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MACROECONOMIC SITuATION: RECOVERY GROWTH uNDER THE BuRDEN OF
unresolved structural problems
Dmitry Kruk
Summary
In 2017, a long period of adaptation to the new institutional environment in the national economy was over, and recovery growth began. The improved external situation helped to achieve this growth, together with price and external stabilization. Inflation indicators and the net external financial position were the best in Belarus' history. This allowed the government to loosen economic policy screws, and domestic demand went up. However, recovery growth was very unstable due to certain structural constraints. The progress in institutional reforms seen in the previous two years came to a standstill.
Trends:
• After a long structural setback, the economy switched to the recovery growth mode; inflation hit a historic low;
• The improving external environment contributed to an increase in output and the comfortable current account of balance of payments;
• The government put the search for solutions to old structural problems 'on hold' and started creating a 'new economy';
• Most growth factors remained unstable.
Introduction
In 2017, the national economy entered a phase of uncertainty. On the one hand, at the end of 2016, there were indistinct signals that the recession had come to an end, and recovery growth began, supported by the government by stimulating domestic demand. In early 2017, a directive was voiced again to achieve an average wage of USD 500 (1,000 Belarusian rubles) by the end of the year, which means that wage and output growth was categorically prioritized over price and financial stability focused on in 2015-2016.
On the other hand, prerequisites for economic expansion in early 2016 were flimsy. First, it was unclear whether the previous contraction of the economy was sufficient to compensate for the
accumulated structural imbalances. Most companies remained weak financially, and a number of the most distressed enterprises (mainly state-owned) fought just to stay afloat. Smaller-scale companies sought to cut spending and optimize their composition. Second, economic growth was impeded by the banks' reluctance to take risks, limited loan offer due to the considerable amount of troubled loans (around 13% as of early 2017) and the weakness of enterprises. In early 2017, huge troubled loans could lead to insolvency of any of the banks and cause a new wave of financial instability. Third, the external situation still remained unfavorable for the national economy.
The search for solutions to old structural problems is put on hold
The economic authorities continued efforts started a year before towards slow and progressive mitigation of structural problems. Measures were taken to institutionally transform the national credit and financial system. In particular, a financial market development strategy was adopted; a number of elements of Basel III agreements were introduced into the national prudential regulation of banking operations; a series of measures were carried out to de-dollarize the national economy, and a gradual transition (2018—2020) of monetary policy towards targeting of inflation was initiated.
However, as before, structural changes were constrained by an unofficial taboo on systemic measures against inefficient large state-controlled enterprises, which mainly caused structural weakness of the economy. The measures taken were one-legged and only affected secondary structural problems.
Bad debts/loans topped the list of the structural problems in 2017. Like many others, it was a derivative of low efficiency in the real sector of the economy. The government tried to find a compromise solution, which, on the one hand, would eliminate fears about the financial standing of banks, and, on the other hand, would not cause shocks to enterprises.
To this end, the government focused on preventing new bad loans and continued to curb new directed loans. In 2017, the limit on directed lending was reduced by nearly one-third against
2016 to BYN 1.9 billion, or around 2% of GDP (BYN 2.8 billion and 3.1%, respectively, a year back). However, the decrease in new loans only led to a slight decrease in the proportion of directed loans to 40%.
These measures did not resolve the problem of accumulated bad debts. For example, in 2017, a pilot project on the resolution of debt problems of 323 agricultural enterprises started as far back as 2016 entered a smoldering phase. Many of the enterprises were given additional concessions, but only 10% of them were able to restore their solvency. Despite this, the state was in no haste to shut down most of the distressed enterprises on this list.
Having failed to find 'good' solutions to key structural problems, the economic authorities de facto put this task on hold. The improved market situation enabled many enterprises to recover. Soured debts stopped growing, and some of the problem debtors got an opportunity to start servicing current debts. Although many bad debtors still have little chance to restore their solvency and pay off their debts, and servicing of the current debts becomes some sort of 'credit shackles', the bad debts problem was no longer that great and acute. The authorities took a breathing spell. In the second half of the year, an interdepartmental ad hoc group was formed to 'work out a comprehensive approach to solving this problem until the end of 2018'.
