Time is Money - Sadeq Institute

SADEQ INSTITUTE
Time is Money: The NTC should focus on the Libyan dinar
For many, what has been most revelatory of the February 17th revolution has been perhaps not the sheer
violence of the Gaddafi regime - the open and systematic handing out of which managed to silence a
population for over 40 years – but a more subtle, though arguably equally-as-grave a subjugation: the
broad economic disenfranchisement of the Libyan people. Behind the thick veil of Gaddafi‟s “Third
Way”, the Socialist State, have emerged economic realities that do not square with the headline figure
many have repeated en route for years: “Libya has the highest GDP per capita in North Africa and the 9 th
largest oil reserves of the world”, a phrase that speaks of potential though we have discovered, certainly
not of reality. One of the most striking images of the recent weeks perhaps: a group of five orphan boys
found, illiterate, clothes in tatters, tending to a flock of sheep; this, in a country with over $160bn in
foreign assets and annual government revenues exceeding $45bn. We knew it wasn‟t good, but did we
know how bad?
Images from inside the villas of the Gaddafi family have exacerbated the sense of injustice so, that much
of the “economic talk” on the Libyan street these days has centered on one of three issues: (1) how soon
can we resume oil production and start sharing in the wealth of our country? (2) how much of our money
did Gaddafi hide outside the country and how do we get it back? (3) how much gold do we have and did
Gaddafi sell any to finance his grip on power? While the sentiment behind these questions is well placed –
and the resumption in oil production a basic necessity – the immediate economic focus of the new Libyan
leadership should be on an issue with little popular appeal beyond economic circles: the stabilization of
the Libyan currency.
“Bullets are still flying in places like Bani Walid and Sirt, surely it‟s too early to speak of currency
stabilization”. On the contrary, let us take Iraq as an example: the US-led invasion began on March 19th
2003, Baghdad was taken 21 days later on April 9th, George W. Bush gave his too-eager “Mission
Accomplished” speech on May 1st and by May 15th, only two months into armed hostilities, the Council on
Foreign Relations, arguably the most influential think tank in the US, published a policy analysis coauthored by one of the world‟s most-sought after economists, Nouriel Roubini, on what should be done
about the Iraqi dinar. The haste with which the US sought to shape the new Iraqi currency (two months
into a war that has thus far lasted eight years and an entire seven months before Saddam was even
captured) should serve as an indicator to Libya‟s leadership. On September 10th 2011, the International
Monetary Fund recognized the NTC as the legitimate government of Libya and in her press conference,
Christine Lagarde, the Fund‟s chief, cited “stabilization of the currency” as the number two priority in
Libya, preceded only by oil production.
Tripoli, Libya
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The Libyan currency: a brief history
Shortly after independence, the Libyan Currency Commission was established and began issuing Libyan
pounds on 24 March 1952, named after the British Pound Sterling, to which it was linked at a fixed rate
of 1 Libyan pound to 1 British pound (GBP; at the time, still linked to the gold standard). At this stage,
the currency was managed by a currency board, i.e. the issuing authority held close to 100% foreign
reserves of GBP for every Libyan pound in circulation and had the ability to exchange on demand;
monetary policy (intended as the setting of interest rates and control of money supply in response to
inflation and economic growth) were left to the market.
In response to the increased sophistication of the Libyan economy, the National Bank of Libya was
established in 1956 and the currency board system was thus replaced by the central bank; the currency
was no longer fixed to the GBP, but was instead pegged to it (significantly loosening the foreign reserve
requirements and allowing for a relatively-more independent monetary policy, though not in the sense by
which independence is understood today in a post-Bretton Woods world). The pegging to the GBP was
de-facto replaced in 1967 by a determination of value relative to the Deutsch Mark and French franc, as
Libya did not follow the GBP‟s devaluation in the same year; nonetheless the gold standard prevailed
globally. On the US‟ abandonment of the gold standard in 1971, the value of the Libyan pound was
determined only nominally against gold, floating against the US Dollar (USD) and GBP.
With Gaddafi‟s coup in 1969 the Libyan pound was renamed the Libyan dinar to acquire a distinctly
pan-Arab character and in response to the nationalization of British Petroleum‟s Libyan assets in 1971 by
the Gaddafi regime, Libya was expelled from the Sterling area, sealing the demise of the close relationship
enjoyed between the Kingdom of Libya and the United Kingdom.
