with the central bank (as required reserves) and invest the rest in profitable ways. Using these profits, banks can increase their reserves, give out bonuses to their executives, pay dividends to their investors, and pay depositors interest (in return for making the money available to the banks in the first place). Yet in Lebanon, banks invested somewhere between twelve to eighteen percent of deposits in government-issued bonds, and somewhere between sixty-one and sixty-six percent with the BdL (either as additional reserves or as certificates of deposit, CDs for short—contracts which boil down to a loan by the local bank to the central bank). The BdL, in turn, used these funds to purchase state-issued treasury bonds and eurobonds. Consequently, approximately seventy-five percent of all deposits in the Lebanese banking sector are invested with the state—either directly through purchasing government-issued bonds or indirectly through placing money with the central bank. For perspective, there is no other country in the world in which more than forty percent of the deposit base (i.e., all deposits in the banking sector) is invested in government debt.
The extreme exposure of local banks to the public debt in Lebanon helps explain the former’s resorting to (illegal) restrictions on the ability of depositors to withdraw. The Lebanese state is today unable to repay its bondholders (particularly the holders of dollar-denominated eurobonds). While the next section examines why that is the case, the point to underscore here is the following: the state’s inability to make repayments on the debt means that the BdL is unable to pay back the banks—and that the banks (as a result of both) are unable to pay back their depositors.
In public perception, the state’s default on the eurobonds maturing on 9 March 2020 came after the banks-imposed capital controls. In reality, the protracted budget negotiations of spring 2019 had already paid lip service to a proposal for restructuring the public debt held by local banks. In addition, strikes by fuel and wheat importers against foreign currency shortages preceded the banks-imposed capital controls by several weeks, indicating that the central bank was running out of US dollars to back these imports.
Why is the State Unable to Repay the Debt?
Public discourse over the past thirty years has indicted the government for squandering the budget dedicated to infrastructure investment—which is typically an important source of economic growth and therefore of tax revenue. Corrupt politicians effectively diverted these funds to major contractors, awarding projects at inflated prices in return for a cut of the profits or political loyalty. This is to say nothing of their turning a blind eye to lack of proper implementation or completion of these projects.
However, journalist Mohammad Zbeeb has carried to the forefront of public debate a deeper problem underpinning state finances: rates of return to investors in much of the public debt are extremely high by any standard. In fact, economist Nisreen Salti has pointed to the developmental consequences of the structure of Lebanon’s public debt: “government bonds yielding the highest interest rates worldwide barely match the rates Lebanese bonds offered during the 1990s.” High rates of return to investors mean that annual payments on outstanding public debt, otherwise referred to as debt servicing, equal about half of total government income and constitute more than a third of total government expenditure on annual basis. In comparison, infrastructure investment constitutes less than ten percent of the annual state budget. Therefore, no matter how efficiently invested the amount, infrastructure investment by successive governments since the civil war was limited and would have been hardly sufficient to cover the growing burden of debt servicing. In other words, corruption and clientelism notwithstanding, the system is inherently set up to fail. It is therefore no wonder the politicians running it have few scruples in filling their pockets along the way.
Two justifications have been given for why the rates of return to investors in the Lebanese public debt are so high. First, during the 1990s, politicians and government officials justified increasing public debt (with its high returns) by pointing to the need for reconstruction funds and to the prospects of economic growth, which in turn would make repayment possible. During that period, however, the return on Lebanese sovereign debt at times exceeded thirty-five percent. In other words, it is as if the Lebanese government committed itself to paying 350 dollars in annual interest on every 1000 dollars it borrowed. It is worth noting that economic growth anywhere near that order of magnitude was virtually impossible, even in the best of circumstances. And this is to say nothing of the ability of the government to generate (or extract) revenues large enough to service the debt should such growth rates obtain.
A second standard justification for high rates of return on the public debt made use of supposed “market fundamentals,” pointing to the underlying risk of default by Lebanon. After all, we are told, the country had emerged from a fifteen-year civil war and could show little to guarantee the consolidation of the post-war settlement and its assumed stability. Yet such claims do not hold up to scrutiny. In particular, the rates of return on subsequent lira-denominated debt issues decreased over time. Local banks thereby lent a far less solvent Lebanese government at much lower rates of return—which shows that the terms of borrowing of the early 1990s, overwhelmingly favorable to lenders, were not in line with market fundamentals.
