Macroeconomic Situation: Slower growth amid price and financial stability

Dmitry Kruk

Summary

The Belarusian economy had its ups and downs in 2018. On the one hand, the output growth rate was the highest in the last eight years. Real incomes of the population increased significantly, which leveled the accumulated imbalances in the nation’s well-being. On the other hand, this growth was still modest, which made it impossible to narrow the wealth gap between Belarus and other countries of Central and Eastern Europe.

Successes were achieved thanks to certain recovery growth that came to an end in 2018. Being aware of the insignificant growth capacity, the government continued looking for ways to increase it, but still did not go beyond the existing political bounds and kept entertaining the idea of a “new economy”.

The price and financial stability was an important accomplishment of those in charge of economic policy.

Trends:

Introduction

The Belarusian economy entered the year in a state of continuing recovery growth. In early 2018, some developments gave reason to predict that the recovery period would fade out pretty soon: improvements in enterprises’ performance remained modest, whereas the debt burden was getting heavier. Besides, as household incomes increased in 2017, there were trends towards price pressure and accelerated growth of demand for imported goods and services.

The gradual economic cooldown did not fit into the plans of the government, which set the output growth rate target in 2018 at 3.5%, staying committed to maintain price and financial stability. This task seemed feasible provided that the external environment will be favorable, and the government was quite optimistic about that.

The growth potion is not found. The search continues

Institutionally, the government apparently pursued a policy of segmentation of the economy and differentiated measures that were outlined a year before. The national economy was inexplicitly divided into two parts: a traditional (dominated by the public sector) and a new (dominated by the private sector) one.

In relation to the traditional economy, the government continued tightening budget constraints. For example, directive crediting was cut to BYN 1.2 billion from 1.9 billion in 2017. As a result, after a series of gradual restrictions imposed since 2015, the role of this tool in supporting the traditional economy has significantly decreased, although the accumulated debt is still large in the total volume of banks’ credit requirements.

No other significant measures were taken to tighten the budget limitations. Proposals submitted by government economists were not supported by the political bloc, which was one of the reasons for the change of government in the middle of the year. New ministers displayed their commitment to progressive changes by means of new incentives and tools for managing state-run enterprises, and included them in their action plan for 2019–2020.

There was even a retreat in relation to some systemic issues. The approach to the problem of bad debts was reconsidered. In 2016–2017, hesitant steps were made to subject unrecoverable borrowers (including state-owned enterprises, mainly agricultural ones) to reorganization and/or bankruptcy proceedings. In 2018, this policy changed to the opposite: in line with new decrees, banks were de facto instructed to stay away from such borrowers. This can be interpreted as a drift towards a mild scenario of solving the problem, i.e. the government hopes to gradually constrain the negative impact on the entire economy.

Seeking to build a “new economy”, the government is concentrating on the improvement of the administrative and regulatory environment. In 2018, the authorities announced the decriminalization of economic risks, compilation of an electronic registry of administrative procedures, facilitated access to government procurement and natural monopolies for private businesses as priority areas. Although certain progress was achieved, the adoption of regulatory acts in most of these areas was postponed to 2019.

Measures taken in previous years to develop the IT sector had a certain effect. In 2018, the High Technology Park (HTP) reported a large number of new residents. Revenues of HTP companies increased 38%. Belarus boosted the export of IT services by 27.2% to USD 1.9 billion. Growth was relatively modest in terms of value added (10.5%).1

Some cautious and selective institutional changes did not result in any prerequisites for economic growth. In almost all equilibrium growth forecasts, experts spoke about 2% or 3% a year. This is obviously not enough to reduce the welfare gap between Belarus and Central and Eastern European countries. Therefore, the government was considering tools to enhance the effectiveness of the cautious and selective changes without putting the general policy orientation in question.

Last year, the government stepped up efforts to increase the attractiveness of the Great Stone Industrial Park for European and Belarusian companies. A tripartite cooperation agreement was signed by the Park administration, its management company and the EBRD.

The policy of “new industrialization of the regions”, in particular the generation of a portfolio of investment projects and proposals on regional development, was supposed to be a driver of future growth, but it did not go beyond mere proclamations.

