Note that the market assumption had been that Moscow might provide a one-off $1 billion loan, with $2 billion also provided by the EurAsEc entity in addition. Kudrin indicated that the $3 billion loan package might not be enough and that the authorities in Minsk may need to look into other financing options, including raising funds from state asset sales – the figure of $2 billion was mentioned – plus perhaps even seeking financing from the International Monetary Fund.
Russia wants access to real assets in Belarus, which the government in Minsk is not willing to dispose of cheaply.
Net-net, the news is disappointing, suggesting that both sides are still playing very hard to get. Russia wants access to real assets in Belarus, which the government in Minsk is not willing to dispose of cheaply. Russia seems to have given the authorities in Minsk, the minimum it could while still maintaining the façade of solidarity within the CIS Economic Union which Moscow is still trying to forge. Interestingly, Eurobond prices have rallied on the news, but disappointment will likely eventually set in as the reality dawns that the financing made available via Russia falls significantly short of the mark.
This does raise the question as to how much financing Belarus requires to address concerns over its external financing position. On this note we refer to the IMF’s latest Article IV review on Belarus, published in March 2011, and which failed to pull any punches in terms of revealing the challenges facing the country, and the likely significant adjustment (fiscal/exchange rate/structural) required to close/cover glaring external imbalances. In its Article IV review the Fund provides balance of payments projections for the period 2008-2016, which we present in the attached table.
Key aspects herein:
* The Fund assumes (under the assumption of no significant adjustment in policy by the authorities) a small widening in the current account deficit, from $8.75 billion (16 percent of gross domestic product) in 2010, to $9.2 billion (14.1 percent of GDP) in 2011, remaining around the $10 billion per annum level over the period 2012-2016.
On the financing side, the Fund assumes:
* Net foreign direct investment rising from $1.3 billion in 2010 to $1.9 billion in 2011;
* Net portfolio investment rising from $1.1 billion in 2010 to $1.9 billion in 2011;
* The Fund assumes loans fall from $3 billion (net) in 2010, to just $1.9 billion in 2011, reflecting no Fund financing after the previous SBA ended;
* The Fund assumed foreign currency reserves were "replenished" by $1.2 billion in 2011, after a $1 billion draw down in reserves in 2010.
* Under the above assumptions, the Fund assumes a financing gap of $4.6 billion in 2011, $5.9 billion in 2012, and $7 billion in 2013. These are huge sums for a $54 billion (2010, likely "shrink" to $42 billion in 2011 through the impact of devaluation) economy and set against official foreign exchange reserves of only around $3.3 billion at present.
Clearly Belarus can close a wide external financing gap through various means, for example, cutting the funding needs, above the line, by slashing the current account deficit via deflating domestic demand and/or an exchange rate adjustment. They can also boost financing, by looking to raise FDI inflows, e.g. through privatization, or by tapping official creditors or markets.
On the current account side, the National Bank of the Republic of Belarus (NBRB) has moved to allow the exchange rate to correct lower. Initially it imposed draconian measures to restrict FX convertibility, which surely had the impact of deflating domestic demand/disrupting economic activity; it now seems inconceivable that the economy can grow at the 10 percent pace reported in the first few months of the year. Subsequently it has moved, in effect, to devalue the Belarus rubel (BYR), by widening the official trading corridor for the currency and this morning announcing it is allowing the rubel to trade freely at the retail level.
The result has been for the rubel to "devalue" by as much as 60 percent, trading down at BYR 5,125. The question is what impact this drastic exchange rate correction will have on the current account deficit?
Presumably it will narrow very significantly. One major point of note, however, is that trends for the first quarter of 2011, suggested a much more significant deterioration in the merchandise trade account, than had perhaps been factored in by the IMF in its original projections contained in the Article IV review. Thus, for the first quarter of 2011 the deficit on merchandise trade more than doubled to $3 billion, from $1.1 billion in the year earlier period.
