BEIRUT: Adel Afiouni, the caretaker minister of state for investment and technology, responds to emailed questions by The Daily Star on the dire state of Lebanon’s finances. Prior to taking his Cabinet post, Afiouni was a successful banker, having served as head of emerging markets in Europe, the Middle East and Africa at Credit Suisse since 2014.
Q: How would you characterize Lebanon’s current economic and financial situation? Are we in the midst of a collapse?
A: Lebanon is witnessing a difficult and unprecedented crisis. The country has been suffering from a sharp economic slowdown, high levels of unemployment and growing inflation. All these issues are inflicting severe pain on the population. This crisis is further aggravated by the government’s dire fiscal situation, the high indebtedness, and the twin deficits (trade deficit and budget deficit), not to mention the recent stress on the banking sector and the pressure on the Lebanese pound.
Half-measures and piecemeal solutions are not an option anymore. A collapse can still be avoided, but only with a drastic and comprehensive economic and financial plan. Such a plan is way overdue. This plan needs to be credible and to earn the confidence and support of the Lebanese people and of the international community. The plan needs to (1) tackle the government’s fiscal deficit, (2) address the country’s short- and medium-term funding requirements, (3) restore the trust in the banking system, (4) put the country back on track for economic recovery and (5) implement social safety net measures [in] parallel in order to protect the population, especially the most vulnerable categories.
Q: I’m interested to get your opinion on several ideas that have been floated recently, including haircuts, implementing formal capital controls and moving toward debt restructuring or rescheduling. What is your position on each of these issues?
A: All those ideas being floated should be discussed as part of a comprehensive solution because the piecemeal approach is not an option anymore, nor effective.
We need to be rigorous and accurate when talking about those sensitive topics and avoid spreading false fears or false expectations.
First, let’s distinguish between two types of haircuts.
The first type of haircut is a haircut on government debt, and this usually happens as part of a government debt restructuring exercise. The talk about this type of haircut is still premature.
What we need first is a comprehensive financial plan starting with a debt sustainability exercise. The current trajectory of Lebanese government debt is clearly unsustainable, and we need to face that and address it.
Therefore, any economic plan needs to start with front-loaded fiscal adjustment to reduce the budget deficit drastically to acceptable levels, and be accompanied with a credible medium-term financing plan to address the government financing requirements over the next few years and the sources available to fund those requirements.
Right now, market conditions are making it impossible for the government to access the bond markets to fund its financing needs.
This is why the government is relying predominantly on the Central Bank for funding, as we have witnessed this [past] week in the repayment of the Nov. 29 Eurobond. Repaying government debt from Central Bank reserves is unhealthy and unorthodox and not sustainable.
Therefore, a medium-term financing plan and a path to debt sustainability is a priority.
Whether this plan needs to include a restructuring and a haircut on the debt is premature. The first priority is the new government’s ability to stabilize the situation and regain the markets’ confidence with a credible team and a credible plan and its ability to attract financing from the markets and from other external sources, because relying on Central Bank reserves should not be an option anymore.
The second type of haircut being floated is a haircut on bank deposits. Such a haircut usually happens when a bank is facing financial difficulties and heavy losses. Haircuts typically only affect depositors once a bank’s losses have depleted the bank’s shareholders’ capital and not before. Haircuts on deposits are very rare.
This is why we need to be extremely accurate and careful when talking about a haircut on deposits to avoid unnecessary panic. The banking sector in Lebanon is facing an unprecedented liquidity crisis due to a breakdown in confidence, but this has not yet turned into a solvency crisis and we hope that a comprehensive financial and economic plan can avoid such an outcome.
Moreover, even if we were to face a banking crisis, the aggregate capitalization of the Lebanese banking sector exceeds $20 billion, and this capital base will, I hope, provide for a good loss-absorption cushion that should reduce the risk of a haircut on deposits and that at least should protect small depositors from any losses.
We need to do our utmost to protect depositors. Avoiding a loss on deposits and avoiding a banking crisis and regaining the trust in our banking system should be our biggest priority. The banking sector is paying the price of an excessive exposure to public debt. This is why a comprehensive plan to address government indebtedness and financing needs is key to prevent and solve any potential banking crisis.
As for capital controls, my view is as follows: Any bank in the world, no matter how large it is, when faced with a run on deposits, can face the risk of a financial collapse. The current liquidity available in the banking sector has proved unable to withstand the demand for withdrawals. We are witnessing an unprecedented demand from customers to withdraw or transfer deposits due, as mentioned above, to a breakdown in trust.
This is why it is very important to take prudential measures in order to avoid any banking collapse and to protect depositors’ money, which is what the current restrictions on transfers and on capital movement are trying to achieve.
However, I believe the current process applied by banks since Oct. 17 is ambiguous and sometimes arbitrary and discretionary, and this is not fair to the citizens and needs to be addressed.
I have been advocating strongly that we need to acknowledge the stress in the banking sector and call a spade a spade and act accordingly to prevent a crisis. My view is that we need to adopt fair, transparent and detailed capital control procedures that protect ordinary citizens, protect their needs and protect banks from legal risk.
Ordinary citizens should continue to access their money to provide for their basic needs and companies should be allowed to perform their basic operations. Temporary capital control is an acceptable measure as long as it is applied in a fair and transparent manner, and as long as it is targeted at large savers mainly and provides for a level playing field. Those details should be ironed out in a clear and detailed circular.
