Can Libya function without a central bank?

Libya is embroiled in a political conflict between two opposing groups vying for control of its central bank

The Central Bank of Libya in Tripoli. The regulator is the only authorised entity to manage the country's oil revenue. Reuters

Libya’s two rival governments have not yet reached an agreement on who would lead the country's central bank. Any delays or failure could plunge Libya's economy into a deeper crisis as it reels from a liquidity shortage and high levels of inflation.

The Central Bank of Libya is the only authorised entity to manage the country's oil revenue, which accounts for more than 90 per cent of the total government income, and is responsible for paying state salaries nationwide.

“The central bank's role is strategic – not only as the manager of international transactions, including oil revenue and international reserves, but also as the government's bank for payments, including salaries for civil servants and the military – which is now a question mark,” said Nasser Saidi, president of Nasser Saidi and Associates.

“Impeding the activities of CBL threatens the very livelihood of Libya, with a loss to all parties and the population … any delays in payments of salaries will trigger further disarray, with an economy already struggling with liquidity shortage,” he told The National.

The recent political turmoil in Libya, which started roughly last month, has highlighted the critical role of a functioning central bank. Other countries in the Arab world, such as Lebanon and Yemen, which have endured dysfunctional central bank systems for many years, have seen their currencies and overall economies crumble, along with the well-being of their societies.

Debt of instability

Libya, which has the largest crude reserves in Africa, has had little peace since the 2011 Nato-backed uprising and removal of Muammar Qaddafi, and its split in 2014 between warring eastern and western factions.

His removal triggered a civil war and a severe humanitarian crisis. The conflict also caused widespread destruction in Libya, damaging its economy, oil production, infrastructure, and vital services.

Libya's 2014 division created two central banks, one aligned with the Government of National Accord (GNA) in Tripoli, which was later replaced by the Government of National Unity in 2021, and the other with the House of Representatives, in Tobruk. The division of the central bank contributed to a large decline in economic activity, disrupted financial markets, and eroded investor confidence.

Foreign direct investment in Libya experienced a sharp decrease from $2.92 billion in 2013 to $829.9 million in 2014, and by 2015 it had reached minus $523.2 million, which meant that more investments were flowing out of the country than into it, according to data from Statista.

The central banks were reunited in 2023 as part of broader efforts to stabilise the country.

The current standoff began last month when the leader of the Presidency Council in Tripoli attempted to remove the long-serving central bank governor, Sadiq Al Kabir, and install a rival board.

This prompted the eastern-based administration to declare the closure of the country's oilfields and halt production. As a result, Libya's daily output of 1.2 million barrels has dropped by more than half.

However, last week, the UN mission in Libya said that the two governments had reached an agreement to appoint a new governor for the central bank, sparking hopes of a swift end to the crisis.

“The current uncertainty threatens to destroy the 10 years of building trust and credibility with the international financial system. While an agreement has been reached between the two factions to jointly appoint a central bank governor, consultations are still continuing,” Mr Saidi said.

“Delays threaten not only the ability of the CBL to provide domestic banking and payment services but access also to the international financial system and source of income from oil sales,” he added.

Over two million Libyans, who depend on government jobs, are facing delays in their salary payments due to the continuing crisis, Oxford Economics said in a research note in August.

“Most of the working people in Libya get a government salary, but the real money is in other budget items, like contracts for securing petroleum facilities or building a bridge … that's where the militias make money and they are putting pressure on the political principals to keep that money coming,” Francois Conradie, lead political economist at Oxford Economics, told The National.

Banking confidence hit

Mr Conradie said that efforts were being made to intimidate commercial banks into ignoring the CBL's directives. He added that foreign correspondent banks had chosen to cease their business with Libyan banks, considering it too risky.

Libya has 20 banks with total assets of around 143 billion Libyan dinars ($30 billion), according to an International Monetary Fund report from June 2023.

Loans and credit facilities are less than 15 per cent of total banking sector assets, the majority – around 60 per cent – are balances at CBL, the report said.

“There's a lot of interference with trade [and] finance, and reasons to fear that if exports are interrupted, then at some point they're going to have to let the currency slide,” Mr Conradie said.

