Currency Market and Banking System: Pressure of adverse factors

Summary

In 2013, Belarus faced a marked deterioration of external terms of trade, which brought about export cuts, drops in industrial output, slower GDP growth rates and expansions in the country’s foreign trade deficit. The domestic money market became unbalanced and the authorities took steps to gradually devaluate the national currency. The considerable decrease in export proceeds affected the supply of foreign exchange in the domestic money market. Meanwhile, the reduction in the import of goods and services was not as significant as the setback in export supplies, which contributed to the growth of the demand for foreign exchange.

In fact, the demand for foreign exchange in the domestic market soared in 2013 on the back of ruble depreciation expectations in the economy, shift in currency preferences to foreign exchange and major wage increases. This resulted in an imbalance in the domestic money market caused by the growing gap between the demand and supply of foreign exchange, which for its part put downward pressure on the exchange rate of the Belarusian ruble and the country’s gold and foreign exchange reserves.

Trends:

• The state and companies need to spend more resources to repay foreign debts;
• The demand for foreign exchange grows amid devaluation expectations and wage hikes;
• Gold and foreign exchange reserves are cut to shore up the ruble;
• Preparations are underway to redenominate the ruble.

Money market

In 2013, the Belarusian ruble depreciated by 11% to the U.S. dollar, by 15.3% to the euro and by 3% to the Russian ruble. The country’s IMF SDDS gold and foreign exchange reserves dropped by USD 1.444 billion in 2013, or by 17.8%, to USD 6.651 billion as of 1 January 2014. Calculated in accordance with national standards, Belarus’ gold and foreign exchange reserves fell by USD 1.526 billion, or by 17.4%, to USD 7.237 billion.

According to the national statistical agency Belstat, the export of Belarusian commodities went down by USD 8.828 billion, or by 19.2% year-on-year, to USD 37.232 billion in 2013. The most affected commodities were oil products, with export deliveries falling by USD 4.328 billion (29.8%) to USD 10.177 billion, complex organic solvents and diluents, with a drop in foreign supplies by USD 2.78 billion (1,703.2 times) to USD 1.633 million, and lubricants, with a decrease in export by USD 1.018 billion (85.1 times) to USD 12.099 million. Export of potash fertilizers dropped by USD 599.318 million (22.5%) to USD 2.063 billion; truck supplies went down by USD 502.536 million (31.2%) to USD 1.11 billion, and foreign deliveries of tractors and truck tractors fell by USD 362.853 million (25.2%) to USD 1.075 billion.

The National Bank of Belarus reported a 13% decrease in currency proceeds from commodity and service flows, incomes and transfers (by USD 6.601 billion) to USD 44.035 billion. Foreign trade operations associated with commodity and service flows, incomes and transfers showed a surplus of USD 426.2 million in 2013. However, also in 2013, Belarus transferred USD 3.3 billion worth of oil product export duties to the Russian budget. The country’s foreign trade thus swings from a surplus to a deficit of USD 2.9 billion if we factor in this payment. In the structure of foreign exchange revenues (currency proceeds associated with commodity and service flows, incomes and transfers) the share of the Russian ruble went up to 40.1% in 2013 from 32% in 2012, the share of the U.S. dollar went down to 24.5% from 38%, the share of the euro rose to 33.3% from 28.7%, the share of the Belarusian ruble went up to 1.2% from 0.8%, and the share of other currencies increased to 0.9% from 0.6%.

Another factor that produced a negative impact on the performance of the domestic money market was the significant increase in foreign debt payments by Belarusian residents (the government, commercial banks and companies). In January-September 2013, USD 4.533 billion was spent to pay Belarus’ gross foreign debt, an equivalent of 8.8% of GDP or 13.6% of the total export of commodities and services. Therefore, increasing amounts of resources from both the state and companies are required to pay foreign debts. In the first three quarters of the year, 11.5% of republican budget revenues were spent on foreign debt payments, an increase from 9.2% in 2012 and 4% in 2011.

