MARKET OVERVIEW

Why we invest here

The recovery in Belarus continued, with real GDP growth reaching 3 percent in 2018, driven by favorable external conditions and stronger domestic demand.

However, according to The World Bank, the pace of growth has been slowing since February 2018, reaching 0.8 percent in January – February 2019 year-on-year (y-o-y), as the base effect has dissipated.

The current account deficit remained mostly flat at 0.4 percent in 2018, but vulnerabilities remain. Gross international reserves amounted to US$7.2 billion at the beginning of 2019, covering only two months of goods and services imports.

The quantitative targeting framework is keeping inflation at historically low levels – it was 5.6 percent y-o-y in December 2019. As the policy rate remained virtually unchanged throughout 2018, real lending rates fell and the credit supply in national currency to corporates and especially to households grew.

Exchange rate flexibility has been retained, while foreign exchange market liberalization continued with the abolishment of surrender requirements.

The poverty headcount at the national poverty line, after peaking at 5.9 percent in 2017, started improving in 2018 to 5.6 percent due to real household income growth.

Economic Outlook

According to the World Bank, the growth outlook in 2019 and in the medium term remains subdued at about 2 percent per annum due to a combination of structural rigidities in the economy and softening terms of trade, as the economies of Belarus’ main trading partners stagnate.

This modest outlook is conditional on partial—at least 50 percent—compensation for the so-called ”tax maneuver” in Russia (the replacement of oil export duties with a mineral extraction tax).

According to the International Monetary Fund (IMF), with no compensation, growth would decelerate toward zero or a recession by 2023, public debt would increase by 15 percent of GDP, and additional fiscal consolidation would be required.

On the positive side, recent measures to liberalize private economic activity, as reflected in the country’s improved 2019 Doing Business rankings and growing exports of information and communications technology (ICT) services, could help maintain a trade surplus in services.

SOEs have continued to be a persistent source of fiscal risk at a time when total public sector debt remained high at 56.5 percent in 2018 as compared to 44.1 percent in 2011.

Hence, advancing SOE reform will help to reduce vulnerabilities and raise growth potential over the medium to long term.

Market Outlook

Last year, Belarus saw GDP growth of 3.0% YoY (up from 2.5% in 2017). Higher oil prices and robust external demand have supported exports, while domestic demand got an impulse from double-digit wage growth in response to ambitious wage targets.

However, in 4Q18, the pace slowed to 1.3% YoY, and the robust start to the year was to a certain degree the base effect tailwind: in 1Q17, Belarus and Russia were still in the middle of trade dispute.

Investment dynamics have been mostly shaped by the ongoing construction of the nuclear power plant.

Prudent monetary policy coupled with increasing central bank credibility were keeping inflation at historically low levels in 2018 (around 5%) despite rapid wage growth. However, Inflation accelerated to 5.7% YoY in December 2018, from 4.6% YoY in December 2017. Nevertheless, the hawkish policy of the National Bank, which has kept the key rate near 10% since the middle of 2018, helped to keep the inflation relatively contained.

At the same time regulator significantly tightened the mandatory required reserves, draining liquidity from the banking system. As a result, it went from a situation of liquidity surplus into deficit, which prompted a visible increase in deposit rates. In particular, the average retail deposit in local currency has increased 3pp since the end of 2017, while the cost of corporate deposits picked up by 2pp in the same period.

Strong external demand, better terms of trade, and a higher-than-expected redistribution of import duties within the Eurasian Economic Union have boosted budget revenues. Expenditures, however, have been rising even faster, particularly capital spending but also wages and salaries. All in all, the overall budget deficit including quasi-fiscal spending on state-owned enterprises reached 1.3 percent of GDP in 2018, from 0.3 percent in 2017.

The Belarus current account deficit dropped to 0.4% of GDP last year, from 1.7% in 2017. The goods balance improved marginally, as a function of higher potash and oil prices.

The current account improvement came mostly as a result of

• An increase in secondary incomes (to 2.4% GDP), which is to a material degree a transfer from Russia;
• And growth of IT and transportation service exports.

The IT industry has been the fastest and most steadily growing export industry at least for the past five years. Last year, its total export proceeds crossed USD 1.0bn (+33% YoY for 9M18). In 2005, Hi-Tech Park was established in Belarus for the development of the software industry. Residents of Hi-Tech Park enjoy a number of tax benefits.