Moving away from self-serving justifications, understanding why the rates of return on Lebanese public debt at times exceeded thirty-five percent necessitates consideration of the networks of interest that bind government officials and the local banking sector. By compiling ownership and political affiliation data on twenty major commercial banks in Lebanon, economist Jad Chaaban shows that “as much as eighteen out of the twenty banks have major shareholders linked to political elites, and forty-three percent of assets in the sector could be attributed to political control. ‘Crony capital’ within the banking sector is also shown to impact the […] banks’ […] exposure to public debt.” In short, the rates of return on different forms of public debt were so elevated because the creditors were (effectively) also the politicians, and paid themselves handsomely out of public funds.
Public Debt and the Returns on Crony Capital
Local banks’ rate of return on lending to the state were considerably higher than the interest rates they paid their depositors. Consequently, Lebanese banks no longer bothered looking for investment opportunities in the private sector. At the same time, few in postwar Lebanon could risk long-term and less liquid investments, so most savings ended up in the local banks, which increased the deposit base as well as banks’ investments in government bonds. The rate of return on lending to the state also made it possible for banks to give depositors high enough interest rates that discouraged the latter from investing elsewhere, even if they could afford to. In this sense, as Salti argues, “growth in the banking sector was more akin to a windfall of rents, rather than the result of financial risk-taking, indispensable intermediation, or acuity in identifying investment opportunities that might have lifted other sectors.” In the process, very little credit went to manufacturing and agriculture. This is why the Lebanese economy is said to be a rentier rather than a productive economy—and the uprising’s agenda calls for the transformation of Lebanon’s rentier economy into a productive one.
Today local banks hold more than eighty-five percent of the total public debt in Lebanon. In other words, most of the debt servicing expenditure ends up accruing to local banks as profits. It is also worth mentioning here that banks were not taxed on profits generated from investing in public debt. In fact, the state revenue that funds the debt servicing consists overwhelmingly of flat consumption taxes that disregard the characteristic of the consumer and disproportionately burden the poor and middle classes. On the expenditure side, moreover, from January 1993 to September 2019, total government expenditure was 236 billion dollars—84 billion of which was debt servicing. Comparing these figures to the two expenditure items that are often maligned by austerity advocates for being at the root of the crisis—72 billion dollars in public sector salaries and 25.5 billion dollars spent on electricity—we can start to understand how the very structure of public debt in Lebanon is in fact a subsidy to the banking sector that is larger than the state’s commitment to public employment or electricity provisioning. In fact, the high returns characteristic of Lebanese sovereign debt have exacerbated socioeconomic inequalities by allowing a few individuals within a network of shared interests attached to the banking sector to accrue ever-growing rents while leaving the state with little resources to spend on social redistribution. As Salti points out, public borrowing of the 1990s and early 2000s was, in large part, a plan with known adverse redistributive consequences: “the available margin of maneuver after debt servicing remains too narrow and implies that the battle against inequality is lost from the start.”
How then does one square the alleged collusion between bankers and politicians with the decision to default on the 9 March 2020 eurobond maturity? Banks lose massively, we are told, when the state defaults. Banks of course saw the default coming, in large part because (as mentioned six paragraphs up) the system was set up to fail. Yet the protagonists in the know worked to fill their pockets along the way. The returns banks earned over thirty years made the investment profitable even when they lost their principal. Consider, for example, that an investor who lends one hundred dollars at twenty percent for ten years accumulates crudely two hundred dollars in interest over the ten-year period. Even if the borrower defaults on the principal amount of one hundred dollars by the tenth year, the investor has still recovered her initial investment of one hundred dollars with half the interest accrued and makes a one-hundred percent return with the remaining half. To gauge whether that’s a fair return on a ten-year loan, consider that putting one hundred dollars in a bank account at 7.17 percent for ten years would return two hundred dollars.
