Geopolitics on the rocks

Can Libya's collapsing economy be the key to stabilisation?

Middle East and North Africa

Libya’s three governments and numerous militias have been vying for power and territory. However, they share an interest in increasing oil production and having money to spend. That’s why an economic deal among the country’s main factions could be the only way leading toward stabilisation.

When it makes headlines in Europe, Libya is usually associated with migrations or jihadism. Yet, it is the country’s economy that today provides both the most important opportunity and one of the most serious threats. A collapse of Libya’s economy could have serious consequences for Europe by pushing even more migrants to try to cross the Mediterranean while the economy is probably the only issue on which the different armed factions can be reconciled, if ever.

A country divided in three governments

Despite international efforts, a UN-backed agreement and several UN resolutions, Libya remains a divided country with three different governments; none of which actually runs the country.

The Presidency Council headed by Faiez Al Serraj is based in Tripoli derives its legitimacy from the Libyan Political Agreement signed in the Moroccan city of Skhirat in 2015 and endorsed by the UN Security Council. Though being highly ineffective, it is the internationally recognised government. The Presidency Council’s nominal control extends only to Western and Southern Libya and even there it is mostly local forces actually controlling cities and villages.

Eastern Libya and some pockets of southern and western Libya are under the control of General Haftar. The head of the armed forces has established a de facto military dictatorship. Hafter and his government, headed by Abdullah al Thinni, have established parallel economic institutions that report directly to Haftar’s headquarters in Marj. While Western and Southern Libya are rather chaotic and policentric, eastern Libya seems more ordinate because of the absence of any structured or powerful opposition to Haftar’s rule, despite some pockets of resistance in Benghazi and Derna.

Finally, a third government is made up by the remnants of the “Salvation Government” which was set up in September 2014 to represent the anti-Haftar coalition Libya Dawn and was never recognised by a single country. The Salvation Government had effectively withdrawn from Tripoli when Serraj arrived on 30 March but came back in October occupying their old headquarters in the Rixos hotel and starting to issue decisions and inaugurate power stations as if they were the legitimate government.

As a consequence of this division between rival governments which in one way or another has now lasted for more than two years, Libya’s bureaucracy and institutions are also divided and dysfunctional. Only three ministries actually work in the capital: Foreign Affairs, Interior, Transports. The Central Bank and the National Oil Company have parallel institutions in the east. The management appointed by Serraj to head the Libya Investment Authority and the Electricity Company are being challenged in court by the previous management.

At the moment, few institutions are completely legal in Libya. The House of Representatives’ mandate expired on 20 October 2015 and it could only be extended by approving the LPA, which the House never did. Because the LPA was never approved into a constitutional amendment, the Presidency Council and the Government of National Accord effectively do not exist in the Libyan domestic legal system. Finally, the mandate of the governor of the Central Bank expired on 26 September and he’s unlikely to be replaced given the political deadlock.

The economic challenges

Libya has an extremely weak central government and no unified security sector but one part of the government has continued to work somehow: the oil and financial institutions which even under Gaddhafi were allowed some level of competence.

The continuity of economic institutions (and of the payment of government salaries) was a crucial factor in keeping minimal levels of stability in the country after the government fled Tripoli and rival executives were set up in the summer of 2014. This was a precise goal of American policy implemented through a series of UN resolutions and the ringfencing of the Central Bank. Yet, this equilibrium could last only for an interim period.

At the current exchange rate, Libya needs every year $ 30 billion to pay for subsidies and for the salaries of its bloated civil service, which employs about 80% of the workforce. Since 2014 and until recently, this sum was financed almost exclusively by tapping into the reserves of the Central Bank of Libya (CBL). These reserves were above $ 100 billion in mid-2014 and dropped slightly below $ 40 billion two years later. At the current pace, without a budget correction and without changes in the official exchange rate between the Libyan Dinar and the dollar, reserves could dry up in less than two years.

The post-Gaddhafi budget policy was highly dysfunctional and it has become even more so with the collapse of the government in Tripoli in the summer of 2014 and the establishment of two rival entities in the east and in the west of the country. Since then, the CBL has paid solely government salaries (both Serraj’s and Haftar’s) and the subsidies on imports. The latter are an important part of Libya’s “social contract” but the excess of supply in subsidised goods fuels smuggling with neighbouring countries. Ultimately, Libya is going broke while paying largely for very improductive expenditure: salaries for a bloated civil service which includes the militias that cause the current chaos; subsidies that are a boon for the smugglers.

