Despite facing crisis conditions in 2011, the Belarusian economy has proven to be remarkably robust, boasting plenty of untapped potential, and there are hopes that its privatisation process will lessen the dominance of large state-owned companies on the country's business landscape.

Sandwiched between the EU to the west and Russia to the east, and boasting an inexpensive and highly skilled workforce, numerous opportunities for privatisation, as well as lower debt levels than many Western countries, the Belarusian economy has much in the way of untapped potential. And operating in the country does not require dealing with stifling bureaucracy – Belarus ranked 69th globally in the World Bank’s Doing Business ranking for 2012 – which provides an indication of the ease with which an entrepreneur could open and run a small to medium-sized enterprise – placing it below Kazakhstan in 47th and Georgia in 16th, but above the average of 77th for eastern Europe and central Asia, and considerably higher than Russia in 122nd.

In July, Standard & Poor's also upgraded Belarus’s short-term foreign and local currency sovereign credit rating from 'C' to 'B'. This was a result of a revision in criteria concerning links between long and short-term sovereign credit ratings rather than an improvement in Belarus’ creditworthiness in the short term. However, the ratings agency also affirmed its 'B-' rating on long-term foreign and local currency sovereign credit ratings on Belarus and, perhaps most importantly, a 'stable' outlook.

An economy in crisis

This last point is particularly crucial given that, just 12 months ago, the country was in the midst of balance-of-payments crisis which Siarhey Pisaryk, chairperson of Belarusbank, the country’s largest state-owned institution, says made 2011 the country’s most difficult since it declared independence in 1991 following the dissolution of the Soviet Union. “We faced major currency devaluation, inflation, and significant deterioration of living standards,” he says. “In 24 months, we went through changes so significant that they would account for 10 years in Europe.”

The causes of the crisis were multifarious. Foremost, however, says Alexander Pivovarsky, the European Bank for Reconstruction and Development’s lead economist on Belarus, were unsustainable increases in state spending. The Belarusian government retains tight control over the economy, and as much as 70% of enterprise in the country is still state owned. In the run up to the 2010 election, president Alexander Lukashenko, who has been in power since 1994, boosted public sector salaries by 50%, while significantly expanding state-sponsored lending and construction programmes. This helped push the current account balance from a surplus of 1.4% of gross domestic product (GDP) in 2005 to a deficit of 10.6% in 2011, according to World Bank figures.

In order to maintain Belarus’s fixed exchange rate, Dmitry Murin, a deputy head of directorate and head of monetary policy with the National Bank of the Republic of Belarus (NBRB), says it was necessary to shore up the Belarusian ruble by deploying the country’s foreign exchange reserves.

This strategy worked initially, and value relative to the US dollar remained reasonably static for the first four months of the year at 3048:1 in April, from 3011:1 in January. By this point, however, the national bank had exhausted $1.2bn of its currency reserves – 25% of the total – and a black market foreign exchange market had emerged. Ultimately, NBRB was forced to withdraw from interventions in the currency market and allow the ruble to depreciate further. “We could not let this situation [the use of reserves] happen again, so [we] began devaluation and tightening fiscal and economic policy as a whole,” says Mr Murin. The result was a fall in value of almost 70% over the year relative to the dollar, with the official rate reaching 4976:1 in June, and dropping as far as 8701:1 in November following the unification of divergent official and black market exchange rates the previous month.

Amid this devaluation, Belarusians began to withdraw their savings from the country’s banks – queuing for days and sometimes weeks to convert them into dollars and euros. When supplies of foreign currency were exhausted, some even invested in domestic appliances such as refrigerators and televisions.

Meanwhile, government lending programmes were suspended, average salaries fell, the refinancing rate reached 45%, up from 10.5% in late 2010, while inflation climbed as high as 108.7% at one point. At the same time, the NBRB raised interest rates from 10.5% to 45% throughout the year, as a liquidity shortage gripped the economy.

