BelarusBusiness outlook 2014-18

Quarterly update – January 2015by Dr Daniel Thorniley

Contents

• News flash• Executive summary• Update on Russia-Ukraine crisis and impact on

Belarus• Features of business• Corporate sales and profits outlook• Economic outlook • Currency outlook• Forecast table

News flash

• News flash• In recent days the Belarus rouble has started to crash against the US dollar and Euro• The National Bank raised rates last week but more emergency measures will be needed if

the collapse continues• We expect further interest rate hikes and eventually informal or even formal capital

controls unless the currency stabilises• Some of this is due to a belated “catch-up” with the Russian rouble given the Belarus

rouble was widely thought to be over-valued compared with the Russian currency • It is unclear how substantial the currency fall will be, but we make initial amendments

and provisos to this report and stress now that all risks are to the downside as inflation could spike further and/or GDP growth could decline much more than anticipated just 1-3 weeks ago

• Already weakening trends could be pushed much further down and the economy is on the edge of a recession

• It seems the country is/was unable to avoid the Russian/Ukrainian contamination which has filtered through via the exchange rate

Executive summary (1)

• Russia is sinking into recession this year and Ukraine will remain in one as well • The other major CIS markets especially Kazakhstan and Belarus are worried about

contamination• The Belarus rouble collapsed in December during the Russian rouble turmoil of that

month and the government imposed a set of emergency currency measures, some of which have since been rescinded

• The National Bank announced a devaluation of the official rate and the currency has shrunk to new lows in January

• The currency slump was exacerbated by previous cuts to interest rates which were designed to support consumer credit

• But as we noted last October, such cuts compounded the risk of another devaluation, which will have severe implications for already-tight government spending and growth, as well as interest rates and inflation

Executive summary (2)

• On the upside Belarus will continue to benefit from some “transit trade” as exporters look to avoid Russian sanctions, while it will keep receiving cheap oil from Russia as it tries to “keep Belarus on side”

• But the uncertainty around sanctions (and particularly the possible impact on any firms operating within the Customs Union), together with falling demand from Russian and Ukraine will have an equally if not larger impact on trade, stability and the currency in 2015 and we have seen this already

• For corporates operating in Belarus, any bounce-back from the 2011-12 currency crisis has now faded and companies see Belarus very much as a single-digit growth market and one where they are not focusing much in the way of resources owing to continued concerns about long-term viability

• Some may be looking to increase their presence while others will be consolidating and pulling back. Some companies will try to benefit from leverage in light of developments within the Customs Union and forthcoming Eurasian Economic Union (from Jan 2015)

• The economy held up a bit better than expected in 2014 at 1.1% but will do well to be able to repeat that performance this year and we think regional uncertainty and a fragile Eurozone recovery could entail GDP growth this year at 0.3% which could slip into negative territory

Executive summary (3)

• 2014 benefitted from a better harvest, reasonable exports and still positive (but softening) retail growth and an industrial bounce-back in the early autumn

• However, the government has stopped its usual policy of hiking wages in times of crises and with inflation still around 20%, real wages are actually now falling

• Industrial output grew about 2% last year on a rising trend and the number could be repeated this year amid some import substitution which could appear more in 2015 if the Belarus rouble weakens further

• Inflation climbed from the start of 2014 at 15% to average close to 20% for much of the year which is close to recent annual averages

• In fact in October-November prices trended downwards to 18% but we think the recent currency devaluation must flow through into higher prices in the first months of 2015

• Another $1.6bn tranche of credit from Russia in September was intended to stave off any currency crisis but the turmoil of December undermined this especially as the Belarussian rouble was strong comparative to the Russian rouble (CIS managers are watching for similar developments in Kazakhstan)

Update on Russia-Ukraine crisis and impact on Belarus

• As we noted above, the main impact is now via the exchange rate: the Belarus rouble is playing inevitable catch-up with the collapsed Russian rouble and general weak economic outlook surrounding Belarus also pushes the currency and economy downwards

• The Russia-Ukraine crisis looks likely to become a messy frozen conflict which will continue to impact business in Belarus in 2014 and into 2015

• However we continue to see low risk of local demonstrations in the style of those in Kiev – authorities have too firm a grip on security and the media and there is also limited popular will (about 11% of the population identify themselves as Russian)

• Belarus is still trying to play the neutral card, for example, hosting the recent ceasefire talks between Moscow and Kiev

• It will benefit from transit trade as companies try to avoid Russian sanctions, as well as better energy prices from Russia, which remains keen to keep it on side

