Macroeconomic Situation: Mixed results, growing uncertainty

Dmitry Kruk

Summary

The year 2020 was overly eventful, yet controversial with respect to the results achieved. The country experienced two major shocks in the first half of the year: the energy conflict with Russia and the coronavirus pandemic. The situation was later exacerbated by the lingering political crisis.

The Belarusian leadership chose its own eclectic way to respond to the pandemic, i.e. limited state support, which was mostly channeled into state-run enterprises. The recovery of external demand, which began for Belarus as early as the beginning of the summer of 2020, made this approach work in terms of GDP dynamics. Net external demand helped achieve a very modest GDP decline. However, numerous new risks that stemmed from this peculiar anti-crisis policy was the price to pay. Threats to the domestic financial stability increased, and a new inflationary trend began to take shape alongside fiscal and state debt management risks. This is highly likely to lead to accumulated deferred consequences.

Trends:

Deteriorated economic environment, growing uncertainty and priority given to issues at hand

The economic turbulence began to take shape in early 2020. First, specific cycles entered a downward trajectory. The recovery effect (after the recession of 2015–2016) had exhausted itself at the turn of 2018–2019. In the absence of other stable GDP growth acceleration factors, its fading became evident as soon as late 2019.

Second, a new Belarus-Russia energy conflict broke out at the turn of 2019-2020. Third, the global economic environment went worse. Growth in Russia and the European Union, which dominate the generation of external demand for Belarusian goods, began to slow down. Besides, the impulses that were unfavorable for Belarus in terms of trade (the export/import price ratio) showed distinct preponderance. This determined the end of the three-year trend of progressive improvement of the trade environment, especially in relation to non-energy commodities.

This predetermined the initial behavior of the economic bloc of the government at the beginning of the year. It halted institutional initiatives to a large extent, and chose to look into routine matters and numerous problems at hand. A series of decrees on state support issued on the last day of 2019, namely on the restructuring of previously granted loans, non-competitive granting of new publicly funded loans, exemption and/or deferral of tax payments, selective exemption from compliance with some legal norms, was kind of a signal that structural matters were put on pause. This was quite emblematic since the tools for providing this state support did not correspond to the list of permissible tools established by framework decree No. 106 of March 23, 2016, which was enacted during the period of constrained reformist efforts of the authorities.

Since the end of the first quarter, economic impact of the coronavirus pandemic and political developments became the new determinatives that, coupled with the above-mentioned economic issues, significantly increased overall uncertainty. The entire economic agenda completely refocused on what could be done here and now, while the problems that could wait were put on the back burner.

Delayed energy conflict with Russia

The Belarus-Russia energy conflict in both its economic and political dimensions was seen coming for almost entire 2019. Russia’s tax maneuver in its oil industry led to a gradual rise of the price of crude oil.

In 2020, the tax maneuver would mean a year-on-year increase in the entry price for Belarus by around four percentage points to 83% of the global price. The main problem with accepting these terms would be a decrease in the refineries’ profitability to next to zero or even losses in the industry. This problem could be partly resolved, using national budget funds and partly by raising prices on the domestic market. The shock would be reduced to relatively modest output losses to 1.5% of GDP compared with 2019, all else being equal, and a decrease in budget revenues by around USD 300 million.1

It would be more and more difficult to find solutions to the oil and gas problems in a similar way at the next stages of the tax maneuver in the years to come, though. By 2022, Belarus will have to either reduce the oil refining volumes, or work out other systemic responses to crude oil price rises, which is hard to do, given the profound significance of the oil refining industry for the national economy. Although it only accounts for less than 1% of GDP, its actual contribution to GDP makes up 8.5% or over, because of the industrial interdependence and the multiplicative influence on demand. Also, the oil refining sector plays an important role in ensuring external, fiscal and financial stability of the entire economy.

As a third option, in 2019, Russia kept suggesting that Belarus adopted a package of agreements on greater integration as a condition for subsidizing Belarusian oil refineries in the form of a reverse excise tax on par with Russian refineries.

Belarusian authorities dismissed all the options as unacceptable, which spread the conflict over almost the entire first quarter of 2020. Russia cut oil supplies to Belarus by nearly 60% year on year, and Belarus’ export of oil products decreased accordingly. The reduction in oil refining triggered a recession.

The government did not dare to overextend the conflict against the backdrop of accumulating problems in the economy and impact of the pandemic. Russia also back-pedaled the issue closer to the end of the first quarter, as global oil prices dropped significantly. Among other things, Russia reduced the special premium for Russian companies that supplied crude oil to Belarus. The entry oil price for Belarus increased in 2020, but only by about a half of what Russia initially requested. This enabled the Belarusian refining industry to survive in macro terms. It continued performing its critical functions, but only close to the acceptable profitability minimum.

