The risks of financial instability
High inflationary and devaluation expectations remain the most important factor determining the situation in the country’s financial market. At the end of March, the population has been a buyer of foreign exchange for the 16th month in a row, having acquired almost USD 25 million on a net basis. The trend of gradual decline persists in the country’s deposit market: a small increase in household BYN deposits (+ BYN 46.7 million in February) does not compensate for the decrease in foreign exchange deposits (-USD 44.4 million). In such conditions, the cost of credit resources in the economy remains high (for example, rates on large consumer loans are in the range of 25-30%), and various lending programs (for example, home purchase) are severely limited. At the same time, we can talk about the potential for maintaining the observed trends in the future. Thus, consumer inflation continues to accelerate: in February it amounted to 8.7% (the maximum value since 2016) and was only slightly less in March — 8.5%. According to the National Bank, the level of inflation expected by the population is also growing: according to the March poll, it amounted to 12.9% compared to 11.3% in November 2020.
However, even in this situation, apparently due to pressure from the government, the National Bank did not dare to raise the refinancing rate and kept it at 7.75%. At the same time, since the value of this parameter in the current economic policy has been greatly distorted, the decision to indefinitely refuse to provide banks with liquidity on an ongoing basis should be recognized as even more significant event. Thus, the National Bank retains the manual market management for an indefinite period of time, thereby recognizing the significant potential for pressure on the BYN exchange rate should the market return to normal operation. In this regard the behaviour of the National Bank at the next auction to support liquidity is quite indicative: only BYN 250 million were provided, while the total demand reached BYN 3.7 billion. Thus, despite certain concerns, the National Bank continues its policy of containing the BYN monetary masses. A side effect of this policy was a reduction in lending in both consumer and corporate segments in February.
The persistence of devaluation expectations in the economy does not give the authorities the opportunity to return to the sustainable practice of replenishing gold and foreign exchange reserves through purchases of foreign currency in the domestic market. Although the National Bank claims that in March it managed to become a net buyer in the foreign exchange market, the country’s gold and foreign exchange reserves reduced by USD 175 million to USD 6.94 billion. The current dynamics of the reduction of the reserves (since the beginning of the year they have fallen by almost USD 530 million) is ahead of the trajectory planned by the authorities. In order to maintain control over the situation, the government plans to raise an amount of USD 1 billion by the end of the year. The government counts on the second tranche of the Russian government loan (USD 500 million), other interstate loans, as well as a new placement of government bonds on the Russian market. The potential of the latter source is questionable: the previous placements of bonds on the Russian market by the Ministry of Finance of Belarus in 2019-2020 did not exceed RUB 10 billion (less than USD 150 million in equivalent). The refusal of the authorities to place Eurobonds on Western grounds looks to a large extent a forced measure, both for economic and political reasons. Since the beginning of March, quotations of Belarusian bonds on world exchanges have fallen markedly, and the current yield on them is in the range of 7.1-7.7%. This can be explained by the increase in reputational costs for the holders of Belarusian bonds, as well as the likelihood of imposing sanctions on the sovereign debt of Belarus, including the blocking of new placements.
The situation with the current budget execution is extraordinary. Thus, a significant budget deficit (BYN 1.37 billion, or 3.5% of GDP) is observed already in the first 2 months, although it usually has a strong growth trend in the last months of the year. The current deficit is primarily due to a sharp increase in expenditures for national activities (up to BYN 3.07 billion compared to BYN 1.27 billion a year earlier). Apparently, a significant part of these expenses is related to the rescue of troubled enterprises (in particular, Belarusian Steel Works). The authorities say that the record deficit will be covered by previously accumulated reserves, as well as borrowing in the domestic market. However, given the prevailing trends, these reserves may be used up already this year, and if economic activity in the country does not intensify, the authorities will face the need to significantly cut budget expenditures.
At the same time, the external sector, which plays a fundamental role in the issue of financial stability, continues to show positive results. So, according to the National Bank, in the first two months of 2021, both foreign trade in services and goods turned out to be surplus (by USD 668 million and USD 88 million, respectively). We can also talk about market improvements for Belarusian goods: the record demand for potash is pushing the recovery of its prices, a significant rise in prices is observed in the world food market, while there are also signs of recovery in investment demand in the Russian market. A positive factor for the balance of payments is the decline in consumer imports, which is observed against the background of stagnation in lending and household income. This situation in foreign trade largely compensates for the risks for BYN associated with the loss of confidence in it inside the country.
The risks to economic growth
At the end of February, statistics recorded the expected slowdown in GDP growth: to 0.8% compared to 1.3% a month earlier. At the same time, the decline was recorded in such sectors as agriculture (-1%), construction (-11.8%), retail trade (turnover decreased by 3.6%). The growth in the communications and information services sector decreased noticeably compared to the previous year: to 2.9% compared to 7% in 2020. To a large extent, the observed GDP growth was generated only by industry (+ 8.3%), and in particular by an increase in oil refining compared to the previous year.