• But there will still be quite a bit of downside in the form of weak exports to these two important markets, compounding already weak economic fundamentals (currency, foreign debt, inflation, fiscal strain, falling real wages – see later)

• The next presidential elections are scheduled for November 2015 but we are unlikely to see change

• Belarus, along with Kazakhstan, signed up for extending the current Customs Union to the Eurasian Economic Union in January 2015, but it remains broadly a trading union and both want

to steer clear of closer political/institutional ties with Russia

Features of business (1)From our December 2014 benchmarking survey (next survey in June 2015)

• Due to its market size (9.5m), Belarus does not rank as a priority for most multinational companies (about 4% of MNCs see it is a mid-term priority among CEE markets, according to our latest, December 2014 survey)

• For 80% of western companies Russia still represents more than 75% of their business volume in the CIS region; Kazakhstan is becoming certainly more important representing about 4-6%+ of CIS business but Belarus still only accounts for 1-2% for most manufacturing companies

• It would appear that most companies are sticking with their business model and structures despite changes in the Custom Union and the Russia-Ukraine conflict but more companies may look at sourcing products and transiting them through Belarus because of either sanctions or opportunities from the Customs Union

• Far fewer companies (just 4%) than 6 months ago (20%) say they are now reviewing their route-to-market which suggest that companies addressed this mostly earlier last year

Features of business (2)

• It could that companies are downsizing their distribution activities or changing the numbers of distributors owing to the Customs Union, while equally some may be trying to upscale as an alternative to Russia

• In general though this is a mixed market where some companies will be pulling back as others investigate openings

• One fifth of respondents (18%) state that consumers are down-trading and we expect this figure to rise as real wages have now started to fall (see later)

• About 4% of firms are planning to hire, mainly for local rep offices or small subsidiaries – few are looking at larger investments owing to economic uncertainty

• Belarus is about average for the CEE/CIS region when it comes to issues with receivables and only 14% of firms report such issues ranking Belarus mid-table from 23 markets surveyed

Corporate sales and profits outlook (1)From our December 2014 benchmarking survey (next survey in June 2015)

• We already thought in early December that some of these corporate expectations were on the optimistic side. Given the currency collapse in December-January, companies will have to re-jig and re-forecast their business outlook downwards

• Belarus is a small volume market but given the challenging times in the CIS region, executives are looking for bits of growth everywhere and hence why Belarus gets a bit more attention recently

• But sales and profit growth is moderating after a recent, steady pick-up in 2012-13 along with some bumps

• In our Survey of 23 markets in the CEE region, Belarus actually ranks 8th in terms of “the rate of sales growth” i.e. this does not account for volume

• But this still means that 27% of respondents from all sectors predict flat sales growth for 2015 and 53% look to single-digit sales expansion with 18% forecasting double-digit sales, again probably on low volumes

• Given our Survey was conducted at end of November, we believe these numbers need tweaking downwards and should be seen as best case

• In fact our most recent figures suggest that in January 38% of firms forecast flat growth and 12% predict negative sales

Corporate sales and profits outlook (2)

• Given that budgets were set in September/October for 2015, most companies will be reforecasting their targets downwards

• Companies are also cautious about profit growth in Belarus owing to high inflation as well as a typically small level of resources dedicated to the market

• Among consumer goods companies the outlook is not bad but could need some downward modification: 46% of companies plan for single-digit sales growth and almost one quarter predict double-digit sales. However, 15% expect flat growth and the same number forecast falling sales

• But such figures do rank Belarus No 6 in the region again for the rate of sales” growth• As usual, the B2B sector is expected to perform weakly as financing remains an issue

and cross border trade softens and the currency could come under more pressure• Fully 40% of firms in this sector predict felt growth and the remainder are clustered in

single digit sales

Corporate sales and profits outlook (3)

• Some companies, as in Ukraine, report that some local companies do have access to “grey funds” or some off-shore FX funds or are generating cash though sales to western markets and can finance purchases from their cash-flow, but this is a minority clearly

• Most companies trade eastwards and denominate their business in a shrinking (Russian) rouble

• For pharmaceutical and health companies Belarus is ranked mid-table with a wide spread of sales results for 2015 with equal proportions of companies looking to flat or single digits or double digits

• Much will depend on whether firms are selling to government or “across-the-counter” retail and the latter tends to perform better these days across markets as governments tighten the purse strings

Revenue and profit results/forecasts, 2014-15all sectors,Comparison of our June and December 2014 surveys