The government response to this crisis had the desired effect, however, and ultimately the Belarusian economy has proven to be remarkably resilient. Tightened monetary and fiscal policies balanced the 2011 budget, finishing the year with a surplus, according to the World Bank, while the ruble was eventually stabilised. In another encouraging sign, the foreign trade deficit shrank by 80% in 2011 and turned in a surplus for the first time in several years, as a devalued currency boosted exports by almost one-third and Belarusians bought fewer foreign goods. Ultimately, the end-of-year growth rate amounted to 5.3%, according NBRB figures.

Crucially, help came too from outside. In May, a deal was reached with the Russian authorities which included $3bn distributed through the Eurasian Development Bank’s anti-crisis fund, as well as generous discounts on gas imports, which represent a subsidy of $2bn to $3bn annually, according to figures from Priorbank, the Belarusian subsidiary of Austria's Raiffeisen Bank.

A new year

So far this year, the Belarusian exchange rate has remained steady, at about 8000 rubles to the dollar, helping bring down inflation growth to less than 2% per month, which could lead to a total 22% growth rate for the year, according Mr Murin.

As a result, money is returning to the banking system. According to the NBRB, this has amounted to Rbs4500bn ($540m) and $900m-worth of foreign currency in the first half of 2012.

State forecasts for future growth are also positive. “We plan on 5.5% GDP growth by the end of the year, and to contain inflation,” says Vladimir Amarin, Belarus's first deputy finance minister. “We also plan to balance the budget and develop a surplus… The fiscal situation should be stable for a number of years.”

A spokesperson for Priorbank, however, forecasts baseline GDP growth of 3% to 4% for the 2012-13 period, and adds that inflation is expected to run at over 20% in 2012 and remain in double digits for some years to come. “Success in fighting inflation will ultimately depend on the willingness of the government to implement the necessary monetary and fiscal measures to keep money supply under control, such as positive real interest rates, budget restraint, caps on administrative lending and moderate real wage growth.” It is a point which Mr Amarin says the government is aware of, and he describes the 2013 budget, which was being finalised at the time of writing, as “balanced and tough”.

Risk worries

Nevertheless, a number of risks, both internal and external, continue to dog the country. In common with much of the rest of the world, the potential ramifications of the eurozone crisis and any knock-on effects of the second round of global financial woes is a concern. A decline in the Russian economy is a particular worry, as a decreased appetite for Belarusian products would inevitably result, while subsidies and financial support could be cut.

However, not all macroeconomic risks stem from external sources. The Priorbank spokesperson suggests that state-planned economic policies, such as the redistribution of income through price controls and administrative lending, extensive support of state enterprises, growth targets and the government’s full employment policy, could also prove hazardous. “Another risk to our baseline scenario could materialise if the Belarusian authorities return to old practices of stimulating domestic demand (through public wage increase and cheap lending to the economy) and push too strongly for growth,” he said.

Another potential cause for concern could stem from the dominant role of state-controlled enterprise – a legacy of Belarus’s history as a constituent part of the Soviet Union. “Belarus will need to reform [the state-owned companies] in order to boost productivity,” says Mr Pivovarsky. “We hear from various private sector companies that when they begin operations and need staff they find it difficult to find people, because workers cling to state enterprise jobs, making it difficult to improve productivity in the economy.” He adds that this is caused by the lack of a social safety net for the out of work, meaning a private enterprise role is perceived as more risky. “It’s still a Soviet-style system, where nobody is really expected to be unemployed so there’s no provision for unemployment protection,” he says.

Investment and privatisation

However, Mr Murin says that in an effort to ensure the inflow of foreign capital, efforts are being directed towards creating conditions that are appealing to international investors, as well as levelling the differences in operational constraints between state and privately operated firms. “We are looking to create conditions that will attract foreign investment, and working to create equal conditions between state and private companies, because currently there is no equality,” he says.

Regardless, the leading position of state-owned enterprise in Belarusian society looks likely to be steadily eroded thanks to an ongoing process of privatisation. However, criticism has been levelled at Belarusian authorities for perceived slow progress. Mr Pisaryk says that this has been for good reason, however. “It may seem that the privatisation process is slow because the state does not want to privatise for the sake of privatisation, it wants to hand over to a strategic investor.” He adds that many bids are directed at successful companies which may not need to be privatised, and that offers are frequently below market value.

