Foreign Exchange Market and Public Finances: Turbulence ahead?

Summary

Massive foreign exchange supply by households, further external borrowing and the settlement of the oil and gas dispute with Russia enabled the government to maintain the stability of the domestic money market and public finances in 2017. Net sales of foreign exchange by households continued despite a certain growth of incomes. A further increase in monetary incomes will lead to a decrease in net foreign exchange supply by households that, coupled with a possible increase in net demand for foreign exchange on the part of enterprises (inter alia, following the abolition of the target purchase of exchange), may result in increased pressure on the exchange rate of the Belarusian ruble and gold and forex reserves. In the public finance sector, fiscal risks are growing amid an increase in restructured liabilities of problem enterprises.

Trends:

• Belarus’ foreign debt grows along with the volume of restructured debts of problem enterprises;
• The main factors of stabilization of the financial and foreign exchange markets (foreign exchange supply by households and export receipts) are not stable;
• The main factor of financial stability (access to international markets) is not limitless.

Households still act as net suppliers of exchange despite growing incomes

In 2017, the domestic money market remained stable thanks to a massive foreign exchange supply by households, further external borrowing and the settlement of the oil and gas dispute with Russia.

In 2017, individuals sold USD 1.759 billion on a net basis1 (including cashless transactions) against USD 1.894 billion in 2016. For comparison, non-residents sold USD 313.9 million on a net basis (452.5 million in 2016), whereas business entities, on the contrary, bought USD 880 million (206.1 million in 2016).

In recent years, unorganized savings of individuals in foreign exchange declined significantly. In 2015-2017, they sold USD 5.662 billion in cash, which was previously ‘stashed at home.’

The decrease in the net supply of foreign exchange by households in 2017 resulted from the growth of the population’s money incomes in real terms and in the USD equivalent. According to Belstat, in 2017, real money incomes (adjusted for the consumer price index with respect to goods and services) increased 2.5% against 2016 to BYN 63.834 billion.2

According to our calculations, money income of the population in dollar terms increased by USD 3.663 billion (12.5%) to 33.018 billion.

The average wage paid to Belarusian workers (excluding micro- and small organizations without departmental affiliation) increased 16.4% year-on-year from USD 362.1 to USD 421.7.

Individual savings with banks denominated in foreign exchange (foreign exchange deposits, precious metals, and foreign currency-denominated bonds) increased by USD 82.2 million (1%) to USD 8.335 billion as of January 1, 2018.

Deposits in Belarusian rubles increased by BYN 1.011 billion (22.4%) to 5.531 billion as of January 1, 2018.

According to our estimates, the population used over 75% of the money income gains in 2017 to purchase goods, services and real estate that also contributed to the dynamics of the domestic money market indices.

Therefore, in spite of the tangible increase in personal incomes in 2017 (by USD 3.663 billion), individuals secured a large net supply of foreign exchange in the amount of USD 1.759 billion.

If the growth of household incomes continues in 2018, we can expect a further decrease in net supply of foreign exchange by individuals. It is possible that net supply will not fully meet net demand for exchange on the part of enterprises, which is fraught with deterioration of the situation in the domestic money market.

In this case, it should be taken into account that the National Bank of Belarus (NBB) lifted restrictions on the target purchase of foreign exchange by legal entities and individual entrepreneurs since April 10, 2018. As a result, there can be a certain increase in net demand for exchange from Belarusian enterprises with negative consequences in the form of accelerated depreciation of the Belarusian ruble vis-à-vis the main foreign currencies and increased capital outflows from Belarus.

Drivers for currency proceeds growth

According to the National Bank of Belarus, currency proceeds generated by commodity and service exports, incomes and transfers of nonfinancial companies and households in 2017 increased by USD 6,552 billion (22.1%) to USD 36.175 billion

The increase in foreign exchange proceeds resulted from boosted exports of Belarusian oil products, agricultural products and foods, trucks, bitumen mixtures, potash fertilizers, liquefied gas, crude oil, etc. facilitated by the settlement of the oil and gas dispute between Belarus and Russia in April 2017 in combination with an improved foreign market environment.

All this contributed to an increase in foreign exchange proceeds. According to the Ministry of Finance of Belarus, extra revenues from export customs duties on potash fertilizers in 2017 amounted to BYN 711 million,3 oil and oil products 440 million, import customs duties 200 million and other non-repayable receipts 919 million.

Last year, Russia transferred export duties on crude oil to the Belarusian budget under oil and gas agreements that explains the significant increase in other non-repayable receipts.

With account of the distribution of import customs duties between the Eurasian Economic Union member states, in 2017, Russia transferred a total of USD 1,188 billion against USD 597.3 million in 2016.

According to the National Bank, the proportion of the Russian ruble in foreign currency proceeds of nonfinancial businesses and households (foreign exchange earnings related to the movement of goods, services, revenues and transfers) fell from 40.1% in 2016 to 38.4% in 2017. Russia paid for 85.8% of Belarusian goods in Russian rubles.