Revenue and profit results by sector, 2014From our December 2014 survey

Revenue and profit forecasts by sector, 2015From our December 2014 survey

Economic outlook (1) – GDP and growth drivers

• The economy was surviving but is also coming under more pressure especially if the currency sinks further

• GDP stuttered along at 1.1% in 2014 after a weak number in 2013 (0.9%) • Given regional pressures and a slow Eurozone we expect GDP growth to decelerate • We expect GDP growth this year of 0.3% but with all risks on the downside • There is now a possibility that GDP will turn flat or negative by at least -1.0% this year

given the currency collapse which we have witnessed in recent days • GDP is then expected to average 2-3% in subsequent years with some chance of a

stronger bounce-back to 3%+ if the Russian economy rallies better than expected• 2013 suffered from a poor harvest, falling potash exports after the break-up of an

export cartel, and a fall-out with Russia over oil re-exports• Growth was expected originally to do better in 2014 but then the Ukraine/Russia crisis

kicked in • Growth in 2014 was helped by a better agricultural output (up 4.0% year-on-year),

moderate industrial growth (up 2.0% on a rising curve in the latter months of the year) and still-solid domestic trade (up 7%), thanks partly to continued wage growth (though this is softening – see later)

Economic outlook (2) – investment, industry and trade

• The industrial and agricultural numbers are a result as well of some “transit trade” as exporters look to avoid Russian sanctions, but the scope for this is limited by weak Russian demand (Belarus imports twice from Russia what it exports) as well as sluggish/falling demand from its other two main markets, Ukraine and Europe

• Exports averaged $3.2bn per month in 2014 compared with $3.5bn the year before and the numbers were very similar for imports, so it does seem as though regional weakness in the West and East is impacting trade flows and that could worsen or stabilise at these weaker levels in 2015

• Fixed investment was heavily negative in November year-on-year at -11% as investor confidence remains hamstrung by continued devaluation concerns which are now compounded by the Russia-Ukraine crisis. Fixed investment for all of 2014 will be down -6%

Economic outlook (3) – investment, industry and trade

• Belarussian firms (75-80% of which are still in state ownership) remain unproductive and Belarus is still reliant on cheap Russian oil and loans – it received another $1.6bn tranche in September 2014 – to keep its currency afloat and the economy moving

• The loan is part of a deal struck when Russia bailed out Belarus from its currency crisis in 2011 – in return Belarus is supposed to sell a number of state assets to Russia, but many of these sales are now in doubt amid worries about the impact of sanctions on any businesses with Russian ties

• Construction activity is also still negative – a result of low confidence and high interest rates – but new household orders picked up 3-4% overall last year but we think construction activity will be flat overall at best in 2015

• Productivity, though low, has also improved thanks to the weaker currency and less rampant wage growth, and Belarus is starting to attract some investment interest that may perhaps have gone to Russia (particularly from China)

Economic outlook (4) – consumption, inflation, wages and credit

• In the past massive salary increases and subsidies kept consumption going, leading to large trade deficits which led to a currency crash in 2011 ending in a 60% rouble devaluation and a commensurate rise in inflation in 2011-12.

• Even so, nominal wages still rose 40% (16% in real terms) in 2013. During 2014 nominal wages were up on average by 18% matching inflation which entailed that real wages were close to flat

• But the trend in the final quarter of 2014 was for nominal wages to be falling slightly faster than inflation and if continues, real wages will turn negative in early 2015 and household consumption could be much softer given also currency fluctuations

• We now think that the weaker currency will entail an upward spike in inflation especially at the start of the year and then average about 21.5% or higher in 2015. This will exert more downward pressure on real wages and on household consumption

• Bank credits were rising at 7% until October-November last year which stimulated private consumption

• Retail sales were surging at the start of 2014 averaging 12.5% growth in the first quarter of that year but had slumped to just 1.0% growth in October. We expect retail sales to turn flat in January/February as the weakening currency raises inflation and undermines consumer confidence

Economic outlook (5) – government budget and spending

• Only about 40% of external debt is public (the rest mainly held by firms), since the largely state-owned banking sector functions to support government spending and state-owned enterprises (SOEs)

• Still government debt is rising on the back of Russia financing – it is now about 35% of GDP and Belarus spends 10% of GDP servicing its debts

• Thus government spending will remain tight: the weak currency brought it close to deficit in 2013 and the budget balance will be zero or negative again in 2014 with spending also flat