While the GBP no longer served as a reference currency, the nominal relationship with gold and peggedvalue to the USD held until the use of gold par values was ended by the IMF globally; at this stage, the
Libyan dinar remained pegged to the USD at a value of 1 LYD = 3.3777 USD which lasted until 1986 (a
value that is now recalled by Libyans as a source of national pride). With the escalating tensions between
the Gaddafi regime and the US, the pegging of the LYD to the dollar was ended in 1986 presumably in
symbolic retaliation (symbolic, as it has no economic consequences to the US) and replaced by a pegging
to the IMF‟s international reserve currency, known as “Special Drawing Rights” (commonly known as
SDR, denoted by “XDR”). The XDR is not a tradable currency in itself, rather it is a unit of measure used
by the IMF, whose value is calculated weekly as a weighted exchange rate of a basket of the world‟s most
traded currencies (its associated interest rate values form the basis of IMF loans). Despite Gaddafi‟s
symbolic retaliation, the USD, as the world‟s de-facto reserve currency, forms a significant part of the
XDR basket.
Tripoli, Libya
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Beginning on 1 May 1986, the rigid peg to the XDR was loosened, introducing a managed-float system
with an associated band. The published band grew from 7.5% to a peak recorded width of 77.5%,
allowing the Gaddafi regime to systematically devalue the LYD at every new widening of the band. As at
the latest values available prior to the February 17th revolution, the LYD had been devalued so much so
that from a 1986 peak value of 1 LYD = 3.3777 USD, every dollar is now worth 1.30 LYD
(meaning, 1 LYD = 0.2960 USD, an over 91% devaluation).
The rationale for currency stabilization
The Central Bank of Libya (established in 1970), headed pre-revolution by Farhat Bengdara, recently
replaced by an unknown Gassem Azzoz, has been representative of the Gaddafi regime in its opacity in
releasing data; Bengdara and Azzoz themselves have not been questioned publicly about the exchange
rate system and systematic devaluation of the LYD in the Gaddafi years (questions towards Bengdara in
the international media have thus far focused on an accounting of the assets held by the Central Bank,
particularly gold, and whether Gaddafi had taken any to finance his last stand; Bengdara‟s answers have
been approximate at best).
Presumably though, the weaker LYD supported Gaddafi‟s policy of national self-sufficiency, that is, a
weaker currency would make imports too expensive, promoting the Green Book imperative for economic
autarky and justifying the need for central planning and the Socialist state. In this sense, a systematically
devalued Libyan dinar largely contributed to an isolated Libyan economy; a reversal of this policy could
therefore lead to a veritable economic transformation of Libya with the demise of uncompetitive
industries, increased specialization, an exponential growth in trade and more choices for Libyan
consumers.
In the near term however, what is likely to trigger public scrutiny over the currency mechanism, will be
one of two issues:
(1) the resistance of the NTC‟s Ali Tarhouni (de-facto interim minister of the economy) towards
liquidating Libya‟s foreign assets - despite dwindling domestic funds - to pay for salaries (which will raise
the question of printing currency), or
(2) the potential discovery of false banknotes rumored to have been used by the Gaddafi regime to pay
for the alleged use of mercenaries.
Tripoli, Libya
[email protected]
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SADEQ INSTITUTE
While the latter issue remains but a rumor, in an unstable transitional stage, any credence lent to this
rumor could lead to a discrediting of the banknotes in circulation and informal use of dollars or euros
may emerge (during the 80‟s and 90‟s economic embargo period, many Libyans will remember dollars
smuggled from Tunisia and Egypt, waved in stacks by make-shift brokers to passing cars on highways
willing to exchange them for extortionate black market rates). It is our view that this is not likely to
happen, particularly if the NTC continues to speak with one voice to the public, as it has through AbdelJalil and now with Al-Keeb (previously Jibril) . Notwithstanding the continued roles of Abdel-Jalil and AlKeeb or a strong replacement, the effects of a banknote discrediting could be easily stemmed by
exchanging old banknotes for new ones on a one-to-one basis on demand at all banks (if this is not
executed rapidly however, a banknote recall followed by limitations on bank cash withdrawals to “buy
time” would not work, as the Gaddafi-imposed limit of 500 dinars/month withdrawal per person in the
late 70‟s - early 80‟s, is a sore memory for Libyans and if repeated, may lead to discrediting of the NTC
and political deadlock).
