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April 27, 2020
The Coronavirus Loan Intervention is a Step in the Right Direction

Nada Mora completed her Ph.D. in Economics from the Massachusetts Institute of Technology (MIT) in 2003. She currently lectures at the Lebanese University and is an LCPS senior fellow.


The Lebanese private sector has faced two major shocks in less than six months: First, a domestic crisis originating in the banking system—the main source of business and household funding—and second, a global economic crisis from the COVID-19 pandemic. The global growth forecast has suddenly turned negative, amid accelerating unemployment worldwide and uncertainty over how deep and how long the recession will be. Already in recession, Lebanon is now contending with this global shock for which it has fewer options. A lesser ability to borrow at low interest rates makes it harder for the government in Lebanon and other emerging market economies to be a lifeline provider-of-last-resort to the private sector.
 
In a typical recession where demand falls below potential output, the policy prescription is for fiscal and monetary stimulus. For example, reduced taxes and interest rates encourage business investment spending, in turn causing firms to hire more workers, causing workers to demand more goods, and so on. While the economic damage of the coronavirus might match that of the Great Depression, the policy prescriptions differ. Instead of stimulating demand, the short-term objective now is to hibernate both demand and supply. First, to save lives, the appropriate public health response is to shut down a large part of the economy. Second, to save livelihoods, governments should offer relief to the private sector in order to survive government-mandated shutdowns. This economic consensus is articulated by policymakers and modeled theoretically. Without customers and without private sector relief, destruction of otherwise healthy and productive firms initially affects workers employed in the pandemic-sensitive sectors of the economy, such as face-to-face services like restaurants. As a result, newly jobless workers reduce demand, causing another round of harmful firm exits and job losses. In Lebanon and other countries with weak banking systems such as Italy, firm exits also push banks deeper into insolvency.
 
Some countries in Europe (such as France and Italy) have targeted support to businesses so they keep workers on payrolls in order to avoid inefficient destruction of firm-employee ties. Other countries such as the US are willing to tolerate more firm failures and exits, and instead offer relief to the labor force via direct cash payouts or unemployment insurance. At the same time, central banks globally have eased monetary policy both conventionally (by decreasing short-term interest rates to zero) and unconventionally (by providing liquidity to a range of financial markets via lending and bond purchases). The central banking rationale has been to maintain the flow of credit to businesses and households.
 
In this light, Banque du Liban (BdL) Circular 547 offers emergency relief to bank customers who have previously borrowed and have payments due in March, April, or May 2020. In effect, this reschedules their loans by allowing banks to lend to customers the amounts needed to cover monthly dues during this period. In turn, BdL lends the equivalent amount to banks. Repayment of these zero-interest loans begins in June for five years, in addition to resumption of the previously accruing loans.
 
This circular is a good first step and it gives some flexibility so that business customers can use the new loans to cover payrolls and other operating expenses. An additional advantage of the new loans covering payrolls is that salary payments are made directly to employees according to a payroll schedule the customer provides the bank, thus reducing the risk that the business customer re-directs money for private benefit. The circular also covers non-business customers with mortgages or car loans for example, reducing financial stress on households.
 
However, there are limitations. First, the covered customers are only those with pre-existing loans. Therefore, this loan relief is a mechanism for BdL to also provide relief to banks so that they avoid capital write-offs from non-performing loans. Yet with the unprecedented coronavirus crisis, many customers with a bank account but who do not have a current loan are suddenly facing financial distress too. For example, based on the most recent World Bank financial inclusion survey, 45% of Lebanese adults have a formal account with a financial institution while only 17% have borrowed in the previous year. I propose that relief should also be provided to customers without a pre-existing loan to avoid unnecessary job losses. Qualifying criteria and credit pricing can be developed with applicants submitting documentation of their pre-crisis conditions. Banks should work with all customers suffering temporary income loss (allowing overdrafts or credit line access) and BdL should subsidize interest rates over a three to six month period for creditworthy businesses prepared to save jobs. A second limitation of Circular 547 is that irrespective of whether the bank lends to the customer in liras or dollars, BdL requires its loan to banks to be in dollars. While protecting BdL from the risk of currency depreciation, this worsens currency mismatch on bank balance sheets, as banks now have to repay BdL in dollars over five years.
 
Some might question whether providing liquidity relief risks adding to inflationary pressure. That risk is higher in the longer run as the economy recovers but is less of a concern in the short run in a depressed economy. Currently, inflation is coming from the pass-through of the depreciation of the market exchange rate to import prices. If the extra liquidity were to cause higher money growth, then there would be added inflation due to the provision of liquidity by central banks. However, during financial crises when overall bank credit growth is negative, the money multiplier breaks down. For example, total credit to the Lebanese private sector has gone down by close to 20% since last year, as have monetary aggregates (which is the sum of currency and deposits). This was also the case in the US following the 2008 crisis. Nonetheless, during the subsequent recovery phase, central banks should watch out for credit growth pressure and act to remove excess liquidity by tightening monetary policy (for example by raising reserve requirements) in order to avoid higher inflation in future years. To summarize, the inflationary risk of liquidity provision is muted under present worldwide conditions. Indeed, in the case of a small open economy like Lebanon, it is possible that by not providing liquidity today, Lebanon risks higher inflation even in the short run. The reason is that without a credit lifeline, many local businesses will shut down, causing more supply shortages and forcing a greater dependence on imports whose prices continue to rise in lira terms.
 
While the Lebanese government and BdL are financially constrained, additional lifelines could be devised to mitigate the economic damage to the private sector. The private sector is very vulnerable because the majority are small firms with fewer than 20 employees, including many self-employed enterprises. Small firms have fewer cash savings that they can drain to survive. In Lebanon’s peculiar case, savings in the form of cash-at-hand are also more valuable than cash-at-the-bank, which remain partly frozen because of the Lebanese liquidity crisis preceding the coronavirus pandemic. Another recent BdL Circular 148, issued on 3 April, aims to ease cash access for holders of the smallest deposit accounts (less than $3,000). It however still remains unclear how this process will be implemented, and it could intensify depreciation pressure. Therefore, I propose that the government unilaterally postpone business rent payments for small firms for a temporary period, as applied in France. Rent is often the biggest business cost for small firms, and such a policy would conserve their limited cash.
 
Another policy that could offer relief in the short-run and revive growth in the medium-run is for the government to issue retail lira “Corobonds” for domestic purchase by private investors. The proceeds should be used to fund specific projects for coronavirus recovery, including community or municipality lending and support for the smaller enterprises and entrepreneurs missed by Circular 547. A similar policy has been announced by Italy with its new “BTP Italia” retail bonds aimed at ordinary savers. Like Lebanon, Italy is constrained by high external borrowing costs due to its high debt and history of government finance mismanagement. Creating a new retail bond market that has adequate oversight and transparency would also help to nudge Lebanon away from a “bank-only-centered” mode. There remains considerable idle private capital in Lebanon that can be tapped. People have lost confidence in the banking system and are mostly either hoarding savings at home or funneling them into nonproductive real estate. By including attractive terms into the new Corobonds (such as through seniority, warrants on future GDP or export growth, or interest payments tied to the inflation rate as planned by Italy) and by applying good management practices (notwithstanding the Lebanese history), private capital can be put to work in Lebanon.
 






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