Q: We have heard many reports of high-level capital flight from the country while small depositors were unable to access their accounts. To your knowledge, has this occurred, and to what extent? Should the average citizen be worried that they will pay the price of this crisis while big depositors stash their money abroad?
A: I do not have any evidence about that, but I call on all banks to rise to their responsibilities and to uphold the highest standards of fairness and transparency in these testing times.
This is precisely why I am advocating for a capital control process that governs transfers in a fair and transparent manner, and that protects small depositors and by the same token protects banks from unwanted pressure. We can’t run a capital control process with a five-liner statement from the [Association of Banks in Lebanon]; we need a more rigorous and detailed process, and this will be key to protecting the interests of the population and the reputation of our banking system.
Q: I have heard from sources that the recent resignation of a Bank Audi board member was tied to a former senior official’s attempt to transfer a very large sum out of the bank. Is this correct?
A: I don’t have any information about this matter, and I am not privy to the reason behind the resignation.
Q: Do you think the large profits made by banks over the past years are deserved? And what role do you think banks should play - or what contribution should they make - to solving this crisis?
A: Banks are expected to finance the private sector and the economy as we all know. Over the last few decades, the public sector’s excessive borrowing has crowded out the private sector, and Lebanese banks have allocated as a result a substantial part of their activity to public sector financing, attracted by the high returns offered. Some banks have even turned into a large government bonds portfolio, using depositors’ money to finance public sector debt. Such a strategy goes against basic risk management and diversification banking rules.
A basic financial rule is that you should not distribute profits that you have not fully locked in. Banks have effectively realized profits from high interest earned from one single customer exposure, the public sector, and that entails by definition a meaningful risk. They should not have distributed those profits to their shareholders. They should have retained those profits in the banks instead as prudential measures would dictate.
A comprehensive economic and financial plan will need to be put in place to solve the crisis as we discussed above. Such a plan will naturally lead to a meaningful cost to be incurred by all major stakeholders in the economy. That cost needs to be shared in a fair manner and the banking system will have to carry part of the burden for sure.
However, it is important to come out of the crisis with a healthy and a strong banking system, even if smaller, because there can be no economic recovery without a solid banking system that can finance the recovery.
Q: Was financial engineering the correct path to take over the last few years? Do you have confidence in the policies of the Central Bank?
A: In hindsight, one can criticize the financial engineering operations done by the Central Bank for having led to a distortion in the interest rates and an artificial inflation of banks’ profits. However, one has to remember that the Central Bank’s priority over the last few years was to boost its foreign currency reserves at any cost and to continue to build a war chest because the foreign currency reserves have become the last resort and the only source available to finance the foreign currency needs of the government and of the economy.
Clearly that could only come at a high cost given the poor state of public finances and the poor state of the economy and the risk premium required to attract foreign currency into the country.
Central Bank reserves are today being used to finance the public deficit and government debt redemption and servicing, to finance the importation of basic goods, to finance the peg and to provide necessary liquidity to support the banking system. While this situation is neither healthy nor sustainable, we should acknowledge that building up a large pool of reserves by the Central Bank is what has allowed us to continue to fund our needs and to avoid a financial collapse until now.
Q: Do you support maintaining the currency peg, and is there a solution to this crisis where we keep the peg and thereby keep the value of people’s savings intact?
A: More than 70 percent of the population relies on an income in Lebanese pounds. A devaluation is therefore a severe blow to the purchasing power of a majority of the population and can lead to serious economic and social consequences. The peg provides a social safety net for the most vulnerable part of the population, and we need to protect those for now. In these difficult times, the cost of maintaining the peg is high but it remains lower than the cost of the pauperization of the population.
Now, this is not going to be easy given the financial challenges we are facing as a country, and the pound has already dropped meaningfully in the unofficial market. This is where I go back to the idea of having a comprehensive plan where we prioritize the use of the Central Bank’s reserves, and one priority in my opinion should be to try to protect the peg.
Q: Finally, I’m interested to know how you have felt during this uprising over the past 40 days. You are someone who recently entered politics in Lebanon. Do you regret it? Have you thought about resigning? Where do you see things going?
A: I spent 30 years abroad as an expatriate and only came back to Lebanon in January 2019 when I was appointed into the government. I had no prior involvement in Lebanese politics and my only motive for accepting the job was to serve my country. I had high hopes that I could bring in my experience and expertise and try to help. For me at the time, my appointment as a minister was the equivalent of the military service that I never did.
I don’t regret accepting the job because one should not say “no” to serving his country, in whatever capacity. I believe I did my best to contribute, and we put in place an ambitious action plan and reform agenda for the technology sector. We were on track to implement necessary and important reforms to boost the knowledge economy in Lebanon. I enjoyed working with the tech ecosystem in Lebanon; we have some really impressive talent in Lebanon, and they deserve government support and help.
But what I also realized during my short experience is that the overall political machine is very inefficient, and that the system that we had in place is unable to address the social and economic and financial challenges that our country is facing.
The Lebanese people have paid a heavy price for the ruling class’ inability to address and solve the economic and financial crises, and to tackle the corruption and the waste in the public sector.
The popular uprising is a legitimate and expected reaction to decades of poor management, bad results and little to no accountability. This is why it is important to respond to the people’s legitimate demands with real and credible change, starting with a new government composed of experts who have the integrity and the credibility and the independence required to carry the country forward and avoid a collapse.
Change is the only hope for our country, and the Lebanese people deserve that.