Macroeconomic Situation: Bad, but Could be Much Worse

Dzmitry Kruk

Summary

In 2022, the Belarusian economy was significantly impacted by the dual forces of war and sanctions, leading to a deep recession characterized by spiraling inflation and moments of financial instability. Yet, certain compensatory measures and economic strategies helped cushion these shocks, resulting in a macroeconomic outcome that, though bleak, was more favorable than anticipated. Unfortunately, the policies (or lack thereof) adopted by the authorities exacerbated the erosion of both economic and human potential. Consequently, the Belarusian economy has become alarmingly reliant on Russia, casting a shadow of uncertainty over its future trajectory.

Trends:

The Quiet Before the Storm and a potential hurricane

Before the Russian invasion of Ukraine, most economic projections hinted at a modest recession of around 2%, spurred by the fading impact of foreign trade successes and the imminent enforcement of sanctions imposed in mid-2021. Although Lithuania began restricting the transit of Belarusian potash fertilizers in February 2022, these fertilizers constituted only about 3.0-3.5% of Belarus' gross value added. Hence, large-scale, immediate alterations in the national economy weren't anticipated.

However, the landscape changed drastically following the regime’s involvement in the Russian aggression against Ukraine, followed by sweeping sanctions. The nation's economy grappled with a sharp double-digit decline in output, significant depreciation of its national currency, a surge in inflation, and comprehensive financial upheaval. The multifaceted sanctions and escalating reputational risks (of doing business with Belarus as a country, as well as with Belarusian companies) led to profound transformations within its economic fabric.

For 2022, pressing economic queries revolved around the depth and duration of the recession, and whether Belarus could avert a comprehensive financial crisis. For long-term concerns include the extent of human capital erosion and the potential loss of current economic capabilities.

Regrettably, the priorities of the Belarusian authorities remained tethered to short-term challenges, often sidelining or overlooking long-term risks.

Sanctions Storm: from Swift Collapse to Gradual Erosion

In response to Belarus' involvement in Russian aggression, Western nations introduced a series of sanctions that encompassed:

The direct implications of these sanctions were magnified as numerous developed countries began distancing themselves from Belarusian businesses. Driven by reputational concerns and apprehensions about potential subsequent sanctions, this shift impacted Belarusian companies (and their products or operations) not previously sanctioned. Echoing this sentiment, several Belarusian enterprises and skilled professionals commenced their exodus from the country. Adding to these challenges was the significant erosion of the Ukrainian market, previously absorbing about 10% of Belarusian exports.

In the face of such compounded shocks, the bleakest projection for the Belarusian economy hinted at a swift decline in output and wealth by roughly 20% within three to five quarters, regressing to 2007-2008 levels. This scenario also entailed considerable financial turbulence and price volatility. Indeed, the months following the war's onset and the imposition of sanctions (March to April) saw the economy teetering close to this trajectory. However, subsequent interventions by the authorities managed to cushion these initial shocks and alleviate their aftermath.

Warm Compensating Breeze: Adjusting to a New Landscape

While prevailing sentiment points to an increasingly challenging environment for the Belarusian economy in light of the war and sanctions, several positive disturbances have also emerged.

Enhanced Price Competitiveness in Russia: Throughout 2022, Belarusian producers witnessed a significant rise in their price competitiveness in the crucial Russian market: by 10%1 per year, by 20% in July-August. The fluctuation of the Russian ruble, initially depreciating due to the invasion of Ukraine, and subsequently strengthening with the spike in oil and gas revenues, played a central role. This presented Belarus with favorable conditions for exchange rate formation and bolstered their trade prospects. The Belarusian authorities could have facilitated the depreciation of the Belarusian ruble (BYN) in relation to the Russian ruble (RUB), thereby enhancing price competitiveness in the Russian market. This would not have introduced further threats to domestic financial stability, especially considering that the USD/BYN exchange rate remained close to its pre-war level during this period.

This effect was most pronounced during the summer months but started to wane in the latter half of the year. Nevertheless, by the end of the year, the price competitiveness remained high relative to historical standards. Throughout the year, this factor played a significant role in bolstering exports to Russia.

Reclamation and Augmentation of Oil Rents from Russia: Belarus not only re-established its oil rents from Russia but amplified their scale. As a result of anti-Russian sanctions, the difference between the Russian oil grade Urals and the international Brent expanded, allowing Belarus to procure oil at prices 30% lower than global prices.2 Just a year prior, this differential was a mere 13%. Based on the initial trajectory of the Russian tax maneuver, the discount was projected to decrease to 5% by 2023. Consequently, Belarus reaped substantial benefits, ranging anywhere from $0.8 to $2.3 billion, equivalent to 1.2% to 3.1% of its GDP.

