The main problem of the Belarusian economy is its limited capacity for long-term growth. In 2014, no significant progress was achieved in building the country’s capacity for expansion; however, the government announced the beginning of the preparatory phase of structural reforms.
Exchange rate targeting became a key component of the government’s macroeconomic policy, while monetary and fiscal policies became even more conservative. The economic authorities for the first time applied limitations on growth in households’ incomes. Furthermore, ‘repression’ of investments for the sake of financial stability continued. However, this policy pattern proved to be inadequate amid new external shocks, despite serous injections of gold and foreign exchange reserves. As a result, a new currency crisis is unfolding in the country, and tensions are growing in the financial sector.
Last year’s macroeconomic performance was characterized by slow expansion, high inflation, and significant external deficit. The accumulated structural and short-term problems pose a risk of a continuous recession in years to come.
- Lack of appreciable progress in structural reforms amid reduction in capacity for expansion;
- Limitations on growth in personal incomes and ‘repression’ of investments based on exchange rate targeting;
- Accumulation of problems that prevent the economy from pulling out of cyclical slowdown;
- Threat of a continuous recession.
The Belarusian economy entered the year 2014 in a depressed state – the structural weakness in the national economy became obvious not only to experts, but also to laymen. In 2012 and 2013, the country’s GDP grew by approximately 1% on a year-on-year basis, and increase in real incomes slowed or even stopped altogether. Financial indicators remained unstable and increasingly volatile, and the economy became more vulnerable to external shocks. Finally, Belarus became chronically dependent on external resources required to cover its current deficit and repay previous loans.
These outward features of the country’s macroeconomic dynamics in the 2010s resulted from a series of challenges that had overlapped in 2014 to form a certain vicious circle: 1
- Lower economic growth potential;
- Transfer into a cyclical recession phase in the economy;
- Weakness of internal demand and disproportions in its structure, lack of effective instruments to encourage internal demand;
- Reduction in external competitiveness, increases in current account deficit;
- ‘Monetary policy trap’ manifested in the ‘fear of floating’ and limited use of interest rate instruments in fiscal policy;
- Dependence on external financing.
This combination of structural and cyclical challenges posed a difficult dilemma for the authorities: which arrangements should be prioritized – those to put in place structural economic reforms, or those to stabilize production and incomes? Structural reforms may result in short-term shortages in the overall volume of industrial output, whereas measures to encourage production may bring about additional structural imbalances in the economy.
The costs of each option are quite significant. Structural reforms and short-term reductions in incomes may lead to social tensions, and the country may fall into a ‘poverty trap,’ for instance, resulting from labor migration and outflows of workforce. The choice of income stabilization and disregard for structural challenges may cause significant losses in incomes at a later stage and an even deeper ‘poverty trap.’
Structural reforms on the economic agenda
In 2014, the Belarusian economic authorities de facto prioritized measures to stabilize current incomes and ensure short-term financial stability. Efforts to build capacity for long-term growth were few and limited in scope.
The most important step in this area is Resolution of the Government No. 264, which for the first time systematized bank loans for state programs. Furthermore, the government said it would phase down directed lending and introduce tighter requirements for directed loans.
However, those new policies failed to effectively reshape the system of centralized distribution of resources. Firstly, this system is still based on a lending pattern, where ‘champions are predetermined.’ Secondly, the share of loans extended for state programs remains high in banks’ loan portfolios. In 2014, such loans amounted to BYR 40 trillion 2 of the combined loan portfolio of the Belarusian banking system, estimated at BYR 104.2 trillion. One should also remember that preferential home loans make up a substantial portion of the loan portfolio – such loans are not considered to be lending for state programs, but they are directed loans nonetheless.
Another example of new policies aimed to put in place structural reforms is the adoption of a package of measures for 2014–2015 to ensure a balanced economic development. The package includes temporary milestones for the development of new regulatory acts for separate industries, state property management, introduction of the institute of independent directors, improvement of mechanisms of state support and lending within the framework of state programs, motivation of state managers, and promotion of collective investment practices. Most of the drafts were expected to be developed at the end of 2014 and in early 2015.
