Belarusian Economy on a Diet to Change its Financial Outlook

emerging europe belarus outlook ebrd

Read the Outlook on Belarus special report

The Financial Diet
Selected quotes

By accumulating the issue inflation and foreign loans, the state capitalism of Belarus fell into the trap of deficit of the economy's financing.

[Since] the main source of this deficit is public finance, one of the ways out of this trap is openness of the economy to foreign investment and stimulation of the private investment.

The problems that emerged in Russia and Ukraine in 2014-2015 reduced export opportunities of Belarus. It encourages logical movement towards other markets, but there Belarusian exports are less competitive.

[The way out of the trap for Belarus] in attracting foreign direct investment for export-oriented enterprises, working for highly competitive and high-tech markets.

It is important to recognise that productivity at the Belarusian state-owned enterprises is lower than that of their private and foreign competitors.

The difference in productivity is due not to technological difference, that are similar to those of the state enterprises' competitors after the necessary upgrades, but the differences is in the management systems, for example, "manual" versus "corporate".

The state, given the limited budgetary resources, is torn between meeting the growing social needs of the population and addressing the economic issues. As a result, the government usually chooses the financing of the social sphere and gets stuck in low rates of economic growth.

Administrative resources in Belarusian state-owned enterprises are aimed at compliance with procedures and regulations, the implementation of assignments and tasks brought sometimes at the expense of profits, which distorts incentives and binds initiative, hinders productivity growth.

The post-Soviet structure of the Belarusian economy with a high share of the raw potash and petrochemical sectors, as well as a close relationship with Russia's commodity-dependent economies, creates the preconditions for the trap of the "resources' curse.”

The state capitalism traps of Belarus discussed above together represent a danger of both the medium-term economic slowdown and falling into the trap of"long-term stagnation" -- the long-term slowdown and underdevelopment.

According to our estimates, which we made at the end of 2015, the long-term trend growth rate of GDP in Belarus is below zero. This means that with no changes in the internal and external environment, there are no conditions for the growth of the Belarusian economy.
source: Charter 97

The Belarusian economy has not had the best time for the past two years, with a recession and a massive depreciation of the rouble.

Kiryl Rudy is President Alexander Lukashenko’s former economic adviser and the co-author of The Financial Diet, a book about reforming the system of public finances and rational spending of budget money. He spoke to Andrew Wrobel about the challenges that the Belarusian economy is facing now.

In your book, The Financial Diet, you speak about state capitalism. How would you define that?

One of the features of the Republic of Belarus is an unstable market economy in the early stages of its development. There is a variety of economic relationships that are constantly in flux, coupled with complexity and unpredictability. The market elements clash with state planning and “hands-on” management.

On the one hand, the country features state ownership of large swaths of property, with administrative or hands-on control over state-owned enterprises, with directed lending, consolidated budgetary resource and far-reaching social security. On the other hand, it has many aspects of a market economy: entrepreneurs, small and medium businesses, private and foreign businesses, a liberal banking sector, a free-floating exchange rate, market prices, elements of a public-private partnership and a functioning Hi-Tech Park.

Kiryl Rudy, Economic Advisor to President Alexander Lukashenko
Kiryl Rudy, Economic Advisor to President Alexander Lukashenko

The special nature of the Belarusian economy is sometimes reminiscent of other countries: modern Russia in the face of sanctions, other post-Soviet countries and China at a certain point in its development. The resemblance is particularly clear when we talk about the active role played by the government in the market economy, something generally referred to as state capitalism. State capitalism is understood as an economy in which the state plays the main role as entrepreneur, employer, the owner of the means of production and the allocator of profits.

So when it comes to the characteristics of the economic model, in Belarus in particular, what are they?

First of all, Belarus evolved under the influence of many factors: objective, subjective, internal, and external. In Belarus in particular these include: the country’s Soviet heritage, the crisis of an economy in transition, the social support for a socialist government during the instability of the 1990s in neighbouring countries and financial influxes from outside the country.

