Progressing Recession Deteriorates Quality of Debts - Belarus Economy Digest
On 27 October, the Belarusian statistical office released revised GDP data. The government actually bets on a quick revival of the economy and bails-out some firms and industries through expanding its own debt.
However, this in turn creates a potential problem of public debt sustainability, as the perspectives for creating the effective economic activity of firms under a bail-out look doubtful. Another troubling trend is that the growth rate of outstanding loans has been significantly higher than the expansion of firms’ economic activity.
No Recession End in Sight
The Belarusian statistical office reported that in January-September GDP contracted by 3.7%. From the perspective of recession, this figure provides ambiguous signals. On the one hand, the deepness of the recession was less than in January-July. On the other one hand, GDP performance in September deteriorated in comparison to August.
Some swings in output dynamics occurred due to late harvesting this year. If this fact is taken into account, the perception that the bottom of the recession is further ahead becomes more reasonable.
The Belarusian authorities prefer to accuse external shocks for the poor GDP performance
New statistics show further that Belarus is experiencing a significant shock in its level of potential GDP. The latter emphasises the partial disorganisation of the important aspects of the national economy, which might increase the length of the recession, which will result in lower living standards.
The Belarusian authorities prefer to accuse external shocks for the poor GDP performance. For instance, the first deputy Minister of the Economy characterised the current trends as 'adaptation to a new normality’. Although external shocks have indeed become a trigger for the recession, currently mainly domestic adjustments speed up and increase the contagion of recession.
However, problems associated with poor GDP performance and lower living standards have both lost their top positions in the economic agenda for now. This is due to the Belarusian authorities announcing the new denomination in 1 July 2016. Although the technical step of removing 4 zeros from prices will not have any effect on economic dynamics, it has attracted much public attention.
Two Patterns of Adjustment to Recession
Belstat reports that the ‘average’ financial stance of firms improved in comparison to previous years. For instance, the average level of sales profitability in January-August 2015 improved modestly in comparison to previous year, although it remains close to the historical minimum. The improvement in profitability became possible mainly due to cost adjustments, as most firms currently face much tighter budget constraints.
However, each firm’s performance is not uniform. The share of loss-makers increased threefold in 2015. The absolute amount of loss generated by these firms during the first 8 months of 2015 approached to roughly 5.5% of GDP.
Government Buys the Debt of Wood-Working Firms
Within the real economy a divide among firms has arisen. Some firms appear to be successful in adjusting to the new environment, due to lower costs and growing productivity. Yet other suffer and for them operating in a recession environment results in progressive loss-making and debt accumulation (see Table 1).
From this perspective, wood-working manufacturing has become a good example. In 2007-2014, the government initiated a so-called modernization of the industry, allocated to the industry more than $1 billion through a mechanism of direct lending. During a meeting between government officials and Alexander Lukashenka in late October devoted to wood-working, the officials recognised that majority of wood-working firms will not become profitable in the near future.
Moreover, a huge amount of debt has been accumulated by these firms (during the modernization campaign) and so it becomes further each firms poor prospects. This in turn becomes a huge challenge for the banking system of the country.
In the case of wood-working, Lukashenka decided that the government should purchase this debt from commercial banks. This scheme looks pretty similar to the one employed in June for supporting state machinery firms. The government in turn is forced clean each banks’ balance sheets from the issue of potentially bad loans by means of increasing government debt.
The Quality of Debt As A New Systemic Threat
Over roughly a decade, the growth rate of outstanding loans has been significantly higher than the expansion of firms’ economic activity. Hence, the fraction of each firms own capital has decreased constantly. Between 2004 and 2014 it fell by 22.1 percentage points down to 57.3%.
Given the sharp growth in real interest rates during the last couple of years, each firms’ costs for debt servicing has increased significantly. Hence, during the recession many firms faced the choice of:
- substituting, at least partially, borrowed funds using their own money;
- limiting the volume of production;
- instigating loss-making activities, expecting that either the interest rate will go down, or the demand will revive in the short-term.
A significant number of firms (especially state-owned ones) had to select the third option, as ceasing/contracting production would have meant a quick default on already accumulated debts.
These threats have also emerged in banking balance sheets. The share on non-performing loans started growing, although modestly (see Figure 1). But one may argue that the problem is gaining momentum. For instance, the growth rate of assets classified as ‘in between standard and non-performing ones’ (i.e. the part of these loans will become non-performing soon) is growing rapidly.
The deteriorating financial performance of firms has already affected banks’ financial results. Due to the deteriorating quality of assets, nearly all the banks display lower profitability in 2015 in comparison to previous year. More than this, some banks have displayed losses in the last quarter of 2015. From this perspective, a long drawn out recession might hit the banks further (individually, or, in the worst case, systemically), thus continuing the feeling of depression in the economy.
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)