The official refusal to further negotiate a new credit program with the IMF in July showed that structural changes had been postponed. The negotiations lasted almost two years, being perceived as an important baseline component of structural transformations in the economy.
Government undertakes to create a 'new economy'
Since a solution to key structural problems was not found, the economic authorities shifted the emphasis on creating a 'new economy', getting back to the old idea of the coexistence of two economic realities. The 'traditional economy' is to primarily ensure employment, pump up the budget, and solve other socio-political tasks. The 'new economy' is supposed to step up economic growth. Each of them follows its own path to deve-
lopment. It is assumed that a gradual flow of resources from the old economy into the new one will ignite steady growth of the national economy as a whole without threats to socio-political stability.
With a view to create the new economy, the country's leadership issued a package of legal acts on fostering private businesses and a decree on digital economy development. Measures were taken to facilitate starting and doing business and the number of regulatory and administrative barriers was drastically reduced to encourage the private sector. Also, additional tax and administrative remissions were introduced with respect to some operations, often conducted by small companies and individual entrepreneurs. The economic authorities expanded opportunities for self-employment of individuals (without registration as small business entities), for example, in the areas of handicraft trades and agro-ecotourism.
The government went even further with the digital economy. The decree issued in late 20171 created a legal framework for issuing and circulating cryptocurrencies and tokens in Belarus through the residents of the High-Tech Park and holding the ICO. In this respect, Belarus can claim the status of a pioneer on a global scale. The fundamental goal of the decree was to reorient the Belarusian IT sector to production. It is expected that this will significantly increase the added value and raise the technological level. For this purpose, the decree introduced a broad list of privileges, special rights and preferential treatment for HTP residents.
The measures taken to create the new economy can be assessed as positive. Elimination of administrative barriers to business will be an important tool for development of private businesses, especially small ones. Self-employment mechanisms can contribute to stabilization of the labor market, and, in the future, can become an 'integrated shock absorber' in this market. Measures to promote digital technologies are also likely to have a positive impact on the technological level. Moreover,
«Декрет № 8 от 21 декабря 2017 г. "О развитии цифровой экономики".» Официальный Интернет-портал Президента РБ. 21 Dec. 2017. Web. 30 Apr. 2018. <http://presidentgov.by/m/official_documents_ ru/view/dekret-8-ot-21-dekabija-2017-g-17716/>.
development of this sector can generate favorable externalities for the entire economy.
However, these measures will be ineffective, unless key structural imbalances in the national economy are eliminated. For example, the key barrier is not the regulatory environment but the inequality with state-owned enterprises. Therefore, measures to develop private businesses not supported by a refusal to sponsor state enterprises will have a limited effect. The same concerns the decree on digital economy development. The emphasis on sectoral preferences will negatively affect the transparency and competitiveness of the business environment in the entire economy. The price paid in the form of benefits and preferences for HTP residents may be excessive in comparison with outcomes. Besides, excessive attention to cryptocurrencies and tokens can make the Belarusian market a place for shady transactions, and capital flows may be excessively volatile.
The improved external situation gives an impetus to growth
In late 2016, after a long period of deterioration, the terms of trade (export/import price ratio) stabilized, and even began to gradually improve in 2017, following the slow recovery of the Russian market, conclusion of an oil and gas agreement with Russia in April 2017 and, as a side effect, the reception of a USD 300 million tranche from the Eurasian Fund for Stabilization and Development.
Exports in physical terms were increasing throughout 2017 to a historic high and even surpassed the level of 2012. In relative terms (relative to GDP), exports reached a five-year high making up 67% of GDP. However, disregarding seasonal factors, exports of few commodity groups (meat products, fish and ferrous metal pipes) grew, whereas other groups showed alternating spasmodic ups and downs. Imports in physical terms were rapidly growing as well, and this growth was more stable.