We also need to add that state capitalism in Belarus is a model of a transition economy. It differs from Central and Eastern European shock therapy, as well as from the Chinese version of gradualism without focused structural reforms or at least without declaring them. At the same time, the structure of the Belarusian economy has changed naturally: the services and the private sectors have grown, under the influence of both regional and global processes that were unrelated to management decisions being made with transformation in mind. Ultimately, the structural change in Belarus has been subtle and it has not contradicted the country’s ideology which has managed to remain attached to state capitalism.

Because that change is subtle, can Belarusians handle the changes?

Yes, state capitalism in Belarus can only function with public support at its back. That support is based on a number of factors, the first being social equality and income growth that stopped in 2015. Periodic macroeconomic shocks and inflation have been caused by expanding the money supply and these have held back the formation of a strong middle class, demanding institutional change. The second factor is the social security provided by jobs at state-owned enterprises. The third is the economy’s socialist leanings, which have led to high tax burden and have consolidated budgetary resources.

Public capital in Belarus has been accumulated primarily through the use of market tools such as banks with foreign capital and private businesses. At the same time, state capitalism in Belarus leans on less market-based tools such as state-owned enterprises, especially in the primary sector, as well as state banks, the Development Bank, and the National Development Fund. The general mechanism for managing those instruments is administrative; it is an approach, especially for state organisations, that includes setting goals, directing credit, budget support and using the government’s administrative resources. This has been sufficient to provide short-term momentum, although over the long term it has supplanted initiative and inflated operational expenses.

So what are the advantages and drawbacks of the model?

Well, state capitalism might well be appropriate when it comes to handling short-term issues. However the assumption risks being made that it also works well over the long term and that is precisely why the current economic structure has remained in place. However, the push to hang on to the current model is limiting its flexibility and it focuses exclusively on handing out, and following up on, orders and on inflating the influence enjoyed by control and law enforcement over the economy.

The path to investment growth for state capitalism in Belarus has its pitfalls: the inflationary pressure, and the debt overhang that has accumulated, limit the government’s ability to rebuild its capital and to finance the economy, in general. Conflicts between neighbouring countries eat away at international trade. High social expenditures and relatively high income levels squeeze the budget and the national economy’s competitiveness. The way in which the economy is restructuring, naturally, means changes are needed in the management system and moving away from a focus on raw materials impacts currency reserves and the budget. That kind of environment slows even naturally occurring economic transformation; it reins-in growth and drops the country farther behind others who have more adaptive economic structures.

Does a financial diet seem to be a solution here?

Speaking pragmatically, the best way to overcome the pitfalls to and to bring back economic growth is to increase capital efficiency. That path is called the financial diet. It includes the optimal distribution of public financial resources, in an effort to achieve macroeconomic stability, by accumulating foreign reserves and targeting the exchange rate. It means long-term financial equilibrium (decreasing the fiscal gap) and a results-oriented focus for public financial services. It will lead to financial independence for state-owned enterprises. It even touches on the state, as well as local budgeting, strategic planning, tax services and improving state control. Bringing in professionals is a key element.

The financial diet is a way to point out what works well in state capitalism. It is not austerity, as state capitalism in Belarus cannot exist without capital. However, budgetary resources do have to be limited, in order to avoid constant depreciation, inflation and the need for more public debt. The external environment, in which the country finds itself, threatens long-term stagnation which underlines the importance of legal order and of both fiscal and monetary discipline. Unfortunately, that is not enough. Therefore, the financial diet, which is just the beginning, also includes a variety of sources Belarus can use, to replenish its capital via private and foreign investment.

I have been following the development of the Belarusian economy for the last few years and it seems there hasn’t been a better time, than now, to discuss the prospects and opportunities. Do you share this view?

I would say that from Belarus point of view the economy has always been open for business and there have always been business opportunities. It’s good that all parties can see that now. International organisations, EU and US government officials have visited Belarus recently and it is a good sign for international business to be more active as it looks like another relief in Belarus cooperation with Western countries.

