BelarusBusiness outlook 2014-18

Quarterly update – April 2015by Dr Daniel Thorniley

Contents

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

Belarus• Features of business• Business Outlook • Economic outlook • Forecast table

Executive summary (1)

• The Belarus rouble has collapsed about 25% since December with some stabilisation recently• Emergency currency controls were imposed in the volatile December but quickly rescinded • The base interest rate was jacked up to 25% on 8 January and rates will stay high as long as an

inflationary threat remains in place• 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 but that has altered in recent weeks with the rise of the Russian rouble

• The economy was hardly buoyant in 2012-2013, and the crisis in Russia-Ukraine pushed the Belarus economy down further through the final months of last year and the economy is on the cusp of a mild recession which is our prediction for this year

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

• The Big unknown now though is whether the Russian rouble will be able to retain its recent gains and what impact this will have on the Belarus currency and economy

• However, we think that the flow-through effects of end-2014 in the region and the poor start to 2015 will at best ensure that growth stabilises close to zero rather than our central forecast of minus -0.5% GDP in 2015

Executive summary (2)

• Note: quite few of the major Belarus economic indicators have swung sharply from highs and lows within recent calendar years and so the average figures cited here do not always reflect what was roller-coaster annual calendar period

• For example retail sales year-on-year in January 2011 were + 22% and zero in November 2011 while in autumn 2014 retail sales were rising 5% but then zero in December of the same year. Other indicators such as real wages perform similarly

• After the 25-30% devaluation at the turn of the year, companies are faced with a similar situation as in Russia and Azerbaijan and less so than in Ukraine

• The currency slump was exacerbated by previous cuts to interest rates in 2011-13 which were designed to support consumer credit

• One question mark now though is what effect will he strengthening Russian rouble have on other CIS markets and their currencies: for example if the Kazakh tenge is to be devalued now, then by how much and similarly how weak will the Belarus rouble develop as the Russian equivalent appreciates strongly? And of course how sustainable is the Russian rouble recovery?

• We think that if the Russian rouble recovery proves viable or only weakens by 10-15% from its current level (52 to the US dollar), then this will have positive effect on the Belarus rouble and eventually the Belarus economy

• It would be a floor beneath any Belarus depreciation which is on-going

Executive summary (3)

• This outlook is supported at the moment by the stabilisation of the Belarus rouble in March-April

• Companies will plan for increased volatility and uncertainty• But some companies are already in “mini-crisis” mode thinking that sales will moderate more

this year as inflation does not decrease and could pop up again after falling at the turn of the year

• Executives are talking about more cash management and taking more care and attention with receivables

• Only one quarter of companies are forecasting rouble sales above 10% this year and if the currency stays down by 15-25%, then the large majority of companies will see declining FX sales in the market this year

• 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 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

Executive summary (4)

• 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 17%, real wages are actually now falling

• GDP will dip into a mild recession this year at -0.5% with risk on either side • After finishing quite well last year at 4% growth, industrial output this year will be minus -3%

while investment will be flat at best after a fall of -8% last year• The economy may benefit from some import substitution which could appear more this year as

the Belarus rouble weakens further• But export and imports both crashed at the start of 2015 with exports having slowed already for

several months• Inflation is now expected to climb to an average of 23% in 2015 and could climb to 25% but was

still in mid-teens in January-February

Update on Russia-Ukraine crisis and impact on Belarus (1)

• 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 declining Belarus rouble took on a more inevitable aspect after the 25% devaluation of the Azeri manat

• But on the other hand it is uncertain what impact the strengthening Russian rouble will have if such attend proves sustainable; if the Russian rouble can retain some of its strength, this ought to provide some support to its Belarus counterpart and the whole of the Belarus economy which did look at risk at the turn of the year

• As in Russia, Belarus could start to “look and feel” a bit better over the coming weeks • 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)

Update on Russia-Ukraine crisis and impact on Belarus (2)

• 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 Belarus “on side”

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

• But just as the Russian currency and economy may be showing signs of stabilisation, so too the Eurozone displays some signs of improvement which could in turn buttress Belarus trade and exports: so while the East and West did look very weak just 3 months ago, there are signs of at least marginal support now

• 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)

• 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 those companies who planned double-digit growth this year will be more challenged to achieve those numbers now

• It is a market where executives are not focusing much corporate investment in the way of resources owing to continued concerns about long-term viability

