Economic Escalation

The Impact of Central Bank Crises on Conflict-Ridden Countries in the Region

26 September 2024


Central banks play a pivotal role in stabilizing the economy of any country. Their responsibilities encompass regulating monetary policy and managing reserves to enhance monetary and financial stability, as well as the efficiency of the financial system. However, in countries grappling with political conflicts or civil wars, significant challenges emerge, leading to widespread economic repercussions.

Several countries in the Middle East have experienced central bank crises in recent times, such as Libya, Yemen, and Lebanon. These crises have left negative impacts on the political and economic stability of these countries, including the devaluation of local currencies, the loss of confidence in financial institutions, and the obstruction and complication of the political process to resolve conflicts.

Three Crises

The indicators pointing to central bank crises in the mentioned Middle Eastern countries can be explained as follows:

1- The East-West conflict in Libya: 

Since the overthrow of Muammar Gaddafi's regime in 2011, Libya has entered a cycle of political and military conflicts between rival governments in the east and west. This political and military divide has extended to economic institutions, including the Central Bank of Libya.  

On one hand, the state of division has directly affected the central bank's ability to perform its primary function of managing monetary policy, and has also exacerbated the liquidity crisis in the country. Commercial banks, which rely on the central bank to meet their liquidity needs, have found themselves facing a severe shortage of liquidity. 

On the other hand, this crisis worsened after the Libyan Presidential Council dismissed Sadiq Al-Kabir, the governor of the central bank, on August 18, 2024, amid the conflict between political factions and attempts to control sovereign state institutions. Al-Kabir was accused of representing a particular political party at the expense of national interests. However, his discharge appears to have been the result of political pressure aimed at controlling the central bank. Al-Kabir later fled the country, citing threats to himself and his staff.

The government appointed by the Libyan House of Representatives responded to this by suspending the production and export of Libyan oil on August 26, which had a tangible impact on the markets. Oil production fell from 1.2 million barrels per day to about 450,000 barrels per day during the blockade.

This crisis led to a decline in the Libyan state's ability to manage its foreign exchange reserves, determine the exchange rate, and control inflation, contributing to a sharp decline in the value of the Libyan dinar and increasing reliance on the parallel market to obtain foreign currencies. The decline was evident in the significant difference between the official price of the Libyan dinar and the unofficial price.

2- The banking divide in Yemen: 

Since 2015, Yemen has been embroiled in an internal conflict between the internationally recognized legitimate government and the Houthis. This ongoing strife, coupled with the pressures stemming from political division, has significantly impacted the performance of the Central Bank of Yemen. The relocation of the central bank's headquarters from the Houthi-controlled capital, Sana'a, to the government-held city of Aden, resulted in a split of the institution into two entities. This division has complicated monetary policies and fueled inflation rates.

Yemen's financial crisis has been further exacerbated by the halt in oil exports for approximately two years, a consequence of Houthi attacks on several oil facilities. The situation escalated on July 10 when the Central Bank of Yemen in Aden revoked the licenses of six banks operating in Houthi-controlled areas, prompting retaliatory measures against banks in government-controlled regions. Amidst this economic turmoil and concurrent with Yemen being affected by Houthi attacks on ships in the Red Sea since November 19, 2023, UN envoy Hans Grundberg sought to mitigate the crisis. On July 23, he announced an agreement between the Yemeni government and the Houthis on measures to de-escalate economic tensions, particularly concerning the banking sector and Yemenia Airways, with both sides agreeing to cancel recent punitive actions against banks.

During his monthly briefing to the UN Security Council in mid-August, Grundberg emphasized the critical importance of unifying the Yemeni currency and establishing a unified central bank. The success of Grundberg's proposals and efforts could significantly contribute to curbing the deterioration of the local currency and reducing inflation rates. However, these UN initiatives face substantial complexities and challenges. A major obstacle is that unifying the central bank would entail overseeing all government revenues in Yemen, a proposition the Houthis are unlikely to accept. They have thus far refused to implement the Stockholm Agreement, which obligated them to deposit revenues from the Hodeidah port into a special account at the Central Bank of Hodeidah branch for salary payments. Moreover, the Houthis have previously rejected similar proposals made by international monetary institutions, further complicating efforts towards economic reconciliation.

3- Declining confidence in the Central Bank of Lebanon: 

Lebanon is suffering from one of the worst economic crises since 2019. Although the central bank played a pivotal role in stabilizing the exchange rate through its "financial engineering" system, it ultimately failed to achieve monetary stability.

