Tag: Belarus

Do Economic Sanctions Work?

Posted on March 19, 2012 | Policy Brief

North Korean rocket displayed under a glass dome, illustrating the resilience of sanctioned regimes—an image exploring the question: Do Economic Sanctions Work?

Analysts have interpreted the recent openings in Myanmar and North Korea as the finally successful result of years of international pressure and economic sanctions. At the same time, debate is hot on the scope for similar measures in Iran, Syria, and, closer to us, Belarus and Hungary. Does economics have anything to say on this? What can we learn from the analysis of past experiences?

On February 29th, after decades of frustrating attempts by the outside world with sticks and carrots, but mostly economic and diplomatic isolation, North Korea announced that it would suspend its enrichment of uranium and its tests of weapons and long-range missiles. It would even allow an inspection by the International Atomic Energy Agency, the first one since the country walked out of the Nuclear Non-Proliferation Treaty in 2003. The recently inaugurated leader, young Kim Jong Un, asked, in exchange, some tons of food aid and the promise of talks. Some believe this was inspired by another recent unexpected “opening”: the turn-of-the-year developments in Myanmar, where a cease-fire and the release of many of the political prisoners prompted a slow but sure thawing in the country’s diplomatic relations with the rest of the world. Some months on, the government’s intentions to move from a military dictatorship to greater pluralism still seem sincere enough. Many have interpreted these events as the finally successful result of years of international pressure and economic sanctions on the two countries. Is the tide turning for sanctions enthusiasts?

At the same time, though, concerns are rising that EU member Hungary is moving in quite the opposite direction, after a change in the constitution that endangers the independence of the media, the judiciary and the central bank. Hungarians protesting in the streets are openly talking about authoritarian evolution drawing parallels with the behavior of the government in Belarus, which only months ago attracted harsh criticism – and stringent sanctions. Hungary might follow suit in this respect as well: its credit line with the IMF is still hanging from a thread, and the EU threatened law suit over the constitutional changes, while a potential limitation of the country’s voting rights in Brussels is whispered as the “nuclear option”.

Although the situation looks increasingly, explosive both in Syria and Iran, even in these cases the hopes of the international community rest exclusively on economic coercion. Syria’s economy is now under severe pressure, after even the Arab League imposed sanctions. This is first time such a decision is taken against a fellow member. Near all trade and financial relations have been cut off, with the exception of some banks in Lebanon and perhaps a few business friends in China and Russia that might still offer assistance to Bashar Assad’s regime. But the country’s foreign reserves, already low one year ago at the offset of the crisis, should be running out by now, and inflation is rising as many consumption goods become scarce. At the same time, although Saudi Arabia is arming the rebel groups, a military intervention sanctioned by the international community seems unlikely, given the recent Libyan precedent.

The sanctions faced by Iran over its nuclear program are also growing to unprecedented severity, and also in this case military action does not seem to be considered an option – except by (understandably) jumpy Israel. Given the stage that the nuclear program has reached, and the level of protection built around it, bombing is not likely to stop it. Experts say that a successful US-lead operation could at most delay it some ten years. Arguably, this would only result in an even angrier Iran equipped with nuclear weapons, in ten years from now. Hence it would appear much more fruitful to try to change the population’s attitude, so that Iranians themselves can in turn affect their political leaders’ attitude, even if this needs replacing the regime altogether. This way the prospect of a nuclear Iran would not look as scary.

As the international community considers over and over its stance in all these thorny situations, a legitimate question in everybody’s mind is: What is the likelihood that the sanctions will work? Does the economic literature have anything to say on this matter?

Achieving the Goal

According to Richard Baldwin, Professor of International Economics at the Graduate Institute of Geneva, “[i]t would be difficult to find any proposition in the international relations literature more widely accepted than those belittling the utility of economic techniques of statecraft.” In other words, a prominent scholar’s synthesis of the literature is that economic sanctions do not work. The anecdote most widely cited by advocates of sanctions is of course South Africa. The economic pressure imposed on the country in the mid-1980s certainly contributed to the strain that the inefficient and costly apartheid regime was increasingly suffering, finally leading to its dismissal. At the opposite end of the spectrum stands Iraq, where neither the comprehensive sanctions nor the oil-for-food program, in principle a quite clever combination of sanctions and aid, could achieve anything. The success of the following military intervention is also a subject of debate, though not one I will address here. Some have drawn the conclusion that the discriminating factor lies in how important for the target regime is the recognition of and identification with the sanctioning part. Others argue the probability that the sanctions succeed is linked to the cost born by the target, or by the sanctioning part (also called the sender), or other observable factors. If truth be told, these are both quite special cases, hard to generalize. But then again, one could argue that every episode involving international disputes is a special case. It follows that the systematic study of economic sanctions with the evaluation of their effects is not a straightforward task at all.

The first step to evaluate the success of imposed economic sanctions is to establish what the goal is. In the most basic terms, there are two types of explicit goals. In some cases, the imposition of an economic sanction is purely punitive towards a policy or act of a regime, or towards the regime itself, and aims at expressing disapproval from the initiating part, when inaction can signal complicity. Hoffman [8] was one of the first to suggest that “sanctions are mostly adopted to alleviate cross pressure situations, resulting when a (foreign) government faces demands for action but war is undesirable”. In this case, it makes little sense to talk about success or failure, as the imposition of sanctions is a goal in itself.

In the extreme case, this type of sanctions aims at destabilizing the target regime, inducing political change. This seems to be part of the aim of actions taken against Syria, although an end to the Iranian theocracy, and Lukashenko’s regime in Belarus, for that matter, would certainly be welcome as well. An analysis of the historical records from 1914 to 1989 [4] reveals that the probability of success with this goal has been 38% when the regime was very stable to start with and up to 80% in “distressed” countries. The single most important factor of success is hence, not surprisingly, the pre-sanctions stability of the political system in the target country. In some cases, paradoxically the imposition of sanctions stimulated political cohesion in the target country – the so called rally-round-the-flag effect. This is what seems to be happening, at least at this stage, in Hungary. The evidence suggests that there is a threshold of political cohesion above which external intervention strengthens the target government. According to Lindsay [13], three factors make it more likely that sanctions produce political integration rather than regime collapse:

If they are seen as an attack on the whole country rather than on a specific faction
If identification with the sanctioning part is weak or even negative
If no alternative to the sanctioned course of action is available or perceived as better

In this light, measures that can be manipulated to punish only or prevalently the regime’s domestic supporters and political base are to be considered as superior. Travel bans and freezes of assets, foreign bank accounts and property of functionaries are examples of this type of measures. Financial restrictions, in addition to be perceived as comparatively fairer, have also been more effective in the past. Moreover, also to the point that the sanctions should not, if possible, hurt everyone indiscriminately, they are preferable to measures that hurt the productive sector, like trade restrictions.

