The Economy Gets Used to Sustained Recession - Belarus Economy Digest
The Belarusian economy keeps on contracting: in January-July it decreased by 4 per cent. However, a number of positive trends have arisen: wages and employment are stabilising, along with improvements in current account balances.
The latter might signal an imminent recovery, but that remains questionable. Increased sensitivity to global financial turbulence and the lack of policy capacities may cause a deeper and sustained recession.
Poor perspectives for leaving recession
In January-July 2015, the economy performed rather poorly: GDP dropped by 4 per cent, and this was accompanied by shrinking employment and wages. This means that in 2015 GDP contraction will be more than 3.5 per cent as most analysts agree. A 4.0 - 4.5 per cent contraction in 2015 seems likely. Moreover, perspectives for 2016 are deteriorating: expectations of poor growth might be soon substituted for expectations of a continuation of recession.
From the demand side, poor investment activity explains the deteriorating environment. The majority of firms have adjusted to a shock reduction in foreign demand by making fewer intermediary imports, which has a roughly neutral effect on GDP.
However, this adjustment has not been sufficient and firms have had to reduce their investments as well. High interest rates and labour costs have strengthened this trend. Such adjustments by businesses mean that the social impact of the current economic downturn has been relatively soft. However, it implies more challenges for a rapid recovery and weakens the environment for long-term growth.
Wages and employment moving towards stabilisation
At the beginning of the year, the labour market reacted sensitively to the economic slowdown: both employment and real wages contracted. However, in the last couple of months this relationship has dwindled. First, the rate of decrease in employment has slowed. Second, the quantity of ‘idle hours’ initiated by employers has begun to go down. Third, real wages have recovered from a huge drop at the beginning of the year, and have actually stabilised near the average level of 2014 (see Figure 1).
A number of factors can explain the stabilisation of the labour market. First, the private sector (or part of it) might be satisfied with the current level of labour costs which resulted from substantial cuts at the beginning of the year because it it more competitive.
Second, in May and June some positive signals in foreign demand may have pushed firms to stop making further adjustments to labour costs. Third, the government might have intensified its administrative tools ahead of the presidential election. From this perspective, Lukashenka’s statement that state-owned enterprises should do their best to save their labour force despite the recession might have had an impact.
Recession improves trade balance
Contraction of demand abroad triggered the current recession in Belarus. Similar shocks in previous years led to a significant deterioration in the trade balance, as a reduction in exports was not compensated enough by a reduction in imports. However, this time the adjustment to foreign demand shocks has been different. Currently Belarus is demonstrating substantial improvements in its trade balance (see Figure 2).
First, this is due to a shift to a floating exchange rate regime, which provides near stable price competitiveness for Belarusian producers. Second, the recession environment contributes to a better merchandise trade balance: less disposable income guarantees less demand for imports. Third, the government has tightened its administrative pressure on imports. Finally, during this year Belarus has displayed a persistent surplus in its trade of goods and services.
Surplus in trade together with the inflow of oil duties which were previously re-channeled to the Russian budget will lead to significant improvements for Belarus. In fact, it means that Belarus in 2015 does not need foreign borrowing to finance its current needs. However new borrowing for repayment of old debts is still on the agenda.
Overall, one may argue that the current recession and new policy mix is a painful but purifying treatment for the Belarusian economy. However, such a conclusion may be challenged because of the increased sensitivity of the national economy to external shocks. This sensitivity stems from structural weaknesses and distortions accumulated during the periods of voluntary policies.
Sensitivity to turbulence in international markets increased
In the current policy mix, the nominal exchange rate should absorb a huge part of the external shocks. Given the relatively stable external environment, this mechanism works properly. That was the case, say, in the second quarter, when foreign financial markets, oil prices and exchange rates of major currencies for Belarus (USD, EUR, RUB) were relatively stable.
However, in case of more severe shocks and correspondingly large exchange rate adjustments, the mechanism stalls. Belarusian households still perceive large exchange rate swings as a signal of further financial turbulence, rather than a shock absorber. This leads to deposit dollarization and demand for hard currency to increase, thus propagating the shock for domestic financial markets rather than dampening it.
A similar story took place in July and, especially, in August. A new round of global financial market downturns led to cheaper oil and depreciation of the Russian ruble. The Belarusian ruble followed a similar path to the Russian one, which resulted in a roughly 15 per cent depreciation in July-August against the US dollar.
Lowering demand for national currency accompanied depreciation. The worries of households also amplified it: Belarus had to redeem Eurobonds issue worth $1bn given a very low level of international reserves. However, a new loan from Russia (the equivalent of $760m) allowed passing the Eurobond redemption without reduction of reserves, which mitigated the pressure on the financial markets.
Although depreciation has not triggered a new wave of panic on the domestic market, it exposed existing challenges. First, the current policy mix is still weak in the face of huge shocks. Second, the authorities cannot afford a rapid reduction in interest rates as it increases sensitivity to shocks. This means that getting out of recession will take a long time, especially against the backdrop of global financial instability. Hence, a deep and sustained recession seems the most likely scenario for Belarus.
Dzmitry Kruk, Belarusian Economic Research and Outreach Center (BEROC)
This article is a part of a joint project between Belarus Digest and Belarusian Economic Research and Outreach Center (BEROC)