The risks of financial instability
The developing political crisis is becoming the main factor creating significant risks for the financial sector and exacerbating its chronic problems. The first consequence of the crisis was a sharp drop in confidence in the national currency on the part of the population and business. As a result, in the second half of August, a situation of rush demand on the foreign exchange market was observed, which was accompanied by an outflow of BYN deposits from the banking system and an increase in demand for BYN loans. Thus, according to official statistics, in August, on a net basis, the population bought more than USD 620 million, and resident organizations – more than USD 650 million. To maintain BYN exchange rate, the Belarusian authorities were forced to take extraordinary measures. Thus, in order to increase the supply of foreign exchange on the market, the National Bank carried out large-scale foreign exchange interventions, the size of which amounted to about USD 1 billion in August. This, in turn, led to the maximum monthly fall in the sovereign history of gold and foreign exchange reserves – they decreased by USD 1.4 billion to USD 7.5 billion.
At the same time, in order to reduce the BYN mass available for currency exchange operations, the National Bank went for a sharp decrease of BYN liquidity. So, it was decided to terminate operations to support the liquidity of banks on a permanent basis (carried out at a fixed rate of 8.75%), retaining only periodic lending through auctions. As a result, banks, given the observed outflow of BYN deposits, began to experience an acute shortage of BYN resources. This, in turn, led first to a sharp increase in the value of money in the economy (rates on the interbank market on certain days reached 25%, and offers of short-term deposits with a yield of 20-25% appeared on the deposit market), and then to the stopping of lending by most banks. So, in early September, the largest bank in the country, Belarusbank, suspended most of the consumer and housing lending programs.
As a result of such measures of the National Bank, the fall of the BYN in early September was stopped, and even some rebound occurred. So, if on August 9, USD exchange rate was BYN 2.45, then on September 1 it reached BYN 2.66 and then began to gradually decline to BYN 2.60. At the same time, it is obvious that it is premature to talk about levelling the risks of its further fall. The operation of the banking system in the mode of stopping credit operations, in addition to losses for the banks themselves, will be accompanied by a decrease in demand in the economy, as well as a deterioration in financial discipline in the real sector. We can talk about both an increase in the risks of non-payment both between organizations and an increase in wage delays. Accordingly, such drastic measures by the authorities regarding BYN liquidity are temporary, and they proceed from the temporary nature of the panic wave in the foreign exchange market. In case the confidence in the BYN and the banking system does not recover (for example, because of positive news about the attraction of significant external financing) and a significant outflow of household deposits continues, the national currency, after the mitigation of measures by the National Bank, may face another wave of decline.
In such a situation, the authorities have a narrow range of decisions. Refusal from foreign exchange interventions in a situation of strong devaluation expectations will lead to further BYN weakening. Such weakening, in turn, will greatly increase the risks in the banking system associated with the growth of bad debts due to the inability of borrowers to service their foreign currency loans. Also, a BYN fall will increase budget spending on servicing the state debt and, accordingly, will increase the budget deficit. The continuation of the active sale of foreign currency by the National Bank may lead to the depletion of the country’s gold and foreign exchange reserves. Taking into account the planned payments on the state debt (they are estimated at about USD 1.5-2 billion by the end of the year), a drop in the gold and foreign exchange reserves to a critical level (about USD 4 billion) may become possible within a few months.
At the same time, the political situation sharply limits the possibilities of the Belarusian authorities to attract new borrowings. Cooperation with international funds has been frozen for an indefinite period. For example, the IMF refused to provide a loan in the amount of USD 940 million under the emergency financing program. Entry into the market for sovereign borrowings can also be blocked, and the cost of such borrowings can be prohibitive. In the context of the reduction of banks’ foreign exchange liabilities, the potential of the domestic market for government borrowings is also sharply narrowing.
In such a situation, Russian or Chinese loans can become the only sources of substantial replenishment of gold and foreign exchange reserves. Thus, the Belarusian authorities have already turned to the Russian government with a request to refinance payments in 2021 in the amount of USD 600 million for a period of 15 years. Obviously, this amount is not enough to tackle the current problems, and the Belarusian authorities will raise the issue of a significantly larger credit line, possibly through the EAEU, like they did in previous years. If the task of replenishing the gold and foreign exchange reserves turns out to be unfulfilled, the authorities may face the dilemma of introducing currency restrictions (obligatory sale of part of foreign exchange earnings, banning the sale of non-cash currency to the population, etc.), although they deny the possibility of such steps at the moment.