Alternatively, sanctions are designed to compel a specific policy change in the target country. This is the case of Hungary and its new constitution, and formally of Iran, which is only required to drop its quest for nuclear weapons. The emerging consensus in the sanctions literature is that concessions are most likely at the threat stage [11]. Nevertheless, there are cases where the threat of sanctions fails and sanctions are then actually imposed. And, although the success rate becomes lower at this stage, there are examples where the target yields only after the sanctions are imposed. It might seem tempting then to investigate whether observable variables can predict the likelihood of success in these cases, because this would teach us something about the current crises around the world. However, trying to understand when and why sanctions have success based on the analysis of empirical data is complicated by a number of challenges.

First of all, there are at least two sources of censoring in the sample of imposed sanctions: because it is only a specific type of disputes that reach this stage, the evaluation based on them will be biased. The first reason why these are special cases is due to the fact that imposed sanctions have already failed at the threat stage. Hovi et al. [9] look at this situation from a game-theoretic perspective and argue that, if sender and target are rational, a threat of sanctions could fail because of one of three reasons: 1) it is not credible, so no actual sanctions will follow the threat; 2) it is not sufficiently potent, meaning that the target considers sanctions to be a lesser evil than yielding; 3) it is noncontingent, i.e. the target expects sanctions to be imposed regardless of whether it yields or not. If any one of these is true, then the target that did not yield at the threat stage will not yield after sanctions are imposed either (or no sanctions will be imposed if alternative 1 is true). Imposed sanctions will work only if at least one of these factors is initially not known with certainty, or wrongly perceived by the target: if the target believes the threat non credible, but then sanctions are actually imposed; if the target was wrong in judging the cost of the sanctions and realizes it only after sanctions are actually imposed; or if the target thought that sanctions would be imposed regardless of its behavior, but is subsequently persuaded that, in fact, the sanctions will cease if it yields. Otherwise, with perfect knowledge and rational decision-making, sanctions that are actually imposed are bound to fail precisely because they were imposed, i.e. because they failed at the threat stage.

Further selection occurs even earlier than the threat stage. The literature has examined thoroughly how strategic interaction during the sanction episode affects sanctions outcomes and duration (for example, [15], [7], [14], [5], [6], [12]). Much fewer studies have undertaken the possibility that states also act strategically before episodes, when choosing whether to challenge the status quo and how much to demand of the target. Theories around this stage of the “game” are referred to as endogenous demand theories. Krustev [11] proposes the idea that perhaps “strategic demands can account for the widely cited discrepancy between the frequent use of sanctions and the modest success rate of these instruments”. His game-theoretic model has the implication that oftentimes sender governments strategically choose hard cases, because “the uncertain prospects that the target agrees to a large demand might outweigh the certain prospects of receiving minor concessions”. This also results in a low observed success rate.

Beyond the difficulties related to selection, another challenge that the analyst faces is to isolate the effect of sanctions. Usually, sanctions are not adopted in a vacuum, but rather complement other types of actions (e.g. diplomatic pressure, military action), which interact with the success of the measures. Similarly, there is the issue of unintended consequences, that also affect the costs on both parts, and hence the likelihood of success. Most importantly, some of these unintended effects might change the situation so drastically that talking about success or failure does not make sense anymore.

Unintended Consequences

Besides the success or failure with the specific goals they are intended to obtain, economic sanctions bring about a host of more or less foreseeable unintended consequences as well. One especially undesirable outcome of trade sanctions has recently been brought to attention from the analysis of former Yugoslavia [2]. Under a regime of import restrictions, private and public actors might be pushed towards the use of unlawful methods in order to avoid the sanctions and reach the international market through unofficial ways. An unhealthy cooperation between politicians, organized crime and smuggling networks might then establish itself and persist even beyond the duration of the sanctions.

This consideration speaks against isolating the target country from trade flows. A case in itself concerns, though, trades which already lie on the boundary of lawfulness and little contribute to the productive sector, such as arms traffic. These can and should be decisively stopped. Aside from the security benefits to such a move, this also has the potential to dry up a significant source of revenue for the contested leadership.

Be it on credit or on trade, it goes without saying that any restriction will hurt the economy. The political consequences of an economic downturn caused by the sanctions are not easy to foresee. Recent research on fragile states [3] studies the relationship between national incomes and two types of political violence: repression, i.e. unilateral violence by the incumbent government, and civil conflict, two-sided use of violence on the part of the state as well as insurgent groups. The link with the national income prospects is given by the consideration that both parts, deciding whether to resort to violence, evaluate the cost and benefits of violent action. The incumbent government has a cost-advantage, being able to dispose of the state resources. The costs for potential insurgent factions go down with deteriorating economic conditions, for example in presence of high unemployment, because then those involved have less to lose. Insurgence then becomes more likely. This theory is consistent with the last century’s worth of evidence, including the recent wave of revolutions in the Arab world, suggesting that countries seeing a decline in incomes move towards democracy considerably faster. The evidence is anecdotal, though, and more rigorous empirical analysis [1] revealed no significant pattern.

Moreover, the step between opposition insurgence and the establishment of a new, possibly democratic, regime might not be rapid at all, as the Syrian tragedy is reminding us of every day. The question is then whether the leverage of economic measures from outside is likely to make any difference during this phase. As analysts push for the political and logistical backing of the international community to the revolt in Syria, and as Saudi Arabia is arming the rebels, we must consider that also measures aimed at supporting eventual opposition factions, or the democratic system in general, might have undesirable consequences. Comparative statics in the context of the same theoretical framework referred to above show that, for example, the promise of financial assistance conditional on free multi-party elections may raise the incumbent’s perception of instability and hence raise the risk of repression and increased looting, unless combined with reforms to strengthen executive constraints. Even pressure for the release of political prisoners might set out a ransom system, with perverse incentives to taking more and more prisoners to be exchanged with economic assistance – this might still be a risk in Myanmar, given the abundance of political prisoners still held by the government.