Recall that the rates of return on Lebanese sovereign debt exceeded thirty-five percent at times, and that local banks hold the larger part of that debt indirectly through the BdL, which pays them a rate of interest that is yet higher than the rate of return on public debt of the same maturity. In the period from 2009 to 2018 alone, while public spending on debt servicing totaled 40.4 billion dollars, banks’ earnings from government debt and BdL investments combined totaled 93.7 billion dollars. When you compare such returns to the current total public debt of approximately 90 billion dollars, it is clear that banks have already earned more than enough money from debt servicing to cover their principal. All the above is to say that (1) most banks understood the default was inevitable at some point and (2) they had already collected large enough profits on their loans to both recover their principal investments and make a profit.
So why are banks unable to pay their depositors today? The fact is that a sizeable portion of these profits have been distributed to bank shareholders as dividends. Yet another element is also important. The government has been repaying its maturing debt with new debt for a while now. This means that much of the revenue earned on government debt by the BdL and local banks, as well as the revenues earned by banks on their deposits with the BdL, remain digital entries that are not backed by real dollars. Local banks then pass on some of this revenue to their depositors as interest on their deposits—again, a digital entry on one’s bank statement. In the meantime, with dollar remittances from the diaspora and foreign aid drying up, actual dollars that went into the system as deposits were increasingly used up in funding Lebanon’s massive trade deficit (i.e., the excess of imports over exports) and in defending the value of the lira against the dollar (which requires selling dollars against lira in the open market). Now the profits that go into the bank shareholders’ personal accounts as dividend distributions are also digital entries. The difference is that shareholders (alongside other connected individuals) knowingly began withdrawing their savings from Lebanese banks at least as early as 2018, draining real dollars from the system, at the expense of the depositors at large. In 2019 alone, more than fifteen billion dollars were withdrawn from accounts across the banking sector—specifically from those accounts holding more than a million dollars each. As a result, total dollar deposits in the Lebanese banking system, approximately 120 billion dollars if you were to tally up account holders’ bank statements, amount to about five times the remaining stock of actual dollars that depositors can draw on, which happen to be the central bank reserves.
The Central Bank’s Dollar Reserves
On 7 March 2020, Prime Minister Hassan Diab announced that Lebanon would not repay the eurobond issue maturing on 9 March 2020. Although Diab presented this as a bold political decision, the fact of the matter is, given the country’s need for dollars to fund vital imports, the government had no choice but to default. That same evening, Diab’s minister of economy claimed that the governor of the central bank informed the government on the day that it had 22 billion dollars at hand in foreign currency reserves. That sounds like a good number. But it would barely suffice to repay the debt and fund vital imports over the coming two years. Lebanon’s import bill averages the following: 5 billion dollars per year for fuel (which the country relies on for electricity, it should be mentioned); 1 billion for flour; and 1 billion for medical supplies. This is not counting foreign currency needed to import meat, other food, fertilizer, and primary materials for agriculture and industry more generally (essential for growing basic food crops). And here we have not even addressed further imports such as clothes, toiletries, other consumer goods, and the ability of Lebanese to travel and spend abroad. If we take this import bill and add 2.65 billion dollars and 2.5 billion dollars in various eurobond issues maturing in 2020 and 2021 (respectively), combined with 1.83 billion dollars and 1.88 billion dollars in interest (on outstanding debt) due in 2020 and 2021 (respectively), we would have already spent 22 billion dollars over the coming two years.
The above calculation takes at face value the claim that there are today 22 billion dollars in foreign reserves at the central bank. But even such assumptions expose us to a large margin of error. For more than a decade, the central bank has been completely opaque about its accounting. While it is legally obligated to annually report its account information to the Ministry of Finance (MoF), if not publish it in the Official Gazette(al-Jarida al-Rasmiyya), the central bank has for years now reported an annual profit-and-loss figure of zero with little additional information to make sense, assess, or develop policy around. So we have nothing to rely on but BdL governor Riad Saleme’s public statement. Is this a trustworthy source? Up until February 2020, Saleme was reassuring the public that the Lebanese lira is solid, and that he stands firmly against the forced conversion of dollar deposits to liras at the official rate of 1,508 liras/dollar. This while the lira lost over thirty percent of its value on the market, banks imposed their ad hoc withdrawal limits and forced depositors to withdraw additional funds in liras at the office rate of conversion.
