Dmitry Kruk: What does the new reality do for the Belarusian economy?
For this reason, Russia has been subjected to a number of extremely harsh sanctions by developed countries and will suffer economic losses. This circumstance alone already means serious economic difficulties for Belarus because of its close ties with the Russian economy.
For our country, however, the situation is even sadder. Involvement in the Russian “special operation” aggravates the situation.
First, the sanctions associated with the war have touched Belarus as well. Admittedly, they are a little less stringent than those against Russia, but the expected damage from them is quite significant. Moreover, there is a high probability that the sanctions against Belarus will be tightened.
Second, the initial effect of the sanctions is multiplied by the catastrophic image losses of Belarus.
Third, the conditions of the new reality are superimposed on the initially extremely shaky ground in the national economy. With the extreme fragility of price and financial stability, the prospects for growth, even before all the circumstances associated with military action, were rather meager.
Finally, fourth, very few ways are seen to improve the situation so far. Of the wide range of realistic options, only democratization of the country, political changes, and not giving up territory and infrastructure for Russia’s use can lead to improvement. Other options would almost certainly lead to a shock to the Belarusian economy that would be not only large-scale, but also permanent. In this case, Belarus will find itself in a fundamentally new environment for itself, a kind of new normality.
All this suggests that the country is at the initial stage of the most severe economic and financial crisis in its modern history. But the Belarusians have already become somewhat accustomed to the words “economic and financial crisis”, “inflation”, “devaluation” and other similar words. It is important to understand the potential depth and duration of the crisis, the extent to which the current circumstances determine the further course of economic events, and the extent to which it is still possible to influence it, and which issues are key today for the economic outlook.
What is going on in the economy of Belarus now
The Russian invasion of Ukraine has set in motion a number of events and processes that are creating a new normal for the Belarusian economy. The main ones are: the destruction of relations with Ukraine, export sanctions, financial sanctions, transport and logistical barriers, the rapid growth of negative expectations, reputation losses (both of Belarusian business and Belarus as a place for business).
In order to arrange what is happening in one system of coordinates and assess the potential consequences, it is more appropriate to consider events and processes from a slightly different perspective – from the assessment of their role in generating shocks for the national economy.
The first and most obvious one is a demand shock. Export contraction is its key component. This is supplemented by a shock of domestic demand, i.e. investment and consumer demand.
The potential scale of an export shock is about 40% of total exports. This shock is composed of six elements. First, there are the direct export sanctions imposed by the EU and Great Britain. Taking into account the old sanctions packages, about 20% of the entire traditional export basket is now under sanctions restrictions of these countries.
Second, the collapse of exports to Ukraine is almost inevitable. The initial estimate of the potential scale of this shock is about 10% of all exports. Ukraine has traditionally been Belarus’ second most important trade partner, and in recent years supplies there have been growing very dynamically, including through the redirection of subsanctioned goods that could not be delivered to the EU. In 2021, 13.6% of all Belarusian exports were directed to Ukraine, and now we can expect it to drop almost to zero.
Third, exports to Russia will also decline. In this case, for purely economic reasons, due to the contraction of the Russian economy. Given the fact that a significant part of the Belarusian export basket to Russia is made up of investment goods (they are the first to be abandoned in bad times), the sensitivity of Belarusian exports to economic activity in Russia is very high. Based on the share of exports to Russia (over 40% of total exports) and the assumption of a ten percent contraction of the Russian economy, the potential for a corresponding export shock is about 5% of total exports.
Finally, there are three other factors, for which it is still difficult to give even approximate estimates due to their non-economic nature and uniqueness. We are talking about self-restrictions of contractors (e.g. refusal of Belarusian goods due to unwillingness to risk their reputation), transport and logistical barriers (failures due to war, sanctions, self-restrictions), and financial sanctions. In the initial stages of the crisis, it is these mechanisms that turn out to be the most sensitive to export compression (especially financial sanctions). With a certain lag, up to two or three months, we can expect the first three to join them, the effect of which will be even more powerful.
A large-scale shock of external demand will almost certainly coexist with a contraction of domestic demand. Despite the fact that investment demand has been subsiding (with some spikes) for the tenth year in a row, it still has room to shrink. Because of the mass deterioration of prospects and expectations (more relevant for the private sector), forced disconnection of the administrative levers of the investment process due to restructuring to the philosophy of survival (more relevant for the public sector), the most conservative estimate of the potential contraction of investment demand is about 10% of its value in 2021. As for consumer demand, against the background of income compression and worsening sentiment and expectations, even a conservative estimate of the contraction potential is also significant – about 5%.
In addition to the demand shock, there is also a large-scale supply shock. Its key mechanism is transport, logistics and financial barriers, which “knock out” intermediate imports, thus stopping the production process. In addition, a new wave of emigration directly affects supply (leading either to a loss of labor, most often in the most advanced industries, or generally related to the relocation of business in general) and the voluntary freezing/collapse of business. The latter can take place, for example, due to unwillingness to undertake new risks, desire to fix existing profits, disorientation in the prospects.