Another important difference between trade and financial restrictions is that the former are likely to result in accumulation of debt. The burden of this debt, that the sanctioned regime is responsible for, will weigh on the future growth of the country, hence on future generations of taxpayers and potentially on a future government, which ideally should not be held accountable for the course of action chosen today by a contested leadership. Alternatively, in the case of a collapse of the economy, the debt could be defaulted. This risk is on the countries or financial institutions that today lend money to the sanctioned regime. In other words, interrupting trade without at the same time closing the lines of credit would put the sanctioning part or third part lenders in the least desirable situation.

In some cases, the target has the possibility to resort to alternative lenders in third countries. Although this is preferable to a situation where the sanctioning part itself bears the risk on the debt, it is not ideal because it frustrates the sanctioning effort. An innovative proposal has been put forward by Jayachandran and Kremer [10], related to the legal doctrine of odious debt. They propose that any debt incurred by a particular regime, that could be argued to be contracted without the consent of the people and not for their benefit, is declared by some supranational institution illegitimate and nontransferable to successor regimes. This would create disincentive for lenders in third countries, and potentially eliminate equilibria with illegitimate lending. Even this type of loan sanctions hurt the economy and hence ultimately the population; however they create a long-run benefit for the population by preventing the accumulation of an unjust debt that today finances mismanagement, looting or repression and tomorrow has to be repaid by someone who never agreed to incur it. It would be very interesting to see this solution implemented in practice!

Conclusion

In short, sanctions are difficult to implement so as to reach the intended goal and minimize the unintended effects, but are maybe even more difficult to study systematically. International disputes are often complicated matters, situations that evolve over long time horizons. The traditional research question of when sanctions work might not be the most relevant one. Including in the analysis the strategic behavior occurring at the threat stage, and even before that, is a first step, although basing policy on the prediction that threats work better than sanctions does not strike me as a very useful conclusion.

The fact that evaluation is problematic and generalization almost impossible does not mean, however, that the study of sanctions is useless altogether. Economic analysis may still be informative for decision-making, and produce innovative ideas on the design of supranational institutions for conflict management, like the proposal on odious debt illustrates.

Bibliography

[1] D. Acemoglu, S. Johnson, J.A. Robinson, and P. Yared. Reevaluating the modernization hypothesis. Journal of Monetary Economics, 56(8):1043–1058, 2009.
[2] P. Andreas. Criminalizing consequences of sanctions: Embargo busting and its legacy. International Studies Quarterly, 49(2):335–360, 2005.
[3] T. Besley and T. Persson. Repression or civil war? American Economic Review, 99(2):292–297, 2009.
[4] J. Dashti-Gibson, P. Davis, and B. Radcliff. On the determinants of the success of economic sanctions: An empirical analysis. American Journal of Political Science, pages 608–618, 1997.
[5] H. Dorussen and J. Mo. Ending economic sanctions. Journal of Conflict Resolution, 45(4):395, 2001.
[6] D.W. Drezner. The hidden hand of economic coercion. International Organization, 57(03):643–659, 2003.
[7] J. Eaton and M. Engers. Sanctions: some simple analytics. The American Economic Review, 89(2):409–414, 1999.
[8] F. Hoffmann. The functions of economic sanctions: A comparative analysis. Journal of Peace Research, 4(2):140–159, 1967.
[9] J. Hovi, D.F. Sprinz, and R. Huseby. When do (imposed) economic sanctions work? World Politics, 57(4):479–499, 2006.
[10] S. Jayachandran and M. Kremer. Odious debt. The American economic review, 96(1):82–92, 2006.
[11] V.L. Krustev. Strategic demands, credible threats, and economic coercion outcomes. International Studies Quarterly, 54(1):147–174, 2010.
[12] D. Lacy and E. Niou. A theory of economic sanctions and issue linkage: The roles of preferences, information, and threats. Journal of Politics, 66(1):25–42, 2004.
[13] J.M. Lindsay. Trade sanctions as policy instruments: A re-examination. International Studies Quarterly, pages 153–173, 1986.
[14] T.C. Morgan and A.C. Miers. When threats succeed: A formal model of the threat and use of economic sanctions. In Annual Meeting of the American Political Science Association, Atlanta, GA, 1999.
[15] G. Tsebelis. Nested games: Rational choice in comparative politics, volume 18. Univ of California Press, 1990.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Inflation Expectations and Probable Trap for Macro Stabilization

Posted on February 27, 2012 | Policy Brief

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As of today, a majority of the negative consequences of the deep Belarusian currency crisis of 2011 seem to have been realized. Hence, the Belarusian economy is now ‘purified’ from main macroeconomic distortions and has a chance for sustainable long-term growth. Nevertheless, there are signals that some nominal and real inertia may generate new shocks for the national economy. From this view, the money market is of great concern, while interest rates signal maintained high inflation expectations. High and unstable expectations may entrap monetary policy and generate new shocks for the Belarusian economy. In this policy brief, we deal with a visualization of inflation expectations and argue for the necessity of a new nominal anchor in order to stabilize expectations for future periods.

In 2011, Belarus experienced its highest inflation and devaluation in modern history. These were consequences of the automatic macroeconomic adjustment determined by a number of both long- and short-term distortions in the national economy. Changes in prices and exchange rate adjusted real parameters towards their long-run equilibrium level. Hence, from a long-run perspective, one may interpret these adjustments as favorable since they ‘purified’ the economy from the macroeconomic imbalances that may have hampered growth. Furthermore, shifting from exchange-rate (XR) targeting to a managed float is another essential aftermath of the currency crisis. Economic authorities had to recognize that accommodative monetary policy (MP) was not compassable with XR targeting since it resulted in a considerable overvaluation of the real XR, and correspondingly, an incredibly large current account deficit. Thus, the new exchange rate regime may be argued to be a new automatic stabilizer for Belarus, providing the level of current account balance consistent with other macroeconomic fundamentals. Overall, the current stance of the national economy might be treated as a chance to “begin again from the ground up”. In this sense, the Belarusian economy as of today is sometimes compared to the Russian economy after its crisis in 1998, which then performed particularly high growth rates.

