Belarus on a roll

By bne IntelliNews July 22, 2009

Ben Aris in Minsk -

Belarus is the pariah in Europe, but unnoticed by the rest of the continent the little republic of 10m has pushed through a raft of reforms and is now poised to boom when things return to normal. A decade of double-digit growth means all the idle capacity has been pressed into service; a row with Russia over energy in late 2006 pushed things along; and now the international financial crisis has catalysed the process as the reform package has melded with the International Monetary Fund recovery programme.

While it's true that President Alexander Lukashenko has retained a tight grip on the economy and the state continues to play the dominant role in it, the republic is not the Stalinist throwback that most reporters portray it as. "Belarus is not a closed country at all - its trade regime is wide open and we do a lot of business with our two 'wings' - Russia and the EU," says Georgy Egorov, chairman of Belvnesheconombank.

Unlike its larger cousin to the east, Belarus actually makes things and exports many of them all over the world; trade turnover was equivalent to 130% GDP in 2008. "There is still lots of growth potential in Belarus. The processing industry is still dominant, but the service industry is now growing in size, although it is still not even at the level of the rest of Eastern Europe, without even comparing it to Western Europe," says Egorov.

Belarus was one of the best places to live in Soviet days, as it was home to many of the high-tech factories that did the final assembly of parts manufactured in the other republics. Bereft of natural resources, the government has followed a simple strategy: capitalise on its low-cost but skilled workforce and its pivotal geopolitical position between the two massive markets of Russia and the EU to produce cheap goods that it can export. "We feel the crisis through the export companies which have seen volumes down by half compared to last year," says Vladimir Nikolaevich Koleda, first deputy general director of BPS Bank. "We have grown at over 8% a year for nearly a decade, but now the growth rate of the economy has fallen steeply."

Setting up shop

Belarus came to a crossroads about two years ago. First the double-digit growth of the economy meant factories had used up their existing capacity and needed investment if production was to continue to expand at the same fast pace. Then there was the row with Russia over Russia in the winter of 2006 when Moscow hiked gas prices, effectively ending the Soviet-era subsidies to the economy. Since then, relations with Moscow have remained strained, most recently resulting in the so called "dairy war" in June when Russia banned imports of Belarusian cheese and milk.

The upshot is that the republic has been making friendly noises toward Brussels and began an impressive, if slow moving, reform programme to open up the country to international investment - but in its own way.

Lukashenko said at the start of July that, "It is becoming obvious that Belarus must not copy the Western political system," but that the country wants closer relations with the European Union. "Squabbles about whose parliament is better and where there is more democracy and human rights is a road to nowhere, a road into an impasse," he said. "It is gratifying that stereotypes of biased attitudes to Belarus have been beginning to fall apart in the European Union recently and that the realization has been coming in that our country is an inseparable part of Europe, and one with its own voice as well."

Over the last nine months, Lukashenko has fired off a ream of decrees that have dramatically improved the ease of doing business. Big chunks of the banking sector have been sold off, companies are now allowed to make profits in a way they were never allowed to do before and it only takes a week to set up a company now.

The trouble is that doing business is still very difficult. Setting up businesses is much easier than it was, but companies are not allowed to outsource their tax reporting and so still have to hire a bookkeeper and wade through piles of paperwork. "A lot has already been done, but the reason you don't see a flood of foreign investment is because not everything has been done to attract foreign capital. There is still a lot more to do, but the state has said that it wants to get into the top of the World Bank's 'Ease of Doing Business' ranking in near future and is working to that end," says Egorov.

Thousands of new companies have set out their stalls in the last two years, but almost all the new small- and medium-sized enterprises (SMEs) involved in trading and bankers in Minsk report they are the main customers for foreign exchange services. However, the state is already talking about pushing small business into production - in the past the government would simply have ordered companies to make things; now it is toying with the idea of raising import duties instead.

There are an increasing number of shops on the main drag through Minsk, Nezavisimaya Prospekt, where it is possible to buy well-known foreign brands. The quality of cars on the street has improved too, with the second-hand VW Golfs imported from Germany giving way to brand new BMWs and Lexus saloons. But in the large TSUM department store where most people shop the products on the shelves are either local or Turkish and displays have changed little from the old days. The retail sector has begun to develop, but clearly Minsk has a long way to go before it starts to resemble the streets of neighbouring capitals Moscow and Warsaw.

The retail sector has been the engine of growth in most of the countries of the CIS in the last few years, but the international crisis arrived to cut short the boom that was just gathering pace in Minsk. Heavily dependent on exports, as the global economy slowed the state-owned companies have been forced to cut back on production and cut the working week to only three days in many of Belarus' most famous factories, squeezing consumption in the process. "Wages are standing still and most loans were taken out in foreign currency, so the devaluation earlier this year is hurting people in the pocket. Many people are in trouble and hardly surviving," says one banker in Minsk. "We can't grow in the retail sector this year. If the export sector picks up, then this will feedback to the local economy and wages will start growing again, lifting the whole banking sector with it."

