Currency Market and Banking System: Early recovery or short-term break?

Summary

In 2012, the money authority pursued a cautious monetary and fiscal policy, thus ensuring the stability of the domestic money market. High interest rates encouraged both households and enterprises to have ruble-denominated deposits with banks.

Higher foreign exchange revenues contributed to an increase in foreign exchange supply by corporate entities. As a result, the exchange rate of the Belarusian ruble vis-a-vis the main foreign currencies changed smoothly and predictably. In the banking sector, assets and equity were on the rise, while return rates and capital adequacy indicators were falling.

Trends:

• Increase in currency revenues contributes to foreign exchange flows from households and enterprises into the banking system;
• Real effective exchange rate of the Belarusian ruble remains favorable for exporters despite ruble appreciation;
• Banking sector calls for additional capitalization amid a growth in distressed assets.

Money market

In 2012, the Belarusian money market remained stable and predictable. The Belarusian ruble depreciated by 2.6% to the U.S. dollar, by 5% to the euro and by 8% to the Russian ruble.

According to the National Bank, in 2012, purchases of foreign exchange by individuals were USD 684.5 million in excess of sales, including cashless transactions. However, Belarusian economic entities sold USD 1.632 bn in foreign exchange more than they purchased. For their part, net purchases of foreign exchange by non-residents (banks and companies) last year amounted to USD 1.875 bn.

The increase in non-residents demand for foreign exchange is attributed to the closure of the swap deal between the National Bank of Belarus and the People's Bank of China (the central banks repaid each other equivalents of USD 930.7 million). Exclusively of that deal, non-residents net demand for foreign exchange amounted to USD 944.3 million. Non-residents mostly acquired foreign exchange from the National Bank in the framework of the scheme to distribute customs duties in the Customs Union.

In 2012, payments continued under previous contracts for exchange of deposits between the central bank and commercial banks. The NBB paid USD 1.258 bn in its liabilities to commercial banks, whereas banks paid the central bank a ruble equivalent of their foreign exchange liabilities, about BYR 9.784 trillion. The resulting reduction in the volume of deposit exchange contributed to an increase in foreign exchange supply in the domestic market and simultaneous withdrawal of Belarusian rubles from circulation.

Furthermore, the banking system saw a major inflow of foreign exchange from households and corporate entities. In 2012, individual foreign exchange deposits rose by 49% (or by USD 2.065 bn) to a new all-time high of USD 6.277 bn as of January 1, 2013. High exchange rates amid lower inflation and devaluation expectations encouraged the Belarusians to save not only in foreign currency, but also in rubles. Last year, individual ruble deposits increased by 75.2% year-on-year, or by BYR 10.424 trillion, to reach BYR 24.278 trillion as of January 1, 2013. Also in 2012, foreign exchange deposits of corporate entities and individual entrepreneurs with domestic banks rose by 17.4%, or by USD 595.5 million), to USD 4.019 bn, and ruble-denominated deposits went up by 45.7%, or by BYR 9.417 trillion, to BYR 30.017 trillion as of January 1, 2013.

According to the NBB, in 2012, foreign exchange proceeds from exports of commodities and services, incomes and transfers of Belarusian business entities (including individuals) rose by USD 3.947 bn year-on-year (by 8.5%) to a new record high of USD 50.636 bn. In 2012, export proceeds were USD 3.218 bn above payments for imports of commodities, services, incomes and transfers.

Also in 2012, Belarus paid USD 3.847 bn worth of oil product export duties to the Russian budget. The country's foreign trade swings from a surplus to a deficit of USD 628.4 million if we factor in this payment. In the structure of foreign exchange revenues (currency proceeds from commodity and service flows, incomes and transfers) the share of the Russian ruble went up to 32% in 2012 from 30.2% in 2011, the share of the U.S. dollar went up to 38% from 27.7%, the share of the euro fell to 28.7% from 35.4%, the share of the Belarusian ruble dropped to 0.8% from 1.8%, and the share of other currencies decreased to 0.6% from 4.8%.

The current dynamics of the real effective exchange rate of the Belarusian ruble vis-a-vis the basket of currencies of the major trade partners suggests that a sharp one-step devaluation of the national currency in nominal terms would be inadvisable. The current real effective exchange rate is still favorable for Belarusian exporters. According to our estimates, the exchange rate of the Belarusian ruble in real terms will remain quite stable throughout the year 2013. However, in order to reduce devaluation expectations and the demand for foreign exchange, the Belarusian authorities will have to keep to a more restrained wage policy in the public sector, including by way of reducing the number of civil servants, by approximately 20%.

Banking sector

Loans to the national economy soared in 2012. The economy borrowed in excess of the targets adopted in the 2012 Basic Monetary Guidelines, which stipulated an increase in lending volumes by 17-23% year-on-year.