How would you describe the Belarusian economy now? How much has it been affected by the recession in Russia and low oil prices? 

Well, it’s hard keep up a good face when the GDP and real incomes decline. The Belarusian economy has definitely been affected by the regional conflict between Russia and the Ukraine, as these are Belarus’ biggest trade partners.

Today, oil price fluctuations are affecting the Belarusian economy because of the flexible exchange rate and its tight ties to the Russian economy and therefore the Russian rouble’s drop. So if we are outlining the external reasons for the current economic pressure, I can absolutely agree with you. But we shouldn’t reassure ourselves and put all the blame outside Belarus. It’s all about productivity and competitiveness. In order to be strong we need to look inside the country all the time and to make the right conclusions.

Background. Euro, Us Dollars And Belarus Rubles
Belarusian rubles, US dollars and euros (source: bigstockphoto)

How is Belarus trying to reduce those external shocks?

There are several methods: cutting costs and improving management. Also, in order to keep macroeconomic stability there should be budget restrictions and monetary policy (monetary targeting) should be tightened.

In order to maintain the balance of payments, Belarus is discussing financial support with the IMF, the Eurasian Fund, and the Eurobond issuance. There is an agenda for structural reforms on the table with the Government, but we need to do it smoothly so we are still discussing the details with international financial organisations.

If we look at various forecasts, most of them say the economy will shrink this year and will start growing again next year. How do you see that?

There are some optimistic and pessimistic scenarios. But you can never be sure about predictions, as a lot of things (political, social and cultural) have an influence on the scenarios. The good thing is that it looks like Belarus doesn’t want to sit by, waiting for good times and getting used to becoming poorer. The country thinks, discusses different options and acts. Let’s see where it goes.

When you look at the World Bank’s Doing Business ranking, you see how much progress Belarus has made over the last decade. In 2006, the country was ranked 129th, five years ago it was 68th and this year it is 44th. What reforms do you think should be introduced now?

Well, there is a Brazilian proverb: “the economy only grows at night when the government sleeps”. There are new options for interaction between business and the government in IT development. I think the introduction of IT into all business operations will make them easier, faster and more efficient. So e-government would be the most the complex but also the best channel for the further reforms.

Belarus is looking to diversify its trade partners and to attract more foreign investors. What are the products and services where Belarus can compete on the European and the global market?

One of the key issues of trade diversification is fair competition. It’s all about tariffs and non-tariff barriers, so if we get a predictive environment where we can sell our products, then FDI will rush to use the opportunity. Right now Belarus is mostly known, worldwide, for its raw materials: potash and oil products. Belarus is famous in Russia for its agricultural products, trucks and tractors.

The best way for FDI diversification is to join the international stock exchange. As the necessary legislation is in place now, I hope Belarus will choose some attractive state-owned enterprises for several IPOs in the European markets.

When I speak with experts, they say state enterprises need to become more competitive and that they are actually hugely in debt. How do you think their situation could be improved and what does it mean for the labour market?

The government is solving the problem of SOE debts and they can do so by restructuring and adding these debts to government debt. However that’s a temporary solution. As I mentioned earlier other options are cutting costs and new management. If that doesn’t work, bankruptcy is an option. Incentives are the issue. If each SOE continues to hope for government salvation, this is the wrong incentive. If some SOEs close down, this would be new for all of them. Yes, it means a more flexible labour market; new jobs need to be created and there needs to be a better unemployment support system.

I recently spoke to a few foreign investors who are operating inside the country, during a panel discussion, which was part of the EU-Belarus Forum in Vienna. They are all satisfied with the outcome of their investment in the country. Where do you see opportunities for foreign companies in Belarus now?

Seeing is believing. The more forums we have, the better the understanding of opportunities. I see that cooperation on a regional level has a huge potential. Local authorities are responsible for the creation of jobs, so FDI is the best channel for them. I invite all international investors to participate at the regional investment forums in Belarus and they will see the opportunities with their own eyes.

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