The proportion of the Russian ruble in payments for imported goods and services, incomes and transfers of nonfinancial businesses and households increased from 46.7% in 2016 to 47.7% in 2017. In 2017, Belarus paid for 80.3% of goods imported from Russia in Russian rubles.

The proportion of national currencies in payments by nonfinancial businesses and households of Belarus to Russian residents (81.1%) is slightly lower than in Russia’s payments to Belarusian legal entities and individuals (86.6%).

In 2018, we can expect a slowed down growth of foreign exchange proceeds and exports of Belarusian goods and services (including due to obstacles to Belarusian agricultural products and foods in Russia).

Foreign debt is growing

In 2017, the government of Belarus raised USD 4.041 billion in foreign government loans and paid off USD 1.029 billion.

As of January 1, 2018, the average interest rate on foreign government loans was at 4.7% per annum. The average remaining maturity of the principal debt is 5.3 years.

As of January 1, 2018, 40.7% of Belarus’ borrowings were channeled into investment projects. Other targets accounted for 59.3% of the accumulated foreign debt.

Russia, China and the World Bank were the main creditors of investment projects in Belarus.

The construction of the Belarusian nuclear power plant is financed from a Russian government’s credit line (USD 10 billion) and Russian Vnesheconombank (USD 500 million). As of January 1, 2018, Belarus spent USD 2.7 billion on the NPP construction from the Russian government’s credit line and USD 292 million from Vnesheconombank’s loan.

As of January 1, 2018, Chinese banks opened a credit line to the government of Belarus for a total of USD 4.6 billion.

Some of the investment projects funded from foreign loans turned out to be inefficient and could jeopardize the sustainability of public finances and the foreign exchange market in the medium term.

For instance, the net loss of two cement producers (Krasnoselskstroymaterialy and the Belarusian Cement Plant, the upgrade of which involved Chinese loans in 2017) totaled nearly USD 80.7 million. The government has to seek additional foreign exchange to service and repay loans granted by the Export-Import Bank of China, although the cement plants fail to pay to the state.

In case of a further increase in the volume of restructured liabilities of distressed enterprises, the government may have to borrow much more to repay and service the previously accumulated external debt.

However, the government cannot borrow endlessly. It has even set a foreign debt ceiling for 2018 at USD 19.6 billion and domestic debt at BYN 10 billion (equivalent to around USD 5.1 billion). The public debt management strategy sets the national debt limit (excluding government guarantees) at 45% of GDP against the actual 39.3% as of January 1, 2018.

If the access to international money markets gets more complicated, the government of Belarus, being on a tight schedule of national debt payments, will have to spend gold and foreign exchange reserves more actively and take unpopular measures, such as public spending cuts.

According to the Ministry of Finance, based on interest rates and exchange rates as of January 1, 2018, the schedule of payments on the public debt of Belarus is as follows (principal debt and interests): USD 3.552 billion in 2018; 3.602 billion in 2019; 3.776 billion in 2020; 3.540 billion in 2021; 3.604 billion in 2022; 4 billion in 2023; 2.587 billion in 2024, and 2.361 billion in 2025.

The foreign debt repayment schedule is as follows (principal debt and interests): 2.886 billion in 2018; 2.382 billion in 2019; 2.443 billion in 2020; 3.134 billion in 2021; 2.984 billion in 2022; 3.578 billion in 2023; 2.371 billion in 2024, and 2.215 billion in 2025.

It should be noted that in addition to external and domestic borrowing, the government of Belarus secures external and internal liabilities of enterprises that may also threaten the stability of public finances. As of January 1, 2018, government guarantees on external and internal liabilities of enterprises totaled USD 3.932 billion in equivalent, or nearly 7.2% of GDP.

In 2012-2017, the government of Belarus had to pay foreign and domestic creditors around USD 1.517 billion as guarantees instead of the enterprises-borrowers.

Finally, in order to reduce fiscal risks, the government has lowered the limit of guarantees on foreign debt liabilities of enterprises from USD 3.4 billion in 2017 to USD 3 billion in 2018. The ceiling of state guarantees on internal liabilities of enterprises was set at BYN 3.1 billion in 2018 against BYN 3.8 billion in 2017.

Conclusion

The year 2018 is likely to see a decrease in net supply of foreign exchange by households that, coupled with an increase in enterprises’ net demand for foreign exchange, may lead to a depreciation of the Belarusian ruble against major foreign currencies.

With regard to certain types of agricultural products and foods in 2018, exports to Russia may decrease, negatively affecting the dynamics of foreign exchange proceeds.

Higher fiscal risks actualize issues related to restructuring, privatization (including that involving foreign investors) and bankruptcy and/or liquidation of some state-owned enterprises.