Lebanese Budget Deficit Financing in H1 2020: A Critical Look

In countries with deficits and debt like Lebanon, what matters is not only how high these deficits and debt can get, but also how they are usually financed. Economic theory predicts that central bank financing (deficit monetization) increases the money supply and consequently inflation, whereas financing from commercial banks could dry up funds and lead to higher interest rates. Foreign financing, on the other hand, relieves the economy from these two adverse consequences, but only at the expense of exposing it to external vulnerabilities. Moreover, under a fixed exchange rate regime, any deficit monetization – especially if not sterilized – could lead to loss of foreign reserves which makes it tantamount to foreign financing of budget deficits.

By any count, the year 2020 is proving to be an economic disaster to Lebanon. The country is suffering from a triple whammy – an exchange rate crisis, a banking crisis, and a debt crisis – with no end in sight in the near future. And most analysts agree that it was the debt crisis – coupled with a corrupt public sector — that had sparked the two other crises. But, surprisingly, the debt crisis has receded in relative significance these days, partly because it is not as “sexy or juicy” as the other two (banking and exchange rate), but mostly because domestic debt which constitutes close to 64% of total debt (with total debt reaching $93.5 billion in June 2020) is losing its real value with rising inflation. That leaves, of course, foreign currency debt which the government has defaulted on, and which represents a real concern especially that almost 50% of it is held by foreigners. Another concern, and this time it relates to domestic debt, is the anecdotal evidence which claims that the current monetization of the deficits is increasing the money supply and fueling more inflation and exchange rate depreciation.

What we want to do in this note is to evaluate the validity of the above observation regarding deficit monetization by looking at the sources of Lebanese deficit financing in H1 2020.

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Lebanese Budget Deficit Financing in H1 2020 f

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