The IMF had originally assumed a narrowing in the deficit on merchandise trade from $9.2 billion in 2010 to $7.6 billion. The point herein is that starting point in terms of the current account position for 2011 may have been on track to be much worse than even the IMF had been assuming with its original $9.2 billion deficit forecast, which underpinned the $4.6 billion financing shortfall estimate; more likely $10-11 billion in terms of the current account deficit, and implying an even larger external financing gap ($5-6 billion) for 2011 – prior to the exchange rate correction. This might suggest that while the current account deficit will correct lower, it could still remain elevated, and a significant risk in terms of the country’s external financing needs.
On the financing side, the sovereign already tapped the Eurobond market this year with a $800m issue. Kudrin’s comments suggest a further $1 billion could be forthcoming from the EurAsEC organization, which more or less equates to the Fund’s assumption of $1.9 billion in loans forthcoming in 2011. Given general investor perceptions of Belarus at present it is difficult to imagine $1.2 billion in portfolio investment inflows; we struggle to see much of this being forthcoming.
On the FDI side, interestingly, finance minister Kudrin indicated that Belarus could raise $2 billion from state asset sales; our read into this is that the message from Moscow is that they would be interested to bid for assets in Belarus, if they were put on sale. Little has thus far been raised in terms of net FDI, but the potential is there, particularly in terms of assets in the fertilizer/transport sector. Note that in terms of FX reserve data, the assumption by the IMF of a $1.2 billion FX reserve increase in 2011 was clearly overly-optimistic, and indeed we have seen at least a $1 billion draw down in official FX reserves this year, and this would account for around half of the financing gap as detailed by the IMF.
Putting all the above together, and taking into the consideration the exchange rate correction over recent weeks, Belarus still faces a significant external financing gap; a view which also appeared to be shared by Russia’s finance minister Kudrin in his comments earlier today. This may need a further /continued exchange rate correction, a deflation in domestic demand via monetary/fiscal tightening, access to more official financing (Kudrin mentioned the IMF) or more aggressive plans for state asset sales. The announcement this morning of $1 billion in financing this year from Russia/EurAsEC is disappointing and falls short of what is likely required to square Belarus’ financing position.
So what is going on in terms of Russo-Belarus relations? And what can be made of Kudrin’s call for Belarus to seek financing from the IMF, and/or push forward more aggressively with state asset sales?
The message from Moscow is thus that if the administration in Minsk is unwilling to follow the script as provided by Russia, it needs to look for alternative financing sources.
Our read herein is that Moscow was only willing to lend more significant sums to Belarus on condition that it was able to acquire strategic assets in the country as part of the privatization program. The two sides seem to have failed to agree on the asset sale side of the equation. Given Moscow’s desire still to promote the concept of the CIS Union/Customs Union – a priority for PM Putin as Russia heads to elections – Russia still felt obliged to provide some financing, but was unwilling to provide a blank check, until clearer commitments were provided on the asset sale side.
The message from Moscow is thus that if the administration in Minsk is unwilling to follow the script as provided by Russia, it needs to look for alternative financing sources. Resort to the IMF would be the obvious choice, but this is likely to come with unpalatable strings attached for the Lukashenko administration. Herein not only would the IMF likely demand painful structural adjustment, with likely far reaching implications for employment and social/welfare provision in Belarus – which are generous by regional standards – but important IMF shareholders (EU and the US) would likely demand political concessions from the regime as the price for support.
With President Lukashenko describing Western governments only as recently as this week, at the annual May Day celebrations, as the biggest threat to Belarus, we do not anticipate an imminent change herein. What seems likely therefore is that Belarus will try and get by/make do, which suggests the risk of further FX weakness, and economic disruption, with a further deterioration in Belarus’ macro indicators – growth will be lower/recession, inflation higher, and debt ratios will deteriorate, albeit we could see the current account deficit shrink significantly.
How this impacts on domestic political stability will be interesting/challenging for the authorities in Minsk, as will likely be their reaction. Past experience suggests more stick than carrot, especially with funds running in short supply.
Timothy Ash is global head of emerging markets research at the Royal Bank of Scotland in London.