Alongside sporadic innovations in the economic mechanism, the government also focused on the dialogue with the World Bank over the project to develop a roadmap for structural reforms for the county. The dialogue was declared to be an important preparatory phase for the implementation of systemic structural reforms.
The government attributed the slow pace of structural reforms to unfavorable market conditions, the need for elaborate preparations, and the fact that many regulatory acts had been developed for a period up until the end of 2015, and any reforms could result in economic ‘malfunctions.’ Officials informally classified the years 2014 and 2015 as a preparatory period for systemic structural reforms, which are expected to begin in 2016, when the new electoral period commences.
Macroeconomic regulation format
Despite structural and situational restrictions imposed on the national economy, the economic authorities sought to develop a policy design to ensure: (1) short-term stability in financial markets; (2) external price competitiveness; and (3) GDP growth. The above sequence indicates the priority status of each of the objectives.
In 2014, exchange rate targeting remained the key instrument to ensure financial stability. The authorities cited the following reasons for pursuing exchange rate targeting: (a) the real effective exchange rate remained close to the equilibrium level; (b) households’ expectations needed to be pegged to exchange rate fluctuations. Therefore, the authorities believed that their efforts to keep the exchange rate of the Belarusian ruble within the planned limits would stabilize households’ expectations in the domestic market. This logic prevailed despite numerous failures of this policy in previous years.
Interest rate policy remained the second instrument to ensure short-term financial stability – it was perceived by the authorities as an additional measure to protect the market and ‘absorb’ shocks that shape expectations. The authorities did not restrain growth in rates in the financial market every time the economy was hit by another shock, but sometimes even encouraged it. At the same time, during the brief periods of relative stability, attempts were made to ensure a reduction in nominal interest rates, which remained extraordinarily high after 2011. The main objective of the policy to gradually reduce interest rates was to promote business activity with a view to attracting additional investment.
Limitations on fiscal and quasi-fiscal operations by the government became the third instrument to make the financial market stable. The authorities cut capital expenditures in the fiscal sector, which was a typical strategy for the past few years. As a result, capital expenditures were reduced by 1.5 percentage points of GDP year-on-year. Further, the authorities continued the practice of alternative fiscal restrictions, which allowed reducing budget spending compared with the originally planned level.
Finally, foreign borrowing remained another important instrument from the point of view of financial stability, as in previous years. The economic authorities were making efforts to raise foreign loans as soon as they saw distrust in the exchange rate targeting policy and worsening of expectations amid external imbalances and low level of reserves. New external loans taken at the start of the year and in the summer of 2014 alleviated shocks (Belarus took a bridge loan from VTB-Bank amounting to USD 450 million in December 2013 and USD 1,550 million in June; both installments were subsequently refinanced by an intergovernmental Russian loan).
Wage policies and administrative regulation of import became the main instrument to ensure the competitiveness of Belarusian manufacturers and reduce the external deficit (in the context of exchange rate targeting). The economic authorities ceased to artificially encourage growth in wages starting the second half of 2013.
In 2014, the income policy was further tightened. For the first time in contemporary history, the authorities began restraining growth in wages seeking to ensure competitiveness in foreign markets. The pinnacle of this practice was the resolution that the government adopted in July to introduce administrative pegs of wages at state enterprises to labor productivity. Further, the first grade wage rate (which is used to calculate wages at companies that apply the unified tariff system) rose by only 6%, whereas consumer prices increased by 18.1% in 2014.
This policy enabled the authorities to freeze unit labor costs in real terms in the first half of 2014 and reduce costs in the second half of the year. Lower unit costs became a factor to maintain competitiveness, which was compromised by increases in the real exchange rate.
The government’s policy on import was not as harsh as its income-restraining measures. However, the reduction in the import of investment and non-energy intermediate materials suggests that administrative instruments were applied to restrict import by state-owned enterprises.
New shocks and currency crisis
In the middle of 2014, external shocks were added to internal challenges. Firstly, oil prices dropped in the second half of the year, to a new five-year low at the end of the year (in late December, Brent was traded at approximately USD 57 per barrel). The new trend in the oil market affected the country’s trade balance. 3
Secondly, the fall in world oil prices and West-led sanctions against Russia resulted in a fast and sharp ‘implosion’ in virtually all of Russia’s commodity markets. The markets for so-called investment goods were affected the most, which became a serious challenge for Belarusian importers.