The increase by the National Bank of the refinancing rate, followed by an increase in rates on BYN deposits on a medium-term basis could be an effective step to restore the attractiveness of savings in the national currency. It was these steps that helped stabilize the banking system in 2011 and 2015. However, at present, the authorities assess this step as inexpedient, since the level of devaluation expectations is too high and it cannot be compensated by a moderate increase in rates. Moreover, such a measure will lead to a commensurate rise in the cost of lending, which will negatively affect the economic dynamics.
The risks to economic growth
Since attempts to organize a large-scale strike movement have been unsuccessful, the impact of the political crisis on economic growth in the short term will be manifested primarily through problems in the banking sector. The current suspension of lending and a possible subsequent increase in interest rates on loans will have a significant impact on both consumer demand and the ability of organizations to continuously finance their current activities.
The medium-term effects of the political crisis also look significant. They will manifest themselves through a drop in the country’s investment attractiveness. The most painful blow to the economy may be the outflow of the IT sector from the country or at least the end of the period of its accelerated growth. Despite the relatively small share of the IT sector in the economy (it is estimated to account for about 3%), in recent years it has provided a significant share of economic growth. So, in 2019, up to half of GDP growth was provided by the IT sector. This sector plays a particularly important role in the economy of Minsk: it provides about 20% of the city’s gross regional product, it is a key generator of demand for office real estate (according to estimates, up to 70% of newly commissioned space is rented by the IT sector). At the same time, IT representatives form a significant part of the demand in the residential real estate market and various services.
The situation in the external sector is not developing in the best way as well. Although the world economy has been demonstrating rapid recovery over the past 2 months (a significant recovery can be observed in the Russian economy), its further dynamics along a V-shaped trajectory is increasingly being questioned. This is due to both the gradually realizing risks of the second wave of the COVID-19 pandemic and the slow recovery of some industries (passenger transportation, tourism, etc.). The deteriorating expectations resulted in another drop in oil prices (the price of Brent again dropped below USD 40 per barrel) and an increase in pessimism in the stock markets. A slower recovery in external demand undermines the plans of the Belarusian authorities, which have reduced all accumulated treasury reserves to finance this year’s budget deficit. As early as 2021, the Government plans to switch to a deficit-free budget, which, given weak external demand and significant warehouse stocks at enterprises, could severely impact economic activity.
A politically motivated aggravation of relations with the Baltic states and Ukraine also threatens to result in significant losses in the external sector. In particular, the implementation of the announced asymmetric sanctions against the Baltic countries by the Belarusian authorities (for example, the imposition of bans for Lithuanian carriers on the transportation of goods through Belarus) may cause a response from neighbouring countries, and given the positive balance of trade with them, the net result for Belarus will turn out to be negative. There is even greater potential for losses in the event of a conflict with Ukraine, which is the second trade partner of Belarus and a key sales market for Belarusian oil products.
At the same time, some positive GDP dynamics will be added by a good result in agriculture, whose growth in 8 months of the year amounted to 7.8%, largely due to a higher yield compared to last year. However, despite this local success, the plans of the authorities to bring the economy to zero growth by the end of the year remain unrealizable. So, with the current drop in GDP by 1.6%, the rating agency S&P in its latest survey predicts a decline in the Belarusian economy by 4% by the end of the year.
The risks to economic independence
The crisis in relations with Western countries against the background of a sharp increase in the need for external financing is forcing the Belarusian authorities to intensify negotiations with Russia, aimed primarily at obtaining emergency financing and maximizing energy subsidies. At the same time, the negotiating position of Belarus, compared to the pre-election period, has significantly weakened, which forces Lukashenka to promptly make some concessions. Thus, Belarus agreed to redirect part of its trade flows from the Baltic ports to the Russian port of Ust-Luga, despite the potential losses from such a decision in the amount of about USD 30 million per year. The government also announced its readiness to pay off the accumulated debt for gas supplies (currently exceeds USD 320 million), which was previously considered as a tool in negotiations to reduce current gas prices. In addition to pressure from Russia in terms of signing integration roadmaps, one can expect the reincarnation of the issue of the entry of Russian capital into a number of Belarusian state-owned enterprises, which was on the agenda in the first half of the 2010s. A loan from China could strengthen the Belarusian position, but at the moment there are no signs of negotiations on this issue.
Belarus is on the verge of being drawn into a spiral of political and economic crisis, when the aggravation of the political situation in the country provokes negative consequences for the economy, which in turn intensify political confrontation. At the moment, the key risks are concentrated in the banking sector and the foreign exchange market. A necessary condition for stabilization is the attraction of significant external funding, which puts the authorities in a vulnerable position in negotiations with Russia on the further development of the so-called “Union State” and the growth of the presence of Russian capital in the Belarusian economy.