The ideal model, says Dmitry Klevzhits, head of investment department with the Ministry of Economy, is finding an international buyer to update the operations of local companies. “Our main goal is to attract strategic investors who will modernise Belarusian companies.”

But not all state firms feel the need for help in modernising. Igar Yemelyanovich, technical director with Belarus Tractors, which produces goods worth $1.7bn every year, says the firm, which once suffered from a less-than-stellar reputation for reliability and manufacturing quality, is now well positioned to compete on an even playing field with its international peers. “We have a combination of high production and advanced marketing which allows us to compete with any of our competitors across the world,” he says. And the firm is keen to seek global partners, he adds. “We are ready to work with investors and want to emphasise our openness to visitors and ability to engage with customers and potential customers internationally.”

For Mr Yemelyanovich and many others, Western investment is a particular goal, especially given the dominance of Russian capital in the Belarusian economy. From across the eastern border, various firms have been as heavily involved in snapping up Belarusian firms as they have in procuring its exports. “We have to trade, and we trade with Russia… [Russians] understand the market very well,” says Andrei Dzhumkov, director of international operations with state-owned Belinvestbank. “They have money and a lot of it, and they’re ready to buy Belarusian business completely.”

But an overreliance on Russian capital is a potential risk that the Belarusian authorities are mindful of. “We are well aware of the risks in being highly dependent on the Russian economy,” says Mr Murin. “We are looking to diversify exports and increase the share which goes to countries other than the Russian Federation.”

Increasing isolation

Attracting funds from the West however, may not prove easy given that Belarusian political policy has caused increased isolation from its European neighbours of late. Criticism over the government’s human rights record – including allegations of suppression of opposition groups and vote rigging – has resulted in numerous diplomatic fallouts. In August, for example, the Swedish ambassador was expelled from the country, and the diplomatic status of other embassy staff was cancelled in retaliation for liaising with opposition groups and supplying books on human rights to a university. Earlier in the year, Polish and EU ambassadors were also evicted after a spat over an EU decision to extend sanctions on a list of Belarusian officials and political figures accused of human rights abuses.

Meanwhile, the EBRD continues to follow what it describes as a “calibrated” approach in Belarus, a stance also used in its operations within single-party Turkmenistan. Mr Pivovarsky describes it as a “more for more” philosophy, whereby involvement with state-backed projects is limited and more support is only given by the bank in exchange for movement towards a more democratic system. In a recent policy statement, the EBRD said: “Due to the negative political developments surrounding the December 2010 presidential election and the international community’s continuing concerns regarding treatment of the political opposition, civil society and independent media in Belarus, the EBRD’s board of directors has decided to 'recalibrate' the bank’s operational approach to Belarus within its existing strategy… As a result, it will now only engage in projects which develop the private sector, improve environmental standards, or improve living conditions for the Belarusian populous.”

There is a feeling among Belarusian enterprise however, that the country has been unfairly singled out for criticism by bodies such as the EU and EBRD, as well as Western media, and suffered financially as a result. “Due to political games there is not much understanding from foreign investors that Belarus is a good place to do business,” says Mr Dzhumkov. “People are afraid to invest because of political risk. This is not a valid concern, however.”

Certainly, in Belarus more than most countries, the political climate complicates matters significantly. But according to the EBRD, Standard & Poor's and others, some level of reform will be necessary for future growth. A World Bank country snapshot published earlier this year concluded that while the Belarusian economy faced “formidable challenges” in reallocating labour and capital to more productive areas of the economy, restructuring state-owned enterprise and supporting the private sector, the economic results could be well worth it. “By successfully overcoming these challenges, Belarus will revive competitive segments of the economy and discover untapped opportunities for growth,” the report said. Doing so will be a politically charged process, says Mr Pivovasky, leaving the country with something of a philosophical quandary in precisely how to achieve its sizeable economic potential while reconciling the required restructuring process with current constitutional norms.

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