In our opinion, realizing the opportunity for a strengthening of long-term growth through structural changes undoubtedly should become a policy priority of Belarus in the near future. However, it should be emphasized that despite “purification” from major macroeconomic imbalances, there are still a long list of short-term challenges. In particular, one may stress the risks of expansionary policy revival; increasing external debt burden; growth in non-performing loans, which may undermine the solvency of the banking system; reduction of foreign demand due to shocks in global economy. These risks are more or less observable and may be monitored. Hence, the realization of one or the other shocks from this list might not come as a surprise, and economic authorities seem to at least realize this, and when possible, take prevention measures.

At the same time, another challenge seems to be more adverse and urgent; namely, the question of inflation and devaluation expectations. In economic theory, expectations play a crucial role in affecting behavior of economic agents. Recognition of the role of expectations at the money market determined intention to “subject” and stabilize these within modern monetary policy frameworks.

In Belarus, given the recent history of high inflation and devaluation, corresponding expectations of Belarusian economic agents are likely to be rather high. Moreover, shifting from XR targeting to a managed float has not yet resulted in provision of a new nominal anchor for the public.

For instance, disinflation was declared to be a priority goal, but there are no strict commitments on its numerical value, as well as in respect to procedures and mechanisms to provide disinflation trends. As of today, the Belarusian MP regime can hardly be classified as a standard regime. The MP Guidelines for 2012 assume indicative targets on international reserves, refinancing rate and the growth rate of banks’ claims on the economy. The latter witnesses the propensity to monetary targeting. However, the instable relationship between the monetary aggregate to be targeted and the ultimate goal (inflation), as well as the indicative nature of this commitment give rise to doubts in respect to treating it as monetary targeting. Furthermore, commitment on bank claims on the economy can hardly be treated as a nominal anchor for the public. According to the taxonomy of MP regimes by Stone (2004), Belarus is currently closer to the weak anchor regime, which assumes “no operative nominal anchor…and central bank reports a low degree of commitment… and high degree of discretion”.

Thus, our hypothesis assumes that there has been an adverse shock in inflation expectations due to weak nominal anchor and recent experience of huge inflation. If that is the case, this may be an additional source of shock for the money market, which may cause a new wave of macroeconomic instability. In order to make policy recommendations, this hypothesis needs empirical support. However, it is difficult to identify expectations in empirical analyses since this variable is typically unobservable and cannot be univocally measured. Instead, expectations are most often treated indirectly through other variables. Many central banks deal with the results of sociological polls on this issue, but these approaches may suffer from different economic meanings and measurements of inflation expectations by economic agents.

An alternative approach was proposed by St-Amant (1996) and extended by Gotschalk (2001), who base on famous Fischer equation representing current nominal interest rate as the sum of ex-ante real interest rate and expected inflation. Further, based on the approach by Blanchard and Quah (1989), structural vector autoregression (SVAR) between nominal and real interest rate is identified with a number of restrictions, which allows decomposing changes in the nominal rate to those associated with ex ante real rate and inflation expectations. The latter may be used as a measure of inflation expectations. Such a measure of inflation expectations assumes explicit economic meaning referring to the money market, i.e. the rate of future inflation, which will provide the, by economic agents, expected level of interest rate. Taking the data from statistics (not polls) and international comparability of such estimates are important advantages of this approach.

We applied this methodology to Belarusian data (nominal and real interest rate on ruble households’ deposits with a term more than a year). The obtained time series measure changes in inflation expectations in the current period for a period of the next 12 months. However, our goal is to visualize the level of inflation expectation and not changes in expectation. Therefore, we use the series in levels, choosing January 2003 as the base period (when National Bank of Belarus actually shifted to XR targeting regime), and assigned a zero level (as starting one) to it. The obtained series of inflation expectations is provided in Figure 1.

Figure 1. Inflation Expectations in Belarus

The estimated series of inflation expectations show a decrease in 2003 – mid 2005, which may be explained by the effectiveness of the new nominal anchor (XR), and correspondingly the expected disinflation. The expectation of reflation in late 2005 till late 2007 may be explained by the more expansionary policy and changes in Russian preferences that took place during this period. After that, there was a period of stable expectation, which is likely to be explained by the credibility of the nominal anchor (nevertheless, there was a shock in late 2008 that is associated with the impact of the global crisis).

The most considerable shock took place in the beginning of 2010, which has a lack of intuitive explanation and might be associated with a phase of radically expansionary policy.

Finally, a new significant shock took place in late 2010 – beginning 2011 which might be associated with the visualized problems at the currency market at that time.

Currently, there is a very high level of inflation expectations and its increased volatility in the second half of 2011 seem to be of a great importance. It signals that economic agents do not treat price shocks as a single-shot, but mostly tend to consider it as a long-lasting process. Hence, the absence of a nominal anchor and the fresh memory of huge inflation seem to be responsible for the current high and instable inflation expectations.

Maintenance of high inflation expectations is a dangerous threat for the money market. Propagating inflation through expectations may be considered as a separate channel within the monetary transmission mechanism (along with interest rate, exchange rate and bank-lending channels). In other words, even without additional fundamental preconditions for inflation, inflation expectations may become a self-fulfilling prophecy.

However, during the last two months (December 2011 and January 2012) this adverse effect seems to have been suppressed by monetary authorities, as the monthly inflation rate reduced radically in comparison to average rate in May-November 2011. This is likely to be the outcome of the significant monetary policy tightening that has resulted in a sharp increase in nominal interest rates by banks. On the one hand, such nominal interest rate complies with the shocks in inflation expectations and real ex ante interest rate (the latter grew as well at the background of the crisis). In other words, current level of nominal interest rates will equalize ex post real rate with ex ante real rate if the actual inflation rate has been as high as current inflation expectations. But on the other hand, if actual inflation had been much lower than expected one (and it tends to be so, in case of keeping on conservative MP), ex post real rate would be much higher than the ex-ante one. For instance, such a situation has already been peculiar during December and January: according to our estimations, ex ante real interest rate in December was about 3.6% in annual terms (preliminary data on January shows that it in this month it is rather similar), but annualized ex post real rate for these months is about 30%.

This suggests that there is a trap for the monetary authorities. If they keep high interest rates, based on the expected inflation, the impact of expectations on actual inflation will be mitigated, but the losses, say in terms of output, will be high because of the extremely high ex post real interest rates. If the monetary authorities facilitated the rapid reduction of nominal interest rates, current nominal rates would not guarantee ex ante real interest taking into consideration the high inflation expectations, which would then constitute a severe shock for the money market. Hence, the mechanism of self-fulfilling prophecy would work.

