The risks to economic independence
In February, the key issue on the agenda was the reformatting of relations with Russia in the oil sector. Having rejected proposals to deepen integration and having practically lost the possibility of receiving compensation for a tax manoeuvre, the Belarusian authorities still hope to improve the conditions for oil supplies by reducing the profit of Russian suppliers. Belarus continues to refuse to buy oil from large Russian companies at a price with a premium for the long-term contract, which led to a drop in Russian oil supplies in the first 2 months of the year by 76% to 709 thousand tons. At the same time, the authorities are actively engaged in the search for alternative oil suppliers, which they manage to do quite satisfactorily. For example, in January-February, the refineries worked at around 50% of their capacity, which allowed to fully supply the domestic market with petroleum products and form a small export portfolio. In March, oil supplies to Belarusian refineries are expected to grow to at least 1 million tons. At the same time, the geography of suppliers is expanding (for example, the Azerbaijani state-owned company Socar should deliver up to 1 million tons per year as a whole) while the authorities seek for new oil delivery methods (it is planned to re-use the Odessa-Brody pipeline in reverse mode). The symbolic image blow to Russian companies could be the establishment of American oil supplies through Polish ports using one of the branches of the Druzhba pipeline in reverse mode. Until recently, the possibility of such an option was assessed as extremely low, but with the assistance of the US authorities, the Polish side expressed its readiness to modernize the pipeline and by the end of the year provide technical feasibility of such supplies.
These steps of the Belarusian authorities are aimed at reducing dependence on a monopoly supplier and generally at strengthening sovereignty, but in the short term they have a significant negative effect on the economy both by reducing the production of petroleum products and by purchasing raw materials at higher prices. According to some estimates, every 10% reduction in the production of petroleum products leads to a drop in GDP by 0.35%. Largely due to the low loading of the refineries, the fall in GDP in January amounted to 1.9%. The reduction in the sale of petroleum products significantly affects budget revenues. So, the loss of budget revenues with a complete refusal to export products made from Russian oil is estimated at about USD 730 million.
It is still an issue, when and under what conditions the current situation will be resolved. The losses of the Belarusian economy are obvious, but the persistence of the Belarusian authorities in the issue of premiums creates certain problems for Russian suppliers. According to some estimates, it was precisely the reduction in oil consumption by Belarus that led to an increase in the discount in the price of the Russian brand Urals to the reference brand Brent. The situation also creates negative image for Moscow’s integration projects, in particular for the EAEU. At some point, the Russian authorities even showed their willingness to compromise (to reduce the premium per year by USD 2), but Belarus decided that such terms of the concessions are insufficient. At the same time, despite the narrowing of work on integration roadmaps, Russia has not yet shown any pressure on Belarus. The issues with the gas price for 2020 and the amount of compensation for the supply of low-quality oil in the spring of 2019 were solved in a constructive spirit (the compensation per ton of low-quality raw materials will be similar to one for other transit countries).
The risks to economic growth
Despite the high importance of the oil refining sector for Belarus, the issue of supplying it with raw materials in the coming months may become secondary due to two more global problems — a slowdown in the global economy provoked by the new coronavirus pandemic and a price war on the oil market. Although the recession scenario is not yet basic, the situation in the global economy is rapidly deteriorating. The economy of China, which has applied unprecedented quarantine measures to stop the epidemic, is currently the most affected. For example, Chinese exports in January-February fell by 17%, and business activity indices show a record low level, which indicates a deep decline in both industry and the service sector. According to some estimates, the economic decline in the Hubei region, which became the epicentre of the outbreak of the virus, reaches 75-80%. Problems in China, tightly integrated into the supply chain of many sectors of the world economy, are already reflected in other major economies. Thus, in February leading indexes characterizing the business environment in world industry fell to the lowest levels since 2009. According to Bloomberg estimates, if in the countries where there are already cases of the virus, the situation will turn into an epidemic (this will affect the tens of the largest economies as well), global economic growth in 2020 will slow down to 1.2% instead of the originally expected 3.1%. In this case, the EU economy will be in recession, and the fall of the Russian economy will be about 3%. In the event of a world pandemic, global economic growth will decline to zero, and the recession will spread to the US economy.
Rising fears about the spread of the coronavirus are affecting financial markets as well — the first week of March was the worst for stock markets since 2008. A significant drop in prices is also observed in the commodity markets, and due to the flight of capital to protective assets, the yield on US Treasury bonds is breaking historic lows. At the same time, the traditional measures of economic authorities to support demand do not give the expected effect. Thus, an unexpected decrease in the discount rate of the US Federal Reserve by 0.5 percentage points, which was adopted at an emergency meeting of the Federal Reserve in early March (the first one since 2008), even more increased panic in the market.
