BEROC: New threats to macroeconomic stability in the Belarusian economy

In the first half of 2013, a deteriorating external environment became the core reason for a downturn in GDP growth, Dmitry Kruk writes.

 Despite the government implemented expansionary policy to spur growth in the GDP, the domestic demand could not fully compensate shrinking external demand. 

GDP growth

Belstat reported further downturn of the GDP growth rate: in January to May it amounted to 1.1% year-on-year against 2.5% year-on-year in from January to April. According to our estimations, it means that in May output contracted roughly by 3.7% on annual basis, and by 1.7% on monthly (seasonally adjusted) basis. Hence, the cyclical pattern of GDP seems to have changed during the last month: between late 2012 and March 2013 the economy showed signs of recovery, while since April it is likely to have fallen and entered a new slowdown phase.

From the demand side, household consumption still contributes to growth mostly. For instance, retail turnover (which is a good proxy for household consumption) grew in May by 19.6% year-on-year, having exceeded the growth rates in the first quarter and April.

A key reason for this confident growth is the intention of authorities to provide the growth of real wages. Some private companies that face a lack of skilled labour (due to labour outflow to Russia and other countries, amongst other reasons) contribute to the upward dynamics of wages as well. Such firms have to provide competitive wages despite losing the competitiveness of their products. Through this in April, real wages grew somehow (both on an annual and monthly seasonally adjusted basis) despite weakening growth and a deteriorating external environment.

Another major component of domestic demand – capital investments – displays volatile dynamics. After substantial growth in the beginning of the year, it has become much more modest in recent months. In May, it grew only by 4.6% year-on-year. This instability stems from the lack of financial resources for investments, while the government seeks potential options to spur the growth of investments.

So the domestic demand is growing, but nominal restraints after the currency crisis of 2011 has narrowed the effectiveness of its stimulation. Furthermore, its expansionary policy is tending to become more and more dangerous against a backdrop of deteriorating external environment. Given the reduction of external demand due to weakening growth in Russia and non-favourable environment at EU markets, such policy will lead to a further deterioration of net exports: first, through an additional demand for imports; second, through higher real unit labour cost, i.e. less competitiveness. Hence, in April merchandise the trade deficit increased almost tripled in comparison to March and reached $293.9m.

Non-financial firms

The cyclical slowdown of GDP has nothing to do with the effect of a high statistical base of the previous year (which takes place due to extra export revenues from ‘thinners and solvents business’ in the first half of 2012). From the production side, all the industries of the economy contributed to the downturn of GDP growth.

For instance, trade – which contributed to GDP growth between January and April mostly – has shown decrease of the growth rate. Another growing industry – agriculture – faced growth downturn as well. All other industries, including manufacturing, demonstrated downward trends well, which however, is more concerning, as in their case the slowdown deepened rather the growth went down.

The branches of manufacturing displayed either downward dynamics, or just a slightly narrowed slowdown in their output. Production of machines and equipment and production of non-metal mineral products were two lucky exceptions from the common trend, as they succeeded to strengthen the growth rate of their output, although rather modestly. Finally, the gross value added (the output in basic prices) fell by 0.1% year-on-year.

Hence, net taxes on products were the item that made growth rate of GDP positive. The latter effect takes place at the background of deteriorating net exports, as more imports increases the tax base for VAT.

Non-financial firms reduced their output in May monotonously, trying to react to an already deteriorated external demand, although with some delays. Although the signs of this deterioration appeared a couple of months ago, a majority of Belarusian firms did not adjust their output to this trend. In some industries, the firms treated this shrinkage of external markets as a short-term one. In some cases, the government restrained adjustment in firms’ output because of its growth targets.

These output growth targets became the core reason for the problem of excessive inventories of finished products and the worsening profitability of non-financial firms. For instance, as of 1 May 2013 in manufacturing, the stock of inventories of finished products reached 82.4% for its monthly average output (an acceptable level for the manufacturing as a whole is roughly 45-50% of monthly average output).

Alongside this, the indicators of firms’ profitability during January to April were extremely low: they were much lower than in the previous year and close to the level of 2009, i.e. the peak of the global crisis. Adjustment of output in May allowed  for a stabilising financial stance of the firms somehow, although it is still far from the level needed for their sustainable development.

Monetary environment

In May, the National Bank of Belarus kept on softening monetary policy trying to mitigate the downturn of GDP growth. It reduced the refinancing rate by 2 percentage points down to 25% (later on in June it made further reduction down to 23.5%). Financial markets adopted this impulse rather rapidly and the interest rates on the main instruments in national currency went down. In some segments of the market, say, those of short-term deposits in national currency, interest rates went down much more substantially in comparison to the refinancing rate: from 30.9 down 23.9% per annum.

The banks reduced the rates so radically due to the high supply of such deposits, while the demand for loans at this level of interest does not match the supply. In previous months, when the National Bank carried out a stricter policy, the banks preferred to keep a definite amount of excessive liquidity. Given the softening monetary policy and expectations of further reductions in the refinancing rate, the banks seem to be increasing their propensity to borrow. In this case, they are reluctant to maintain excessive liquidity and prefer to reduce their rates on deposits.

The equilibrium at the financial market still seems to be fragile against rather fresh memory of high inflation and depreciation. Through this, a new wave of deposit dollarization – which might take place in case of further rapid reduction of interest rates – might be a threat to monetary equilibrium. In May, there was a first warning – the growth rate of households’ savings deposits (on annual basis) went down, which might signal that the current level of rates is getting close to its threshold. 

BEROC