Furthermore, the increased ex ante real rate (and high probability of even higher ex post real rate in national currency) could give speculative incentives for a number of economic agents. For example, many agents could increase the share of national currency in their savings portfolio, either avoiding buying hard currency (which took place during the peak of the currency crisis) for new deposits, or changing the nomination of their deposits to the national currency (i.e. selling the hard one). In a sense, this trend may be interpreted as the compensation of losses on ruble deposits in the last year, which is needed to revive the demand for such deposits. But in any case, these internal processes (along with restricting money supply by the National bank) influence the domestic currency market. Through this, the supply and demand are formed not only due to current and financial international flows. Hence, due to these incentives for hard currency supply and demand, the current value of the nominal rate may substantially deviate from the equilibrium rate. The latter may be defined as in Kruk (2011): the one that may clear the market immediately (given short-term trends in current account flows at the background of medium-term values of other fundamentals).

Figure 2. Actual and Equilibrium Exchange Rate

Note: For 2010Q1-2011Q1 official rate of the National bank is taken as actual nominal rate, for 2011Q2 the exchange rate at the ‘black market’ (used by internet shops), and for 2011Q3 ‘black market’ and later the exchange rate of the additional BCSE session are taken.

The assessments of the equilibrium exchange rate based on this methodology (Kruk (2011)) show that in the third quarter, the actual rate almost equals the equilibrium rate. For 2011Q4, all necessary data is not available yet, but an approximate assessment correction of the equilibrium rate of the Q3 for average inflation between Q3 and Q4 may be used (i.e. in real terms the rate should not have changed in order to sustain equilibrium). Such an assessment indicates that the actual rate in the Q4 is again overestimated by roughly 5-10% in comparison to the equilibrium rate.

At a first look, such an ‘overhang’ at the domestic currency market seems to not be a great problem. But along with the trap stemmed from the high and unstable inflation, this may contribute and propagate possible shock at the money market. Furthermore, this ‘overhang’ is due to speculative incentives, which in turn, are due to high inflation expectations. Hence, high and unstable inflation expectations are a prime cause of this ‘overhang’.

Finally, we may argue that unfavorable inflation expectations is a multidimensional problem, which generates grounds for shocks at the money market and entraps monetary policy at the current stage. Therefore, restraining inflation expectations must currently be an absolute and unconditional priority of economic policy.

This gives rise to the issue of which policy tools that are needed for solving this problem. Tight monetary policy alone may not be enough and/or its losses in terms of output may be unacceptably high, especially taking into account that keeping the Belarusian economy depressed is likely to cause huge migration and thus reducing the prospects for long-term growth.

Our view on the problem of inflation expectations supposes that they stem both from recent experience of very high inflation and the absence of nominal anchor. Inflation memory cannot easily be removed, but introducing a new nominal anchor seems to be worthwhile. Among possible options, given the desire to preserve autonomous monetary policy in Belarus, the introduction of inflation targeting (IT) is seen as inevitable. A shift to this regime is associated with plenty of obstacles and might not be realized immediately (Kruk (2008)). A gradual shift to IT through its intermediary phases (so called IT Lite) is more expedient and complies more with the requirement of obtaining new powers and capacities at the National Bank of Belarus.

Taking on more and more strict commitments in terms of inflation and implementing mechanisms and procedures peculiar for IT (the latter is even more important than commitments themselves) will increase credibility and public trust for the National bank. The other side of the coin involves decreasing and less volatile inflation expectations, which do not challenge monetary policy and facilitate low and stable inflation. Another advantage of IT is the possibility to mitigate price shocks.

Our main policy recommendation is therefore that it is necessary to shift to an IT framework as soon as possible, starting from exploiting the forms of IT Lite. The advantages of this step overweigh all the obstacles, including those associated with the reluctance of economic authorities to change institutional preconditions.

However, one important clause should be emphasized. Shifting to IT (especially gradually through IT Lite) does not guarantee that current high inflation expectations will be reduced automatically and immediately. In other words, it does not guarantee that the cost of reducing inflation in terms of output will decrease (though for the present Belarusian situation there are grounds to suspect that it would facilitate). For instance, Mishkin (2001) shows that “there appears to have been little, if any reduction, in the output loss associated with disinflation, the sacrifice ratio, among countries adopting inflation targeting… The only way to achieve disinflation is the hard way: by inducing short-run losses in output and employment in order to achieve the longer-run economic benefits of price stability”. However, an introduction of IT assumes that new shocks in inflation expectations may be prevented, and due to it, low and stable inflation will be more likely.

▪

References

Blanchard, O., Quah, D. (1989). The Dynamic Effects of Aggregate Demand and Supply Disturbances, American Economic Review, Vol. 79, No.4, pp.655-673.
St-Amant, P. (1996). Decomposing US Nominal Interest Rate into Expected Inflation and Ex Ante Real Interest Rates Using Structural VAR Methodology, Bank of Canada, Working Paper No. 96-2.
Gottschalk, J. (2001). Measuring Expected Inflation and the Ex Ante Real Interest Rate in the Euro Area Using Structural Vector Autoregressions, Kiek Institute of World Economics, Working Paper No.1067.
Mishkin, F. (2001). From Monetary Targeting to Inflation Targeting: Lessons from Industrialized Countries, World Bank, Policy Research Working Paper No. 2684.
Kruk, D. (2008). Optimal Instruments of Monetary Policy under the Regime of Inflation Targeting in Belarus, National Bank of Belarus, Materials of International Conference “Efficient Monetary Policy Options in Transition Economy”, pp. 305-322.
Kruk, D. (2011). The Mechanism of Adjustment to Changes in Exchange Rate in Belarus and its Implications for Monetary Policy, Belarusian Economic Research and Outreach Center, Policy Paper No. 004.

Privatization in Belarus – Obstacles and Perspectives

Posted on January 23, 2012 | Policy Brief

20121008 Monetary Policy in Belarus since the Currency Crisis 2011 Image 01

For a long time Belarus considered privatization as a minor factor in influencing the economy’s development, competitiveness and effectiveness. The former economic model relied on concessional loans and donations from Russia and various international organizations. The 2011 financial crisis led to the breakdown of this model and forced the authorities to reconsider privatization. A draft of a new law on investment has been prepared, which is aimed at increasing foreign capital inflow to the country. However, it does not contain sufficient measures to significantly raise the investment attractiveness. In turn the lack of such attractiveness can have a very negative effect on the economy in the near future.