Thirdly, the new market environment in Russia brought about a significant depreciation of the Russian ruble vis-à-vis main world currencies. Whereas in the third quarter the Russian currency was losing its value gradually, the final three months of the year saw a dramatic reduction in the exchange rate: the Russian ruble lost 72% of its value against the U.S. dollar in 2014 (43% in the fourth quarter alone).
Fourthly, the Russian food ‘anti-sanctions’ also produced a serious impact on the Belarusian economy. Belarus was in a state of euphoria all throughout summer: the sanctions were perceived as a positive shock, i. e. a chance for domestic producers to boost their supplies to the Russian market, including through additional processing of imported foods in Belarus. However, the negative effect of the shock was manifested in autumn. Russia de facto accused Belarus of smuggling the goods subject to ‘anti-sanctions’ and restricted supplies of Belarusian meat products – one of the most important export commodity groups – citing far-fetched reasons.
The National Bank of Belarus had been trying to keep the exchange rate parameters of the national currency up until the currency panic in Russia. 4 As a result, a new trend emerged in the second half of the year towards a strengthening of the Belarusian ruble vis-à-vis the Russian ruble – by 49% in July-December. The stronger Belarusian ruble affected the price competitiveness of Belarusian exporters in the Russian market, which brought about a reduction in the volume of orders, non-payments, etc.
Also in the fourth quarter, Belarus saw a hike in import from Russia. The strengthening of the Belarusian ruble against the Russian ruble within the single customs space became a major impetus for both organized and unorganized trade channels. Automobile deliveries from Russia reached their peak in November and December, becoming a vivid example of the new trend.
The situation produced a devastating impact on the current account of the balance of payments in the second half of 2014. 5 The authorities initially tried to refrain from any serious moves hoping that the situation would improve soon. At the end of summer and in autumn, fiscal and quasi-fiscal operations were restricted only slightly.
However, the external deficit continued to expand. The media channel was added to the list of foreign trade channels of ‘infecting’ the Belarusian economy. Amid increasing alarming expectations companies and individuals increased purchases of foreign exchange and started converting BYR-denominated savings into foreign exchange deposits. Following currency panic in Russia, conversion of deposits became an overwhelming trend.
The authorities only had gold and foreign exchange reserves to neutralize the dangerous trend. In the period from September through December, the country’s gold and foreign exchange reserves dropped by USD 1.2 billion (about 20%), even though the NBB attracted approximately USD 1.1 billion from external sources to add to the reserves in December 2014. 6
The liquid portion of gold and foreign exchange reserves was almost completely exhausted, which forced the authorities to de facto admit that ruble devaluation was inevitable. However, the devaluation move was originally masked by the introduction of a special tax on purchases of foreign exchange. To neutralize further shocks, the authorities increased rates on instruments to provide liquidity, began restraining ruble-denominated lending, and imposed currency limitations and price-formation restrictions.
Changes in macroeconomic indicators
The need to maintain internal financial stability and anchor the external deficit narrowed the room for maneuver when it came to commodity production. Nominal exchange rate targeting, which tends to appreciate the real exchange rate, limited the capacity for expansion through increases in external demand. Throughout the year, export expanded in volume terms only in a very narrow group of commodities. Potash fertilizers played the most important role in this process. In 2014, potash export increased by 66.4% year-on-year in volume terms, making a crucial contribution to the overall increase in export supplies.
Other important commodity groups showing stable growth in volume terms were ferrous metals and ferrous metals products, and wood products. Other essential commodity groups showed either stagnation or a reduction in export volumes. The most serious export drops were reported in the automotive industry and mechanical engineering – trucks, tractors, trailers, farm machines, engines, etc.
As a result, export expanded by 4.3% in volume terms in 2014. Average export prices went down by 6.2% year-on-year in U. S. dollar terms, which caused a reduction in export in value terms by 2.2%.
The country managed to avoid serious troubles with its external deficit in 2014 due to import restraints. Reductions in volumes of output were recorded in most of the import-consuming industries, and administrative restraints helped keep import deliveries almost at the level of 2013 (import expanded by 0.3% year-on-year and remained lower than in 2013 until the final months of the year). Import prices dropped by 5.5%, and total import shrank by 5.2% in value terms.
