Boom is over, bust is looming

 Belarusian Soviet system - sequel

The state of the Belarusian economy predetermines many social and political factors as well as reactions of voters. In autumn 2006 only 16%[1] of the population and about 20% of businesses predicted difficulties with new Russian prices for gas and oil. Over 60% of both businesses and population were pleased with the social economic situation. Almost the same number of people considered themselves to be middle class though their income and expenditure patterns were far from the standards of this social category. In such social economic situation it was difficult to expect mass actions of protests against the policies of the government. The situation in Belarus in the period of 2002 – 2006 was considerably different from the situation in Poland in the second half of 1980-ies and Ukraine on the eve of its orange revolution or in Georgia before its pink revolution. That is why it would be wrong to compare the situation in Belarus with these countries. Both the tendencies and the standards of living in Belarus were in the upward position and had a major impact on political preferences of Belarusians.

Jaroslav Romanchuk

President of Scientific research

Mises Center (Belarus)

Pensions and wages are paid in time. State enterprises that dominate the economy and make about 80% of GDP do not have problems with access to credit. The state still owns about 80% of all assets in the country. It controls about 85% of the financial system including banks an insurance markets. In such situation the government and its “vertical line of power” manage the whole economy as one big corporation. All prices with very rare exceptions are regulated. Profitability margins are set. Norms of various items of production costs are also defined by the government both for state and private entities. A private company is denied the right to set wages at the levels that are different from those of the government. Both private and state companies are ordered production targets.

Such level of decision making centralization turned Belarus into a full-fledged mobilization economy. State companies can not fire redundant labor. Moreover, they are ordered the increase of wages for workers irrelevant of their financial status. Banks can not resist administrative orders to give cheap loans to state enterprises. Another peculiarity of the Belarusian system is that each region and even district is ordered production and sales targets. Each territorial unit sets the quota of local goods to be sold. 70- 80% of the goods that are sold in any district and region should be made locally. It means that there is no single economic area even inside Belarus. Big and successful Belarusian producers can not compete freely inside their own country. Such policy discriminates against any foreign goods irrelevant of the country of origin too.

Sources of relative stability and welfare

Good luck, huge Russian energy subsidies, free access of Belarusian goods to Russian market, the quality of the inherited capital and soft monetary and fiscal policies are key factors of relative stability and economic growth in the mid-term perspective.

1) Good luck means that external demand for the goods produced in Belarus soared due to high oil, metal, potash fertilizers and chemicals prices. The growth rate of the world economy in the period of 2002 – 2006 was very high and it boosted the growth inside Belarus.

2) Russia has been providing Belarus a huge energy grant (the difference between work market prices for gas and oil and the prices set for Belarus) for more than ten years. The size of this grant varied in different years from 15 to 20%. Historically it is a unique situation when one country receives such aid from another. In fact A. Lukashenko managed to monetize the so-called “intangible assets” in the form of promises to form the union state, to introduce the single currency with Russia, to sell its gas system and to sign the Constitutional Act. The Kremlin trusted him and thought that it would dictate its terms. Such arrangement was beneficial to Russian oil barons as they also benefited greatly from using the off-shore like conditions of oil refining in Belarus and exporting oil products. The events of the end of 2006 and the beginning of 2007 demonstrated that Belarusian authorities have not delivered on any promise they made. Hence the reaction of the Kremlin was quite strong and emotional but economically the gas price rise and the change of oil refining schemes were quite moderate. The Kremlin has not abandoned the plans to form the union state with Belarus, i. e. to make Belarusian authorities pass a considerable part of political and economic decision making to Moscow.

3) Belarus benefited greatly from having free access of Belarusian goods to the Russian market (based on the agreements made in 1995). At the same time Belarus is the most protectionist country in the world in terms of blocking Russian goods to its own market. It introduced about 80 different forms of protectionism that discriminates against Russian business. Until 2007 Russia has not introduced any counter measures against Belarusian goods. In the context of much hampered access to the Russian market of Ukrainian and EU goods Belarus definitely was in the favorable position. In 2006 Russia is the destination of 99.6% of all Belarusian export of meat and meat products, 96.3% of dairy products, 40% of tractors, 76.7% of trucks. Russia is still a key market for Belarusian TV sets, refrigerators and other industrial goods. Before 2007 it effectively subsidized Belarusian producers. They also got aid from the government and managed to compete in Russia. Since 2007 the existing competitive advantages of Belarusian produces are waning. Higher energy prices, higher taxes (tax burden in Belarus is about 10 percentage points heavier than in Russia), overregulation, extremely unfavorable business climate and lack of incentives of managers to adjust to the changing conditions make Belarusian state business more and more vulnerable. The performance of the Belarusian economy in the beginning of 2007 showed that the real and financial sectors are much exposed to external shocks than many experts estimated earlier. The  government had to raise taxes and duties and requested a big loan from Russia. Inventories soared, priced went up considerably and banks refused to give loans in Belarusian rubles. Inflation and devaluation expectations are very high. The population began to slowly withdraw ruble deposits which forces the National Bank to raise its discount rate. The shock of losing hard currency revenues from selling oil products is likely to speed up the deterioration of the overall economic situation in Belarus.

