Belarus Needs to Pick up the Pace of Reforms

Ben Aris in Moscow

Belarus was a star reformer in the World Bank's latest "Doing Business" report, and Prime Minister Syarhei Sidorsky has led a charge over the last year to push through an unprecedented package of reforms and privatisations, designed to attract foreign capital. Trouble is, time is running out for the one-time pariah nation as the crisis eats away at its resources.

Changes emanating from Minsk have been coming thick and fast over the last year. The country once famously described as the "last dictatorship in Europe" opened its charm offensive last November in London with the first ever Belarusian Investment Summit. Since then, the government has been actively pushing through an ambitious programme of change designed to loosen the state's grip on the economy.

The prime minister's job used to be nothing more than play lackey to the president's lead, but Sidorsky is now the head of an administration with a real and full docket of change to implement. The first dividends from this sea change were paid out in September when the World Bank ranked Belarus amongst the world's 10 best business reformers. "Belarus eased the process for getting construction permits by simplifying approval processes," the World Bank said. "Restrictions relating to redundancy dismissals were eased by raising the threshold for prior notification requirements. Tax payments were made more convenient through increased use of electronic systems - reducing tax compliance times - while lower ecological and turnover tax rates and a reduction in the number of payments for property tax reduced the tax burden on businesses."

The progress is more than welcome, but the small republic sandwiched between Russia and the EU remains a tough place to work. According to the businessmen working in Belarus that bne has talked to over the last few months, all report the same thing: there is growing enthusiasm and commitment to the reform process at the top level. However the problems for new projects is going the last mile; dealing with the small guys at the bottom of the chain of command who actually supervise the work. Here, progress has been much slower and attitudes have changed little, making it very difficult to actually implement ideas approved by the higher-ups.

Right model?

President Alyaksandr Lukashenka has gone for a gradual transition from Soviet to open society, a la China, which has delivered some real benefits. The biggest victim of the collapse of the Soviet Union was anyone over the age of 50 and an entire generation was largely abandoned to its miserable fate in the chaos of the 1990s. Not so in Belarus, where the old system continued to work more or less unchanged.

The transition in emerging Europe has been a boon for the young, who have been presented with the gamut of opportunity. Some have made fortunes overnight, while more recently the less ambitious have the prospect of a normal job and a better standard of living than their parents could ever dream of. But again, not so in Belarus; the cost of the slow pace of reform has been to cap the opportunities, so the pace of growth has been a lot slower than elsewhere.

Coming from the relative freedom of Western Europe, most critics are predisposed to reject Belarus' model out of hand, but the trouble is that until the crisis struck last year, it was actually working pretty well. "Whatever its critics may say about the Belarusian economic model, there can be little doubt that it has proved (until recently) to be extraordinarily successful in meeting the objectives of strong economic growth and full employment," Vlad Sobell of Daiwa Securities wrote in a recent report.

The country's fiscal position is relatively sound, with a deficit of 0.6% of GDP in 2007 and a balanced budget in 2008, according to the International Monetary Fund (IMF). During much of the present decade, Belarus' economy grew at an annual average rate of 9.5%, amongst the fastest rates in the CIS. GDP growth has come off that pace, but the government is still expecting to put in a small positive increase this year. Unemployment rates were always low and fell further from 3.1% at the end of 2003 to 1% in 2007. And according to European Bank for Reconstruction and Development (EBRD) calculations, Belarus reached the level of 1989 GDP in 2003, significantly earlier than Russia (2007) and Ukraine (which is still not there yet).

Despite the central planning nature of industrial policy, the republic has still made enormous progress towards economic diversification and industry is largely oriented towards exports.

A series of rows with Russia, starting with a fight over oil transit in the winter of 2007 and ending most recently with the so-called "milk war" over diary exports to Russia, has forced the republic to open up. Brussels has even gone as far as to invite Belarus to join the Eastern Partnership policy, which is a de facto validation of Lukashenka's regime.

However, all this action doesn't mean that Minsk is about to abandon its close relations with Russia; rather Lukashenka is attempting to build a classic "multi-vector" foreign policy, which includes better relations with Western Europe (that accounts for about 40% of the republic's trade), but at the same developing its commercial relations with its main customer, Russia (also about 40% of trade).

Crisis spanner

Despite the progress, the Belarusian model is not sustainable. The growth of recent years was fueled by a variety of factors - a Russian boom, high revenues from oil and gas transit, cheap and skilled local labour - but the most important was the republic's simple taking up of the spare capacity left over from Soviet days. This capacity has now been filled and for the country to continue strong growth, it badly needs investment.

The global economic crisis has accelerated the growing pressure on Minsk's public finances caused by the shrinking amount of spare Soviet-era capacity. Driven by government orders, unusually for the region exports from Belarus have fallen faster than imports to the republic. At the same time, the rising price of Russian oil and gas caused a widening of the current account deficit, which has ballooned from $1.4bn in 2006 to over $5bn in 2008, equivalent to 8.4% of GDP. But since the crisis struck, this number has leapt again to 17.7% as of the end of the first quarter of this year.

Belarus' gross external debt has also been rising fast as the government starts to import new equipment to add new capacity, rising from $2bn in 2002 to $5.2bn in 2005. As the current account deficit increased sharply in 2007 and 2008, the growth of external debt has picked up speed, reaching $15bn at the end of 2008, equivalent to about 25% of GDP.

The external debt position remains manageable, but the IMF says the deficit could top 10% by the end of this year, which the state would struggle to finance. State-directed spending has also held up GDP growth and investment, which was also unusually for the region in positive territory, up 16.9% over the first eight months of this year. The bottom line is much of Belarus' apparent economic health is actually artificial and unsustainable. "The economy is living off borrowed time," says Sobell. "To their credit, the authorities appear to be well aware of the gravity of the situation and have embarked on credible steps to cope with the crisis in a comprehensive manner. The key moves have been the request in 2008 for a $2bn long-term balance of payments loan from Russia (with an additional $500m to be provided by Belarus' ally Venezuela) and the start of negotiations with the IMF in October 2008."

The state began the reform process because it wanted to keep up its exception pace of growth. But since the crisis struck, it will have to go even faster, because the need to attract more foreign capital has gone from a nicety to a necessity. The government has responded well and introduced a slew of new rules, but the time has come to make them work.