Reforming the budget and reining in spending is a gigantic task. Whoever wants to reform the Libyan economy will fight against several odds: the vested interests which profits from the current system, including organised crime and militias; the lack of political legitimacy in a country with extremely weak institutions and no functioning parliament; an angered population that had high expectations from the unity government and has seen the situation getting worse and worse.

Since September, with Haftar’s “liberation” of the Oil Crescent where 60% of the country’s oil resources are either produced or transported, oil output has been growing dramatically and Libya has been granted an exemption by Opec so its production could still grow to levels where it would make a difference to the budget. Output, which was merely 300,000 barrels per day last summer, is now oscillating between 600,000 and 700,000 bpd and the NOC aims to bring its level to 900,000 shortly. Increasing and sustaining production will need funds for maintenance and only a fraction has been disbursed so far. The head of the NOC, Mustafa Sanalla, has the trust of both Serraj and Haftar and during the Rome Mediterranean Dialogues in December has proposed an economic deal to share the country’s wealth.

This would be the right direction as all parties need money and for money to be produced there needs to be oil output which in turn needs minimum levels of security and working relations between rival factions. A glance to the map of oil fields, pipelines and terminals shows how delusionary are talks (mostly in the Western media) of a partition of Libya into its three Ottoman provinces of Tripolitania, Cyrenaica and Fezzan. Each region needs the other and UN resolutions mandate that all oil be sold through a single National Oil Company which responds to the internationally recognised government.

Sanalla is therefore right that oil is both the source of much of the fighting in Libya but also an asset on which a new process of de-escalation can be built, one that instead of buying time at the expense of the budget, as in the current case, actually improves the economic conditions of the country.

Can the economy be the key?

Stabilising Libya through an economic deal is a fascinating proposition but one that meets daunting practical challenges. The bureaucracy, as described above, is divided and often dysfunctional, Libya has no real Ministry of Finance and the Central Bank governor Sadiq al Kabir has so far worked also as a de facto Treasury Secretary, decided when and if to disburse the money. There is deep distrust between him and Prime Minister Serraj who in turn has not shown any economic skills, going as far as proposing to sell Libya’s gold reserves to solve a liquidity crisis.

Between late October and early December, Americans and Europeans have convened two summits in London and Rome respectively, bringing around the table Serraj, Kabir, Sanalla and other prominent economic decision-makers. Serraj has finally appointed a Minister of Finance and a Deputy, though the legitimacy of his government is questioned because he was never approved by parliament. In late December, Temporary Financial Arrangements worth LYD 37 billion were agreed but important challenges lay ahead.

The first challenge is the exchange rate. Libya’s revenues are mostly in dollars while salaries are paid in dinars. The official exchange rate is one fifth the black market rate and the premium between the two makes smugglers and the informal sector rich while depriving the country of liquidity. While the government would like a devaluation, the governor is cautious as it could create more inflation and lead to a spiral similar to the one experienced currently by Egypt.

The second challenge is the approval of a new budget, one that more realistically takes into account market prices for oil, reduces subsidies, pays just one salary to every Libyan and ultimately reins in spending. It is unclear whether a government that has never received its stamp of approval from parliament (and which is unlikely to receive one in this ice age) can approve bold reforms. The LPA only authorises the government to approve emergency measures but even for those it will need cooperation from the Central Bank.

The third challenge is to keep oil flowing and to further restart production, particularly in the Murzuq basin in the south-west of the country which, if fully online, is worth 400,000 barrels per day. The pipeline that leads from the basin to the terminals on the coast was recently reopened by the two main oil fields feeding it are not fully online yet.

Though these challenges are daunting, stabilisation through the economy still seems more promising than through an agreement on who heads the security sector which has been the priority of most negotiators in the last year. Haftar is unlikely to bow to the militias of the west and accept the oversight of a civilian government –at least not now that he’s winning against both and the stars of the international system are aligning in his favour. On the other hand, it is in his interest to keep oil flowing, reach an agreement on the budget, make it work and get payments of salaries and money for the part of the country that he controls.

An economic deal is unlikely to end Libya’s three rival governments nor will it end the increasing rift between east and west Libya. But it could lead to a freeze in military operations in the name of the shared interest between the big players in having oil production and money to spend. The problem is whether the context that allowed the latest small economic arrangements to emerge will continue: Trump administration could be less interested in Lybia than Obama’s while the European countries that are most interested in Libya (the UK, France and Italy) are all focused on more pressing domestic problems. It will be up to the Libyans to work out the deal and who knows whether what is left of its economic bureaucracy will take the lead.