It is expected that the trend of economic slowdown will continue in the future. This conclusion can be used to combine the forecasts of several international financial institutions on the development of the Belarusian economy, updated in March. The most complimentary forecast for the authorities, containing a small increase in GDP by 0.1%, was presented by the EDB. At the same time, the World Bank and IMF expect the Belarusian economy to decline in 2021 (by 2.2% and 0.4%, respectively). It is important that a recession or, at best, stagnation of the Belarusian economy is expected against the background of rapid economic growth in the world and the region. Weak economic dynamics are expected due to a decrease in investment demand in the country (both due to a decline in lending activity and pessimistic economic sentiments), as well as a drop in household income. The end of the period of rapid growth is also expected in the IT sector, which has been a key driver of the economy in recent years. A significant problem for the industry will be the outflow of personnel abroad: for example, according to statistics of recent months, the number of employees in this sector has stabilized instead of a significant increase in previous years.
The medium-term growth potential of the economy is severely limited by the inefficiency of the public sector of the economy, where the authorities continue to refuse to carry out meaningful reforms. The attention of the government is more focused on solving current problems at the micro level (for example, material support of a state company, accelerating modernization projects of some enterprises, helping troubled enterprises). Perhaps a detailed plan for the development of the economy, the development of which was previously announced by Prime Minister Raman Halouchanka, could shed light on the steps taken by the authorities to resolve the fundamental problems of the Belarusian economy. However, this document was actually made secret for the public. The reasons for this decision can only be guessed at (for example, the expert community spoke about the reduction of budget spending on social needs provided for by the document or the activation of credit support for state-owned enterprises). In any case, such a communication policy of the government further reduces the level of trust of economic agents and supports inflationary expectations.
The risks to economic independence
Perhaps the most significant risks of a sharp deterioration in the economic and financial situation in the country are associated with the possibility of increased sanctions pressure from the EU and the United States. Already from April 26, American sanctions on 7 state-owned enterprises of the petrochemical sector may be unfrozen. These sanctions have been in effect since 2006, and were frozen in 2015 due to the improvement in bilateral relations. The exports of these enterprises to the United States are relatively small, and the effect of the sanctions during their period was not critical for the Belarusian economy. However, since 2017, the American authorities have greatly changed the regulations on the application of sanctions, which made it painful to get on such a list even in the absence of trade and financial transactions with American companies. So, now the authorized body (the Agency for the Control of Foreign Assets of the US Treasury) has the ability to include in the sanctions list organizations of any jurisdiction that cooperate with sanctioned organizations. Accordingly, the inclusion of such a mechanism for Belarusian enterprises threatens to bring down their export-import operations, since even Russian companies are trying to avoid violating American sanctions as much as possible.
There are also the first announcements of the fourth package of EU sanctions against the Belarusian authorities. According to some reports, the preliminary list contains about 200 individuals and dozens of companies. However, since the adoption of this list requires a consensus decision by all EU countries, its final version is traditionally very different from the preliminary one.
Belarusian counter-sanctions, the decree on which was signed at the end of March, may also have a negative impact on economic growth. At the same time, a specific list of goods and organizations that fall under the restrictions has not yet been determined, and it will be created by the government.
The growing tension between Russia and Ukraine also creates problems for the Belarusian economy. The financial consequences of further escalation of the conflict may be a weakening of the BYN against the USD and an increase in the cost of borrowing in the Russian market. Allied relations with Russia could also lead to tougher conditions for Belarusian suppliers in the Ukrainian market, which has historically been the second largest export market for Belarus.
In the current situation, the dependence of the economy on favorable relations with Russia is becoming increasingly critical. The strategic weakening of the Belarusian authorities creates preconditions for big concessions in the process of deepening integration within the framework of the so-called “union state”. Thus, the Ambassador of Belarus to Russia Uladzimir Siamashka noted the intensification of work on roadmaps for integration, and predicts that they will be agreed upon by the end of April this year. Also, according to his estimates, by January 2022, all agreements stipulated by the roadmaps will be signed (however, Siamashka is known for being overly optimistic in his estimates, many of which are not subsequently confirmed). In case of “payment” by the Russian authorities, such concessions may even create short-term positive effects in Belarusian economy, but they will limit sovereignty and narrow the range of possible directions for Belarus’ development in the future.
The situation in the financial sector continues to be determined by the high level of inflationary and devaluation expectations. The high cost of credit resources and the pessimistic sentiments of economic agents create prerequisites for a further decline of the country’s economy, despite the rapid growth of the world economy. The main shock risk may be the further tightening of sanctions by the US and the EU. At the same time, the country’s surplus trade balance acts as a stabilizing factor.