The former issue however is the more likely scenario; that is, as the NTC‟s Ali Tarhouni is resisting
populist calls to have all foreign Libyan assets liquidated and repatriated to Libya, the alternative that will
emerge in public discourse is the currency will have to be printed domestically to pay for salaries. From an
economic (as opposed to populist) perspective, this is the sensible decision, as Libya‟s foreign assets are
invested in a variety of portfolios, the nature of which should be determined before making decisions to
liquidate, potentially at a loss. Additionally, foreign assets have been invested as strategic long-term
reserves for future generations and while there is a pressing short-term need, this view should not be
entirely forfeited. In the interim, loans taken out based on future oil revenues, collateralized by frozen
assets, could be an acceptable financing option. Once domestic funds run out however, the “printing
money and currency mechanism” conversation will have to be held publicly and it is important for the
NTC to send a clear message to the public as to how it expects to pay for upcoming salaries, and to the
international community, as to how it expects to print money (and maintain its value) to finance any
interim external debt taken on. Overall, the NTC should recognize that any decision made now regarding
the currency affects future policy flexibility and it is therefore critical to get it right.
What are the options?
For the new head of the Central Bank, Azzoz, who is said to have launched a competition to “re-design”
the Libyan banknotes (it would be embarrassing for the NTC to continue paying the workers of a “free
Libya” with banknotes depicting Gaddafi for much longer), there are a number of options regarding the
dinar, though a revaluation seems inevitable. There exist a variety of exchange rate mechanisms available
to any monetary authority; the analysis here presented will borrow the framework used by Roubini and
Setser in their Iraq policy analysis for the Council on Foreign Relations (“Should Iraq dollarize, adopt a
currency board or let its currency float? A policy analysis, Roubini, N. and Setser, B., Council on Foreign
Relations, 15 May 2003). Their analysis was chosen as a relevant case study due to the similarities
between Iraq and Libya in terms of economic reliance on oil, relative population size and rapid change in
governance.
Tripoli, Libya
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Roubini and Setser focus their analysis on three exchange rate mechanisms:
1. Dollarization
2. Currency board
3. Managed float
The first option, dollarization (or euroization) entails using the USD or EUR as the currency of Libya in
an interim stage and usually occurs informally in emerging economies with discredited domestic
currencies; this was relevant in Iraq as the US government and the Federal Reserve were shipping millions
in small-denomination US dollar banknotes to the „new Iraq‟ as an interim solution and contractors
rebuilding the Iraqi infrastructure were paid in US dollars. This is not relevant – at least at the time of
writing - in Libya as a shipment of newly minted Libyan dinars has recently been unfrozen and delivered
to the NTC by the UK government where they were being printed. It also appears people in Libya have
not made a “run on the banks” to withdraw their deposits and are managing to make basic purchases with
the volume of dinars in circulation instead of resorting to an alternate currency. At a policy level,
dollarization entails relinquishing monetary policy authority over to the Federal Reserve and the Central
Bank would de-facto have little to no power.
The currency board system has much the same effect; while the currency would be a local print and
design, it would have to be backed one-to-one with foreign reserves of the anchor currency (for
arguments‟ sake, the US dollar); that is, for every Libyan dinar, an equivalent value of US dollars would
have to be held in reserves by the Central Bank and be exchangeable on demand at the fixed exchange
rate. This is in essence, putting a Libyan face on a dollar note and entails the same loss of monetary policy
authority as dollarization.
The third option, a managed float exchange rate mechanism – advocated by Roubini and Setser for Iraq
and herein advocated for Libya – entails a new Libyan dinar whose value relative to other currencies is
allowed to float within an acceptable band (for example, ± 5%). In order to preserve the band (which can
itself be readjusted upwards or downwards if need be), the Central Bank would make ad-hoc
interventions by buying or selling Libyan dinars in the open market (vice-versa, selling the reference
currency, e.g. the US dollar, or buying it) to respectively revalue or devalue the currency. Interventions
would be carried out with foreign currency reserves, of which Libya holds in excess of $100 billion. The
Central Bank would hold discretion over its growth and inflation targets, interest rate decisions and
money supply volumes.
Tripoli, Libya
[email protected]
www.SadeqInstitute.org
SADEQ INSTITUTE
Which system should Libya adopt?
What should be categorically avoided are the first two options: dollarization or a currency board. In
particular, any form of informal dollarization should be stemmed at the outset (whether it occur in trade,
payment of salaries, or everyday purchases and transactions occurring privately); the key here for the
NTC is in the payment of salaries as a significant proportion of Libyans are employed by the state and
will make purchases with the currency they are given. In parallel, foreign and domestic companies
resuming operations in Libya should be forced to make payments to their employees and settlement of
trade contracts in Libyan dinars (perhaps by instating a routing of all payments to domestically-held bank
accounts once liquidity has been credibly established).
