Chronicle of the Middle East and North Africa

Lebanon Dollarization Widens Inequality Gap

Lebanon dollarization is considered as informal, and this phenomenon has created an endless cycle of recurring crises in the country. In the lack of a comprehensive solution, there will likely be an increase in poverty and inequality.

Lebanon Dollarization
A worker updates product prices to US dollar in Beirut as the country’s grinding political and economic crises show no signs of abating. Joseph EID / AFP

Ali Noureddine

This article was translated from Arabic.

Dollarization refers to the adoption of a foreign currency by a country’s population for their daily transactions, pricing of goods and services, and banking activities.

In simpler terms, dollarization occurs when residents of a country stop using their national currency, in part or entirely, due to its failure to perform basic functions such as facilitating buying and selling, saving, and measuring value.

Typically, dollarization rates increase in countries experiencing monetary turmoil, exchange rate instability, and other issues that erode confidence in their local currency. While the term dollarization often involves the US dollar, it can also involve other strong foreign currencies such as the euro or the British pound.

The expansion of dollarization in Lebanon

Lebanon has experienced high levels of dollarization in its financial system since the 1990s. Even before the local currency’s collapse in late 2019, deposits in foreign currencies, particularly the US dollar, accounted for about 68.8 per cent of total bank deposits.

Additionally, more than 67.6 per cent of checks traded between banks were in foreign currencies. Despite this, consumers still used the Lebanese lira for paper money transactions in the market.

However, the current financial collapse has led to a dangerous phenomenon of high rates of dollarization in the consumer market. Merchants and service providers are now pricing their products and services in dollars and demanding cash payments in dollars or the equivalent in lira based on the parallel market price.

This trend is now affecting supermarkets, private generator service providers, gas stations, as well as basic services and commodities such as hospitals, medicines, medical supplies and insurance fees. This trend is primarily due to the continued rapid daily decline of the local currency’s value and its inability to perform its natural role as a means of measuring value or purchasing goods and services.

The repercussions of dollarization in Lebanon

The main problem in Lebanon is that according to statistics only 3 per cent of residents receive salaries or income entirely in US dollars, while the vast majority receive their wages in Lebanese lira. Between the start and end of 2022, the exchange rate of the dollar in the parallel market increased from 27,500 lira to 42,400 lira, a 54 per cent increase in just one year, and currently hovers around 80,000 liras after peaking at 90,000 lira to the dollar at the end of February.

This dollarization of prices and the continuous depreciation of the local currency against the dollar means that residents’ purchasing power is eroding almost daily in Lebanon. This explains the high rates of extreme and multidimensional poverty and the soaring cost of food which consumes the largest proportion of residents’ incomes during the current crisis. It’s worth noting that the Lebanese state has not yet approved any comprehensive wage correction to address this crisis.

The Lebanese government continues to collect taxes in the local currency, while income taxes are calculated in dollars using a low exchange rate that is currently only 19% of the actual exchange rate in the parallel market.

As a result, importers and traders are able to collect and guarantee their profits in cash US dollars, while the government’s revenues are severely limited due to the low exchange rate used to collect taxes. With every further deterioration in the value of the dollar in the parallel market, the actual value of public budget revenues, denominated in Lebanese lira, continues to decline.

It’s widely known that increasing public revenues directly translates to expanding the government’s role in financing social protection networks, providing free education, and ensuring the quality of teaching in public schools and the state-affiliated Lebanese University.

However, the significant drop in the value of public sector employees’ salaries denominated in lira compared to market prices denominated in dollars has led to the closure of most public administrations.

Dollarization has distorted the monetary environment in Lebanon. While initially a response to the chaos and decline of the lira, it has now become a problem in and of itself due to the rise in prices in comparison to incomes earned in the local currency.

The complexity of the monetary crisis has also increased as a result of dollarization, with anyone who obtains liquidity in lira immediately seeking to convert it into dollars on the parallel market, further driving up the dollar’s exchange rate. In this manner, dollarization has created an endless cycle of recurring crises.

Formal and informal dollarization

Economists distinguish between various levels and types of dollarization. One of these is official or full dollarization, which occurs when a government makes a legal decision to abandon its national currency and replace it with a foreign currency. This has occurred in countries such as Panama in 1904, Ecuador in 2000, and El Salvador and Guatemala in 2001. These countries typically make this decision due to urgent circumstances that require relinquishing the ability to create their own currency in exchange for reliance on the currency of another country.

The formal or full dollarization strategy has a number of problems, according to economists. For instance, it takes away central banks’ ability to print money, which prevents them from acting as the last-resort lender for the government and the banking sector.

Furthermore, it deprives the central bank of the capacity to establish its own monetary policy by controlling interest rates, money supply, and the amount of money injected into the market.

As a result, when countries adopt comprehensive or official dollarization, central banks lose crucial tools to tackle inflation and economic stagnation. El Salvador, for example, has suffered from recurring economic crises since adopting the formal and comprehensive dollarization model over two decades ago.

In the case of Lebanon, the prevailing situation cannot be classified as official or complete dollarization, as is the case in Panama, Ecuador, El Salvador, and Guatemala, but rather as informal dollarization. The market’s propensity for pricing and transacting in dollars was not the product of a formal strategy or deliberate government actions, but rather due to the loosening of the currency market and the volatility of exchange rates. Compared to the effects of official or total dollarization in nations like El Salvador, the adverse impacts on the people of Lebanon are more severe.

Therefore, comparable with nations that adopt complete or official dollarization, nations that suffer from informal dollarization experience all the negative effects that come in the wake of losing financial and economic sovereignty. Additionally, they also deal with other issues, such as a decline in the purchasing power of wages paid in local currencies as a consequence of declining market exchange rates. This situation results from the lack of advance planning for dollarization scenarios.

So long as the nation is in a financial crisis that undermines trust in the local currency, the Lebanese people will continue to suffer from the effects of dollarization in the market. Implementing a thorough financial recovery plan that tackles the crisis of the banking sector’s losses and the collapse of the Lebanese state is necessary to rebuild trust in the local currency.

Bank failures, public budget concerns, and the disruption of foreign transfers to the official financial sector are to blame for the fluctuating exchange rates and chaos in the currency market. The high rates of dollarization and the declining value of the lira indicate that, in the lack of a comprehensive solution, there will likely be an increase in poverty and inequality.

user placeholder
written by
All Dima articles