Belarus is right now facing a currency crisis primarily due to three factors:

A growing deficit of trade and payment balances;
The National Bank’s continuing Belarusian ruble emission partly because of pre-elective directive wages’ raise;
A lack of foreign currency reserves required to keep the USD exchange rate at BYR 3100 level.

However, the key problem is a growing negative balance of payments, which in January-June 2011 amounted to USD (-1032.6) million against USD (-82.2) million in January-June 2010.

The Belarusian ruble devaluation, which occurred in May 2011, managed to improve the trade balance situation and gradually lead to export earnings growth. That in turn reduces the current account deficit, which amounted to USD (-1630.4) million in the second quarter of 2011 against USD (-3657.2) million in the first quarter 2011.

Negative foreign trade balance mostly forms negative balance of payments of the country, and problems with external payment capacity are likely to occur under conditions of trade deficit preservation. Moreover, taking into account that the main repayment share of external debt should be paid in 2012-2014 it is necessary to attract additional funding sources.

Table 1. External debt repayment scheme

For this to be feasible privatization as a major long-term capital raising instrument will be required for the following reasons:

Belarus will not be able to borrow in the external markets in the near future. This is due to impossibility of attracting loans from international organizations as well as extreme expensiveness and inexpedience of sovereign debt securities placement in global stock markets.
Before the 2011 crisis, public and private companies were able to attract bank and state financing programs’ sources for the financing of their activities. However, the unstable economic situation in the country has forced the authorities to cut the state programs’ funding (BYR 12 trillion instead of requested BYR 36 trillion, while BYR 22 trillion were spent in 2011) in order to prevent further inflation and to provide a budget surplus. Moreover, the economic crises resulted in a decline in domestic demand of the population and the corporate sector simultaneously, with reduced domestic savings levels as a consequence. During the first eleven months of 2011 savings dropped by 25% in USD terms in comparison to the corresponding period of the previous year. These occurrences in the economy make a search of a strategic partner through additional issue of shares or mergers with other agents the only source of financing attraction for state and private companies.

Speaking about the current situation, it should be noted that Belarus planned to get around USD 3 billion from privatization in 2011. 178 assets were to be sold according to the privatization plan. However, just around 38 assets were sold in 2011 and the country managed to gain around BYR 150 billion (USD 17.6 million) from that. Thus, the result cannot get positive evaluation right now.

The main reasons for the slow privatization process and weak foreign capital inflows are the following:

The multiplicity of agencies responsible for privatization. There are too many responsible decision-makers, which potential buyers have to contact. In addition, it is not very clear which agency is responsible for this or that asset. The State Property Committee and the National Agency for Investments and Privatization (NAIP) supervise the state asset sales today. However, ministries and local authorities are also responsible for privatization plan accomplishment.
Difference in asset valuation methods. Investors, while analyzing any investment project, tend to focus on the cash flows that the project will be able to generate and how soon the costs will be covered. The Belarusian side values the asset according to its’ book value, below which the price cannot fall. This often results in large price differences.
Additional requirements. The presence of additional requirements is a common phenomenon, but only when the price negotiations are more flexible. But it distracts investors in case the requirements are followed by a fixed overestimated price.
Lack of transparency. Periodically the deals are announced, which were closed not during the auctions or tenders but after the closed backroom negotiations. That also affects negatively investors’ opinion about the country
High share of public sector. Private sector is mostly represented by small and medium businesses. Thus, the strategic investors’ interest in them is initially lower. Moreover, they are unable to invest by themselves due to a lack of resources.

In addition, the authorities and enterprise management demotivation in the privatization process, an undeveloped culture of IR and consulting services usage, and the fact that it is often non-controlling stakes that are put up for sale, are also obstacles in the process.

These are the main problems influencing the foreign capital inflow rates. Their solution and elimination should increase the economy’s investment rates as there is an interest in the country’s assets and it is high enough.

As was mentioned earlier, the sale price of an asset is estimated according to its’ book value in Belarusian rubles. The national currency devaluation, which occurred in May and October 2011, has significantly reduced assets’ real value in USD terms and therefore a sharp drop in prices occurred. Starting from March 2011, the national currency depreciated by 181%, and the fall in real value of assets on sale was comparable. The analysis of transactions, which were closed during the auctions held in 2011, showed that the companies acquired by the investor were generally highly undervalued even in the beginning of 2011.As a result of devaluation, the ratio of asset price to revenue (P/S) dropped by 1.67-1.8 times. OJSC “Zhlobinmebel” (P/S=0.3 January 2011, P/S=0.18 in June 2011), OJSC “Vitebskles” (P/S=0.37 – January 2011, P/S=0.2 – June 2011) .

On the other hand, in accordance with Presidential Decree #476, the revaluation of fixed assets should be done by January 1, 2012 and adjusted to PPI, which equaled to 82% in October, 2011. Such adjustment will still not be able to cover the depreciation resulting from the devaluation. Therefore, there will be a gap between the announced corrected asset price and its real value at least for another year.

Nowadays, the demand is formed by Belarusian export-oriented companies. Their products have become more competative in the markets as a result of devaluation and have caused some growth in earnings. Consequently, they are ready for vertical and horizontal integration with attractive companies operating in the local market in order to expand the production and increase their niche in the global markets.

As for foreign investors, macroeconomic stabilization is necessary in order to make them wanting to enter the Belarusian market. Moreover, foreign buyers are attracted by the strategic Belarusian companies rather than by the small and medium business. This is because they are then able to generate sufficient profit volumes even in the short-term period.

Conclusion

The privatization process will be much more active and intensive in the forthcoming 2012, in comparison to what we have seen during 2011. This is determined on the one hand by a great need in external capital and on the other hand by sufficiently favorable acquisition conditions. However, obviously the privatization process and plan should be reviewed and optimized.

It might be more efficient to put on sale, not just companies’ shares, but also controlling interest as it should increase buyer interest.

It is also possible to sell assets at a minimum fixed price (in case it has losses and no perspectives with current owner), or the authorities could reduce the amount of requirements which accompany the transaction.