This affected the situation in the domestic money market. According to an NBB report, purchases of foreign exchange by individuals (including non-cash transactions) exceeded sales by USD 2.38 billion. In the meantime, sales of foreign exchange by corporate entities exceeded purchases by USD 400.8 million. For their part, net purchases of foreign exchange by non-residents (commercial banks and economic entities) reached USD 872.1 million in 2013.

The population therefore made the largest negative contribution to the performance of the domestic money market. The marked increase in purchases of foreign exchange by individuals should be attributed to devaluation expectations and wage hikes. In 2013, the average payable wage amounted to BYR 5,139,400, an equivalent of USD 570.6, which was a new record high (an increase by USD 127.1, or 28.7% from the level recorded in 2012). The average weighted U.S. dollar exchange rate was used to calculate the average wage: BYR 8,458.97 per U.S. dollar in 2012 and BYR 9,007.74 per U.S. dollar in 2013.

See Table 1 below for a comparison between average wages in selected countries (USD equivalent): Kyrgyzstan – 235.9, Armenia – 388.1, Ukraine – 408.5, Azerbaijan – 539.2, Kazakhstan – 714.1, Lithuania – 863.3, Latvia – 933.9, Russia – 938.4, Poland – 1,149.7.

If we calculate the average wages in the above countries minus the income tax and other taxes on wages adjusted for purchasing power parity (PPP), i. e. if we apply a single price scale to the wages, the situation will look the following way: Kyrgyzstan – USD 419.6, Armenia – USD 566.9, Azerbaijan – USD 612.7, Ukraine – USD 643.8, Kazakhstan – USD 696.1, Latvia – USD 860.3, Lithuania – USD 965.8, Russia – USD 986, Belarus – USD 1,090.8, and Poland – USD 1,302. Based on a PPP analysis Belarus appears to be second only to Poland and is ranked ahead of Russia, Lithuania, Latvia, Kazakhstan, Ukraine, Azerbaijan, Armenia and Kyrgyzstan. Therefore, it seems unwise and even dangerous from the point of view of external and internal economic sustainability to further push wages.

In 2014, the growth of wages will be curtailed in real terms (i.e. adjusted for inflation) and in the U.S. dollar equivalent. This year, the gap between the growth in real wages and labor productivity is expected to considerably narrow compared with the previous year. The curtailment of the growth of wages will enable the Belarusian government to accumulate the funds it requires to pay the external public debt.

Awaiting redenomination

We believe that Belarus may announce currency redenomination in June 2015. The financial authorities will change the face value of banknotes, and either three or four zeroes will be cut probably starting 1 January 2016. Technically, redenomination should occur at the start of the year. The main objective of potential currency redenomination is to curb inflation and normalize the situation in the domestic money market. However, in this context, redenomination should be preceded by a campaign to bring down the inflation rate to a single digit (within 10%). Inflation must be checked because redenomination is as a rule accompanied by stronger inflation and devaluation expectations and hikes in the demand for foreign exchange in the domestic market. We expect inflation to slow to below 10% on an annualized basis in 2015, which will allow the authorities to announce redenomination starting 1 January 2016.

Against a backdrop of relatively harsh monetary and fiscal policies in the two years to come, the situation in the domestic money market is expected to improve, and net demand for foreign exchange will likely narrow. The Belarusian administration will be interested in having a predictable exchange rate of the national currency in 2014–2015 in order to avoid complications during the presidential election campaign. Meanwhile, the anticipated cancellation of the export duty on Belarusian oil products (Russia is expected to take place on 1 January 2015, i. e. when the Eurasian Economic Union becomes operational), will lead to a USD 3–4 billion increase in annual foreign exchange proceeds of the Belarusian state budget.

The next presidential election will take place on or before 20 November 2015, so the election campaign will likely be followed by redenomination, a move that will help switch the electorate’s attention to new banknotes.