• Russia has agreed to relieve Belarus of proposed oil duties from next year, and it will doubtless keep providing cheap oil in return for political support or at least neutrality vis a vis Ukraine and the EU

• There will likely be some pre-election spending next year ahead of presidential elections planned for November and we could see spending rising and a small budget deficit

• Any shaper rouble depreciation would make spending matters worse, while a lack of progress on privatisations will continue to limit funds available for investment

Currency outlook (1)

• We said in October that, “To help consumers and promote investment, the central bank cut its reference interest rate to 20% in September (from 45% at the start of 2012), but this is likely to keep inflation elevated while adding to currency risks”. This has certainly proven the case given the Russian rouble contamination

• Prior to the closing days of December the Belarus rouble had already fallen 15-20% versus the dollar during 2014

• In mid-December the National Bank introduced emergency measures including a 30% tax on foreign currency purchases and temporarily banned “over the counter” foreign currency purchases. However, these measures were then rescinded, perhaps prematurely, a few weeks later

• Last week (early January) the Bank was forced to revert to protective polices to prevent a Belarus rouble implosion. The Bank increased its benchmark rate for the first time since 2011 and rolled out other emergency measures

• The key refinancing rate was bumped back up to 25% with immediate effect • The Bank also devalued the rouble by 7% against the dollar and scrapped entirely the

remaining 10% fee imposed on purchases of foreign currency by individuals

Currency outlook (2)

• For reference the National bank of Belarus has posted the following record of the exchange rate versus the US dollar and Euro which shows the extent of the recent currency collapse:

US dollar Euro1 December 2014 10.81 13.4720 December 2014 10.89 13.401 January 2015 11.90 14.468 January 2015 12.80 15.3013 January 2015 14.00 16.50

• This represents 28% decline against the dollar in just 3 weeks. Much will depend on whether measure instituted by the national Bank can curb the collapse

• We presume that government measures may be able to stabilise the FX rate but there is no guarantee. We do presume that at whatever rate the Belarus settles this year, it will then depreciate about 3-4% in subsequent years again presuming stabilisation in Russia and Ukraine

Economic forecast table(The 2015 economic forecast is variable deepening on the extent of the rouble

depreciation which accelerated in January)

2012 2013 2014 2015 2016 2017 2018GDP 1.5 0.9 1.1 0.3 1.7 2.3 2.9Fixed investment -9.8 7.5 -6.0 0.8 3.0 3.6 4.2Industrial output 5.9 -4.8 2.0 1.3 2.7 3.1 3.4Household spending 7.8 14.3 2.0 0.9 2.5 2.9 3.3Government spending -1.0 -2.5 -0.5 1.3 0.5 1.0 1.5Real wages 22.0 15.8 0.0 -1.0 2.2 3.0 3.3Retail sales 14.0 18.2 8.0 1.0 3.2 3.3 3.7Consumer prices (average) 59.2 18.3 19.0 21.5 14.0 12.0 9.5Budget balance (% GDP) 0.5 0.2 -0.5 -1.8 -1.6 -1.6 -1.5Current account (% GDP) -6.1 -10.2 -8.0 -5.5 -5.0 -4.8 -4.6Rouble/euro (average)* 10,762 11,834 13,800 17.000 17,780 18,120 18,480Rouble/dollar (average)* 8,336 8,971 10,300 14,600 15,330 15,900 16,500

Note: Real annual % change unless stated

*base-case, see our earlier notes on depreciation/devaluation risks

© 2015 CEEMEA Business Group*

*a joint venture betweenDT-Global Business Consulting GmbH, Address: Keinergasse 8/33, 1030 Vienna, Austria,Company registration: FN 331137t and GSA Global Success Advisors GmbH, Hoffeldstraße 5, 2522 Oberwaltersdorf, AustriaCompany registration: FN 331082k Source: DT-Global Business Consulting GmbH and CEEMEA Business Group researchBasic data sources come from central banks, own intelligence network, CEEMEA Business Group corporate survey, governments and other public sources. Interpretation, views, forecasts, business quotes and business outlooks by DT-Global Business Consulting GmbH and CEEMEA Business Group.

This material is provided for information purposes only. It is not a recommendation or advice of any investment or commercial activity whatsoever. The CEEMEA Business Group accepts no liability for any commercial losses incurred by any party acting on information in these materials.

Contact: Dr Daniel Thorniley, President, DT-Global Business Consulting GmbHM: +43 676 534 6852 / E: danielthorniley@dt-gbc.com / W: www.ceemeabusinessgroup.com