BEROC: Belarus Economy in 2012: Low Growth and Fragile Stability

The currency crisis of 2011 has revealed the limits of the Belarusan economic model.

On the one hand, it became obvious even to the most conservative government officials that changes in economic policy are required.

On the other hand, the resurgence of oil exports in the first half of 2012 allowed the government to avoid necessary reforms. The economy finishes this year with a low output growth rate, but fragile macroeconomic stability is achieved.

The prospects for 2013, however, do not offer much optimism, at least in terms of growth performance.

Drivers of economic growth

In 2012, economic growth has slowed down despite rising real incomes of the households. In the second half of the year, this factor superseded net exports as a key driver of GDP growth during the first half. The political promise to increase monthly average wages to $500 lifted real wages - both in national and foreign currency - from spring 2012 on. Real wage growth surpassed the corresponding dynamics of labour productivity.

In order to stifle inflation, the National Bank increased real interest rates, while the government continued stringent fiscal policy.Although poverty dropped to 5.3 per cent (with regional rates about 6.3 per cent), households are hardly above the level of 2007. Yet, average household still spent more than forty per cent of their incomes on food, despite low food inflation in 2012.

Privatisation and investment

Facing a problem of weak growth, authorities announced plans to set up ‘highly productive’ enterprises, but no meaningful steps have been made. In similar fashion, privatisation has not been moved beyond discussions. Authorities seek to maximise privatisation revenues by looking for the most generous bidders, both at home and abroad.

However, re-nationalisation of two major confectionery factories made foreign investors very cautious in entering the Belarusan market.The Investment Forum held in November 2012 has resulted in twelve ‘intensions protocols’ only.

The inflow of foreign direct investment reached the planned figure of $ 1.2 billion before the end of the year. Industry attracted about eleven per cent of that modest amount. This is a low rate to contribute to modernization of the national industry.

China and Russia are two major foreign investors. As for China, it is more concerned with promoting its own exports rather than investing. Russia has helped Belarus to obtain a third instalment of a loan from the Eurasian Economic Community, while the provision of the fourth instalment was negotiated successfully.

Fiscal stringency

Authorities have not abandoned its stringent fiscal policies, though wage increases in the public sector contributed to rising expenditures on healthcare and education. Restrained fiscal policies have been determined by the need to contain inflation, particularly against the background of high inflationary expectations.

It could realistically be expected that the 2012 budget would be at least balanced or turned into a small surplus (below one per cent of GDP). This is due to a relatively modest foreign public debt burden, which is to increase from 2013 onwards.

This increased burden could lead to a budget deficit, given that the structure of revenues and expenditures would remain unchanged, including financing of investment programs. Although the government has substantially cut subsidization of industry and agriculture in 2012, it is likely to remain at the level of 3.5-4 per cent of GDP.

Limits of monetary policy

To a large extent, economic growth has been suffocated by a policy of high interest rates. This policy is adopted to combat high and volatile inflationary expectations, resulting from the 2011 currency crisis. This policy was necessary to stabilise exchange rate, particularly in the first half of the year. However, inflationary expectations have not been reduced as people retain memories of devaluation and accelerated inflation.

Throughout 2012, the majority of banks have been recapitalised to cover the real losses of regulatory capital incurred after the devaluation-fuelled inflation of 2011. Given high interest rates policy, banks have been unwilling to expand credit supply, and to take additional credit risks.

In the environment of credit shortage, only banks with access to cheap capital - particularly subsidiaries of Russian banks - were able to expand their credit portfolios and to increase their shares at the domestic market. The mix of borrowers has also changed towards larger shares of export-oriented companies and households. Both categories of lenders can bear the burden of increased interest rates.

It appears that monetary policy is constrained. On the other hand, the National Bank has to stabilise exchange rate in order to make inflationary expectations less volatile. On the other hand, fluctuating exchange rate helps to balance the current account. In this situation, interest rates policy remains the only efficient tool available to the National Bank, but this policy does not address the problem of inflationary expectations.

Current account and exchange rates

Exchange rate fluctuations are welcome to balance the current account. Over January-July, it reached surplus due to the lasting effects of 2011 devaluation and sales of ‘solvents and thinners’ (oil products in disguise, exported without paying customs duties to the Russian budget).

But from August to October, current account turned to deficit. Apart from the effects of real exchange rate appreciation (as prices in Belarus rise faster than in major trading partners), exports of notorious ‘solvents and thinners’ were stopped, while one of the refineries began to operate at lower capacity due to the scheduled maintenance.

Moreover, deterioration of exports performance is related to slower economic growth.Situation at the foreign currency market mirrored the dynamics of net exports.While over the first half of the year, supply of foreign currency by households exceeded their demand, between June and October, demand exceeded supply.

However, by the end of the year, hoarding of foreign cash has become less attractive than national currency deposits. As for the enterprise segment of the currency market, similar dynamics was observed (with a surplus over the seven months and a deficit in August and September).

Implications of Russia’s membership in the WTO

A strong challenge comes from Russian membership in the WTO. Belarusan producers are likely to face more intense competition at home and abroad. WTO membership makes Belarus a de-facto member, due to the Customs Union with Russia. Heavy trucks production could be adversely affected in the short run, while production of refrigerators, TV-sets, and pharmaceuticals - over the medium to the long run.

Moreover, WTO rules demand to reduce support for agriculture, which is heavily subsidised. In response, Russian government may impose quotas on Belarusan agricultural products. In that case, dairy and meat production would be negatively affected.

The challenge of labour migration

Another important challenge is also related to the eastern neighbour: Russia becomes an increasingly attractive option for temporary labour migration. In 2012, formal employment continued to decrease, and released labour forcehas opted for temporary labour migration. Despite administratively-enforced wage increases, wage gap remains an important push factor of migration. Estimates vary from 400 to 700 thousand temporary labour migrants from Belarus per annum.

At home, a pilot labour force survey provides a very preliminary figure of unemployment, ranging from five to six per cent, which is rather similar to the figure recorded in the 2009 census.

The problem of ‘disappearing labour’ has also been recognised by the authorities. The President demanded to check job leavers at wood processing companies with modernization underway, while the Deputy Prime Minister proposed to charge non-contributors to the State pension fund for visiting hospitals.

Prospects for 2013

A forthcoming year is the time to prepare for repayment of accumulated foreign debts, as debt burden increases considerably in 2014-2015. Current account pressures are likely to remain strong, so depreciation of the national currency seems to be a feasible option. As the economy drifts away from the peak of the political business cycle, expansionary policy is no longer necessary. In this situation, economic growth is likely to be modest.

BEROC