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Wed 30 Oct 2019 10:30 AM

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Capital controls seen on the cards for Lebanon as crisis deepens

Banks have been closed since the start of the uprising two weeks ago and only plan to reopen once the political situation stabilises

Capital controls seen on the cards for Lebanon as crisis deepens

Lebanon’s central bank Governor Riad Salameh told Reuters on Monday that there would be no capital controls. But a day of violence on Tuesday, followed by the resignation of Prime Minister Saad Hariri, has added to the uncertainty among investors.

Calls are mounting for Lebanon to impose formal restrictions on the movement of money to defend the country’s dollar peg and prevent a run on the banks when they open their doors after nationwide protests.

Banks have been closed since the start of the uprising two weeks ago and only plan to reopen once the political situation stabilises. The longer they remain shut, however, the more a backlog in dollar demand builds and speculation swirls about the measures the banks will need to take to avert financial collapse.

In a sign of crumbling confidence, banks have been getting calls from clients asking to move their money abroad while others are working at a frantic pace to transfer funds to Swiss accounts as soon as lenders resume operations, local and foreign bankers said.

As tensions intensify, influential local economists have raised the alarm - calling for limits on the transfer of funds outside the country. Two senior banking executives, speaking on condition of anonymity due to the sensitivity of the issue, have said emergency measures were the logical next step given there is no political solution to the crisis in sight.

Capital controls are again becoming the weapon of choice for embattled governments in need of some breathing room, with Argentina tightening its restrictions late Sunday after a left-leaning populist won the presidential elections. Such a step - even if temporary - would mark a turning point for Lebanon since it’s likely to cause a backlash among diaspora investors, the country’s financial lifeline.

Lebanon’s central bank Governor Riad Salameh told Reuters on Monday that there would be no capital controls. But a day of violence on Tuesday, followed by the resignation of Prime Minister Saad Hariri, has added to the uncertainty among investors.

Dwindling choices

Lebanon, one of the world’s most indebted countries, has few viable options. Hundreds of thousands of Lebanese have been on the streets for two weeks, demanding the resignation of a political class they say has pillaged state coffers to the verge of bankruptcy whilst leaving the public with failing public services and daily blackouts.

The worsening sentiment is playing out in the market. The yield on Lebanon’s dollar bond due 2021 jumped 3.85 percentage points to 33.64% Tuesday. The gap between bids and offers for the security widened to the most since the 2008 financial crisis, reflecting sparse liquidity.

Spread on bids and offers widens to the most since the 2008 financial crisis
Charbel Cordahi, who advises the largest Christian bloc in parliament on economic issues, suggested in a tweet a series of emergency measures including setting limits on transfers outside Lebanon at $7,500 a week and a reduction in yields to 4.5% on certificates of deposit held by lenders at the central bank as well as on Treasury bills.

“This would be a solely technical arrangement until the situation stabilizes and shouldn’t exceed three months,” he said.

To keep its lenders stable and defend the dollar peg, Lebanon relies on inflows from the millions of Lebanese living abroad. However, capital inflows needed to finance the large current account and fiscal deficits have slowed as confidence has dwindled. Meanwhile, outflows have gathered pace.

Last night, Fitch Ratings downgraded two top Lebanese lenders, Bank Audi and Byblos Bank, to CCC-, the fourth-lowest rank and one level below the sovereign. Its so-called support rating for both is “No Floor,” meaning it believes the state’s “ability to support” banks “cannot be relied on given the low sovereign rating.”

“In our view deposit stability is now at greater risk as depositor confidence has also suffered,” Fitch said.

Currency shortage

Importers have complained for months that banks were no longer allowing them to transfer Lebanese pound holdings into dollars to pay for shipments. Instead, businesses were increasingly turning to exchange bureaus for hard currency, and paying more than the official rate of 1,507 to pounds to the dollar.

For much of this year, some lenders have placed informal limits on the dollars they will supply to holders of Lebanese pounds, or charged additional fees for withdrawals in foreign currency or for transfers outside of Lebanon.

Those measures have not been ordered by the central bank. Bankers and economists say a decision to set formal caps on money transfers and withdrawals -- or to force banks or the central bank to take a so-called haircut on their investments in government debt -- should come from the government. Some steps may require parliamentary approval.

“They might tighten the capital controls that are already in place to avoid a run on banks, preserve deposits and try to maintain the stability of the national currency,” said Jihad Hokayem, an economist and lecturer at Lebanese universities.

Day-to-Day

Lenders have been replenishing ATM machines to allow people to access their salaries and meet their day-to-day needs but have set a daily limit on withdrawals of 1 million Lebanese pounds ($663). Banks are also helping importers fulfill their letters of credit through the back office to avoid shortages of food or other supplies, bankers said.

It was a “policy mistake” for banks to close in the face of protests, according to former Lebanese Economy Minister Nasser Saidi. “This creates panic & a run on the banks as depositors fear lack of access to their deposits, further #LBP depreciation, the imposition of capital controls on transfers & more bank closures.”