Question

1. Lebanon is currently facing both a foreign debt crisis and a banking crisis. What is the difference between the two? Discuss their implications for Lebanon. How can Lebanon recover?

2. Reflect on levels of economic development and crises like those that currently face Lebanon. How does corruption and fiscal mismanagement leave a country vulnerable to economic disaster? What are the implications of this? How is the situation exacerbated by the novel coronavirus pandemic?

3. How does Lebanon’s persistent trade imbalance contribute to its foreign debt crisis? Would a floating exchange rate help to alleviate the situation? Explain the relationship between exchange rates and imports and exports.

Answer 1

1.

Lebanon recently defaulted on its debt worth $1.2bn Eurobond. The country is facing both a banking crisis as well as foreign debt crisis.

A country is said to face a foreign debt crisis when it faces difficulty in paying back its foreign debts, be it from institutions such as banks or the IMF. The country's debt-to-GDP ratio has reached a worryingly high level of 170%. When a country doesn't have enough foreign exchange reserves, such as to pay for imports, for paying back debts it is said to be going through foreign debt crisis.

When a country's banks economic health is in stress it is said to be going through a banking crisis. For example, people in Lebanon have lost trust in banks and are withdrawing their money in large numbers which has led to the banks facing severe cash crunch. The government had taken loans from the banks at a very high interest rate which was unsustainable. Now, the government doesn't have enough money to pay back to the banks, nor can the government ask the central bank to print money as the value of currency has already deteriorated exponentially.

2.

Large scale corruption and economic mismanagement has indeed put the country's economy in tatters. As mentioned above, banks were promised a very high return on the loans that the government had taken from the banks. Consistent running of budget deficit has also made sure that the country's debt pilep up to unimaginably high levels.

The implications are large scale erosion of wealth of the country and ultimately the poor.

COVID-19 and its effects such as lockdown has forced most of the countries plunge into recession. Lebanon has also been equally hit. Most of the workers have lost their jobs and sudden closure of the economy has brought down both the aggregate supply as well as aggregate demand level. Tax revenues of the government is expected to fall by more than 50% leading to further deterioration of government's financial helath. All this has only worsened the already fragile economy.

3. Lebanon's current account had a trade deficit of $12 billion in the last year. The country was already facing foreign exchange shortage. Continuous reduction in foreign exchange reserves due to higher imports than exports has further put even more pressure on the economic front of the economy. When imports rise the local currencies' value further deteriorates leading to inflation in the home ccountry whereas higher exports helps a country earn foreign precious echange.