This largely helps put the resolution of fundamental disagreements on hold. First, Belarus rejected the logic of taking the oil refining sector beyond the framework of the Eurasian Economic Union as a result of Russia’s tax maneuver. Second, the next phases of the maneuver still make systemic changes in the oil refining industry of Belarus inevitable, so it can be expected that this delayed conflict will return to the agenda before 2024.

An idiosyncratic way to respond to economic impact of the COVID-19 pandemic

The coronavirus pandemic and its impact on the economy fundamentally changed the economic landscape. The overall uncertainty about its impact was great as never before. When formulating anti-crisis policies, most countries channeled their efforts toward avoiding the most negative scenarios. Measures were taken to stabilize both supply and demand. Businesses received support to neutralize the potential output erosion and prevent the breaking of production linkages. This support was often offered on condition that jobs were preserved. State support was mainly given to the most affected industries and, sometimes, to small and medium enterprises.

As concerns demand, the vast majority of countries provided massive support to households by means of installments, deferrals of payments and other available tools, which made it possible to solve several problems simultaneously: to maintain consumption and payment discipline, and to avoid income disparities. This largely led to budget deficits and public debt burdens.

Belarus was dealing with the economic effects of the pandemic in quite a different way. Firstly, it took a long time to work out responses of any kind. During the first month of the pandemic, the authorities only took pinpoint, small-scale measures.

Secondly, the government resorted to traditional prescriptive policy, first and foremost, price regulation. The list of socially important goods, the prices of which were tightly controlled, was significantly expanded during the first few months of the pandemic. Thereby, the authorities tried to prohibit the negative consequences in a directive way, while other countries focused on providing incentives to producers and buyers to prevent such consequences.

Thirdly, the COVID-19 response, which took much more time than expected and was positioned as systemic, can hardly be considered de facto as such. The key legal act – decree No. 143 – offered a limited list of tools of support for businesses and quite modest support for households. Companies were given an opportunity to apply for installments and deferrals on tax, rent and energy payments. Also, companies were given some new rights in the field of employer-employee relationships, and just some relaxed support rules were set to households.

Fourthly, anti-crisis measures of the largest scale, which were sometimes not even officially described as such, were taken to support state-owned enterprises. On the one hand, the enterprises were administratively forced to maintain output regardless of sagging demand. On the other hand, the negative consequences of this for the financial health of the enterprises was smoothed over through unconventional measures, mainly by means of restructuring old debts and lowering the costs of their servicing. This support was provided, as a rule, on a case-by-case basis. Sometimes, creditors changed, or calling in loans was converted into a creditor’s share in the borrower’s capital. The granting of new directed loans also intensified contrary to the previously declared intention to curtail it by the end of 2020.

In fact, during the COVID-19 crisis, the authorities’ actions were determined by the following key guidelines: limited support for the economy; priority of nonconventional support tools; limited direct financial injections; unconditional priority of large state-owned enterprises when granting support; priority of supply over demand, and minimized direct support for households for conditionally external and internal reasons. The external reasons include a limited room for maneuver in using stimulating economic instruments. Given the numerous structural flaws, such as the dollarization, considerable inflation expectations, and onerous state and corporate debt burden, an active stimulating policy is fraught with risks to macroeconomic and financial stability. The internal reasons include attitudinal and political viewpoints of the authorities, for example, unswerving support for large state-owned enterprises, regardless of their potential and original financial standing.

Growing threats to financial stability

Financial destabilization was a profound effect of the coronavirus crisis, somewhat inevitable due to numerous structural flaws and, partly, handcrafted due to the peculiarities of anti-crisis policies. First of all, this is about the poorer debt sustainability of the corporate sector resulting from continued surplus production during the pandemic-inflicted crisis. Enterprises accumulated inventories, which led to a washout of already scarce circulating liquid assets and reduced ability to service debts.

Liquidity, especially in foreign exchange, and the exchange rate of the national currency were also the sore points. At the very beginning of the year, households began to withdrew foreign exchange deposits from banks on a large scale basis amid the growing crisis and spiked increase in demand for foreign exchange. These trends grew stronger following the outburst of the political crisis in the second half of the year. As a result, about 25% of all term deposits in foreign exchange (around USD 1.5 billion) was withdrawn in 2020. This was a serious blow to the liquidity of banks, which were only partially able to substitute the outflow with other own resources. The depreciation of the Belarusian ruble was another consequence.

Under the circumstances, the National Bank had to use its foreign exchange reserves to cope with the negative trends in crunch time, and, in the second half of the year, it substantially revised monetary policy mechanisms. The National Bank took ruble liquidity injections into the banking system under almost total control, trying to curb demand for foreign exchange and to reduce the spending of the gold and FX reserves. Keeping in mind the debt sustainability of state-owned enterprises, the National Bank refrained from raising the refinancing rate, which remained unchanged in the second half of the year, while manual liquidity management was basically no longer a policy tool.