The oil price discount became the primary driver for rejuvenating the capacity for oil processing and the export of oil products. By the year’s end, this capacity had recovered to about 90% of pre-war levels, and for the entire year, it stood at 63%. Though direct data on who the final buyer of Belarusian oil products remains obscure due to sanctions, a significant portion of the oil products might be sold in the Russian market.

The rejuvenation of oil refining became a chief contributor to alleviating the economic downturn induced by the sanctions. Even though the direct contribution to the GDP was modest (around 1%), when considering the inter-industry repercussions, the sector contributes approximately 11% to Belarus' GDP. By mitigating the initial blow to the export of petroleum products, the authorities successfully staved off substantial losses tied to this shock.

Advantageous Terms of Trade: 2022 saw Belarus experience its most favorable import-export ratios in eight years, approaching historic peaks between 2012 and 2014. This shift was attributed to the global inflation surge and the resultant hike in worldwide prices for many traded commodities. Concurrently, Belarus implemented strategies to curb the rise in import prices by: (1) stabilizing gas prices and maintaining low oil prices, and (2) curtailing investments, particularly by opting out of purchasing high-end investment goods.

The enhancement in macro-level terms of trade played a pivotal role in staving off financial destabilization. Despite a tangible decline in physical output for numerous enterprises, the monetary value of revenues witnessed a more modest downturn and even registered an uptick in certain instances.

Exploiting Vacant Niches in the Russian Market: As numerous Western companies retreated from the Russian market, certain Belarusian manufacturers seized the opportunity to fill these voids.

Adaptation in Business Operations: Both state-run and private businesses showcased commendable agility in adapting to the novel landscape. This adaptation often took the form of establishing new supply chains or locating alternate trading partners. Some entities even found avenues to navigate around the sanctions.

Each of these effects played a role in cushioning the initial economic shock and diminishing its detrimental impact on production.

Helmsman at the Helm: (Un)conventional Measures

Beyond the compensatory effects, which largely arose serendipitously, the Belarusian authorities took active measures to mitigate the impact of various economic shocks.

Ensuring Low Gas Prices

In 2022, this conventional instrument for Belarus’ budget gained new significance. Amid the backdrop of war and Russia's deliberate push to hike energy prices, gas prices in Europe soared to record heights, peaking at about €3,000 per 1000m3 (compared to an average of roughly €200 per 1000m3 over the previous decade). By securing an agreement with Russia at the start of the year to maintain the 2021 gas price for Belarus (approximately $128 per 1000m3), the Belarusian administration effectively locked in an average annual rate that was about 10% of European spot quotes.

Given the actual volume of gas imports, the monetary advantage of this gas price discount was substantial: $18.3 billion, or 25% of the country’s GDP. However, if Belarus had to purchase gas without this discount, its acquisition volume would likely plummet. The heightened price would render many industrial sectors unprofitable and make utility payments unaffordable for a significant portion of the populace. As such, this calculation serves more as an illustrative benchmark, and the derived figures shouldn't be seen as a direct reflection of production dynamics or overall prosperity.

Reducing the Public Debt Burden

The savings achieved on external debt payments can be considered a unique innovation. This was primarily due to a sovereign debt restructuring agreement with Russia, which postponed payments amounting to $1.4 billion, originally due from March 2022 to April 2023, to 2028-2033. However, a deliberate default also played a role in the savings. Following a series of regulations which declared that, in the face of sanctions, public debt payments would primarily be made in Belarusian rubles, coupled with instances where dues were not settled, rating agencies Fitch and Standard & Poor’s downgraded Belarus' rating to the default level.

From the perspective of international lenders and the conventions of international financial markets, the default rating assigned by two out of the three major rating agencies is enough to confirm a default. Yet domestically, this did not trigger a financial crisis, as the government's obligations continued to be met and regarded as priority. The situation is unprecedented, and from an economic standpoint, the default is somewhat ambiguous.

Based on the initial payment schedule for 2022, Belarus was obligated to settle about $2.5 billion of external debt. According to official statistics, $1.6 billion was disbursed. The savings of $0.9 billion likely reflect the 2022 agreement with Russia. Moreover, due to the deliberate default, the actual foreign currency strain of servicing the public debt may be even lower than the statistics suggest. The authorities set aside funds for state debt payments in Belarusian rubles within state-owned banks, preserving foreign exchange assets in reserves. As a result, in addition to conserving foreign currency, these funds created an additional liquidity buffer for banks.

Besides the savings on payments, Belarus managed to procure substantial new public debt. Even though the authorities closed the specific data on public debt to the public in 2022, available statistics indicate that in 2022 new government borrowings totaled $1.56 billion, even though the authorities did not disclose detailed information. These new loans likely originated from Russia under the so-called import substitution program valued at 105 billion rubles (approximately $1.7 billion based on the exchange rate at the time of the announcement).