Further, the possible combination of the election campaign and redenomination looks a reasonable move, because any presidential election campaign in Belarus is traditionally accompanied by an increase in the demand for foreign exchange. As a result, the authorities will manage to at least halve the period when the demand for foreign exchange is normally above average. The two alternative scenarios envisage redenomination starting 1 January 2015 and 1 January 2017; however, neither seems probable. In order to redenominate the ruble beginning on 1 January 2015, the authorities will have to officially announce it at least six months before the move (i. e. prior to June 2014); however, inflation is projected to reach 11% this year, and the demand for foreign exchange in the domestic market remains quite high, especially from individuals. Therefore, it does not seem there are prerequisites for redenomination to occur next year. On the other hand, the Belarusian authorities will hardly be willing to postpone the move until 2017. Moreover, officials have been making statements about the possibility of currency redenomination on a regular basis, and new banknotes that look like euros are said to have already been printed.

Essentially, the political decision on redenomination has been made; however, the timeframe for the ruble to have its face value reduced is not the only thing that remains vague. It is not clear how many zeros the national currency will lose-three or four. The latter option seems more likely, because once the ruble’s face value is cut 10,000 times, it will buy approximately 1 U.S. dollar (the biggest note – BYR 200,000 – currently buys USD 20.5). Therefore, in order to make payments possible, the authorities will have to introduce coins. The main advantages of redenomination are the improvement in the quality of notes, simplification of payments and reduction in the burden on accounting, financial and statistical services.

Conclusion

We believe the Belarusian ruble will be gradually depreciating against the basket of foreign currencies throughout 2014. Although risks in the economy tend to grow, the likelihood of stepwise devaluation of the national currency is quite low for several reasons.

1. The monetary authorities (the National Bank and the Finance Ministry) will be putting in place a relatively harsh monetary and fiscal policy in order to limit ruble money supply and lending in Belarusian rubles. Money issuance is currently restricted to standard arrangements to support the ruble (short-term) liquidity of commercial banks on market terms and the Finance Ministry’s ruble-denominated transactions on its accounts with the National Bank.

2. In 2014, the government will curtail the growth of wages of public sector employees and workers employed by state-run enterprises, which will eventually slow the increase in wages in the private sector. As a result, and given the anticipated hikes in prices for some goods and services (including utility fees and transport fares, etc.), individuals’ demand for foreign exchange will likely go down, which will be a natural result of the lower purchasing power of individual incomes.

3. Amid tight monetary and fiscal policies, the banking sector appears to be short of ruble liquidity. High interest rates stop individuals from converting their ruble-denominated incomes into foreign exchange deposits–people are encouraged to save in rubles. In 2014, rates on ruble-denominated instruments, including rates on transactions to support banks’ ruble liquidity) will gradually decrease; however, the process will depend on the situation in the domestic money market.

4. The government will have a good chance to have its foreign debts refinanced. In 2014, the country is expected to receive the sixth and final installment of the EurAsEC Anti-Crisis Fund (ACF) loan, the remaining USD1.5 billion portion of the state loan from Russia, some of which was already disbursed, place a new USD700 million issue of foreign exchange bonds in the domestic market and a third issue of Eurobonds (which might amount to USD800 million). Further, the monetary authorities expect an increase in privatization proceeds in foreign exchange, which will produce a positive impact on gold and foreign exchange reserves and state budget revenues.

5. When it comes to the real effective exchange rate of the Belarusian ruble to the basket of currencies (adjusted for inflation in the main trade partners of Belarus), a step devaluation of the national currency seems quite unlikely.

6. Devaluation expectations will probably go down throughout 2014; however, this process will be non-linear. Therefore, along with the above factors, lower devaluation expectations will contribute to the lowering of pressures on the exchange rate of the Belarusian ruble and gold and foreign exchange reserves.