COMMENT: Belarus - Looking to reform or just for cash?

By bne IntelliNews October 17, 2013

Tim Ash of Standard Bank -

A spat with Russia over potash seems to be being "cooled down" by both sides, and a compromise solution seems likely.

-- Belarus has seen a marked deterioration in its external financing position over the past year, with the current account moving from a surplus to a deficit now of 8-9% of GDP, as exports have dropped sharply.

-- Foreign exchange reserves have dropped by around 10%, and while high by comparison to levels seen in 2011, still only provide around 1.5 months of import cover. Greater FX flexibility does provide a degree of insulation for FX reserves, but the external financing position remains vulnerable.

-- President Alexander Lukashenko is hence now looking for external support, with ministers detailing plans for economic reform which they hope might entice the International Monetary Fund (IMF) into extending a new programme, and state asset sales which they hope will bring Russian loans and financing. Political constraints are likely to stall IMF financing, but Russia is always ready to deal when it comes to assets up for sale in Belarus. As ever in Russo-Belarus relations, it all comes down to price.

-- The broader economic outlook appears challenging, with real GDP contracting by 0.6% on year in the second quarter, which stands in stark contrast to official full year projections for 8.5% real GDP growth.

-- Lukashenko seems eager to stabilise the macro/economic situation well in advance of the 2015 presidential elections, hence his move now to secure external financing and support.

How to make friends and influence people - the Lukashenko way

After appearing to have burned bridges with the West, and then more recently with Russia over the battle to control the global market in potash - a key export for Belarus - the Lukashenko administration seems now to be eager to rebuild these very same bridges.

First, on the issue of potash, the administration seems to be sending signals that it wants to resolve the dispute, and in fact offer Russia concessions in other areas of mutual cooperation, particularly with respect to the economy.

In terms of the potash case, the conditions of the detention of the CEO of Uralkali, Vladislav Baumgertner, appear to have been moderated to house arrest, while the administration in Minsk has signalled that it would view favourably a request by Moscow for his extradition on condition that Baumgertner is charged with offenses in Russia. This all seems to be part of a face-saving solution, with Minsk also calling for the resurrection of the potash consortium between Uralkali and Belaruskali. Meanwhile, Minsk has indicated that Russian companies would be welcome to take increased stakes in a range of Belarus companies, including the Mozyr oil company, and MTS - albeit a 51% stake in MTS has been on the table for some years now, with the only issue being the hitherto lofty $1bn price tag. Indications are that with Belarus eager to secure cash the latter price tag might now be reduced.

Second, President Lukashenko has again repeated his desire to secure a new financing arrangement with the IMF by year-end. That said, on numerous occasions over the past two to three years, government officials have made similar comments, including as recently as March 2013, and prior to that September/October 2013 - complaining subsequently that the IMF was not being cooperative. The Fund has since argued that they want to see firm commitments to economic reform before moving towards agreeing a new programme. This time around the administration seems to have begun to put together the framework of a new reform programme for 2013-2014 including:

• The aim to limit the budget deficit to 0.8% of GDP this year, and 1% in 2014;

• Planned hikes in excises (+10-20%);

• Plans to raise $4.5bn in privatisation receipts over the next year, with 50 enterprises earmarked for sale;

• Plans to reduce bureaucracy and red tape, and improve the business environment;

• Plans to reform/rein-in monopolies particularly in the energy, telecoms and communications sector.

All the above comes as the government is seeking to complete negotiations with the Russian-led Eurasian Economic Community's (EurAsEc) anti-crisis fund for the release of the latest tranche of $440m in Funds by the end of 2013 - as part of the original $3bn financing programme for Belarus. The EurAsEc support for Belarus was originally tied to a far-reaching programme of economic reform, including fiscal consolidation and structural reform. The latter reforms have generally lagged - the assumption had been that Russia pushed the latter reform programme to drive forward privatisations/state asset sales through which Russian companies could secure stakes in key strategic assets in Belarus. In the event, Russia has thus far been disappointed.

The macro challenges facing the Lukashenko administration are now quite significant, as there has been a fairly generalised deterioration in the country's credit matrix over the past six months.

The external accounts have, in particular, seen a marked turnaround over the past year, with the current account, moving from a position close to balance in mid-2012, back to a deficit of $5.5bn as of the second quarter, equivalent to around 8.7% of GDP. While the current account is still significantly lower (half) the level seen in early 2011, at the time of Belarus' last balance of payments crisis, when the Belarus ruble lost around 60% of its value, the trend deterioration is quite striking and indicates an underlying lack of competitiveness, and difficult market conditions for key exports - particularly potash, which accounts for around 5% of exports, and has seen a marked drop in prices after the collapse of the consortium between Belaruskali and Uralkali earlier this year.

Trends on the merchandise trade account have significantly driven the deterioration on the current account. Herein, data from the central bank suggests that exports were lower by around 23% for the period January-August, while imports moderated just 10.2%, which took the deficit on merchandise trade to $1,966m from the surplus of $2,445m posted in the year earlier period.

In terms of the financing of the current account, in recent years the deficit has been funded through a combination of asset sales, generating net FDI inflows of $2.2bn in the year to the second quarter, foreign loans (mostly from Russia/China), and some draw down in FX reserves. Ultimately this is likely to continue to be the strategy going forward, ie. reliance on state asset sales and foreign loans, plus perhaps also a modicum of policy tightening/exchange rate adjustment to narrow the current account and hence external financing needs.

Recent months have seen downward pressure on official FX reserves held by the central bank. Indeed, the central bank lost around $700m in reserves in the period since April, and the wave of emerging market selling seen around concern over US Federal Reserve tapering.

However, this still represented only around 10% of total reserves, which still remain considerably above levels seen in the run up to the 2010-11 crisis - that said, reserves dropped precipitously and quickly over the course of 2010, and through to mid-2011 until Belarus secured emergency financing from the EurAsEc organisation. At present we don't quite appear to be at such a serious juncture, but the Lukashenko regime seem now to be taking no chances, now moving to secure additional external financing and while options are available. Perhaps they are mindful still that FX reserve cover still only stands at about 1.5 months, ie. half the level normally required prudent.

One significant advantage this time around for the authorities in Belarus is that they operate a much more flexible exchange rate regime, and have allowed the ruble to weaken in response to the weakening trade and current account positions. This seems to have taken some of the pressure off FX reserves and bought the authorities some time.

All the above comes as growth has seriously disappointed, with the second quarter posting a real GDP contraction of 0.6%, after 3.8% growth in the first quarter. This compares with the government's grandiose projection of 8.5% real GDP growth for the full year in 2013, followed by 5.7% growth in 2014 - important given that presidential elections are due in 2015. By contrast, the IMF in its latest WEO projects 2.1% growth in 2013, followed by 2.5% growth in 2014, and 3% in 2015.

Lukashenko's apparent decision to seek external assistance now - perhaps funded by selling of state assets - perhaps reflects a desire to avoid a pre-election balance of payments crisis, but also to begin to try to buoy the economy and growth pre-election.

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