Belarus de-facto devaluation a half-hearted step in right direction

By bne IntelliNews March 30, 2011

Tim Gosling in Moscow -

In the face of building pressure on its foreign exchange reserves, Belarus announced a partial increase in the flexibility of its currency on March 29. A step in the right direction, but analysts are unconvinced it's a big enough one.

After resisting calls from many quarters over the last few weeks to increase the flexibility of the Belarusian ruble, the National Bank of the Republic of Belarus (NBRB) finally gave in, announcing it has widened the band around the official exchange rate in which the currency can trade on the interbank market from 2% to 10%. In essence, given the huge downside pressure on the currency, this is an 8% devaluation.

The move is the latest by Belarus to try to stem the heavy selling pressure on its currency, which has been provoked by a 20% drop in its forex reserves since the start of the year on the back of a chronic trade deficit that ran close to 16% in 2010. Whilst analysts have been calling for increased flexibility of the ruble and a tightening of monetary policy as short-term responses to dampen demand for imports, the government has been trying to deal with the rapid decrease in forex liquidity via regulation, whilst hoping to borrow its way out of trouble.

But Minsk's borrowing options are narrowing. It is being isolated by the West due to the vicious crackdown on protesters after the flawed re-election of President Alexander Lukashenko in December, whilst on March 29 Moody's Investors Service joined Standard & Poor's in downgrading the country's foreign and local currency bond ratings; the country is now rated 'B2' by Moody's and 'B' by S&P. "Current levels of official foreign exchange reserves of approximately $1.3bn fall short of Moody's estimate of a 2011 external financing requirement of between $8bn and $10bn," the rating agency said in a statement.

Meanwhile, Russia has responded to requests for up to $3bn in loans with a demand for strict economic reforms, which is delaying the process.

Lukewarm response

Still, Petr Grishin of VTB Capital, reports that the International Monetary Fund (IMF) country chief for Belarus, Chris Jarvis, welcomed the widening of the currency band in a conference call on March 29. That said, Jarvis also implied that in his view, Belarus still has a policy choice - although a very difficult one - between tighter fiscal and monetary policies and some devaluation on the one hand, and much tighter policies and little devaluation on the other.

The response from analysts has been similarly mixed.

On the one hand, the move was welcomed as a step in the right direction after the authorities spent most of March erratically trying to regulate the forex liquidity problems away. For instance, on March 15 the central bank instigated a 30-day advance notice for local banks looking to buy foreign currency on the national currency exchange. On March 22, it halted cash foreign currency sales to local banks, only to repeal the 30-day requirement the following day to allow payments for medicines, energy imports and debt servicing. "The move to devalue, in effect, the ruble will be seen as a positive sign in the short term, as it will help to ease pressure on forex reserves," suggests Timothy Ash of Royal bank of Scotland, the hope being that the weaker currency will dampen import growth in order to contain the current account deficit. At the same time, adds Ash, it could also be taken as a step towards securing that bailout from Moscow.

However, analysts are at the same time disappointed with the limited scope of the widening. "We believe that a more drastic deviation of the [over the counter] rate from the official rate should be allowed in order to deal with the excess imports problem," says VTB's Grishin.

Raiffeisen International Bank described the move as "too small to have a significant effect."

Alexander Kudrin at Troika Dialog is the only one to put a clear marker down, suggesting that a "10% devaluation is hardly a way out, given that inflation in Belarus exceeded 10% in 2010 - 30% would be better." However, even that wouldn't bring the ruble into line with "the "calculated" exchange rate, defined as the ratio of money supply to gross international reserves," he says, which is closer to 50% below the official rate, but "it could solve the balance of payments problem."

At the same time, analysts fret that the move will practically close down forex operations of all colours for the meantime. With the establishment of multiple exchange rates, the retail cash market, practically stalled already, will go into a deep freeze as banks have no incentive to sell their precious forex for less rubles than they can get on the interbank market.

Meanwhile, the limited size of the widening will hit the interbank market and business transactions, says Raiffeisen. "In expectation of further weakening of the rouble, holders of foreign exchange will likely follow a strategy of FX hoarding," the bank says in a note.

The Austrian bank raises suspicions that the authorities may not be motivated purely by economics, suggesting: "the maintenance of a stable forex rate on a mostly illiquid cash market is rather a face-saving measure, not to confront the population fully with a devaluation."

The obvious question then is, is a 10% devaluation enough? "I would argue it certainly helps," says Ash. "But longer-term currency trends will be dependent on how rigorous government efforts are at reform, and whether the government/NBRB is able to convince the population at large that further currency decline is in the offing, or that they have drawn something of a line in the sand."

Looking ahead

After resisting calls to increase the flexibility of the ruble, the latest about-face in Minsk suggests that Moscow's echo of the IMF call for deep economic reforms has convinced the Belarusian authorities they have little choice but to adapt their approach in the short term if they are to secure a bailout.

However, a commitment to make the reforms needed to avoid further crises down the road looks doubtful. "A 10% devaluation on its own is not really a game changer, as the sheer size of the current account deficit implies a fundamental and structural lack of competitiveness of the economy," Ash points out.

As Moody's notes, its downgrade is partly based upon worries that the country will struggle to carry out the deep-seated structural reform needed to "smoothly transition from [the] current external debt funded growth model to one that relies on productivity and competitiveness improvements for output growth."

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