            4) Inherited capital is another factor of economic growth in Belarus. All key enterprises that ensure economic growth and expert revenues were set up in the Soviet Union. In 2006 only 170 major tax payers formed 45 - 50% of all budget revenues. 20 biggest exporters make over 80% of all exports outside CIS countries. Since 1994 the structure of the economy has changed very little. Belarus benefited from the physical and production infrastructure that was created long time ago. It was lucky that markets of metals, fertilizers and chemicals were on the very favorable state of their business cycle. At the same time many government officials stated on numerous occasions that the dominating state sector does not have comprehensive investment plans and corporate strategies to become competitive. The fact that only 3% of Belarusian export of manufactured goods is considered hi-tech proves that the existing model will face severe problems once the favorable stage of the business cycles is over. There is much evidence that the year of 2007 is the turning point in the economic development.

            5) Soft monetary and fiscal policies also contributed to the favorable economic situation in 2002 – 2006. A few chosen sectors (agriculture, construction) and enterprises (big industrial plants) operated in the environment of easy money and exclusive fiscal arrangements with the budget. The authorities used such measures of active industrial policy as debt cancellation, government guarantees of state enterprises’ loans, tax breaks, subsidized energy and protection from foreign competitors. In 2006 the monetary indicator M2 increased by 44.5%. Deposits of the population went up by 41.6% and amounted to about $3.6bln. The money of the population with very generous oil product revenues (in 2006 they amounted to $7.67bln.) enabled banks to considerably increase crediting of the economy. In 2006 the amount of loans soared by 57.6%. In 2007 it will be very difficult for the government to keep the inflation low (in 2006 it was 6.6%) and to prevent the Belarusian ruble from devaluation.

Challenges ahead

The boom period of the Belarusian economy that lasted from 2002 to 2006 is over. The economy has entered the stage of cooling down and the adjustment to the new much less favorable external conditions. Higher energy prices, more protectionism against Belarusian goods from Russia, peaked prices for metals and fertilizers, weak financial base, accumulation of investment mistakes inside the country, loss of competitiveness in the traditional markets and the deficit of modern technologies accompanied by the obsolete production base predetermine the beginning of the downturn of the Belarusian economy. The speed of the deterioration will depend on the decision of the government and enterprises and on the behavior of the Russian government. It is not likely that Belarus will face a full-fledged financial crises in 2007 but the accumulation of economic and social problems will become visible.

            Since 2002 the growth rate of real income of the population and wages was consistently higher that the productivity growth rate. Such was the policy of the government. The government is likely to discontinue it as the banks and enterprises will have to operated under much heavier financial constraints. As utility, energy, transportation prices are bound to grow and consumer goods are likely to become more expensive too (higher taxes, duties and production costs) the population will face the deterioration of its welfare. More people will fall behind the poverty line. The authorities will have to shorten the list of budget beneficiaries. The ones that are left behind are likely to change their political preferences and attitudes too. A few anti-entrepreneurial measures are also likely to mobilize the social and political resistance to the regime. However if the government received loans from Russia ($1.5bln.) and manages to sell short-term treasure bonds (the plan is to sell T-bills for $1bln.) it can cushion the adjustment effects in 2007. It will dramatically increase the debt burden of Belarus and will not liquidate the sources of the problems of the Belarusian system. It will just give some breathing space for the government but in the mid-term (2 - 3 years) the negative tendencies are likely to lead to considerable deterioration of the social economic situation. There will more much higher demand for reforms and market solutions. Even the current government will be forced to look for the policies to adjust to the challenges ahead. As there is little coordination between various state bodies and even fierce competition among them to keep their share of the budget pie the activities of the government itself will be the biggest destabilization factor in the year to come.

Economic indicators of the Republic of Belarus 2002 – 2006

Source: Ministry of statistics of the Republic of Belarus 2003 – 2007

Trading partners of Belarus 2003 – 2006

*including the countries that joined EU in 2004

Source: Ministry of statistics of the Republic of Belarus 2004 – 2007

Belarus in the light of indices:

Ø      Human development index (UN 2006) – 67^th place;

Ø      Economic freedom index (Heritage Foundation) 2007 – 145^th place out of 157 countries;

Ø      Growth competitiveness index – (World economic Forum 2006 – 2007) – 87^th place out of 117 countries;

Ø      Corruption perception index (Transparency international 2006) – 151^st place

Ø      Governance indicators (World bank 2006): 1) “voice and accountability” – 202^nd place out of 213 countries, 2) “political stability” – 118^th place, 3) “effectiveness of the government” – 191^st place, 4) “quality of government regulation” – 199^th place, 5) “rule of law” – 181^st place, 6) “control over corruption” – 172^nd place;

Ø      Hospitality to investment index (Forbes 2006) – 131^st out of 135 countries.