The Hoped-for Political Stability Stirs the "Submerged" Exchange Rate Since March 2023

Logically, in a flexible exchange rate system, a currency's value is determined by demand—just like any other commodity. If demand rises, its value appreciates against foreign currencies, and vice versa. However, this principle did not hold in Lebanon between November 27, 2024 marking the end of the war, and the election of the president on January 9, 2025. Despite estimates suggesting that demand for the national currency increased by up to $300 million during this period, its value remained stagnant. Could this experience, though limited in scope, signal the national currency’s inability to benefit from the billions of dollars expected to flow into the economy in the coming days for aid, reconstruction, and investment?

"The Lira Is Dead"

At first glance, monetary economist Layal Mansour is unequivocal in her assessment: "Yes, absolutely." She explains that "the official exchange rate of 89,500 lira differs from the actual market rate. Moreover, in an economy that is more than 92% dollarized, the central bank’s attempt to sell dollars to prop up the lira is a futile exercise that drains foreign currency reserves without satisfying the market’s insatiable demand for hard currency. Even if such a measure temporarily strengthens the lira, the improvement would be short-lived, and the exchange rate would soon decline again."

In this scenario, the central bank would throwing dollars away in an already dollarized economy. Unlike crisis-stricken nations where local currencies still function as a medium of exchange, the Lebanese lira is no longer widely accepted, cumbersome to use, and lacks credibility. Salaries in both the public and private sectors are paid in dollars, goods and services—including public utilities—are priced in dollars, and aside from some government fees and taxes, the lira is nearly obsolete in daily transactions.

"In this phase, particularly given the high levels of dollarization, the economy would benefit more from channeling incoming dollars into investments and development projects rather than increasing the central bank’s reserves to later inject liquidity for the sole purpose of boosting lira demand," Mansour argues.

The Pitfalls of Exchange Rate Liberalization

Economic and monetary analyses of the lira’s trajectory often clash with nationalist sentiments that seek to revive it through arousing patriotic feelings. If this logic prevails, dollar inflows may be used to bolster the central bank’s reserves and later sold to increase demand for the lira. While this could lead to a temporary appreciation of 10,000, 20,000, or even 50,000 lira per dollar, "the process would not only be short-lived but also so fragile that it could ultimately send the lira’s value plummeting to even lower levels," Mansour warns.

She points to Egypt’s experience as a cautionary tale. "Every time the Egyptian pound is floated, its value declines despite massive dollar injections from the IMF, Arab countries, state asset sales, remittances, and revenues from tourism and the Suez Canal.

The Exchange Stabilization Fund

What sets the post-2019 financial and monetary collapse era apart from the previous period is the central bank’s shift from a fixed exchange rate policy (currency peg) to what Mansour describes as a "disguised" Exchange Stabilization Fund (ESF). Unlike before, the central bank ceased lending to the government in both lira and foreign currency, imposed strict spending controls on the lira, and restricted banks' access to liquidity. In essence, it downsized the economy to match the inflow of foreign currency, ensuring that incoming dollars were no longer used to prop up a currency that people had already abandoned artificially.

Mansour believes that formalizing this implicit Exchange Stabilization Fund as an official policy is the only viable path to pulling Lebanon out of its monetary crisis and ensuring a steady inflow of investment. "Before 2019, when the lira was still strong, trusted, and widely used, increasing foreign currency reserves at the central bank boosted confidence in the currency. Today, however, the situation is entirely different."

Suppose Lebanon shifts from the current artificial stabilization policy to a fully floating exchange rate in compliance with IMF demands. In that case, Mansour warns that this "would trigger an unprecedented collapse of the national currency. The initial wave of optimism would soon be replaced by a harsh realization of the country's overwhelming dollar needs, leading to a renewed plunge in the exchange rate."

For Lebanon’s new reality, a new monetary framework is required—one that is exclusively based on either a Currency Board or full official dollarization, Mansour insists. "And if there is a serious intent to implement such a policy, it must be done now or never. The current window of opportunity is the only chance for Lebanon to adopt a credible and sound monetary strategy. If the decision is not made today, the country may miss this chance forever."

Shifting to a new exchange rate system is a significant decision that requires bold leadership and technical expertise. Such a move would eliminate Lebanon’s independent monetary policy, restricting the country to issuing lira only in proportion to incoming dollar inflows. It would also remove the central bank’s ability to intervene in the market through interest rate adjustments. However, in Mansour’s view, "Lebanon’s dollarized, service-oriented economy is well-equipped to handle these changes. Halting excessive interest rate interventions could benefit the economy and encourage investment."