Lebanon is drowning in a torrent of anxiety and frustration, facing the worst economic crisis in decades with projections of a 12 percent contraction this year — the largest since the end of the civil war in 1990. Thousands are out of work and protests swell in the streets in the middle of a pandemic. There is little else that most Lebanese can do in the face of a runaway currency depreciation that has driven up prices and eroded disposable incomes. Financial institutions have cut off access to savers" deposits while rioting has forced banks to fortify their buildings and seal off ATMs with iron curtains. sectarian tensions have also flared up. The end is not in sight, nor are there concrete visions of what a post-crisis Lebanon will look like — only that new realities are settling in, far different from the Lebanon of old. Before asking what can or should be done, Lebanon must first reckon with what went wrong and find a way to learn from it. The current crisis is the product of an unusual decade-long monetary policy. Banque du Liban, the central bank, raised interest rates for depositors to fund spiraling public debt and sustain generous subsidies on a host of imports — from basic goods such as wheat and fuel to luxury cars. The policy was also aimed at attracting inflows to maintain the Lebanese pound’s 23-year peg to the US dollar, affording a measure of currency stability. As a result, Lebanon became an attractive destination for foreign money with a high rate of return, as most other central banks cut rates to aid recovery after the 2008 financial crisis. Awash in so much liquidity during a global downturn, the Lebanese government was well positioned to make strategic investments, boost social safety nets, reduce the public sector wage burden or fund a sustainable expansion of the private sector. Instead, Lebanon became content with a veneer of prosperity from free-spending lifestyles highly dependent on overseas dollars and government subsidies on imports, crippling the agriculture and manufacturing sectors that are key to mounting any decent recovery or establishing resilience to economic headwinds. The peg worked to reassure foreign investors but it was overvalued by at least 50 percent, making Lebanese exports less attractive. Meanwhile, Banque du Liban continued to pay higher rates even as the funds entering the country were insufficient to cover interest and capital payments. Apparently, the only way out was to dig further in, based — surprisingly — on misguided expectations that deposits at commercial banks would continue to rise. Well, the opposite happened. Before asking what can or should be done, Lebanon must first reckon with what went wrong and find a way to learn from it. Hafed Al-Ghwell Local deposits fell sharply in 2018 and, a year later, foreign deposits crashed too. The financial engineering scheme at the heart of Lebanon’s monetary policy unraveled spectacularly. Paychecks, savings and deposits of ordinary Lebanese in local banks were lent to Banque du Liban at attractively high rates. In turn, local banks purchased government debt, resulting in consistent profits and dividend pay outs to shareholders, many of whom were politicians — which incentivized perpetuating the scheme for as long as possible. The government, on the other hand, kept accruing more debt; for instance, propping up the ailing state electricity company EDL to the tune of $1.5 billion a yea, and trying to buy votes by ratcheting up public sector hiring. Today, with a debt-to-GDP ratio of 176 percent, Lebanon is one of the most indebted countries in the world. The cost of subsidizing EDL alone amounts to 40 percent of Lebanon’s entire debt. Additionally, more than half of public revenues now go to servicing domestic and external debt, followed closely by public sector pay; all of this at a time when public budgets must prioritize boosting public healthcare capacity, and set aside funds for stimulus packages to kickstart stalled economies. Lebanon has defaulted on $30 billion of eurobonds while local banks have lost more than $20 billion in shareholder capital as the painful work to formulate some form of recovery begins. Talks continue with the IMF on an aid package worth $10 billion focusing on policies and reforms aimed at restoring stability, particularly in the financial sector, which is still the backbone of the Lebanese economy. However, the IMF wants to see progress on reforms and the implementation of new capital control laws first. There is also the risk that IMF members may block any deal with a Lebanese government in which Hezbollah plays a dominant role. Prime Minister Hassan Diab has little room to maneuver since he owes his ascendancy to support from the Amal movement, a Shiite party with close ties to Hezbollah, and President Michel Aoun’s Free Patriotic Movement, a Christian political party. The lack of momentum since April is a stark reminder that sectarianism will continue to neuter or outright cripple a much-needed government’s response — even when a crisis affects all Lebanese equally. However, international consensus remains that Lebanon needs to enact wide-reaching reforms to fix the root causes of the ongoing crisis. There is little faith in Diab’s recovery plan released in April and optimistic statements from IMF officials concerning Lebanon have failed to instill any confidence in buying Lebanese debt — which is trading below other debt-ridden nations such as Argentina, Ecuador and even Venezuela. Investors worry that disagreements between the central bank and local financial institutions on the scale of the losses from this crisis will also complicate recovery efforts. Estimates put that figure at $81 billion, but since the Lebanese pound was overvalued and some of the debt is in foreign currency, could be much higher. Unfortunately for ordinary Lebanese, even protesting as a last resort may not be enough to shake the government out of its intransigence or reluctance to enact bold reforms. While the government could still act, they did not — and now that they cannot act without foreign assistance, the path out of this crisis can no longer be determined by the Lebanese people on their own. In short, the country must prepare for very painful remedial steps that the global community is now demanding before intervening. Gone are the days of unbridled spending buoyed by misguided monetary policies and a stubborn unwillingness to confront the natural result of trying to finance large fiscal deficits with short-term deposits. Hafed Al-Ghwell is a non-resident senior fellow with the Foreign Policy Institute at the John Hopkins University School of Advanced International Studies. He is also senior adviser at the international economic consultancy Maxwell Stamp and at the geopolitical risk advisory firm Oxford Analytica, a member of the Strategic Advisory Solutions International Group in Washington DC and a former adviser to the board of the World Bank Group. Twitter: @HafedAlGhwell Disclaimer: Views expressed by writers in this section are their own and do not necessarily reflect Arab News" point-of-view