Explaining Parallel Rates in the Lebanese Context

Why Parallel Rates Form?


The official rate of a currency as set by the central bank, is the price at which it is willing to supply dollars, but that's as long as dollars are available. When dollars start running out, central banks need to make it more expensive to purchase dollars, hence they devalue the currency. If the central bank chooses not to devalue, it can provide limited amount of dollars to the market for specific imported products, and create an official second rate (a parallel rate) for the rest of the products. If the central bank chooses to provide limited dollars without creating an official parallel rate, a parallel rate will develop by itself. When importers find a hard time getting dollars from the central bank they shift their demand towards the currency exchange houses. Currency exchange houses will naturally raise the price of dollars, and it is their right, because they are pricing based on supply and demand.

How does Lebanon receive and spends its dollars?


Lebanon receives dollars in the following ways:

  1. Remittances from Lebanese abroad to help their families
  2. Personal flows from Lebanese abroad in hunt for safety and high interest
  3. Tourism
  4. Investments from abroad
  5. Exports

Lebanon spends its dollars in the following ways:

  1. Imports for private and public sector
  2. Servicing and refinancing government dollar debt (Eurobonds)
  3. Lebanese traveling abroad
  4. Lebanese investing abroad

Why is Lebanon running out of dollars?

The difference between the inflows and outflows that we described result in a net balance, which is the balance of payment. Lebanon has been in the negative because Lebanese abroad haven't been sending as much dollars due to slower economic activity in the countries where they live and because of restrictions. More recently, they are afraid to send money to Lebanon because the risks are going up due to the accumulated corruption leading to potential financial collapse which threatens their deposits. More dangerously, they are taking their money out. This is the main driver of the drop of reserves at the central bank. Additionally, tourism, investments and exports all slowed because of the Syrian war since 2011. The high debt servicing requirements and the obscene amount of imports have always been draining the reserves due to an overvaluation of the currency ( and now that inflows have stopped, that drainage becomes lethal.

How Much dollars are left?


 According to rating agencies, the usable reserves are less than the $30bn reserves in cash that BDL currently has in gross terms. Standard & Poor's estimates them at around $19bn and Moody's estimates them between 5bn and 10bn dollars. Usable reserves are how many dollars BDL will be able to "burn" defending the currency, before it starts tapping into the required reserves that it collects from banks as percentage of people's dollar deposits, with some variation of the definition per agency. This means,  we have at best 5 to 10 months before we completely run out of money.

Explaining Parallel Rates in the Lebanese Context

What did the Central Bank of Lebanon (BDL) do to attract dollars since 2016?


After a delay in electing a President in 2014, the country went into a long period of lack of confidence. The reserves of the central bank started declining, so BDL started increasing interest rates but only selectively to large account holders who are willing to bring back dollars from outside Lebanon. The interest that was paid was partially in USD and partially in Lira, starting with 10% when the market was giving 5%, then reached 20% when the market was providing 10%. It was named "financial engineering" by BDL. The engineering kept going since May 2016 until before the beginning of protests in October 2019, with the last known transaction, a 1.5bn dollar deposit directly at BDL

What did BDL do after it failed to attract dollars in 2019?


With the drop in reserves, BDL incentivized the banks to place dollars with it for long maturities to have more immunition to defend the Lira. When the trade financing requirements started putting pressure on banks in demand for letter of credits to import goods, they found themselves illiquid.

Traders started going to the exchange houses to get dollars in cash bills which led to a pressure on the exchange rate and created the parallel market. Simply, the supply of dollars are now less than the demand. To alleviate the pressure on the parallel rate, BDL issued a circular guaranteeing dollars at the official rate of 1507.5LL/USD only for fuel, pharmaceuticals and wheat, which constitute a quarter of total imports. Despite this, the parallel market on the rate remained and started getting worse after the protests.

What to expect going forward?


The weakness of the Lebanese economy and the weakness of its exports have led to a place where the Lira requires more dollars to support it at the 1507.5LL/USD official rate. This weakness started showing its face once the flow of deposits dropped sharply and outflow of deposits started. To reverse the trend, confidence in the markets and hence the government and BDL and their policy making approach in the next phase need to be laid out and need to be convincing. The best case scenario is Lebanon maintains the 1507.5 LL/USD rate if it forms a government and implements reforms fast. The worse case scenario is a delay in the formation of a government and reforms, and continued loss of confidence, which could take the Lira to unchartered territories. In all cases, the parallel market will remain for a while and it's worth following. We will try to keep you updated by doing constant market sounding with exchange houses and posting them.