Probability of the currency crisis repetition in Belarus is quite high

By Leonid Zlotnikov, Belarusian Analytical Workroom

Would a wage increase up to USD 500 by the end of 2012 entail 2011-like currency crisis recurrence with high inflation and devaluation?

The author of this article elaborates on this pressing question.

Belarus increasingly lags behind Russia in terms of population’s income standard. In 2000 income per capita was USD 750 in Belarus and USD 903 in Russia, in 2011 - USD 3017 and SUD 8464 respectively. By the end of 2011 as a result of high inflation (208%) and Belarusian ruble devaluation (by almost 3 times) real wages decreased by 13.6% compared with the end of 2010. Salaries decreased from USD 515 (December 2010) to USD 340 (December 2011). Labour outflow from Belarus to Russia, skilled labour in particular, increased. Personnel shortage started affecting a variety of professions. All of this raised the authorities’ concerns, particularly in the view of the Parliamentary elections scheduled for September 2012.

The authorities have found a simple solution to a complex economic problem: the President requested the Government to raise the average salary in the country up to USD 500 by the end of 2012. Previous administrative wage increase in 2010 (the Presidential election was held at the end of 2010) resulted in the currency crisis, inflation and falling incomes in 2011. But the lesson has not been learned.

Conventionally population’s incomes grow accordingly to GDP growth, i.e. in compliance with the production for consumptive use growth. Projected GDP growth in 2012 was 5%. Obviously, such an increase in GDP cannot ensure the required increase in income. However the task is being successfully fulfilled, at least in dollar terms: salaries by the end of August had reached USD 475. So why do wages increase and, most importantly, will the country once again fall into a deep devaluation and inflation 2011-like? Answers to these questions are the subject of study in this article.

All is not gold that glitters

One of the ways to increase salaries is to redistribute gross domestic product (GDP). Note, that GDP is divided into three parts: population’s incomes, state budget revenues, and businesses profits (gross investment composed of net investment and depreciation). Population’s incomes can be increased by reducing other types of incomes without increasing GDP. In fact, that is what actually happens in 2012. Here are a few examples.

In the first half of 2012 business and government spending on investments decreased by 18%. The cost of salaries growth in 2012 was partially covered at their expense.

Another way to increase salaries is to redistribute business entities’ profits and costs. For example in 2012 it is envisaged, that the population will pay nearly twice as much for utilities from their increased incomes (today the state subsidizes about 70% of the public services costs). Accordingly, the part of GDP that goes to state revenues could be reduced, with simultaneous reduction in budget subsidies for these purposes and businesses’ expenses on cross-subsidization of the population. Currently the Government is considering an increase in deductions from the wages to the Social Security Fund and a corresponding reduction in employers’ contributions to the budget. Therefore statistics will show increases in real wages, which however would not imply an improvement in the population’s well-being (i.e., goods and services’ consumption by the population will not increase).

In 2012 the National Bank statistically increased the real incomes of the population without increasing consumption. Real wages, according to statistics reports, in the first half of 2012 increased by 16% (June 2012 against December 2011). Money supply M2 in January-July 2012 increased by 37.8% (BYR 15.5 trillion) with 3% GDP growth. This data implies that inflation in January-September 2012 (taking into account lag and money circulation growth rate in 2012) should have been at least 130%, i.e. it should have brought in line GDP and real wages growth. But the National Bank’s high refinancing rate diverted part of the increased money supply available for the population into fixed-term deposits, which increased by 49% (BYR 4.6 trillion). On the other hand, the National Bank, using the monetary policy instruments, halted the transformation of people’s savings and other financial resources of banks (totally about BYR 7 trillion) into growing domestic demand and thereby artificially depressed the inflation rate in 2012. As a result, as of September 18th, inflation was 114%.

Therefore the increase in real wages (up to 118%) was almost entirely predetermined by the National Bank’s policy. If money supply, currently restrained by the National Bank, gets into the money turnover, inflation will immediately reduce real incomes.

In July 2012 Belarusian salary was USD 471 and increased compared with December 2011 (USD 340) by 39%. Simultaneously, its purchasing power, calculated at the real exchange rate has increased by 18.8%. Potentially the president’s promise to raise the average wage from USD 345 in December 2011 up to USD 500 by the end of 2012 could be fulfilled. This is achievable with an annual inflation rate of 123%, BYR 9 thousand per US Dollar exchange rate by the end of the year (both figures comply with the National Bank’s monetary policy projections), and the average salary of BYR 4.5 million. However in December 2012 the purchasing power of USD 500 will be the same as USD 425 in December 2011. This discrepancy is primarily a consequence of the artificially controlled inflation by the National Bank.