As a result, the contribution of net export to GDP was positive and amounted to 1.1 percentage points. However, this is hardly something to be proud of. Firstly, after last year’s enormous deficit (17% of GDP) 7 amid conservative economic policy, one could have expected a more impressive growth. Secondly, the positive contribution of net export is commensurable with the negative contribution of statistical discrepancies to GDP (minus 1.3 percentage points). The latter is traditionally associated with foreign trade dynamics, including foreign trade transactions that were not duly accounted for. Therefore, de facto Belarus made very little progress in 2014 as far as its efforts to reduce its external deficit are concerned.
In nominal terms, the commodity trade deficit amounted to USD 4.4 billion, down by 24.5% year-on-year. The country’s current account of balance of payments also included the USD 2.4 billion deficit of primary incomes and USD 2.3 billion deficit of secondary incomes, which was partially neutralized by a surplus in Belarus’s trade in services, at USD 2.2 billion. Therefore, the current account deficit totaled USD 5.1 billion, or 6.7% of GDP, down by 3.7 percentage points from the level reported in 2013.
The government’s policy to limit personal incomes resulted in a slower growth in consumption by households. Back in 2013, the increase in consumption by households was expressed in double digits, whereas in 2014, consumption increased by 4.5%. Fiscal restrictions brought about a reduction in final consumption expenditures by state institutions (by 1.9%). Overall, final consumption expenditures increased by 3.3%, contributing 2.6 percentage points to GDP.
Investment demand became the most vulnerable component of aggregate demand. Because of high interest rates, conservative credit policy of Belarusian commercial banks, as well as fiscal restraints, investments were falling throughout the year. Accumulation of fixed capital shrank by 8.9% year-on-year, making a negative contribution to GDP amounting to 3.6 percentage points. GDP expanded by only 1.6% in 2014.
When it comes to supply, industrial output contributed the most to GDP growth – 0.6 of a percentage point. However, the increase in industrial output was almost fully ensured by three industries – mining, the chemical industry (potash fertilizers), and oil processing. Other industries showed either stagnation or a fall in output, compared with the year 2013.
Other sectors that generated growth included wholesale and retail (they contributed 0.5 of a percentage point each), transport and communication, and agribusiness (0.2 of a percentage point each). Construction made the largest negative contribution to GDP of all major sectors – minus 0.5 of a percentage point.
This industry-wise growth pattern suggests that the quality of economic expansion was poor last year. Further, because of the unfavorable external environment (lack of growth in demand for potash fertilizers) the Belarusian economy may have entered a recession as early as 2014.
Below is additional evidence of the low quality of growth, tense financial situation, and macroeconomic vulnerability:
- Persistently high inflation rate (consumer prices showed an average annual growth of 18.1%);
- High nominal interest rates (in excess of 45% at the end of the year);
- High external deficit (current account deficit of 10.4% of GDP, net export in real terms at minus 15.7% of GDP);
- Low profitability of companies (the average profitability rate increased from the year 2013, but remains close to the all-time low registered a decade ago);
- Trend towards a consistent decline in employment (by 1.3% in 2014).
From the point of view of macroeconomic performance, the year 2014 looked a lot like the three previous years and was characterized by low economic growth, a high inflation rate, and a significant external deficit. The Belarusian economy entered a low growth phase and is facing the threat of slipping into a ‘poverty trap.’
Throughout the year, only sporadic attempts were made to increase the potential for long-term growth. However, the economic authorities de facto admitted that structural reforms in the economy were inevitable and announced a preparatory phase to get ready for reforms.
Some new trends could be observed in the country’s macroeconomic policy: the economic authorities were ready to sacrifice immediate results for the sake of ensuring macroeconomic stability. The trend was manifested in measures to limit further growth in incomes in order to maintain external competitiveness and tight monetary and fiscal policies.
Nevertheless, even this conservative policy failed to ensure the intended effect. New financial shocks and return to cyclical slowdown (which make the threat of a recession increasingly relevant in 2015) resulted from the strategic weakness of the national economy and excessive commitment to the policy of exchange rate targeting.