Political uncertainty, together with the shock of the coronavirus (COVID-19) epidemic that is ravishing the country unchecked, has weighed heavily on Belarus’ economy, which could be headed towards a crisis, according to a note issued by the Institute of International Finance (IIF) on August 26.

Already weak and with not enough money in reserves to ensure the stability of the currency, the nationwide protests threaten to deliver yet another shock to the already teetering system.

Highly dependent on Russia’s energy subsidy and domestic state-owned enterprises (SOEs), poor relations between Moscow and Minsk have hurt the first, and a general strike by protesters may bring the second to a standstill.

Belarus has some $3bn of debt obligations to meet this year. Belarus' self-appointed President Alexander Lukashenko’s brutal unleashing of the OMON riot police on the peaceful demonstrators has already closed access to international capital markets, leaving Russia as the lender of last resort of the small unreformed republic. As the protests enter their third week, a political stalemate is setting in and a quick resolution to the conflict appears increasingly unlikely.

Markets reacted sharply to the initial emergence of the conflict and have not bounced back in a meaningful way since the election, according to IIF.

“The Belarusian economy more broadly had been struggling even before the COVID-19 shock and disputed presidential election,” said Elina Ribakova, deputy chief economist at IIF, and Benjamin Hilgenstock, an economist, in a note on August 26.

“The failure to reach an agreement on energy supplies from Russia resulted in a sharp reduction in oil imports in 1Q20 and a deterioration in balance-of-payments inflows, which are highly reliant on Belarus’ eastern neighbour. The COVID-19 pandemic, and the government’s extremely poor response, worsened the situation, in turn fuelling public discontent with President Lukashenko ahead of the election. The president had largely dismissed the public health emergency and few containment measures were taken, resulting in the fifth-highest number of infections in Eastern Europe,” Ribakova and Hilgenstock said.

The Belarus economy has changed little since the end of the Soviet Union and is still heavily dependent on several very large truck and tractor plants as well as metallurgical works and a large phosphate deposit.

However, in Soviet times Belarus was where most of the final assembly of the Union-wide manufacturing industry was done and consequently had the best plants and the most skilled workers. The trucks, tractors and fridges made in Minsk are of decent quality and the Republic has a lively export industry that brings in much-needed foreign exchange revenues. And in the last decade the country has built up a world-class software engineering industry that now accounts for $2bn of exports a year and is equivalent to about 7.5% of GDP.

Nevertheless, the SOEs, including the banking system where almost all of the major banks belong to the state, makes up three quarters (76%) of capital. And the poor macro fundamental situation will almost certainly get worse.

“While inflation appears under control (5.2% in July vs. the “less than 5%” target) despite substantial wage increases ahead of the election and the recent devaluation of roughly 20% year to date, high dollarisation is a financial stability concern, particularly given low reserves of $4.3bn (or 1.2 months of imports). An additional vulnerability lies in the high share of FX in corporate lending (over 50%) and public debt (~80%),” says IIF.

And the key lever on the health of the economy is the Russian energy subsidies. Russia discounts oil and gas deliveries to Belarus which it can then on-export via its pipeline network to western Europe, and it has earned some $100bn in the last decade on the margins.

More recently, Russia seems to have tired of propping up its “little brother” and has begun to cut the subsidies with the so-called tax manoeuvre that is estimated to cost Belarus several billion dollars a year in the coming years – a cut that it can’t afford, as Lukashenko has only been able to run his neo-Soviet system thanks to the extra cash he receives from Moscow. The upshot is the two countries have been bitterly quarrelling for most of the last year over the changes and Lukashenko has been demanding compensation to little effect.

“The country receives around 24mn tonnes of oil per year free of import duties as well as a transfer from Russia’s budget for the re-export of refined oil,” Ribakova and Hilgenstock said. “The transfers will expire in 2024, when Russia introduces a new energy taxation system (“tax manoeuvre”), where export duties are being phased out and a revised extraction tax remains. The loss to the Belarusian budget could be as high as 2% of GDP, and the BoP impact around 4%. As negotiations with Russia broke down and COVID-19 led to a sharp drop in external demand, the current account deteriorated markedly.”

Partly thanks to the closed nature of the economy Belarus has a manageable level of debt, but it is rising and likely to reach 60% of GDP due to the economic slowdown and devaluation. It is going to need to borrow more money to roll over existing debt, but it is not clear where it is going to get this money from.

“While Belarus successfully issued $1.25bn in Eurobonds in June, market access is now limited due to political uncertainty. In addition, negotiations with the IMF appear to have broken down, and EU support is not tenable in the current environment,” Ribakova and Hilgenstock said. “There are now five different maturities on the Eurobond sovereign curve plus the Belarus Development Bank bond and a bond by the largest domestic retailer. While repayments are still a few years off, total external amortisation needs are about 25% of GDP.”

IIF says unless the political crisis is resolved, and resolved soon, the outlook for Belarus is “challenging.”