Auspicious start of the year

The economy showed fairly strong growth by 4–5% in early 2018. The recovery was a kind of compensation for consumption and investment missed during the 2015–2016 recession. The stabilization of prices and the current account achieved in previous periods had a certain strength reserve, and recovery growth did not encounter any obstacles like price pressure and/or pressure on the exchange rate.

The trading environment (export vs import prices) was better than in the past three years, yet noticeably worse than the historical maximum in 2012–2013. The real effective exchange rate that was close to its 6-year low was also favorable from the point of view of price competitiveness. As a result, at the beginning of the year, the price competitiveness of Belarusian commodities reached its 5-year peak. This helped to maintain high external demand: in the first half of the year, the physical export volume reached its all-time high.

The inertial trend towards a slower inflation increase to the historical minimum continued, reaching 5%. The National Bank lowered the nominal refinancing rate from 11% to 10% per annum, which, however, had practically no effect on its real level. This resulted in smooth dynamics of the nominal and real rates in the money, credit and deposit markets.

The end of the recovery growth period

Since the second quarter of 2018, economic growth clearly slowed down. Companies chose wait-and-see tactics after a period of active recovery investment in 2017, considering, firstly, a decrease in return on investment due to the basic weaknesses of the companies and the low quality of their investment projects; secondly, the apprehension of a decrease in external demand, and, thirdly, the limited access to sources of financing, while the financial standing of the companies was in decline and the debt burden was heavy, which put up a barrier to investment.

In 2018, the republican budget expenditure on investment was reduced, and external sources of financing became less accessible. The contribution of banks to the investment financing decreased. Also, households reduced spending on housing construction, which had a negative impact on investment dynamics.

Unfavorable trends in the external environment, i.e. slower growth of the global economy and a reduction in the volume of trade, had negative effects on the economy together with the pressure on the exchange rates in developing economies and increased tensions in relations with Russia caused by the presence of trade barriers to Belarusian commodities.

In the autumn, Russia forced Belarus to stop applying the usual schemes in trade in Russian oil products, which secured a stable increase in the export of oil products, profitability of Belarusian oil refineries and oil traders, and revenues from the duties on oil products.

Due to the factors above, foreign trade was declining throughout the year. Outrunning growth of the physical volumes of exports relative to imports changed to the opposite trend. Accordingly, net external demand also affected output.

A favorable situation was observed in the consumer demand segment thanks to increased household incomes and a retail lending boom. At the same time, households’ propensity to import noticeably increased. From the point of view of “growth arithmetic”, the expansion of consumer demand contributed less to output growth.

In late 2018, output increased 3.1%,2 mainly due to the increase in consumer demand (ultimate consumption by households) by 4.5 percentage points and the increase in investment demand (gross fixed capital formation) by 1.3 percentage points. A negative effect was produced by the decrease in external demand (net exports) by 2.7 percentage points and by other components of domestic demand.

The industrial sector made the largest contribution to GDP (1.4 percentage points) in supply terms. The highest growth rate was reported in woodworking, production of chemicals (including potash fertilizers), vehicles, machinery and equipment, and pharmaceuticals. Wholesale trade accounted for 0.6 percentage points, construction for 0.2 percentage points and transport for 0.2 percentage points.

Price and financial stability

Despite the rapid slowdown of growth, the government refrained from excessive stimulating intervention. Economic policy was carried out rationally and even conservatively in some areas, which made it possible to maintain price and financial stability.

Against the backdrop of a gradual increase in price pressure, in the second half of the year, the National Bank decided to stop lowering the nominal interest rate. The government maintained a generally favorable monetary environment, even when the general economic situation deteriorated.

Under stable monetary conditions, the money supply in real terms showed growth comparable with the output dynamics (a 4.3% increase). Most of the year, households acted as a net supplier of foreign exchange, and the National Bank was able to improve the composition of the gold and foreign exchange reserves (although their absolute value remained almost unchanged) and pay off part of the foreign debt. As a result, average annual inflation was at 4.9%, which is a significant achievement for Belarus. Low inflation and the fluctuating exchange rate enabled to maintain external stability. The current account of the balance of payments was the best over the last 14 years (0.4% deficit of GDP).