• Yes, companies have looked at alternatives to the Russian market but recent trends across the CIS and in Belarus show that there are no easy solutions or compensations for a slower Russian market

• Some companies 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 the Eurasian Economic Union

Features of business (2)

• 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 4-9%+ 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 (3)

• 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 (18%) of respondents in our Surveys 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. There is some increasing risk that payments and cash management will become marginally more challenging and it is something to monitor without yet being a serious threat

Business outlook (1) – 2015 sales projections

2015 Sales projections Main CIS Markets (in local currencies)

Russia Ukraine Kazakhstan BelarusGrowth of 10%+ 41% 14% 40%

24%Growth of 5-10% 23% 8% 20%

28%Growth of 1-5% 9% 8% 16%

12%Zero growth 10% 24% 25%

25%Decline 1-10% 12% 25% 6%

10%Decline of 10%+ 5% 21% 3%

1%

Source: Business Russia/CIS Group Surveys

Business outlook (2)

As the MD of one of the world’s top-10 consumer goods companies commented last week:

“It’s been a mixed market for us in recent years, sometimes up 8-15% and then low-singles or flat on a weakening currency. But the Russian crisis has started to impact and we sense this in consumer confidence and spending patterns. I do not predict a major crash this year but we have had to reforecast for a negative trend versus our budget which was set last autumn. But as you know, in recent days the strong Russian rouble may turn some of this around but how quickly or if at all are still questions. All our CIS markets are now uncertain and that includes Belarus. We have started to examine more some of the smaller central Asian markets through distributors”

Business outlook (3)

• We conduct two Surveys of the Belarus market: one which compares another 22 CEE and CIS markets and one which compares it with just CIS markets. The latter version is the most recent taken at the start of February (and will be updated later in April). The figures in the previous table are from this most recent Survey

• The table shows that even in early February Belarus ranked behind Kazakhstan and what was then a weaker-looking Russian market, and Belarus appeared “average” and certainly stronger than Ukraine

• Again we underline that these figure refer to the rate of sales growth and not the volume of business

• One quarter of respondent forecast flat rouble sales growth and 11% predict negative sales while 40% predict single-digits ales and another quarter look to double digits. This very much has a feel of “not bad/ok” but the coming weeks will indicate whether companies will have to down-scale these estimates moderately or not

• The rate of Belarus rouble depreciation will define whether these results turn out to be not so bad in FX terms or very weak

• Given the Belarus rouble is down about 25% and could well stay like that through the year, then most FX results will be either weak or possibly much worse if any further deterioration occurs. This worst case is NOT yet our current central forecast.

Business outlook (4)

• 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 in B2C• 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 flat growth and the remainder are clustered in single-

digit sales

Business outlook (5)

• 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 and such companies may soon be benefitting from the stronger Russian rouble if the Russian currency can retain its recent large gains

• 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

Economic outlook (1)GDP and growth drivers

• Opening note: quite few of the major Belarus economic indicators have swung sharply within recent calendar years and so the average figures cited here do not always reflect what my have been a roller-coaster calendar year

• As we predicted in our last quarterly report (January 2015), the risks for the GDP outlook this year were all to the downside and that has started to happen

• The economy stuttered along at 1.4% growth in 2014, after a weak number in 2013 (0.9%), with agriculture and transport posting annual gains of 3% while industrial output rose 4%

• Given regional pressures and a slow Eurozone, the 2014 figures were not bad but with the depreciating currency and mixed news out of Russia, we expect a small recession this year of minus -0.5% (close to the consensus view) and with some possible downside risk to -0.8%

• Industrial trends support this: in the 5 months to November 2015 industry expanded 7% but then declined -1.4% in December and fell on average by -7% in the first two months of 2015

• So industrial output is on a downward trend • 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

Economic outlook (2)investment, industry and trade

• Exports averaged $3.6bn per month in 2012-13 and averaged $3.2bn monthly in most of 2014 but on falling scale to $2.8bn in November. But the year-end turmoil took its toll: exports crashed to just $2.3bn in January and $1.9bn in February

• Imports saw a similar picture at an average last year of $3.3bn per month and this was maintained to the end of the year but then imports too slumped by 50% at the start of 2015

• Repeated devaluations in recent years have prompted large agricultural and industrial exporters to price in US dollars and the rising dollar will help them this year as will lower energy prices

