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Monday 31st May 2021
A Currency Board could stop Hyper Inflation in Lebanon

Inflation in Lebanon fell to 121.7 percent in April 2021 from 158.9 percent in the previous month. The reason for the decline is that food inflation fell to an 11-month low of 228.6 percent in April from 394.8 percent in March. Inflation is calculated as a function of the CPI index. The Consumer Price Index (CPI) is an overview of the prices households pay for goods and services. This data is collected and calculated by the Central Administration of Statistics (CAS)

Inflation In Lebanon

It seems unlikely that this trend of lowering inflation will continue as the government considers an end to subsidies. The caretaker finance minister, Ghazi Wazni, says: "Subsidies are costing 500 million a month and BDL dollar reserves have now reached a critical level of $15.8 billion." It is expected that hyperinflation could occur once the subsidies for importing food and essential goods are eliminated. 

At this crossroads, it is important to resolve the currency crisis. This is a primary crisis we face as a country. The currency crisis is a symptom of much more serious underlying systemic problems. The underlying problems are much more complex to solve because of our sectarian politics. We could look at countries that have faced hyperinflation and take notes. Bosnia-Herzegovina, which is also sectarian in its population structure with Orthodox Christians, Catholics and Muslims, successfully stabilised its currency in 1997 and controlled hyperinflation. How did they manage to do that?

When it comes to (hyper)inflation, the burden of devaluation hits the poor and middle class the hardest. Their purchasing power declines and inequality increases. In addition, negative coping mechanisms such as more child labour, more child marriages and cutting down on food are adopted to detrimental effect. Poor households spend most of their income on food and food inflation has devastating effects.

What is a Currency Board and how will It control hyperinflation

A Currency Board is essentially an independent authority created by law whose sole function is to stabilise the exchange rate of the currency and control the money supply. No money can be printed unless it is 100% backed by US dollars or gold. Lebanon has the second-highest gold reserves per capita after Switzerland and ranks 20th in the world with 286.6 tonnes of gold worth $18 billion.

The Currency Board has no discretionary monetary policy powers, only exchange rate powers. The Board is not authorised by law to print money to lend to the government. Its only function is to exchange the national currency it issues for an anchor currency at a fixed rate. The currency of a currency board is a clone of its anchor currency.

According to Professor Steve Hanke, founder of the Institute of Applied Economics, Global Health and Business Studies at Johns Hopkins University in Baltimore, Lebanon is in intensive care and the most important way to get Lebanon out of intensive care is to stabilise its currency. The rest of the reforms can then follow. He argues that once the exchange rate is stabilised. Aid money will flow into Lebanon and investor confidence will be restored. Lebanon can then plan and implement reforms once it is no longer on the hot seat. He personally advised and helped Bulgaria in 1997 when the country was facing hyperinflation and inflation was under control within a month of the introduction of the currency board.

Dr. Hassan Ahmed Khalil was the first to propose the establishment of such a board in the late 1990s

What are and other Solutions to curb inflation in Lebanon

According to Professor Hanke, whenever the Currency Board has been established in its 70-year history, it has never failed. The most recent cases are Hong Kong 1992, Estonia 1992, Lithuania 1994, Bulgaria 1997, Bosnia-Herzegovina 1997. So what is the problem, why doesn't the Lebanese Government set up the Currency Board?

There could be several reasons why this magic wand of a solution has not been adopted in our country. The inability to form a government means that no important decisions would be made. There would also be doubt and uncertainty about how independently and without any interference the currency board would be allowed to operate. There could also be a lack of understanding about how the Currency Board would affect Lebanon's Gold Reserves. Most experts believe that our gold should not be liquidated, but that some of the gold should be used as collateral to maintain an overdraft. Nassib Ghobril, an economist and head of the economic research department at Byblos Bank, told Xinhua. that "We should definitely not sell our gold reserves. We need to encourage the authorities to take an overdraft against part of the gold reserves of about $6 billion, which will be injected into the economy through banks." 

One of the critics of setting up a Currency Board is Jean Riachi, chairman and Chief Executive Officer at FFA Private Bank. He thinks CB is another form of the peg and the problem with peg is that it cannot adjust to external situations, comparing this CB peg to the dollar peg of 1500 LBP.

Some other ideas to curb inflation are Floating Peg, digitizing the currency, distributing aid in dollars. None of these ideas seems as radical as what Currency Board seems to offer. 

Update - Would Sayrafa help in reducing inflation in Lebanon

The central bank has tried injecting USD into the market in the past to stabilize the value of the lira towards LL3,200, with limited success.

With Sayrafa, the BDL seems to have developed its own version of Prof Steve Hanke's Currency Board. The central bank announced on May 18 that it was launching a foreign exchange trading platform called Sayrafa, which aims to stabilize the lira and curb black-market trading by being the sole reference for Lira/USD exchange rates in the country.

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