Finally, it should be noted that the privatization of small companies will not generate sufficient amounts of foreign capital to the country. In order to achieve that goal, Belarus will have to sell some large strategic assets. It already sold the state’s controlling interest of OJSC “Beltransgaz” to OJSC “Gazprom” for USD 2.5 bln. As for other assets, it is most likely that these will be 51% of shares sale of OJSC “MTS”, 51% shares sale of OJSC “Naftan” in exchange of USD 1 billion syndicated loan issued by “Sberbank Russia” and EABR, as well as a merger of OJSC “MAZ” with Russia’s corporation “Russkie Mashiny” or OJSC “KAMAZ”.

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References

http://nbrb.by/statistics/BalPay/Analytical/Current/
http://banki.bel.biz/?p=4167
http://www.interfax.by/news/belarus/101635
http://belstat.gov.by/homep/ru/indicators/doclad/2011_11/6.pdf
http://www.gki.gov.by/about/press/news/e4fc4311733e0af1.html
http://minfin.gov.by/rmenu/departament/itogi-emit/itogi-oao/
http://www.president.gov.by/press127520.html

Multidimensional Approach to the Energy Security Analysis of Belarus – Part 2: Economic and Geopolitical Trends

Posted on October 17, 2011 | Policy Brief

Author: Mykhaylo Salnykov, BEROC

Energy security is a complex phenomenon incorporating a variety of economic, social and environmental aspects of a country’s life. Building on a previous FREE policy brief, published on September 5, which dealt mainly with the situation up until today, this text deals more with the future. It takes a detailed look at existing trends and discusses potential positive effects and challenges to energy security in Belarus. It also provides potential measures for addressing adverse effects of these trends on the country’s energy security.

When evaluating energy security consequences of external and internal factors, a decision maker is advised to view energy security as a complex phenomenon. The main components of Belarusian energy security identified in the first part of this paper published in the FREE Policy Brief Series September 5, 2011, include (i) primary energy source distribution (diversification of energy sources, especially away from natural gas as well as reducing the economy’s energy intensity), (ii) international trade considerations, (iii) the geopolitical context (with a special focus on diversification of energy suppliers and an optimal use of the country’s gas- and oil- transporting systems), and (iv) environmental considerations of the energy use (related to both actual and the perceived impact of the energy production and consumption on the environment).

Other dimensions of energy security also include the social impact of energy production and consumption, as well as the sustainability of energy use.

Below, I provide a detailed look at these and other existing trends. Potential positive effects and challenges in the context of energy security of Belarus will also be discussed. Finally, potential measures of addressing adverse effects of these trends on the country’s energy security will be suggested.

Main Energy Security Challenges for Belarus in 2011-2020

The following components of the energy security of Belarus are considered to be of primary importance:

Reducing energy intensity of the economy;
Diversification of energy sources used in heat and power generation, especially diversification away from natural gas consumption;
Diversification away from Russian fuel imports;
Securing stable operation of gas and oil pipeline systems close to full capacity;
Reducing impact of energy production and consumption on the environment.

The main trends in Belarusian and regional policy and economy, as well as their impacts on the aforementioned components of energy security are the following:

Natural shale gas and liquefied natural gas revolution in Europe;
Launch of the Nord Stream gas pipeline system in 2011-2012;
Construction of nuclear power plant station in Astravets;
New suppliers of hydrocarbons to Belarus.

I will purposefully not discuss important topics as carbon-free technologies development in Belarus, participation in the international carbon-reduction dialog, etc., since these trends are unlikely to become anything close to significant determinants of the Belarusian energy security puzzle within the next decade.

Natural Shale Gas and LNG Revolution in Europe

Recent developments in the technology of natural shale gas extraction in Europe and elsewhere, bring a lucrative prospect of boosting the world’s natural gas supply. Several of the European countries, including Austria, Germany, Hungary, Poland, Sweden, Ukraine and United Kingdom have announced plans to study fields with shale gas extraction potential. This could secure European gas supplies, drive gas prices in Europe down, and diversify European imports away from Russian natural gas. The natural shale gas extraction development factor will be further reinforced by the increased volumes of the LNG imports to Europe from the Americas and Northern Africa.

Contraction of gas prices in the European market will positively affect Belarusian economy as natural gas imports from Russia will become less expensive even if no active steps by the Belarusian government are undertaken. Nevertheless, the natural shale gas and LNG revolution will also widen the body of potential importers of natural gas via pipelines from Poland and Ukraine and by sea freight from seaports in the Baltic States. Specifically, in the summer of 2010, the Belarusian government announced having plans of negotiating a possible construction of a Belarusian LNG terminal in Lithuanian Klaipeda. This terminal is projected to have an annual capacity of five to eight billion cubic meters of natural gas which would be transported to Belarus via the pipeline system.

The shortcoming of the lower prices for natural gas and diversified body of importers in Europe is a reduced demand for Belarusian natural gas transit capacity as Russian exports to Europe contract. Moreover, potential transportation of shale gas from Poland via the pipeline system (see Figure 1) is likely to conflict with the Russian gas transit going into the opposite direction. From an economic perspective, it is very likely that benefits for Belarus obtained from lower gas prices will overweight potential losses from the reduced transit of Russian natural gas to Europe.

Figure 1. Natural gas and oil pipeline systems in Eastern Europe.

Source: http://www.eia.doe.gov/emeu/cabs/Russia/images/fsu_energymap.pdf

From a political perspective, Belarus losing its role as a transit country would substantially weaken its position in foreign relations with both Russia and Europe.

A possible side effect of the lower prices for natural gas is reduced incentives for the Belarusian government to reform power and heat generating sector and contract the energy intensity of the economy. While the former outcome may be economically justified by lower gas prices and diversified sources of natural gas in the new economic environment, the latter raises serious concerns over the pace of economic modernization in the country.

On the other hand, the environmental impact is mixed. While lower incentive to modernize the economy could result in a slower progress of lowering the pollution intensity in energy use, increased incentives to use natural gas, one of the environmentally friendliest hydrocarbons, would play a positive role in ensuring that the intensity of pollution reduces.

Launch of the Nord Stream Pipeline System

Dubbed by the Belarusian President, Aliaksandr Lukashenka “the silliest Russian project ever”, the Nord Stream pipeline system will allow Russia to redirect 55 billion cubic meters of natural gas (nearly 33% of the current Russian gas exports) via this more direct route to the final consumers. Thus, if European demand for Russian gas stays unchanged, the gas transit through Belarus and Ukraine will drop to nearly 100 billion cubic meters from the current 158 billion cubic meters. The 100 billion cubic meters figure is close to the capacity of the Ukrainian gas pipeline system alone. Therefore, one may hypothesize that in the worst case scenario Belarus may suffer a complete loss of its gas transit revenues.