At the same time, Belarus retains perhaps the highest state ownership levels among post Soviet economies with open markets. According to Belstat, at the end of last year almost 50% of workers were employed by state-owned enterpises (SOEs), which also accounted for approximately three quarters of total industrial production in the country and generated near 60% of its corporate revenues. The government provides support to SOEs in multiple forms, which have become a routine part of doing business in the country. Large number of SOEs could potentially represent thin spots in the Belarus credit profile if external support to the country narrows and triggers a scaling down of state support. In 2017, direct support to SOEs accounted for near 15% of total consolidated budget expenditures. Overall, the combined volume of state support in Belarus in 2017-18 is estimated at 4.0-5.0% of GDP annually. There is no doubt that, since the 2014-2015 crisis, the progress of making the state less ubiquitous has been significant, as has been the result of the effort to tighten the fiscal stance, reduce and regularize state-directed lending, make monetary policy rule-based, harden the budget constraint for the SOEs, and improve the business climate for the private sector. It is now a deep mistake to claim that Belarus is a “planned” economy. However, this is a long road for the economy to significantly reduce the inefficiencies of the state-owned sector.

2019 saw a weak start of the year for the Belarus economy (+1.8% GDP growth), however, the growth accelerated visibly going into 2Q19. Monthly GDP accelerated to 5.5% oya in April, up from 1.8% in 1Q and 1.1% in 4Q18. The acceleration was driven by construction and to a lesser extent IP on the production side, and by capital investment on the demand side, while consumption has remained strong.

Interestingly, growth picked up despite decelerating bank credit, with both consumer and corporate credit slowing down into the mid-year. Fiscal spending also slowed in 1H19. It appears that both monetary and fiscal policies have not been particularly supportive and will likely remain so in the near term.

That is why the recent very high numbers will hardly be sustained. Meanwhile, inflation surprised to the downside in recent months, slowing to 5.5% oya in April from the peak of 6.2% in February. Moreover, the exchange rate appreciated too. The NBRB may test the waters with a modest cut in the summer.

In 2019, headline CPI was also affected by the government decision to cut domestic fuel excise (although this step was later reversed).

It should be noted that in the last few years Belarus has been able to use better its transit potential, as freight and passenger flows were distorted due to tensions between Russia and the Ukraine. Belarus is also a part of China’s One Belt / One Road initiative, while easing its visa regime in 2017 helped boost inbound tourism and passenger traffic.

Nevertheless, energy transfer from Russia to Belarus remains a key. The energy transfer is facilitated through several channels: i) oil refining export duty arbitrage; ii) the compensatory export duty free crude shipments, and, rarely, iii) ‘excess oil-product-exports’. Together, they delivered some 4.7% of GDP to Belarus in 2018. An additional 2.4% GDP was due to the natural gas channel. None of these official channels has been designed to be invariant to domestic changes in Russia.

The oil tax maneuver is the cardinal point of contention now. The Russian government is in the midst of eliminating the wedge between global and local prices of crude oil. A part of the maneuver is an increase in mineral extraction tax (to contain the fiscal impact) and a “negative excise” subsidy to domestic refiners (to arrest the growth of retail prices at the pump). Belarus is asking for compensation, which Russia views as a separate request.

It can be noted, however, that in the last twenty years, Moscow and Minsk have been through several episodes of uneasy trade negotiations. In 2010-11 and 2016-17, there were debates over the gas price; in 2010 and 2014 there was a conflict about export duties on Russian crude oil supplies. The early 2000s witnessed hard talks about the Union State project. It could be that because of this historical memory, that the Eurobond market has been fairly resilient to Russia/Belarus headlines, as investors assume that ultimately a resolution will be found that secures future Russian financial support to Belarus in some form (as was the case previously).

Energy disputes with Russia continue, but Belarus’ stronger external position should provide a cushion. Although the issue of compensation for the oil tax maneuver has been put on the back burner, the new dispute related to contamination of the Druzhba oil pipeline has occupied headlines of late. Curtailed oil supplies may lead to a temporary drop in oil processing and exports. Meanwhile, the last $200 million tranche of Eurasian Fund loan has been delayed.

Yet, Belarus is expected to weather these hardships well. Given the narrower CA deficit and improving access of corporate sector to external financing, NBRB should continue increasing FX reserves this year.