Signing of a Tax Agreement with Russia

The Agreement “on Common Principles of Indirect Taxation” entails Belarus adopting Russian tax administration rules and practices, which includes integrating Belarus into the Russian system with the relevant software. In exchange, Belarus will be granted inter-budgetary transfers, framed as compensation for the impacts of the Russian tax reform. Given the current oil price levels, the yearly volume of these inter-budget transfers is estimated to be around $0.5-0.7 billion.

In return for this compensation, Belarus has, in effect, relinquished a significant portion of its tax sovereignty. Although the main short-term benefits of this skewed exchange are slated for 2023, Belarusian refineries were essentially subsidized by the Russian budget as early as the fall of 2022 and through schemes involving Russian intermediaries.3 This played a role in the resurgence of oil refining in the latter half of 2022.

Policy Interventions

The authorities reverted to their extensive history of hands-on regulation, which can provide some stabilization in the short term. This encompasses manual oversight of supply and logistics chains, direct price control, mandates on production, employment and wages, directed lending, and recapitalization of state-owned banks.

These measures have broadened the leeway in both monetary and fiscal policy. Beginning in mid-2022, monetary conditions were deliberately eased, encompassing both reductions in interest rates and policy tools designed to promote lending and create positive monetary momentum. However, much of this momentum was stifled by banks. Facing high risks and prevailing uncertainties, they adopted a more conservative stance, favoring the preservation of liquidity surpluses over taking on hard-to-evaluate risks in a wartime and sanctioned environment. The excessive monetary stimulus, when combined with price shocks from sanctions, logistical challenges, and heightened global inflation, amplified inflationary pressures. By mid-year, inflation hovered around 20%, but subsequent factors like the appreciation of BYN against the USD, subdued consumer and investment demand, domestic low energy costs, and politically influenced consumer price regulations started to counteract its growth. On an annual scale, inflation decelerated, but it remained in the double digits.

Double Macroeconomic Results for the Year

With a decline of 4.7%, 2022 marked the deepest recession for Belarus in the past 28 years. The country's output level regressed to that of 2017. Inflation peaked at its highest in eight years, with a cumulative annual inflation of 12.8% and an average annual rate of 15.2%.

However, given the conditions of war and sanctions, Belarus could have spiraled into a full-blown financial crisis, potentially losing up to 20% in output and revenue. From this perspective, the worst-case scenario was avoided, making the actual losses seem moderate in comparison.

There are even glimpses of optimism. Both the average real wages and the real incomes of the population contracted significantly less than the output, declining by 1.8% and 3.6% respectively. By year's end, real wages began to rebound, almost reaching their pre-war levels.

Considering both perspectives, the economic outcomes of 2022 can be summed up as: "bad, but it could have been much worse." This, however, does not mean that the year was good.

Russian Anchor and a Bomb in the Cargo Hold

A significant long-term outcome of the year was Belarus' evolution from being highly dependent on Russia to being wholly reliant on it. In foreign trade, Russia's share surged from 50% in previous years (about 40% in exports and 55-60% in imports) to 60% (approximately 60% in both exports and imports).

The energy and credit dependence of Belarus on Russia intensified. The special conditions for energy supply became crucial for the functioning of the Belarusian economy. Regarding debt, Russia is not just Belarus' primary creditor and the lender of last resort but, essentially, its only accessible creditor.

More significantly, new areas of dependence emerged: fiscal, logistical, and infrastructural. Inter-budget transfers from Russia, facilitated by the agreement "On General Principles of Indirect Taxation", are expected to account for about 10% of the Republican budget revenues. This creates a significant Russian influence on the Belarusian fiscal domain: any disruption in fund transfers can destabilize the entire public finance system.

Exports outside of Russia also hinge on the Russian logistical infrastructure, including seaports and railways. Furthermore, Russia can exert substantial influence through Belarus' infrastructural dependence on its software for critical areas like tax administration, banking settlements, and other transactions.

By the end of 2022, Russia possessed a comprehensive set of tools to influence the Belarusian economy's current state. If Moscow desires, it has the capability to thrust the Belarusian economy into chaos.

Conclusion

2022 proved to be a tumultuous year for the Belarusian economy. In sheer numbers, it underwent a swift and profound recession, paired with soaring inflation and pockets of financial instability. Yet, the depth and severity of the economic downturn were notably less than initially anticipated. This was because the shifts in the external landscape brought not only adversities but also stabilizing influences. Furthermore, the economic authorities' (un)conventional strategies played a part in mitigating the crisis.

However, in terms of qualitative characteristics and prospects, the picture is more somber. Belarus is continually battered by external shocks that systematically erode its economic foundation. The government's short-term interventions have only exacerbated the decay of the national economy, driving the nation into complete reliance on Russia. Given these circumstances, Belarus' economic trajectory is now largely influenced by Russia and the health of its economy.