• We will see in the coming months whether traders can bounce back quickly from the devaluation effects

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 was still negative through most of 2014 at -6% but at the turn of the year construction and investment figures surged according to official data as new housing construction rose by more than 20%

• It is not clear how sustainable this trend will be but it is possible tat investment could rally at about zero this year after an -8% decline last year on the back of this housing construction

• 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)household consumption and wages

• 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 real wages were on a downward trend last year: +6% in January 2014 but -2.3% by November

• In the first two months of 2015 real wages were negative by -3.2% and this is impacting retail sales and will keep household spending down to moderate growth of just 0.9% this year after rising 2% last year

• Consumer product companies probably need to manage expectations downwards and look at more value products

• 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 0.4% in December averaging 8% for the whole year. At the start of 2015 retail sales held up at 4.7% in January but then slowed to 1.2% in February. Retails sales could slow to about an average of 1% growth this year

• Consumers, as in Russia, may have been buying “ahead of inflation” which could explain January’s quite high figure. This flurry of retail spending can continue for several weeks as we saw in Russia but then retail sales are likely to come under pressure: we predict growth this year of just 1% but as with household spending the risks here are slightly to the downside

Economic outlook (5)inflation and bank credits

• We now think that the weaker currency will entail an upward spike in inflation and then average about 23% in 2015. This will exert more downward pressure on real wages and on household consumption

• But inflation in the first two months of 2015 was fairly calm at an average of 17% compared with an average of 18.5% in the second half of 2014

• Nearly all will depend on the strength/weakness of the currency and intended government spending in 2015 (an election year)

• We presume that as the effects of Belarus rouble weakening filter through the figures that inflation will moderate at 17% in 2016 and then then trend down to 13% in 2017, but similar predictions of moderating inflation in the past have been thrown off track by currency volatility

• Bank credits were rising at 7% until October-November last year which stimulated private consumption and we imagine banks will come under more strain this year and unless the government prints money and pushes the money on the banks, lending ought to decelerate this year to close to zero

Economic outlook (6)budget and external accounts

• 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

• Government spending was quite tight last year but there will likely be some pre-election spending this year ahead of presidential elections planned for November and we could see spending rising and the budget deficit increase from -0.5% in 2014 to -1.8% this year

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

• Russia has agreed to relieve Belarus of proposed oil duties from 2015, and it will doubtless keep providing cheap oil in return for political support or at least neutrality vis a vis Ukraine and the EU

• Export and import weakness will probably balance out this year but with imports down more than exports and thus we see the trade balance improving marginally in proportional terms and thus we see the current account deficit decreasing from -8.0% last year to about -5.5% this year

Currency outlook (1)

• We said last year 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

• During last December and January the Belarus rouble started to fall and by April had slumped about 25-28% versus the US dollar

• 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, a few weeks later

• The key refinancing rate was bumped up (for the first time since 2011) to 25% with immediate effect and this is likely to stay at his level until the rouble and inflation start to show better trends

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

13.471 January 2015 11.90

14.468 January 2015 12.80

15.3013 January 2015 14.00

16.508 February 2015 15.30

17.1011 April 2015 14.30

15.20• This shows a 28% decline against the dollar in just 3 weeks in December-January. But it is also

clear that the Belarus rouble has stabilised in recent weeks thanks to the measures taken in January but most of all thanks to the stronger Russian rouble . The rally against the Euro depicted in the above table is also due to the Euro softening again versus the US dollar

• We did presume that government measures could stabilise the FX rate but there was no guarantee. Now the currency will be hugely affected by whatever happens to the Russian rouble

• 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 2012 - 2018

2012 2013 2014 2015 2016 2017 2018GDP 1.5 0.9 1.1 -0.5 1.7 2.3 2.9Fixed investment -9.8 7.5 -8.0 0.0 2.8 3.4 4.2Industrial output 5.9 -6.0 4.0 -3.0 2.7 3.1 3.4Household spending 7.8 14.3 2.0 0.9 2.3 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 2.8 3.1 3.7Consumer prices (average) 59.2 18.3 19.0 23.0 17.0 13.0 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 16.200 16,800 17,600 18,400Rouble/dollar (average)* 8,336 8,971 10,300 15,200 15,800 16,700 17,500

Note: Real annual % change unless stated

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

Disclaimer

© 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