Boosted exports have become one of the key factors that triggered recovery growth. Impulses generated by increasing external demand began to spread across the board contributing to an increase in domestic demand. However, some of these
impulses were quenched by growing imports: the contribution of net exports to the output dynamics was only positive in 1Q17.
Foreign trade had a positive impact on nominal indicators. A surplus (in monetary terms) was achieved in trade in goods and services: usD 66 million according to the balance of payments methodology (76.6 million a year before)2. Also, the primary income deficit decreased by nearly USD 150 million, and the secondary income surplus went up by USD 450 million. The current account of balance of payments in 2017 (deficit at 1.7% of GDP) showed the best result since 2005.
The financial account of the balance of payments also looked well. First, the government managed to raise around USD 2,4 billion, including 800 million from the EFSD, 700 million from the Russian government, 600 million borrowed for the construction of the nuclear power plant and from Russian banks, and 300 million from Chinese banks.3 Second, the government raised USD 1,4 billion by placing Eurobonds. Although the cost of these borrowings can be called high today (USD 800 million until 2023 at 7.125% per annum and 600 million until 2027 at 7.625%), in the medium term, they will cause a slight decrease in the cost of servicing the public debt, as the yield on earlier Eurobonds was even higher. As a result, in 2017, debt payments by all economic agents were painless, and the country even managed to increase its international reserves (USD 2,0 billion, 3.8% of GDP). This, in turn, made the exchange rate stable: the nominal effective rate only decreased 2.3% year-on-year, and the ruble even grew stronger against the US dollar and the euro. This also appreciably contributed to the domestic financial stability.
The monetary environment has stabilized
By 2017, inflation expectations, which had been exceeding actual inflation since 2011, decreased. Throughout the year, they fluctuated within the range comparable with actual inflation,
«Внешняя торговля / Годовые данные.» Национальный статистический комитет РБ. Web 30 Apr. 2018. <http://www.belstat.gov.by/ ofitsialnaya-statistika/makroekonomika-i-okruzhayushchaya-sreda/ vneshnyaya-torgovlya_2/godovwe_danne/>.
«Государственный долг.» Министерство финансов Республики Беларусь. Web. 26 March 2018. <http://minfin.gov.by/ru/public_debt/>.
in many respects thanks to the National Bank's tight monetary policy pursued for two years.
Changes in the monetary environment predetermined new trends in the dynamics of its key indicators. Inflation was steadily declining reaching historic lows at the year-end (4.6% on a cumulative basis and 6.0% on average). Since the National Bank continued to focus on the actual indicators (rather than the forecast), the rapid slowdown in inflation and the reduction in inflation expectations gave it an opportunity to lower interest rates. There were 8 reductions in rates in 2017 to 11% per annum by the end of the year (17% at the start of the year). This led to a transition of the base level of real interest rates to a range of 3% to 5% per annum, which is close to their medium-term equilibrium level.
Milder monetary policies were also manifested in the resump -tion of growth of the money base and monetary aggregates (they virtually did not increase during the two previous years). Saturation of the economy with additional liquidity and lower interest rates directly influenced business performance and the population's behavior. Households began to save less and borrow more. Demand for loans led to a real boom in this segment of the lending market. Similar trends (yet on a smaller scale, as many companies already suffer from a severe debt burden, and their investment optimism is not so great) occurred in the corporate lending segment, where lending began to warm up closer to the year end.
Against the backdrop of the monetary environment stabilization, these trends on the credit and deposit market promoted an increase in consumer and investment demand (the latter meant the end of a long period of investment depression) thereby contributing to the beginning of the recovery growth of output.
Revitalization of the labor market
Stimulated wage hikes were an old-new feature of the 2017 economic policy. The president first set a political task to achieve an average nominal wage of USD 500 (BYN 1,000) as early as the end of 2016. This time, fulfillment of this task differed from that in previous years.
For the most part of the year, the authorities did not resort to its artificial stimulation. Therefore, during the first three
quarters of 2017, real wage growth rates were low and mainly natural. The wage growth rate was comparable with the labor productivity growth rate. The level of real labor unit costs (the share of labor costs in revenues, which is an important indicator of price competitiveness of enterprises) remained basically unchanged and remained close to its equilibrium level.
