Soviet model may face trouble despite weathering the crisis

Belarus has only been dealt a passing blow by the global economic crisis, but its method of fighting recession – pumping credits to state-owned industries so they continue producing despite falling sales – has stored up big problems for next year.

While its ex-Soviet neighbours Ukraine and Russia suffer severe contractions this year, Natalia Koliadina, the International Monetary Fund’s representative in Belarus, estimates its economy may end the year with zero economic growth or slightly above. Last year it grew 10 per cent.

While some other analysts are gloomier – foreseeing a contraction of as much as 5 per cent – Belarus still remains a star performer in the region.

A big reason for its relative success is the country’s hand-steered method of economic management, which has more in common with Soviet-style planning than free markets.

Alexander Lukashenko, the authoritarian president, has decreed that production should fall to no more than 20 per cent below pre-crisis levels.

This has prompted the state-owned companies that make up three-quarters of the economy to keep churning out trucks, tractors and other equipment despite sales to Russia – Belarus’s main export market – falling by half.

“We work like we’ve always worked, as a state-owned company,” says Mikalai Dubovets, the deputy marketing director of the Minsk Tractor Works, the largest tractor builder in the former USSR.

With credit growth at about 40 per cent year-on-year, state banks are also lending to households to keep the construction sector afloat. The loans are heavily subsidised – 5 per cent in the city and 1 per cent in the countryside – at a time when inflation is 12.5 per cent.

“Domestic growth has basically been financed by banks,” says Dzmitry Kruk, an economist at the IPM Research Centre, a think tank.

This level of lending could potentially create trouble for the banking system. Although the government claims that non-performing loans are at about 4 per cent, Standard & Poor’s, the rating agency, sees the possibility that problem loans could jump to 35-50 per cent of the portfolio in the event of recession over the next two years.

“The liquidity of the banking system has been deteriorating,” says Ms Koliadina.

A creaking banking system is just one of a host of troubles facing Belarus as its economic model comes under strain.

The country has a deserved reputation as the least reformed part of the former USSR – but the Soviet-style system created by Mr Lukashenko actually worked for many years, thanks in large part to cheap energy from Russia.

“The government still believes in what we call real socialism,” says Herbert Stepic, chief executive of Raiffeisen International, the subsidiary of the Austrian bank RZB and which owns Priorbank, the third largest bank in Belarus.

The first shock came in 2007, when Russia decided it no longer wanted to subsidise its neighbour, which was showing decided reluctance about following through on earlier pledges to unite with it. Gas prices have tripled since then, to about $150 per 1000cu m, making it increasingly difficult for Belarus’s heavy industry to compete.

That prompted Mr Lukashenko to begin a tentative opening to the west.

“Our further development means we need new technology and new methods of management which are tied to privatisation,” says Andrei Kobyakov, the deputy prime minister.

The country undertook a series of economic and regulatory reforms in 2007-2008. The most important included the introduction of a 12 per cent flat-rate income tax, increasing the permitted share of foreign ownership in banks from 25 to 50 per cent, and ending the “golden share” principle under which the government could take over businesses that were or had been owned by the state if it was felt they were in economic danger.

The changes created a rush of interest in the country, and there were a few privatisations, including the sale of a brewery and a mobile phone operator, as well as of 50 per cent of the gas transmission network to Russia’s Gazprom. But in recent months sales have ground to a halt.

There have been some foreign investments, including companies interested in creating a logistics centre in Minsk for the shipment of goods from the EU to Russia, but as was the case with privatisation, there is more interest than money.

“Belarus is not high on the radar screen of investors,” says Valdas Vitkauskas, head of the Minsk office of the European Bank for Reconstruction and Development.

The reason is the global economic crisis, which hit Belarus in the fourth quarter of last year.

As exports fell by about half in the first six months of the year, the country ran into severe external funding difficulties. Its sales of machinery to Russia dropped, as did those of refined Russian crude to western Europe, which accounted for 25 per cent of exports. With foreign currency reserves dropping to $3.7bn at the end of last year, the country was rescued by a $3.6bn IMF loan, as well as $1.5bn from Russia and Venezuela.

The lack of new external funding will be an increasing problem for the government next year. Russia has withheld payment of a previously promised $500m stabilisation loan. It will also be more difficult to dip into the public purse.

As part of its commitment to the IMF, Belarus agreed to balance its budget this year – a goal it is unlikely to meet, with a deficit in 2009 expected to be 2 per cent of gross domestic product.

Although debt as a percentage of GDP is still relatively low – only expected to reach 33 per cent this year – it jumped from 25 per cent a year ago, with the cost of pumping aid worth about 7 per cent of GDP into the state sector.

The government’s conservative estimate for next year foresees GDP growth of 2-3 per cent, while the IMF expects 1.8 per cent. Any recovery is unlikely to be smooth.

“The country did well during the crisis, but it has historical structural problems which will make it difficult to recover,” says Mr Stepic.