Recently, Riad Salameh, the former governor of the Central Bank of Lebanon who held this position from 1993 until late July 2023, has become the focus of political and legal controversy. Increasing pressure and demands for an investigation into his management of the bank have led to several charges against him, including mismanagement and corruption.

Many blame Salameh for the collapse of the Lebanese economy. Inflation has reached staggering levels, and the Lebanese pound has lost more than 95% of its value against the US dollar. The currency's value plummeted from 1,530 Lebanese pounds per dollar in October 2019 to more than 90,000 Lebanese pounds per dollar currently, decimating the purchasing power of the Lebanese people.

Similarities and Differences

By observing central bank crises within the region's conflict-ridden countries, several similarities emerge among the three nations regarding the impact of political and military conflicts on the financial and banking sectors. Concurrently, these countries differ in the nature of the crises they faced and how they addressed them, as follows:

1- Impact of conflicts on central banks: 

The three countries share the commonality that internal political conflicts and civil wars have undermined the independence of central banks, leading to a deterioration in their ability to manage monetary policies. Central banks in these countries faced severe political pressures that affected their capacity to maintain the stability of national currencies and monetary policies.

2- Loss of confidence in the banking system: 

In all three countries, the deterioration of central bank performance has led to a loss of confidence in the banking system as a whole. This has contributed to citizens resorting to the informal economy and the parallel market to obtain foreign currency, exacerbating the economic and living crisis and increasing the inflation rate.

3- Differences in the nature of internal conflict: 

In Libya, the internal conflict is characterized by being centered around two rival governments. This led to the division of the Central Bank of Libya into two branches in the west and east since 2014, before the bank announced the reunification of its branches in August 2023, amid local, international, and UN welcome.

In Yemen, the situation differs due to the ongoing war between the government and the Houthis, resulting in the continued division of the central bank between its branches in Aden and Sana'a.
Lebanon's crisis, in contrast, was not the result of a direct civil war but rather stemmed from political and partisan divisions. The reliance of Lebanese banks on unsustainable policies further complicated the financial crisis.

4- The Impact of natural resources on monetary policies: 

In Libya, which heavily relies on oil revenues, these resources provided a relative advantage in securing financial stability. However, the division between Eastern and Western governments hindered the effective utilization of this wealth. Lebanon, in contrast, lacks significant natural resources to support its economy, exacerbating its economic crisis as the central bank depended on external support and remittances from expatriates. Yemen possesses modest oil and gas resources compared to other countries. Yet, these assets have been poorly exploited due to ongoing conflict and Houthi attacks on oil facilities in areas controlled by the legitimate government, compromising the central bank's ability to secure necessary foreign exchange reserves and protect the economy from collapse.

Negative Impacts

As a result of these crises and the decline in central bank performance, the most prominent economic repercussions can be identified as follows:

1- Decline in foreign exchange reserves and growth of the parallel market:

Foreign exchange reserves are one of the primary tools relied upon by central banks to maintain national currency stability and finance imports. In Libya, reserves have declined significantly, leading to a widening gap between the official price of the Libyan dinar and its parallel market value. Sadiq Al-Kabir stated in March 2024 that his country's foreign exchange reserves amounted to about $29 billion, indicating that this figure is less than what the Libyan economy needs. He also described the statement by Abdul Hamid Dbeiba, head of the Government of National Unity, that reserves reached $84 billion as "inaccurate." Consequently, if political instability in Libya persists alongside the repercussions of Al-Kabir's removal, it threatens a further decline in foreign exchange reserves.

In Yemen, the decline in the Yemeni riyal's value and increased reliance on the parallel market to secure foreign currencies are expected to continue. This is compounded by the sharp decline in foreign exchange reserves, which have eroded significantly since the Houthi coup against legitimacy and the ensuing crises, despite economic support provided by Gulf countries to the legitimate government.

In Lebanon, the central bank's reserves have been depleted as a large portion has been used to support the economy and secure basic commodities for the Lebanese people. This has led to a decline in their size to about $10 billion currently, compared to about $34 billion in October 2019.

2- Decline in the independence of central banks: 

In these three countries, a decline in the independence of central banks is anticipated due to political conflicts, increasing internal and external pressures, and interference in their operations and monetary policy management.

These crises faced by central banks reflect the impact of political and military conflicts on their ability to maintain economic stability and manage monetary policies effectively, resulting in declining living standards, rising unemployment, and increasing poverty rates. Although there are similarities, the nature and causes of these crises differ among the countries. The solution, therefore, lies in reducing economic escalation between competing or conflicting parties, aligning with the political settlement process or completing transitional stages, and building legitimate institutions. This approach aims to end banking division, strengthen central bank independence, and implement necessary economic reforms.