Finally, a wide group of nominal and financial shocks complements the set of shocks. The main ones are price and exchange rate shocks. They arise due to a combination of different types of sanctions (export, financial, and transportation), which sets new equilibrium levels of relevant variables. So far, these shocks have had only a minor impact on the economy. Their main impact is yet to be felt by the economy.
At the initial stage, an important role has been played by a shock of foreign exchange liquidity, which quickly caused its implosion in the banking system. With some time lag, we are yet to face the impact of a broader range of nominal and financial shocks: inflation and devaluation expectations, asset quality and solvency of banks, financial position of firms, and fiscal shock.
We now have a mix of almost all real and nominal shocks. This is the worst possible combination in terms of shock typology. The combination of supply and demand shocks usually leads to a large-scale and prolonged drop in output accompanied by inflation. In our case, due to the presence of nominal and financial shocks, the most probable outcome is a deep output and income contraction, employment contraction accompanied by inflation, exchange rate depreciation, financial destabilization, which with high probability grows into a full-blown financial crisis.
To better understand the new reality, it is important to “digitize” it. But it is important to understand that as the crisis unfolds, the economy will go through a series of forks. Different solutions at these forks can lead to different trajectories. In addition, there are still few opportunities to at least partially buy out the initial shocks. Therefore, at this stage it makes little sense to talk about forecasts, but it is quite reasonable and possible to “digitize” the scenarios.
If this kind of “digitization” is based on the assumptions about the shocks described above, then the outlook is very bleak. It presupposes a 20% contraction of the GDP, a decrease in real wages by approximately 15% (in dollar terms, a decrease from 560 to approximately $330), an 8% increase in unemployment, an acceleration of inflation by approximately 40%, and depreciation of the Belarusian ruble by almost 2.5 times, to 6.3 rubles per dollar. Under the above scenario, these figures can be roughly chronologically associated with the outlook for 2022. Belarus has not faced a recession of this scale since the 90s.
Moreover, this recession makes a simultaneous collapse into a deep financial crisis almost inevitable. With such an economic downturn, a significant portion of borrowers will be unable to meet their obligations to banks (and to the government). Consequently, a vicious cycle of financial defaults would quickly materialize on the agenda. This, in turn, could trigger a new iteration of the recession.
The agenda for economic policy
Understanding the potential scale of the threats, it is logical to ask the question: Can these threats be contained or at least mitigated? The availability of economic policy instruments usually allows us to give at least a partial affirmative answer to this question. But in our case there are many details, in which, as always, lies the devil.
First, the arsenal of standard economic policy instruments is extremely scarce. The available gold reserves (about $8.3 billion) and the government’s ruble deposits (about 4 billion rubles) cannot cover all the emerging real and financial gaps. Fiscal policy options are practically exhausted. Monetary policy against the background of negative expectations, systemic flaws of the financial market is also very weakened.
Second, even with respect to the available buffers, there are great risks in the possibility of their use. For instance, the prospect of blocking a considerable part of Belarus’ gold reserves, similar to Russia, is widely discussed today. Hence, there is an important conclusion: the safety margin and possibilities to mitigate shocks on the basis of standard instruments are extremely low. At best, they can only slow down and prolong the development of crisis phenomena.
Realizing this, the current authorities are trying to find “non-trivial” solutions for stopping the shocks. In practice, this boils down to the trivial thing – an attempt to get various forms of support from Russia (tools to promote exports to Russia, cheapening of the entry price of Russian energy carriers). In a sense, based on short-term economic prospects, such steps may seem logical. But the important thing is that even if these attempts prove successful, they can at best only slightly reduce the scale of threats to real indicators (GDP, income) and partially plug financial gaps.
Technically, this logic of behavior can be characterized as an attempt to suppress the beginnings of the crisis, preventing it from spreading across many economic fronts. They behaved in a similar way at the beginning of the covid pandemic. Back then, this logic worked, but it was because the export shock ended quickly. Now, the prospects for a quick end to shocks are very weak, and “non-trivial” solutions are limited in scale and duration of impact.
Therefore, contrary to the bravura statements, the crisis phenomena in the economy will multiply. And numerous economic fronts will emerge, the appearance of which the present authorities are trying to avoid. Against this background, I believe, very soon the authorities will be forced to admit the impossibility of nipping the crisis in the bud and defining priorities for themselves. For example, as to what is the more important problem for them – the output squeeze or the financial crisis – and for what purposes the available resources and policy objectives should be used in the first place.
So far, I believe, there is still some room to avoid a full-blown financial crisis and to temper the inflation-devaluation prospect by accepting as inevitable an output contraction (buying it off as far as possible). The desire to continue to play nice makes the worst-case scenario more and more likely: a deep and prolonged recession, intensification of the inflation-devaluation spiral, and complete disorganization of the financial system.
Leave a comment