ERASE, Currency Crisis, Inflation and Currency Devaluation, Economic Update

Monetary Policy Driving Exchange Rate Volatility

11:31 | 30 January 2022LIMS output
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Monetary Policy Driving Exchange Rate Volatility

The Lebanese pound (LBP), pegged for over 20 years at around 1,500 to the dollar, has been in a free fall since late 2019. On January 11, the pound hit a new all-time low of 33,000 LBP to the dollar, before closing the month at an exchange rate of 21,000 LBP to the dollar. The drop was a result of the central bank’s intervention, selling dollars to banks with no ceiling on the volumes, as long as banks are reselling those dollars to their clients against the local currency. The new exchange rate made the numbers of the government’s draft budget look more aligned with the market realities.

LIMS pointed out that the continued plummeting of the LBP is due to an erratic monetary policy. The past 2 years saw an increase of currency in circulation from 6,000 billion LBP in late 2019, to 42,000 billion LBP at the outset of 2022. Authorities printed money to cover the government deficit and commercial banks’ losses, rather than passing reforms. Moreover, the transition to a floating exchange rate is also driving the LBP’s volatility given the permanent political, social, diplomatic, and security matters. 

Since the beginning of the crisis, Lebanese banks started applying capital controls on the dollars deposited prior to October 2019, also called “old dollars”. Old dollars can only be withdrawn in LBP at an exchange rate set by the central bank, lower than that of the market rate, and financed through increasing the money supply. LIMS clarified that the LBP’s devaluation in the first half of January to 33,000 LBP to the dollar was fueled by the central bank’s decision to raise the exchange rate of old dollar withdrawals from 3,900 to 8,000 LBP to the dollar. It was also the central bank’s intervention through Circular 161 that brought the exchange rate down to 21,000 LBP to the dollar. However, the drop was achieved at the expense of the FX reserves, thus increasing the central bank’s losses, and exacerbating the banking crisis. 

LIMS restated that only a currency board can ensure long-lasting monetary stability in as little as 30 days. Due to its strict, rule-based monetary arrangement and full reserve system, a currency board guarantees a fixed exchange rate indefinitely.

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