If the CBL is cut off from corresponding with other central banks, it could face difficulties in maintaining the value of the Libyan dinar against the dollar, he added. “You can say there's a currency risk”

Libya’s economy relies heavily on crude exports, with oil revenue making up more than 50 per cent of the country’s gross domestic product. Production stoppages have historically impacted growth more severely than natural disasters or wider geopolitical factors.

In May, the IMF projected that Libya’s gross domestic product will grow by 7.8 per cent this year, following a 10 per cent expansion in 2023.

In Libya, the central bank is vulnerable to government instability. However, in some countries, these financial institutions themselves can end up destabilising the economy through misguided policies and unconventional approaches.

“When thinking about ‘dysfunctional’ central banks, I think it helps to categorise them. There’s a more common form in which the central bank is undertaking policies that adversely affect its job of keeping inflation low – think Turkey and Argentina in recent years,” said William Jackson, chief emerging markets economist, Capital Economics.

“The dysfunction in countries such as Lebanon and Libya is altogether different, idiosyncratic and symptomatic of the broader political dysfunction in each country,” Mr Jackson told The National.

In Turkey, keeping interest rates too low led to excessive credit growth and boom-and-bust cycles, while in Argentina, the central bank’s funding of the government's budget deficit caused inflation to rise by injecting too much money into the economy.

Lebanon’s central bank troubles

Lebanon's economic collapse, largely attributed to its central bank's actions, has been one of the most severe in recent history.

The Banque du Liban, under former governor Riad Salameh – who was arrested last week on suspicion of embezzlement – introduced “financial engineering” in 2016, a set of mechanisms designed to maintain a fixed exchange rate between the Lebanese pound and the US dollar.

However, this policy ended up weakening the country's banking sector and further increasing public debt.

“The now notorious financial engineering operations essentially transferred the Lebanese banks’ foreign exchange reserves to the central bank, which then used them to service the foreign debt of Lebanon’s government and to cover some of the trade deficit,” the Peterson Institute for International Economics said in a report last year.

“In return, the banks received paper assets on terms that made them look profitable, but that cannot now be honoured by the central bank,” the report added.

Mr Salameh's monetary policies, along with government corruption and mismanagement, are thought to have triggered Lebanon's economic crisis, marked by slowing growth, a weaker currency, a failed banking system, and widespread poverty.

The banking sector is facing more than $70 billion in losses and its currency has lost more than 90 per cent of its value since 2019, when the country defaulted on its debt for the first time in its history.

“The key point is that the central bank should play the key role in the economy of setting interest rates to control inflation, acting as a banker to the government, facilitating the functioning of the financial system and channelling foreign currency into and out of the country,” Mr Jackson said.

“If it can’t perform these roles, you’re likely to see inflation spiral and activity disrupted as firms can’t access foreign currency or credit.”

Are central banks necessary?

John Maynard Keynes, the British economist whose work inspired Franklin D Roosevelt’s 1933 New Deal programme, was a strong advocate for central banks and their role in economic stability.

He said that monetary policy tools, such as interest rate adjustments and open market operations, could be used to influence aggregate demand and offset economic downturns.

During periods of economic slow down, central banks lower interest rates to encourage borrowing and spending, while during periods of inflation, they raise rates to curb demand.

There are very few countries in the world without central banks.

Small nations without their own central banks typically adopt the currency of a neighbouring nation or regional monetary union.

For instance, Monaco and Andorra, two small European countries, depend on the European Central Bank (ECB) for their monetary policy, while Liechtenstein relies on the Swiss central bank.

Despite global acceptance, the system of central banks has not been without its critics. Foremost among them was Austrian economist Friedrich Hayek, Mr Keynes' intellectual rival and a proponent of free market economics.

Mr Hayek believed that by controlling the money supply, central banks were engaging in centralised planning, which conflicted with the idea of free markets.

He also argued that central banks caused inflation by printing too much money, eroding savings, and leading to economic instability.

Central banks have also been criticised for their limited effectiveness in addressing deep-rooted economic problems, such as structural unemployment and income inequality.

In recent times, there has been a growing interest in alternative financial systems, such as commodity-backed currencies or decentralised finance, as a means to ensure economic stability without relying on central banks.

Despite these developments, the US Federal Reserve and a few other major central banks continue to exert significant influence over global financial markets.