The situation in the global economy affects Belarus primarily through the foreign trade channel and affects sales of key export positions. So, the conditions for the Belarusian potash industry are becoming even worse. In the absence of a contract with Chinese consumers (which will be even more difficult to achieve now), the production of potash fertilizers in January fell by almost 44% compared to last year. The export of Belarusian investment goods, which is already facing problems in the second half of 2019, will also be affected. In the event of a stagnation or even recession in the economies of the USA and the EU, even the IT sector (in particular, its part working according to an outsourcing scheme), whose export of services in 2019 became a key driver of GDP growth, may get under pressure.
The negative foreign trade picture is complemented by a powerful drop in oil prices, provoked first by fears because of the coronavirus, and then by Russia’s refusal to continue the OPEC + deal. This deal, concluded in 2017, was designed to limit the supply of oil on the world market and help stabilize prices at a level acceptable to oil producers. Apparently, the breakdown of the agreement is explained by Russia’s desire to start a dumping war against American shale oil producers, whose share has been gradually growing since 2017. Saudi Arabia also began an active struggle for market share, the very day after the failed negotiations with Russia, it announced a record reduction in prices for buyers and its readiness to increase production volumes. A full-fledged price war amid weak demand will push oil prices to a further drop. Despite the fact that Belarus is not an oil producing country, the fall in oil prices traditionally has a significant negative impact on its economy. This is due to a reduction in the margin of the oil refining sector and weakening demand in the Russian market. At the same time, however, there is a certain bonus: the losses of Belarusian refineries from the supply of petroleum products to the domestic market are reduced, and the importance of negotiations with Russian oil companies is reduced as well.
The risks of financial instability
The fall in oil prices, traditionally accompanied by a weakening of the Russian currency, creates significant risks for the Belarusian ruble (BYN). Moreover, additional problems arise against the background of an already worsening situation in the foreign exchange market. So, BYN exchange rate has noticeably weakened against the US dollar and the Euro since the beginning of the year (by 6.5% and 4.9%, respectively). The net demand for foreign currency from the population and legal entities increased significantly (their net purchase amounted to USD 128 million and USD 270 million, respectively). As a result, the National Bank was forced to spend reserves for foreign exchange interventions in the domestic market, which became one of the factors causing the fall of foreign exchange reserves almost by USD 440 million, or 4.7% in February. Moreover, the situation on the global financial market worsens the conditions for attracting resources to support gold reserves by placing new Eurobonds. Thus, in early March the Ministry of Finance of Belarus after holding meetings with potential investors decided to postpone a new outlet in the bond market for an indefinite period.
The observed BYN depreciation and turbulence in world markets, as well as problems with the oil refining sector, can create serious prerequisites for the growth of inflationary expectations of the population. Additional risks in this situation are created by another decrease in the refinancing rate by the National Bank to a record low of 8.75% in February. Although similar measures are now used by many central banks to support demand, in the context of the high dollarization of the Belarusian economy, excessive easing can stimulate credit growth and create additional pressure on BYN. At the same time, acceleration of annual inflation has not yet been observed — the current price movement follows the trajectory of the previous year, and according to the results of January, annual inflation amounted to 4.7%, which is below the standard level of 5%.
The budget of Belarus was planned on the basis of the forecast for Urals price USD 60 oil per barrel and an average annual rate of 2.24 BYN/USD. A reduction in budget revenues due to a drop in exports of commodities and a slowdown in economic activity will require the authorities to use the reserves accumulated in previous years (about BYN 4 billion in the accounts of the Ministry of Finance), and in case of their shortage the revision of the budget expenditures will be necessary. Given the upcoming elections, a reduction in social spending is unlikely to be politically acceptable, and the choice is likely to be made towards reducing spending on supporting the economy. Under the conditions of the Belarusian model (in particular, the authorities’ desire to avoid the bankruptcy of inefficient state enterprises as much as possible), the reduction of such support will create additional pressure on the banking system in terms of the growth of bad debts and contribute to the growth of financial problems at the micro level.
The economy of Belarus faces a whole set of serious challenges: the risks of a serious slowdown in the world economy and the outbreak of a price war on the oil market are added to the problem of small loading of the oil refining sector. The implementation of these risks can be an economic shock for the country and require the authorities to use measures to stabilize the financial system.