Currency Market and the Banking System: Back to 1998

Summary

Last year, the Belarusian economy suffered from severe economic shocks caused primarily by the sharp depreciation of the national currency, unchecked inflationary processes, rise in prices for imported energy, and increase in the debt burden on Belarusian residents. The drop in real incomes of Belarusian households amid tighter monetary and fiscal policies helped stabilize the situation in the money market. Households will be able to restore their spending capacity to the pre-crisis level in 2.5-3 years, at the earliest. However, during this period, Belarus will be faced with growing risks of labor outflows, mainly to Russia. The downward pressure on the ruble and the country’s gold and foreign exchange reserves will continue on the back of the substantial repayments under previous loan arrangements.

Trends:

• Growth in wages and government expenditure put pressure on the stability of the national currency.
• The monetary authorities gave up plans to target the exchange rate in favor of free float based on currency demand and supply.
• In the medium term, serious depreciation risks will remain, caused by the need to repay external debts.

Devaluation shock

The year 2011 saw the most serious challenges to the Belarusian financial system over the last decade. The alarming manifestations of the economic crisis resulted in a panic demand for foreign exchange, which was caused by inflation and depreciation expectations, and shift in savings preferences towards foreign exchange. A serious imbalance brought about by the gap between the foreign exchange demand and supply emerged in the domestic market, putting a tremendous downward pressure on the Belarusian ruble and the country’s gold and foreign exchange reserves.

The monetary authorities eventually opted for free float in the currency market, giving up their original plans of a targeted exchange rate vis-à-vis the basket of foreign currencies. As a result of this, the exchange rate of the ruble was formed with minimal interventions of the National Bank based on demand and supply and under the influence of fundamental macroeconomic factors.

The result was the depreciation of the Belarusian ruble against the U.S. dollar by 2.8 times (64%), and against the euro and the Russian ruble, 2.7 times (63%). Such violent fluctuations of the national currency were last marked more than 13 years ago, in 1998 (following the August crisis in Russia). Back in 1998, the official exchange rate of the ruble against the U.S. dollar fell even more, by 4.5 times (78%).

The depreciation of the national currency understandably resulted in additional inflationary pressures. In 2011, consumer prices increased 110%, construction prices rose 110%, producer prices hiked 150%, freight tariffs went up 150%, and farm prices soared 170%.

It should be noted that the ruble depreciation in 2011 was largely due to the ungrounded increase in wages in 2010 (wages were pushed then for Alyaksandr Lukashenka to meet his election promises). Over a relatively short period of time, the average wage went up more than 50% to an equivalent of USD521.2 in December 2010 from USD344.4 in January 2010.

Moreover, in December 2010, the average wage reached a new record high of USD1,253 on a purchasing power parity (PPP) basis (See Table 1). Belarus made it into the top-five neighboring and CIS member-states by wages. That period’s leaders were Poland with USD1,813.9, Estonia with USD1,423.9, Russia with USD1,317.8, and Lithuania with USD1,303.6. Belarus was followed by Latvia with USD1,181, Kazakhstan with USD880, Ukraine with USD734.2, Azerbaijan with USD730.4, Georgia with USD723, Armenia with USD675.4, Moldova with USD554.7, Kyrgyzstan with USD554.4, Turkmenistan with USD482.3 and Tajikistan with USD285.1.

1. The countries are sorted in descending order by the average wage in December 2010 on a PPP basis (the average price level in the USA is 100%)
2. Data on the average wage in Poland, Estonia, Lithuania and Georgia are presented as of the fourth quarter 2010, and in Turkmenistan, the average wage in the year 2010 is given.
Source: the author’s calculations based on statistics of the IMF, national statistical services and central banks.

At the same time, as a result of last year’s devaluation moves, the level of Belarusian wages in U.S. dollars equivalent markedly decreased. The average nominal wage had fallen to USD337.8 by December 2011, compared to the April 2009 level; however, given the seasonal nature of wage increases (late-year bonuses and additional benefits) the average wage in December 2011 was the country’s lowest since December 2006.

Money market

By reducing real wages and tightening monetary and fiscal policies, the authorities managed to stabilize the situation in the domestic market. According to the National Bank, in February 2012 alone, sales of foreign exchange by households, including cashless transactions, were USD177.1 million above purchases. Over the last six months (September 2011 to February 2012), sales of foreign currency by households were USD1.026 billion in excess of purchases (including cashless transactions).

Households thus have turned into net sellers of foreign exchange, thus supporting the exchange rate of the Belarusian ruble against the basket of foreign currencies.

For their part, Belarusian companies also sold more currency than they bought from banks in February 2012: sales were USD131 million above purchases. In the period December 2011 through February 2012, sales were USD574 million above purchases.

In January 2012, banks reported a substantial increase in households’ currency deposits, which was mostly due to high interest rates. Retail foreign exchange deposits rose by USD259.9 million in January 2012, or 6.2%, to reach USD4.472 billion (on February 1, 2012), which is a new record high since April 1, 2011.

Incidentally, households increased their foreign exchange deposits by USD985.8 million in the second half of 2011 and the first month of 2012, or 28.3%. Households have become the main suppliers of foreign exchange to the country’s banking sector. As for corporate entities, their foreign exchange deposits with banks rose 2% in January 2012 to a new record high of USD3.492 billion as of February 1, 2012, which can be attributed to new currency receipts and shrinking external receivables.