The situation changed in the 4th quarter: the government began to actively use both economic and directive tools to ensure wage growth. As a result, the real wage growth rate in Q4 was around 30% (regardless of seasonal factors). This giant leap caused a wave of consumer optimism and demand.
The situation on the labor market was closely connected with income policy. Over the first three quarters of the year, the lingering decline (since 2011) in employment gradually faded. By the end of the year, employment stabilized, and enterprises increased the number of new jobs. These trends intensified in the 4th quarter on a wave of income stimulation. This gave grounds to believe that the long-lasting trend towards downsizing was over. At the same time, the unemployment problem was not off the agenda. In 2017, the actual unemployment rate was at 5.6%, having slightly decreased against the previous year (5.8% in 2016).
It is also significant that in 2017, the economy felt predominantly favorable impulses from income stimulation, although these effects did not last long. A negative impact on price stability, exchange rate dynamics, the fiscal position and competitiveness and profitability of companies was the downside of this policy. These challenges have already been taken to 2018. A new round of struggle to achieve USD 500 in the average wage raised the question whether the wage increase at the end of 2017 was a one-time injection, and the government will refuse to pump up wages, or it will maintain wages at artificially high levels in 2018 putting macro stability at risks.
Recovery growth began. It is weak and unstable, though
A round of structural adaptation of the national economy to new conditions ended in 2017. Thanks to the external situation, a number of natural trends and some stimulating measures, the economy entered a recovery growth phase. Output increased
2.4%. In terms of demand, the main contribution to this growth was provided by internal components (3.8 percentage points). In particular, 2.4% growth was ensured by an increase in household consumption expenditure, and 1.3% by gross fixed capital formation. External demand contributed 4.5% to output growth, but imports grew faster and limited this growth to 6.2 percentage points. Therefore, the contribution of net exports to the output dynamics was negative (1.7 percentage points).
In terms of supply, the industrial sector provided the greatest contribution of 1.5% percentage points, whereas other major sectors (agriculture, transport and trade) only provided 0.3 to 0.4 percentage points each. Construction was the only large industry remaining in a state of decline in 2017 (minus 0.3 percentage points). This reflects rapid and artificial growth of this industry in the fat years and its dependence on artificial maintaining of demand.
Throughout the year, economic growth showed signs of instability. The second half of the year saw a decline in output growth that indicates the weakness of the recovery growth factors and gave grounds to assume that, other things being equal, the economy would reach the equilibrium growth path (2% to 2.5% per year). The situation somewhat changed in late 2017, as new acceleration factors emerged, particularly, rising world oil prices (17% per quarter), intensified administrative wage growth, and a surge in consumer and investment optimism. This surge, however, can only transform into an extended period of increased growth as a result of a permanent improvement of the external situation.
Other mentioned drivers cannot provide a sustained acceleration of growth without threats to external, price and/or financial stability. Therefore, in a more comprehensive sense, this growth surge at the end of 2017 is rather a manifestation of the weakness and instability of the environment of long-term growth of the national economy.
Conclusion
In 2017, the long period of adaptation of the national economy to the new institutional environment marked by a setback was
over, and recovery began, the improved external situation being the main driver. Price and external stabilization also contributed to this growth to a certain extent. This allowed switching to moderate economic policy that resulted in increased domestic demand and average real wage, and revitalization of the labor market.
Recovery growth was very unstable in 2017, though. This once again underscores the existing structural limitations, which impede national economy growth. Certain progress in institutional transformations achieved in the previous two years did not continue in 2017.
The macroeconomic situation improved, and the search for solutions to a number of chronic structural problems was postponed. Meanwhile, the government started creating a 'new economy', implementing the concept of two-sector economic development. To date, it seems very doubtful that this concept can ensure a significant increase in the growth potential. Therefore, weak and unstable growth will likely remain the main development scenario in the medium term.
