Fitch says changing Lebanon’s dollar peg painful but benefits possible

Changing Lebanon’s currency peg to the U.S. dollar would be a painful move that would witness the country’s pound weaken sharply, ratings agency Fitch’s Director of Sovereigns, Toby Iles said on Friday. However, the move could also reap long-term benefits, Iles added.

The 22-year-old currency peg has come under growing scrutiny as the country grapples with its worst economic crisis in decades amid widespread protests that toppled the coalition government of Saad al-Hariri.

“If you were to change the peg, it amounts to a repricing of the Lebanese economy …and given the imbalances that one sees in Lebanon, such as the current account deficit, it would result in a much weaker currency,” Iles told Reuters.

“The near-term costs of coming off the peg would be painful, even if an adjustment could bring long-term benefits.”

A number of countries have unshackled currencies in recent years to allow economies to adjust to large current account deficits and other imbalances.

The central bank has repeatedly ruled out a break in the peg which fixes the pound at 1,507.5 to the dollar. But with black market exchange rates indicating a discount of more than 20% in recent days, observers say a double-digit devaluation has become increasingly likely.

The possible imposition of capital controls as banks reopened on Friday following a two-week closure posed a “big question”, Iles said.

“Even if it could help stem outflows in the near term, Lebanon needs inflows, and failure to get the inflows would mean a huge readjustment of the economy in a very short period of time, and a massive recession,” he added. “And how would that play into political dynamics?”

The central bank promised not to introduce controls when banks re-opened. While no formal curbs were imposed, banks told customers they could not transfer funds abroad unless for specific reasons such as education, health or family support.

Customers also faced limits on U.S. dollar account withdrawals.

With 75 percent of deposits denominated in dollars, possible large withdrawals could hit FX reserves as banks face a big mismatch in FX liabilities, or short-term deposits, and FX assets, or dollars parked at the central bank which – apart from reserve requirements – had longer maturities, said Iles.

“Would it allow banks to access their U.S. dollar deposits at the central bank ahead of maturity to make dollars available? If it did that, then any bank run on U.S. dollar deposits would feed through on lower FX reserves, and that would be kind of a self-reinforcing cycle.”

Source: Reuters