According to the central bank, in January 2012, foreign exchange proceeds from exports of commodities and services, incomes and transfers of Belarusian business entities (including individuals) rose by USD1.547 billion year-on-year (71.1%) to USD3.723 billion. In January 2012, export proceeds were USD467.6 million above payments for imports of commodities, services, incomes and transfers, building on the USD363.7 million surplus recorded in December 2011, while in January 2011, payments for imports exceeded export receipts by USD931.9 million. During the nine months from May 2011 through January 2012, the surplus of export-import operations of Belarusian businesses (including entrepreneurs) amounted to USD3.608 billion.

We have to remember, though, that Belarus paid USD3.07 billion worth of oil product export duties to the Russian budget in 2011. The country’s foreign trade statistics will look less impressive if we factor in this payment. In January 2012, Belarus transferred USD336.6 million in refined oil export duties to Russia. As a result of this, in January 2012, Belarusian export-import operations came to a surplus of USD131 million (USD467.6 million net of the mentioned transfers).

Nevertheless, it should be noted that the increase in foreign exchange proceeds should be attributed primarily to the depreciation of the national currency. The positive effects of the mentioned depreciation factor are short-term and may be exhausted within the next few months.

External debt risks

In our opinion, the downward pressure on the exchange rate of the Belarusian ruble and the country’s gold and foreign exchange reserves in 2012 will depend on its repayment of external liabilities. Based on our estimates, this year’s payments by all Belarusian residents to service their foreign debts will total USD17 billion, which is an unprecedented figure for Belarus. The country will enter a turbulence zone in 2012-2013, as it will have to repay substantial external debts.

Belarus does not seem to have sufficient gold and foreign exchange reserves to effectively meet its debt repayment schedule, despite recent borrowing and privatization proceeds. Based on the IMF methodology, Belarusian foreign exchange reserves had reached a new record high of USD7.981 billion by February 1, 2012; however, one has to keep in mind that more than half of the total reserves (56.6%) has been formed by foreign exchange borrowing from commercial banks. As of February 1, 2012, the banking sector’s claims on the central bank stood at USD4.516 billion. Reserve assets proper (foreign exchange) in the structure of gold and foreign exchange were only at USD3.774 billion on February 1, 2012.

According to the Finance Ministry, Belarus will have to spend more than USD7.6 billion to service its public external debt – the country will have to repay the IMF loan under a Stand-By Arrangement, government loans from Russia, Venezuela and China, as well as bonds floated in the Russian market in late 2010. In 2015, Belarus will have to repay its USD1 billion debut Eurobonds issue.

Belarus’ public external debt had grown to USD13.428 billion by February 1, 2012, according to the Finance Ministry. Unfortunately, other Belarusian residents’ external liabilities (those of the National Bank, commercial banks, and companies) are also substantial. As of February 16, 2012, the National Bank’s external liabilities were at USD1.476 billion, and the overall debt of the banking system stood at USD5.786 billion (as of February 1, 2012).

Belarus’ total external liabilities had reached a new record high of USD34.028 billion by January 1, 2012, about 92% of GDP. According to our estimates, in 2011, Belarus’ GDP shrank to USD37.002 billion from USD54.94 billion in 2010 (the author used his own calculations of the average weighted exchange rate of the Belarusian ruble to the U.S. dollar, at Br2,993.74 in 2010 and Br6,075.94 in 2011, which allows for black market exchange rates). The external debt to GDP ratio has therefore exceeded the adopted security threshold of 60%. To compare: in 1999, Belarus’ overall external liabilities were at mere USD2.37 billion, and their share of GDP was 15.6%.

On a per capita basis, the country’s external liabilities amounted to USD3,595 as of January 1, 2012, or Br30.019 million per capita (on a ruble basis), or Br61.342 million per employed worker, which makes up 21.3 average monthly wages. In order to repay the country’s external liabilities (principal and interests), Belarusians would have to work for about two years without being paid any compensations, which is quite alarming.

Belarusian residents have almost exhausted possibilities for taking external loans on a market basis. As a result, both the banking system and the corporate sector will see major capital outflows on a net basis. Repayments of external debts will affect economic growth, including GDP growth rates, industrial output, capital investments, real incomes of Belarusian households, etc.

Conclusion

In our opinion, the authorities will hardly risk financial and economic stability again in 2012 and will prefer increasing wages gradually, keeping an eye on the situation in the currency, credit and deposit, and consumer markets. If they don’t proceed in this way, the financial system and the national economy will be unable to “digest” another fast and ungrounded rise in wages without painful consequences. The country will then hardly be able to restore the spending power of Belarusian households to the pre-crisis level sooner than in 30-36 months (given the expected reduction in the purchasing power of the U.S. dollar).

In the next few years, Belarus should expect labor outflows to foreign countries, especially to Russia. On the one hand, the Belarusian government is somewhat interested in promoting labor migration, which will help deal with unemployment and increase foreign exchange receipts from individuals.

According to our estimates, the Belarusian ruble will depreciate to BYR10,200 to the U.S. dollar in 2012. At the same time, in the medium term, Belarus will be faced with serious depreciation risks generated by the need to repay earlier foreign loans and credits.

The author has made use of proprietary analytical reports by Prime-Tass Business News Agency, reports by the National Bank and Belarusian Statistical Committee (BelStat).