Worse yet, while Saleme declares his foreign reserves to be twenty-two billion dollars, in truth, the net reserves figure is actually negative. This is because while the central bank may be holding twenty-two billion dollars, it effectively owes local banks four times that amount. As mentioned above, local banks normally place some of their customers’ deposits with the central bank as a combination of reserves and certificates of deposits. In other words, at this point, the twenty-two billion dollars which the Lebanese state would be using to repay the debt or import vital goods are nothing but the deposits in Lebanese banks—or what remains of them. Generally, countries do not wait to be this far down the hole before calling for a restructuring of their public debt. They often make such a call as soon as their net reserves hit zero, but in the case of Lebanon it took a mass protest movement that came in the wake of a deep dive into negative reserves.
It is therefore not surprising that the Diab’s cabinet, with the approval of all parties in power, first agreed to withhold repayment on the eurobond issue maturing on 9 March 2020 and then decided stopping all future payments. This step, however, leaves the government’s maneuvering field open in a number of directions. From there, the government may negotiate with its creditors a small break from debt servicing of three to five years, it may convince the creditors to forgive a sizeable portion of the debt, or it may default unilaterally on the whole debt and face the legal battles. It also leaves open the question of who internally will bear the losses from an eventual default.
To summarize, Lebanon’s economic problem is structural. Its current manifestations are the inevitable result of the postwar political economy, which was predicated on the transfer of a steady stream of rents from society at large to a small oligarchy of connected interests through an over-priced and therefore irrevocably growing public debt. The sequel to this article moves on to proposed solutions to this problem, arguing for a deep restructuring of the Lebanese public debt that slashes principal as well as interest, dollar as well as lira-denominated, on all the debt, externally as well as internally-held.
 At the time of writing, it seems these policies may obtain some form of legal cover directly from the judiciary, so that elected officials wash their hands from any responsibility for the resulting hardship.
 The amounts discussed throughout the article are unavoidably approximative values because the data from various sources does not concord. For instance, the central bank reports a total deposit base for 2018 at 276 trillion liras, while Bilanbanques, published annually by Bank Data Financial Services in collaboration with the Association of Banks in Lebanon, gives the 2018 figure as 302 trillion liras. In another example, total deposits invested by local banks with the central bank appear as 159 trillion liras on the central bank’s balance sheet, but they appear as 230 trillion liras as per the Lebanese banking sector consolidated balance sheet published by the central bank for the same year. The disparities are partly due to differences in accounting conventions. For instance, it is unclear when public-sector deposits with the banking sector or the central bank are included in the calculations and when they are not. Nevertheless, most analysts agree that there is a clear effort to obfuscate the numbers. A major source of uncertainty is the “financial engineering” of 2016, the size of which is still not known with certainty. In particular, it is not clear how some of the swaps involved have been accounted for in the balance sheets of the banks or of the central bank. There is also the fact that the data is changing in real-time, and particularly fast in this time of crisis.
 The ratios given in this paragraph were compiled by activists drawing on Bilanbanques, a compendium of data and performance ratios in the banking sector published annually by Bank Data Financial Services in collaboration with the Association of Banks in Lebanon.
 In 2003, the government established a five percent tax on earnings generated from the public debt. It was never collected, and subsequently repealed in 2015.
 These figures were compiled by Ameen Saleh, ex-head of accounting at the Ministry of Finance. Having served for more than thirty years, Saleh has repeatedly shared these figures on various media outlets.
 Data compiled by Mohammad Zbeeb.
 Due to limited liability laws, if the bank cannot pay its depositors, the shareholders are only liable up to the value of their shares, not the dividends they earned from those shares (which they have incorporated into their own private property). Also, it should be mentioned here that Lebanese banks were self-congratulatory in their self-reporting about their generosity to their shareholders: “With dividends distributed rising more than banks’ bottom lines [i.e. net profit], the consolidated sector’s dividend payout ratio rose anew last year […]. This is considered as quite generous on behalf of Lebanese banks that are sharing the amelioration in earnings generation with their shareholders […].”
 See Appendix 2 from a report by the Banks Supervision Committee at the Central Bank leaked on 13 February 2020.
 It is worth noting, analysts point out that the twenty-two billion dollars are not all usable foreign currency reserves. But the calculation here assumes that in a humanitarian crisis, what is usable and what is not usable changes.