Similar trends occurred in fiscal policy. The government maintained a steady surplus of the consolidated budget, which is necessary for a gradual reduction in the public debt. At the end of the year, the surplus of the consolidated budget made up 3.8% of GDP. As a result, the financial stability risks associated with the debt burden got lower. The public and gross external debts decreased. The ratio of the public debt to GDP was down 5 percentage points to 42.3%, and the ratio of the gross external debt to GDP decreased by nearly 7 percentage points to 65.6%.

At the same time, the debt burden on the private sector did not change significantly, remaining at risk both in quantitative and qualitative terms.

Consumer lending boom

Significant transformations took place in the credit market. The most important trend of the year was the retail lending boom. Since companies had accumulated considerable debts and their problems with asset quality continued, banks preferred to lend to households. In turn, thanks to higher incomes and lower real interest rates, households increased demand for loans.

As a result, in 2018, banks’ requirements to households increased 30.1% on average (the corporate loan portfolio increased by almost 10%). Considering that a rapid increase in household lending can threaten financial stability, the National Bank used administrative tools to insure against risks.

Real incomes rose, social tensions eased

Income policy was, perhaps, the only area of stimulating intervention in the economy. The government took direct and indirect measures with an emphasis on the poorest groups of households that incurred losses the most in 2015–2016, and this situation continued until 2018. The behavior of some employers, which was probably caused by increased competition for human resources, including with foreign employers, also contributed to an increase in incomes and a decrease in unemployment.

The noticeable increase in household incomes allowed smoothing out the accumulated imbalances in welfare and decreasing social tension. Real wages grew by 11.6% and real incomes in general by 8.0%. Compared with the 5-year low in 2016, real wages increased 19.1% (to the all-time high) and real incomes went up 10.5%.

Social transfers (pensions and social security benefits) also increased, which made it possible to increase the well-being of the poorest households. Real pensions increased 8.2%, reaching the historical peak of 2014. The poverty rate decreased to around 5.5% by the end of the year (from the peaks above 6.0% in 2016 and 2017).

The labor market stabilized after a long period of decline since 2010 (mainly due to demographic trends). So did the employment rate. Unemployment decreased from the peaks close to 6% in 2016 to below 5% in 2018, and the number of new jobs increased.

The spectrum of risks is expanding rapidly

In late 2018, despite generally good results achieved in the national economy, the range of threats and risks expanded considerably. External threats include slower global growth, adjustments in the global financial, currency and commodity markets, inaccessibility of external financing, “political” risks posed by the Russian ruble, and Russia’s economic pressure on Belarus.

Internal threats became more serious in this situation. In the second half of the year, inflationary expectations increased significantly, and inflation was about to accelerate at the end of the year.

The risks increased among other things due to the growing contradictions in domestic economic policy. In the area of monetary regulation, this concerned the interest and exchange rates. Neutralization of external shocks implies the need for a significant depreciation of the national currency and/or a higher interest rate. However, in Belarus, this policy would exacerbate the debt problem, since a relatively high ruble rate is preferable for troubled borrowers (a significant part of their debt is denominated in foreign exchange) and relatively low or lowering interest rates. The government is also interested in a relatively strong ruble from the standpoint of state debt stability.

In the fiscal segment, external shocks make a downfall of budget revenues almost inevitable, and the possibilities of systemic budget cuts are limited. This means a further loss of the freedom of maneuver in fiscal policy. For example, fiscal incentives are advisable when growth is modest and slow, and such incentives cannot be provided without creating a budget deficit. With the current status quo, the latter poses a threat to price and public debt stability. Moreover, should the situation go worse, the fiscal authorities will be unable to carry out stabilization policy and their actions will have a negative impact on macrodynamics.

Conclusion

Last year, the government pursued rational and effective economic policy, which gave an opportunity to secure price, financial and external stability and reduce the national and gross foreign debts.

On the other hand, growth slowed down during the year and almost stopped at the end of the year. A wide range of risks emerged. Being aware of the limited growth capacity, the government continued looking for opportunities to strengthen it, but did not go beyond the existing political bounds and focused on promoting the idea of a “new economy”. This idea has been flirted with in one form or another for several years now, but the results achieved are insignificant.

In the aggregate, all the arguments above determine a rather modest short- and medium-term outlook for the national economy.