Bank reforms

Nowhere is the progress clearer than in the banking sector. Over the last year or so, about a dozen foreign banks have moved into Minsk, bringing with them their sophisticated products and management. The big state-owned banks still dominate the sector, but new entries like the hugely successful Bank of Georgia, which bought Narodny Bank last year, says that it is in the process of launching all the products it pioneered in Georgia on the local market. The dowdy Belarusian banks can afford to be dowdy no longer, as the fires of competition have been lit.

Credex Bank is typical of the new breed of banks operating in Minsk. Established in 2001 by British investors Ximex Executive with only €500,000 of capital, the investors recently increased the bank's capital to €1.5m and it has aggressively gone after the SME business. A universal bank, Credex is hoping to make a living in the gaps in the market left between the giant state-owned banks. "Currently, most of our business is corporate and most of that is SMEs," says the young general director Alexander Aksenevich. "The big state banks do most of the large industrial business and leave the SME niche to us, which is growing now."

Aksenevich says that steady moves towards liberalisation have allowed the SME sector to grow and is creating more opportunity for banks such as Credex. However, the problem is the banks are having to feel their way in the dark in the sense that few of these new companies have any credit history or track record. "The international crisis has not been felt directly in Belarus, as we are not integrated with the rest of the world. The problems we have come to us via our clients who are exporting and we feel the affects of a slowdown in the global market through the impact this has had on their businesses," says Aksenevich.

The most important change in the banking sector doesn't appear in the lists of decrees emanating from the presidential palace, but is having a seismic affect on the sector.

Until last year, interest rates on loans were not set by demand or in reference to central bank overnight rates. Instead, the leading bankers would meet once a month in the regulator's offices where the governor would "suggest" a rate that allowed the bank to make some profit but keep the cost of borrowing affordable for the (largely state-owned) companies. Private bankers in Minsk interviewed for this article say that since the middle of last year banks are now free to charge what they like and rates have jumped to around 20-25% on commercial corporate loans. Administrative fiat has been replaced by market forces in the banking sector; Belarus' banking sector is now a boom waiting to happen.

Still, the development of the banking sector is in its early stages. Virtually all the banks interviewed for this article said the bulk of their funding comes from deposits and some 80% of their income comes from doing business with large state-owned companies. What retail banking there is, concentrates on payroll programmes for corporate clients, which was the first stage of the retail rollout in most other countries in the CIS. The more progressive banks are developing the SME sector, but the assets on offer are small potatoes compared to the state business.

Perhaps the most exciting reforms in the financial sector have been to lay the foundations of a domestic capital market. Nearly all the infrastructure is now in place, but for the market to take off Belarus needs to attract some foreign capital. "There are now more than a 100 professional participants in the domestic capital market, but foreign companies still don't have permission to set up. This should change by the end of the year, however, the capital market is still very small and we need foreign resources it we are to develop it," says BPS Bank's Koleda.

Crisis as catalyst

The international crisis came at a bad time for Belarus, asphyxiating the early consumer-led growth and sucking out resources from the badly needed investment programmes. But at the same time it has forced the government to deal with the IMF, which has imposed some international standards on the republic, which is still very uncomfortable with being told what is best.

An IMF deal for $2bn signed at the end of last year comes with strings attached that will accelerate reforms already in the works. The government has promised to sell off a big piece of market leader Belarusbank to international investors and to bring forward plans to introduce international accounting standards on all banks and business, which could be imposed as soon as the end of this year.

After nearly a decade of strong growth, the slowdown to 1.4% of growth over the first five months of this year has squeezed everyone and while bankers in Minsk say that the things are starting to get a bit better, they remain cautious about the rest of the year as everything depends on how the economies of Russia and the EU fare. "May was better than April and April better than March, but I am not sure that we have passed bottom yet," says Koleda. "But we need to see what happens in our neighbours. With 60% of our exports going to Russia we are closely linked to their fate. If the situation in Russia worsens, then it will be impossible for us to grow."

The businessmen in Minsk are being pragmatic about their prospects and believe that the economic woes will probably pay some useful dividends. The state's reform programme was hijacked by the crisis and since the IMF entered the game the two have been merged, which might not be a bad thing. Likewise, many of Belarus' exporters realised they should diversify away from just selling to the Russian market, but now they having to actually do it. "The crisis has presented new challenges and if we can work in these conditions, then we will come out leaner and more competitive," says Koleda.

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