According to the National Bank, borrowers owed banks BYR 208.35 trillion, an equivalent of USD 24.312 bn, under loan agreements and in the framework of other active transactions, which is a new all-time high. The debt increased by BYR 55.851 trillion, or by 36.6%, in 2012 alone. Of the total amount, the debt denominated in Belarusian rubles increased by BYR 20.253 trillion, or by 22.3%, to BYR 111.257 trillion, and the foreign exchange-denominated debt went up by USD 3.965 bn, or by 53.8%, to a new all-time high of USD 11.329 bn as of January 1, 2013.

Therefore, amid high interest rates on ruble-denominated loans and stable exchange rate of the Belarusian ruble, companies and organizations have boosted their demand for foreign exchange loans. In order to prevent further dollarization of assets in the banking system and reduce the demand for foreign exchange, the National Bank imposed temporary restrictions on corporate loans in foreign exchange to finance activities other than import of commodities and services.

However, a logical question would be: will Belarusian companies be able to meet their financial commitments while paying improbably high interest rates? In December 2012, the average full interest rate on new ruble-denominated loans to corporate entities reached 37.7%, which compares to the 7.6% average rate on foreign exchange loans.

The quality of the loan portfolio is currently at an acceptable level. In 2012, troubled loans of customers and banks under loan agreements and other active banking transactions (including extended and overdue loans) increased by 46.7% to BYR 1.145 trillion as of January 1, 2013. As a result, the share of troubled loans in the total amount of loan debts increased to 0.47% from 0.39%. As for troubled assets of commercial banks, they increased by 70.5% in 2012 to a new all-time high of BYR 11.973 trillion. The share of troubled assets in the total volume of assets exposed to credit risk increased to 5.5% in early 2013 from 4.16% at the start of 2012.

In the meantime, commercial banks failed to create sufficient provisions for unrecoverable loans, managing to accumulate only BYR 8.533 trillion, or 71.3% of the total amount of troubled assets. To meet the target, banks would have had to channel BYR 3.44 trillion of their profits to provisions, whereas total profits of the banking system for 2012 amounted to BYR 5.394 trillion. In other words, if banks had met their commitments, they would have been left with only BYR 1.954 trillion in profits. As a result, the banking sector requires additional capitalization, because otherwise it will see lower profitability, liquidity and capital adequacy rates.

Return on equity decreased to 12.74% in 2012 from 14.87% in 2011, while return on assets rose to 1.82% from 1.65%. In 2012, bank assets increased by 24.9% to a new all-time high of BYR 331.193 trillion, and combined equity of Belarusian commercial banks rose by 20% to BYR 44.905 trillion. As a result, capital adequacy decreased to 20.81% as of January 1, 2013 from 24.7% in early 2012.

The share of foreign capital in the registered capital of Belarusian banks rose to 19.61% in early 2013 from 14.54% at the start of 2012. The current quota on the participation of foreign capital in the Belarusian banking system is set at 50%. In 2012, non-residents funds in the liabilities of Belarusian banks increased by 2.2% to USD 6.117 bn; however, the share of non-residents in liabilities of the banking system fell to 16.3% on January 1, 2013 from 19.3% at the start of 2012.

Belarus has 32 commercial banks; there are only four banks with 100% Belarusian capital (Belagroprombank, Belarusbank, Belinvestbank and Paritetbank). See Table 1 below for the list of countries that invest in the Belarusian banking system and operate subsidiary banks in Belarus.

Note. The countries are ranked by the external debt of Belarusian banks, highest to lowest.

Source: Author's methodology based on the data of the National Bank of Belarus.

As of October 1, 2012, the main foreign creditors of Belarus were Russia with USD 2,056 million, or 39.3% of the total debt to non-residents, Germany with USD 1,312 million (25%), Iran with USD 283.4 million (5.4%), Austria with USD 223.7 million (4.3%), the Netherlands with USD 156.8 million (3%), Switzerland with USD 138.8 million (2.6%), Italy with USD 124 million (2.4%), Poland with USD 121.4 million (2.3%), the Czech Republic with USD 104.1 million (2%) and the UK with USD 103.3 million (2%).

Conclusion

We believe that given the recently introduced restrictions on lending to corporate entities in foreign exchange, banks will have to sell currency in order to meet the requirement for ruble-denominated loans of companies and households. This will boost the supply of foreign exchange in the domestic market and will facilitate de-dollarization of active transactions in the banking sector.

The lower inflation rate amid increase in the share of ruble instruments in the assets and liabilities of commercial banks will enable the central bank to gradually reduce the refinancing rate and reserve requirements in 2013. Overall, it is likely that all interest rates in the country's financial market will go down in 2013.