In a related option, what should also be avoided is a pegging of the value of the dinar to the dollar or euro
(as was previously the case with the dollar until 1986, the GBP before that and now to the SDR). In all
these cases, the Central Bank of Libya loses all sovereignty over its monetary policy (that is, it cannot set
its own interest rates to adjust to the inflationary conditions in Libya). As elucidated by Roubini and
Setser in their Iraq paper, the US/EU are net oil importers and Libya is a net oil exporter, which means
an increase in the price of oil hurts them (as it is such a significant input-cost), but benefits Libya; if Libya
adopts their monetary policy (by pegging the LYD to the USD for instance), it would be setting interest
rates too high in a slowdown (exacerbating the crisis) and too low in inflationary times (causing more
inflation). This is the trap the GCC (Gulf Cooperation Council) countries, whose currencies are pegged to
the dollar, are currently suffering from. The US is in a recession following the global financial crisis, so
the Federal Reserve has slashed interest rates to the lowest rates on record (close to 0%; negative in real
terms if inflation is taken into account). At the same time, the price of oil has shot up, amassing great
wealth for GCC economies. The economic growth in the GCC generates inflation (as too many riyals or
dirhams chase too few goods), which should be tamed by raising interest rates. However, because GCC
currencies are pegged to the dollar, the GCC central banks have to follow the Federal Reserve in slashing
their interest rates – simply creating more inflation. In essence, their currencies fixed exchange rates
systems have not allowed monetary policy to provide “counter cyclical output stabilization” (i.e. adjusting
to absorb the impact of inflation due to booming oil prices) and the real purchasing power of its citizens
is thus eroding.
Tripoli, Libya
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SADEQ INSTITUTE
Additionally, since the 2007 global financial crisis, the reliability of the dollar as the reserve currency of
the world has come under severe scrutiny and its value has in real terms been on a steady course of
devaluation; pegging the Libyan dinar now could spell instability down the line and not serve to reverse
the devaluation carried out by the Gaddafi regime. An alternative pegging to the euro is not desirable
either as the very survival of the Eurozone‟s single currency is in these days coming under severe test by
the economic crises in its peripheral states.
What the Central Bank of Libya should adopt is a managed-float currency system whereby the LYD is
allowed to move freely against a basket of world currencies within a band, thus reflecting a truer market
value, which is almost certainly higher than that of the Gaddafi-era LYD (the Iraqi dinar continues to
shoot up since the free float system was put in place in 2004). While an entirely free-floating currency
system is also an option, a managed-float system (i.e. one that has a band) can provide stability and
predictability to the economy. A managed-float system would overall provide the Central Bank of Libya
with the appropriate discretion in managing interest rates to control inflation as well as the ability to
intervene to absorb terms of trade shocks (that is, intervening to devalue the currency to protect nominal
domestic wages and employment and to reroute consumption from imports to domestic goods, when
there is an oil price shock).
Next steps
The current LYD-XDR pegging (and the XDR‟s large weighting towards the USD and the EUR) is an
unsustainable and undesirable option for Libya and should be replaced in the near term with a managed
float against a basket of currencies. An initial “free float” period can be used to establish a range of
reference values for the managed band.
To ensure this can occur, the Central Bank must first of all be an independent and credible institution.
Citizens‟ first scrutiny in a transition phase should be on Gassem Azzoz‟s qualifications as Central Bank
chief: he must be, importantly, a technocrat, not a politician, and an economist by background. It is of the
essence that political interference with Central Bank functions be refuted. Along with Ali Tarhouni, who
heads up the economic affairs ministerial portfolio for the NTC, Azzoz should establish a clear currency
agenda (which system will be chosen to determine the value of the LYD?) and step up to the media
forefront, rather than be relegated to counting the gold bars in the coffers of the state.
Tripoli, Libya
[email protected]
www.SadeqInstitute.org
SADEQ INSTITUTE
In a related matter, public calls have been made recently through several media outlets by Jamal
Abdelmalek, Chairman of the Libyan Bank of Commerce and Development (an until-recently stateowned bank) to “immediately de-peg the LYD from the US dollar”; that such a high-level banker is
seemingly not aware of the currency‟s peg to the SDR and has not been as yet publically rectified by the
NTC or the Central Bank, does not serve to instill confidence in the economic management of the new
Libya (irrespective of his role as a private, not Central Bank, banker); a more proactive and public
approach from the Central Bank is urgently needed and a cadre of qualified technocrats, supported by
technical assistance from the IMF and the EU, should replace the old guard in Libya‟s banking sector
which is almost-entirely state-owned.
The reality of currency stabilization is that once a system is adopted, it will be difficult to replace and
when the NTC begins paying salaries in new oil revenues – a matter of when not if - the decision will
have to be made.
By Fayruz Abdulhadi
November 12, 2011
London, UK
Tripoli, Libya
[email protected]
www.SadeqInstitute.org
SADEQ INSTITUTE
Tripoli, Libya
[email protected]
www.SadeqInstitute.org