Therefore the real wages (their purchasing power) will increase by 125%. It should also be taken into account that a wage increase will take place at the cost of transferring subsidies for the payment of utility bills and other services to the population. And this will not increase consumption. As a result, the actual salaries will increase by approximately 120%. This is not 150%, to go by the change in wages according to the nominal USD exchange rate, but nevertheless is a phenomenally good result.

One has to keep in mind that this is feasible thanks to the money supply blocked by the National Bank from the circulation. Increased population’s incomes will be held back from growing into demand to a greater extent. However that is not the only threat to the economic stability in the country. Difficulties with currency will be a lot more complicated.

Currency needed to meet growing demand

Let’s calculate the volume of extra cash income the population will receive if salaries increase up to USD 500 (pensions and other types of cash incomes will grow along with salaries).

Population’s earnings growth rate at current price level will be BYR 36.1 trillion in the 1st half and BYR 54.7 trillion the second half of 2012 (BYR 90.8 trillion in a year). Let’s assume that in 2013 people’s real incomes will not fall. For example, exchange rates will change according to the inflation rate and so on. If so, in order to maintain the end of 2012 real incomes’ standard the government will require circa USD 15 billion. (Again, our calculations will be valid only if the government meets its projected parameters).

The demand by the population will increase by approximately 20%, increasing the consumer goods imports too (not all goods are manufactured in Belarus). More importantly, foreign currency demand from domestic enterprises will increase as domestic goods production cost by more than 50% composed of the cost of imported energy, materials, and so on. In one way or the other, circa half of the increment in income will translate into a currency demand.

Note, that when companies produce goods for export, they return their production costs in foreign currency, when production aims domestic consumer market or non-productive construction, the currency then is “used up” forever, and new production cycles require a continuous currency supply.

Corresponding currency inflow to balance out rising ruble incomes should be about USD 6 billion in 2012 and USD 7.5 billion in 2013 and subsequent years (in the latter case USD exchange rate is BYR 9 thousand per USD). If such currency inflows are not secured, if increased incomes are not complemented by the increased consumer goods and services supply, the 2011 crisis situation will repeat itself (inflation, devaluation).

Skimmed reserves

In the first half of 2012 the government managed to avoid a collapse in prices, the Belarusian ruble even strengthened and gold reserves did not reduce (except for currency reserves). There are a few reasons behind the relative stability in the Belarusian economy in the first half of 2012.

First, as mentioned above, the National Bank pulled out part of money supply from the circulation (about USD 1 billion). Second, it partially “used up” investments (they decreased by 18% (by 1.5 billion) in January-August 2012). Third, high inflation in 2011 seized about USD 4 billion from businesses in the states’ budget favour (taxes on artificially inflated profits and differences in exchange rates). Therefore in the 1st half of 2012 the state had the means to increase the state employees’ salaries. Fourth, revenues from the petroleum goods exports, including ‘solvents’ and ‘lubricants’ increased, entailing current account surplus. In addition, EurAsEC Anti Crisis Fund’s loans have been received. That is why there was enough currency to increase production / import rates without any pressure on the USD exchange rate.

In the second half of 2012 positive economic effects from certain favorable factors have been exhausted. Budgetary savings come to an end. After the suspension of ‘solvent’ exports and, accordingly, reduced revenues, the achieved current account surplus (USD 0.14 billion in the 1st half-year) fell back into negative values. Since June, the population started buying more currency than selling. In Q2 of 2012 cash and non-cash currency purchases by non-residents increased. As population’s incomes grow, the demand for currency will increase rapidly. Potentially there might be a spike in foreign currency demand if the population starts converting BYR deposits in foreign currency. Yet that is not all. There is still a huge problem of repaying the ‘used up’ foreign debts.

Hoping for a miracle or new subsidies from Russia

A table, published by the IMF in September 2011 shows Belarus’ financial requirements to repay external debt, to cover the current account’s negative balance and other payments, as well as to accumulate country’s reserves. Meeting these challenges would be impossible without new borrowing. IMF experts reviewed all the available sources of foreign exchange earnings in the country and accumulated all data in one table.

The table was put together by IMF experts in June 2011, however shortly after the economic situation in the country has unexpectedly changed. Namely, at the end of 2011 the second stake in Beltransgaz was sold and an unexpected loan from Russia’s Sberbank was received. As a result, the gold reserves doubled. Starting from 2012 Russia reduced oil and gas prices for Belarus, which improved the balance of payments by approximately USD 3.5-3.7 billion a year. In the first half of 2012 revenues from the petroleum products sales increased sharply (inter alia, from the sale of ‘solvents’). All of the above improved the payments balance. Now Belarus has a USD 11-12 billion debt to pay off, not 14-17 billion.