The measures above helped stop the escalation of threats to financial stability. The exchange rate of the ruble, lending volumes, and rates on credits and deposits played a role of some sort of dampers. The Belarusian ruble depreciated by about 14% against the basket of currencies and by nearly 22% against the U.S. dollar in 2020. In the second half of the year, banks substantially reduced lending (except for directed crediting), and significantly raised the lending and deposit rates, which produced some stabilizing effect on liquidity. This somewhat mitigated the symptoms of financial fragility, yet its underlying causes remained.

The mitigation of financial threats in 2020, basically, cost about 20% of the country’s gold and foreign exchange reserves (USD 1.9 billion), while the public debt burden was growing. The gold and FX reserves contracted despite the significant external borrowing aimed at replenishing them. Belarus placed USD 1.25 billion in new Eurobonds and borrowed USD 1 billion from Russia and the Eurasian Fund for Stabilization and Development under political agreements.

Foreign trade miracle

The chosen format of anti-crisis measures turned risky not only from the financial stability angle, but also in terms of the output smoothing efficiency. This could only work as a measure to support output, if demand showed rapid recovery. On the upside, external demand for Belarusian commodities did begin to quickly recover since the middle of the year, which was quite a stroke of luck.

Moreover, external demand was a driver for further output growth in the second half of the year. The physical volume of exports recovered to its pre-crisis level with regard to most commodity items as soon as autumn 2020, and continued to grow. Imports grew at a much slower pace, which was no less important for the output dynamics and external and financial stability. This was a result of a decline in domestic demand (primarily investment demand) amid escalating financial threats and growing uncertainty, sharp fluctuations of the ruble exchange rate, and measures taken by the government to ration imports.

The reorientation of the growth regime towards external demand was an important macroeconomic trend after a four-year period of growth that was mainly based on domestic demand. This foreign trade miracle can be regarded as the leading cause of the good-looking GDP dynamics in 2020. This also helped alleviate the threats to macroeconomic and financial stability.

Contradictory results of the year

The economic results of the year were contradictory. Given the number and scale of the shocks that took place, the most probable scenario was a considerable drop in output and incomes accompanied by intense financial stress. In fact, GDP only declined by 0.9%, which is much less than, for example, during the 2015–2016 recession. Furthermore, the decline in Belarus’ GDP amid the coronavirus pandemic was one of the smallest in the world. Despite the pandemic and economic contraction, the average real wage in Belarus continued to increase by an impressive 8.2%, while the official unemployment rate remained at 4.1%.

Social transfers (pensions, benefits, etc.) showed some growth during the year, and the poverty rate decreased by 0.1 percentage points to 3.3%. Financial stress was limited. Although inflation accelerated considerably to 7.3% as of the end of the year and went beyond the target level of 5%, it remained relatively acceptable.

However, although the results looked pretty good in terms of annual statistics, they were ambiguous when viewed from a longer term perspective. Numerous risks re-emerged as the cost of anti-crisis efforts, first and foremost in the form of threats to financial stability, which was largely expected and predictable. They are fraught with delayed financial stresses comparable with the 2011 currency crisis, which, in many respects, was a delayed payback for voluntaristic economic policy in the preceding years.

Secondly, new risks and threats are gradually taking shape and growing both at the micro and macro levels. For example, many state-owned enterprises that had found themselves in a worse financial state with increased labor costs have resorted to deferred cost-cutting measures, and this, accordingly, makes them heavily dependent on state support.

At the macro level, the depreciation of the ruble and eclectic monetary policy have led to increased inflationary expectations again. There is a threat of a new inflationary trend, rather than just a short-term acceleration of inflation, as in 2020. Similar risks have emerged in the fiscal and public debt management. The trade surplus reduced dramatically due to declined revenues in many respects caused by Russia’s tax maneuver and reluctance to reconsider spending. This brings about a fundamentally new situation in the fiscal sector, and places additional strain on the future foreign debt management.

Conclusion

The year 2020 was an overly eventful and ambiguous in terms of the results achieved. Exacerbated by the political crisis, peculiar anti-COVID policies led to a proliferation of multiple risks. Threats to financial stability have intensified on a large scale, a new inflationary trend is taking shape, and risks have emerged in the fiscal sector and in the public debt management.

These risks make it quite likely that delayed negative consequences will build up in the future. For example, the probability of a delayed and prolonged recession looks high. For Belarus, the coronavirus crisis may well turn out to be a W-shaped rather than V-shaped recession, as we can tentatively conclude based on the 2020 data. Moreover, keeping in mind the structural flaws, which are also exacerbated by the pandemic and the 2020 political crisis, an L-shaped recession may take place, leading to a sharp economic decline.