Simultaneously, borrowing conditions have deteriorated. Investors are generally reluctant to lend to developing countries. This is even truer for Belarus. In the 1st half of 2012 gross external debt decreased by USD 0.9 billion, while during the same period in 2011 increased by USD 4.5 billion. Due to the lowered country’s credit rating foreign partners more often require prepayment from our enterprises. As a result, only in Q1 of 2012 the currency outflow from the country in terms of “trade credits” was USD 1.5 billion (domestic companies have reduced debt by approximately USD 0.75 billion, and foreign have increased by the same amount). The volume of external lending to banks has decreased. Potentially, in the coming years the currency inflow to the country will decrease. We have incorporated adjustments to the Table 1 to reflect the mentioned changes in the economic situation (see figures in parentheses). Adjustments for 2015 – 2016 were not taken into account.

Table 1 shows only the bottom lines, so as not to overload readers with special terms1. The first line shows the required currency outflow from the country. For example, in 2012 it was USD 15.3 billion according to the IMF, and (USD 12.6) billion when taking into account changes in the economic situation. The second line outlines the volume of potential currency inflows to the country from available sources (loans, including trade, foreign investment, exceptional financing).

The IMF forecast shows, that country’s foreign exchange revenues will not cover all the due payments, entailing “residual financing gap” (Line 3). IMF experts could not achieve a balanced payments balance. Available resources will not cover the increase in gold reserves at USD 3 billion a year, and repayment of debts. External financing deficit is estimated by IMF experts at USD 5-6 billion per year (slightly less following our adjustments). Such deficit could encourage the government to look for alternative development strategies (economic liberalization, which would create more favorable conditions for attracting foreign investment. That would also open doors for talks about the new IMF loan).

The bottom line in Table 1 shows the deficit in the external financing of the Belarusian economy after incomes increase in 2012. To maintain the high level of household consumption, to repay the current account’s negative balance and to pay off the debts the country needs to raise USD 20-22 billion a year. With the global crisis, this problem is clearly defeating. In these circumstances, there is no policy the National Bank could implement to keep the U.S. Dollar exchange rate under control. Even if Belarus sells Belaruskali, the largest and most efficient enterprise in the country, economic stability will not last longer than one year.

All in all, it is difficult to imagine how the repetition of the 2011 crisis could be avoided within current economic model, in particular, with curtailed economic liberalization and privatization.

Signs of recession

The Belarusian economy showed negative trends in the second half of 2012. Official statistics says, GDP growth rate is gradually falling – from 3.6% in January (compared with January 2011) to 2.5% in January-August. Comparing the indicators’ dynamics in 2012 only, we observe that, since June GDP has declined. In August 2012, GDP was lower than in January by 13.7%, industrial production fell by 21% (see Figure 1). Drop in sales resulted in growing stocks of various kinds of machines and equipment, for the first time BelAZ dump trucks, one of the most important Belarusian export products, have accumulated in warehouses. In August compared with July, the production of paints and varnishes, including solvents and thinners decreased by 16 times. This means that Russia’s refusal to supply raw materials for their production will reduce the volume of Belarusian exports in the second half of 2012 by about USD 2.4 billion.

Production efficiency dropped: raw materials’ cost in the production cost has increased by 3.7% (from 69.6% to 73.3%) over the last year, pay roll and social deductions decreased by 2.1%.

2012 was successful for agriculture. Grain yields rose by 3 quintal per hectare and grain yield exceeded 2011’s volumes by 14%. But agriculture’s efficiency remains low. For example, agricultural enterprises owe to suppliers, creditors and tax authorities 9.3 times more than buyers owe for their products (the national average is 2.46 times). Therefore, increased agricultural performance does not result in improved well-being.

In the 1st half of 2012 the population was noticeably poorer. Income growth has not yet offset their decline in the second half of 2011. In 2011 the proportion of the population with available income per capita2 under USD 200 (at mid-September 2012 USD exchange rate) was 40%, and in 2012 (1st half) it was 46.8%. Another fact, which reflects the deteriorated living standards, is that a year ago, a family was spending 39.5% of its income on food, now it is 45.3%.

In the second half of the year Belarusian economy’s competitiveness will decline. Reasons behind it include: increased production costs of Belarusian goods due to increased wages and raw materials costs, as well, increased competition in the Russian market (the main sales market for the Belarusian processing industry) after Russia’s WTO accession. In addition, competition will increase after Ukraine’s entry into the CIS free trade zone (the FTZ already includes Russia, Belarus and Ukraine), which took effect on September 20th. The FTZ was founded on the WTO principles and all duties were mutually coordinated or abolished altogether. This means that Belarus will lose the opportunity to arbitrarily restrict the penetration of cheaper Ukrainian goods to the Belarusian market.

Current economic situation in Belarus will push the government to act more decisively. However its actions are not likely to be directed towards economic liberalization and the next economic downturn will not be prevented.

Leonid Zlotnikov, Belarusian Analytical Workroom