In fact, even optimistic scenarios of the distribution of the residual transit demand between Ukrainian and Belarusian pipeline systems, imply both a substantial reduction of volumes transferred via Belarusian pipeline system, and a decline in transit tariffs triggered by strong price competition between Belarus and Ukraine. As a result, profits from the gas pipeline system in Belarus are likely to diminish.

This negative outcome is reinforced by the above mentioned trends of increased extraction of natural shale gas in Europe as well as prospective development of the LNG trading routes with Northern Africa and Americas. A conservative estimation of the reduction of European demand for Russian natural gas indicates that it can be reduced by 28 billion cubic meters (17% of the current Russian imports). Coupled with the launch of the Nord Stream, the decline of transit volumes through Belarus and Ukraine can be nearly 75 billion cubic meters annually, which is more than a 50% reduction from current levels.

Notably, these 28 billion cubic meters is an equivalent of the natural gas consumption by Poland and Hungary alone, the European countries currently most dependent on Russian gas imports.

Thus, the launch of the Nord Stream presents a substantial threat to the stable operation of the Belarusian gas pipeline system and requires careful policy steps (which will be discussed further ahead).

The fact that Belarus loses an important lever of its transit capacity may lead to lower negotiation power in fuel prices dialog with Russia, thus, leading to the smaller subsidies for the Russian oil and gas imports. However, a reduction of the world gas prices due to the growing European production of natural gas and LNG trade is likely to at least partly offset this effect.

Reduced profits received from the natural gas transit is likely to lead to a decrease of budget funds available for technological modernization of the Belarusian economy, which, in turn, may lead to an inadequate pace of changes in energy efficiency and pollution intensity of energy use as well as slower modernization of the power and heat generating sector and diversification away from the natural gas use.

On the other hand, the launch of the Nord Stream and reduced negotiation power towards Russia could increase incentives for Belarus to diversify away from Russian fuel imports as subsidies for the Russian oil and gas imports will contract.

Construction of Astravets Nuclear Power Plant

Although the launch of the Astravets nuclear power plant is unlikely to happen before 2017-2018, debates around this controversial project and its rationale requires a discussion of its energy security implications long before the plant is constructed.

The projected two-reactor nuclear power plant has an operating capacity of 2.4 GW. Unadjusted for load fluctuations in demand, this figure is an equivalent of 63.5% of the electricity consumption in Belarus. A rough seasonally unadjusted estimate of the Astravets nuclear power plant electricity production is a 35-40% of the daily peak load electricity consumption in the country – a usual figure for the baseload demand figure. Therefore, it is expected that once in full operation, Astravets plant could provide for the entire baseload demand on electricity in Belarus.

Some opponents of the Astravets plant construction note that the plant’s capacity may be excessive as several other nuclear power plants are being constructed in the region, including a plant in Lithuania and Russia’s Kaliningrad oblast. It is suggested that it may be optimal for Belarus to purchase electricity from these plants rather than constructing its own. This view, however, does not take into consideration two important issues. Firstly, it is highly unlikely that anything but the excess baseload electricity production will be traded (i.e. limited volumes of energy at night for approximately 5 to 6 hours per day); at all other time Belarus would need to rely entirely on its thermal power plants to generate electricity. Secondly, shifting from the dependence on hydrocarbon imports to the dependence on electricity imports will not cause a substantial improvement of the country’s energy security.

Current production of electricity by fossil fuel operated power plants in Belarus is an equivalent of 18 TWh, 55% of the total electricity consumption in the country. A launch of the Astravets nuclear power plant would allow reducing fossil fuel operated power plants’ utilization to virtually zero level. In addition, nearly 15% of the combined heat and power plants may operate as heat plants only.

Yet, it is unlikely to lead to the substantial changes in the usage of the existing heat plants: while nuclear power plants can provide heat, Astravets is located far from densely populated regions of Belarus, which makes heat delivery to the final consumer close to impossible because of the high losses in transfer.

As a result of decreased utilization of power plants and CHP plants, demand for natural gas from the heat and power generating sector will be reduced by 38%. Thus, the share of natural gas in the sector’s consumption balance will shrink to nearly 50% from the current 91% figure. The Astravets plant launch will also lead to nearly 25% reduction of the sector’s demand for petroleum products.

Therefore, the economy-wide TPES of natural gas is likely to contract by 28.5% and TPES of crude oil and petroleum products by nearly 2% once the Astravets plant is in full operation. The estimated annual benefit from the reduced imports of hydrocarbons is likely to reach USD 1 billion at current fuel prices.

Overall, Astravets power plant launch is expected to have strongly positive effect on diversification of energy sources in heat and power generating sector as nuclear power will gain the second largest share among the energy sources used in the sector and the natural share will reduce to nearly 50% of the total consumption by the sector. The plant construction is also likely to have a positive effect on the energy intensity by reducing losses from the power generating sectors and by closure of obsolete plants.

Moreover, the effect on diversifying fuel imports away from Russia is two-fold. Although Belarus will be able to reduce its Russian gas imports by almost a third of its current level, nuclear fuel for the Astravets station is likely to be imported from Russia. Nevertheless, given positive shifts in Belarusian regime’s relations with the West, it is highly likely that by the time of the power plant launch, the current suspicion of the Belarusian government by the international community will have vanished and alternative importers of uranium would then become an option.

Overall, the Astravets plant will have very limited impact on Belarus’ role as a transit corridor for Russian hydrocarbons.

Environmental consideration is probably the most controversial issue with respect to the projected plant. The issue becomes even more uncertain when one takes into account not only objective environmental costs and benefits, but also subjective factors, such as suspicion of Belarusians to nuclear power – a legacy of the Chernobyl accident.

A nuclear power plant will undoubtedly lead to a reduction of pollution intensity in the Belarusian economy. Yet, there are a number of factors that may offset the seeming gains. Firstly, a low probability of technological disaster at the power plant, mean that most Belarusians consider the plant as an environmentally but dangerous project for the country. Secondly, Lithuanian environmentalists have expressed their concerns over the proximity of the projected plant to the Lithuanian capital, Vilnius (only 40 km), especially as the Neris (Viliya) river that flows through Vilnius will be the main water source for the Astravets plant. Thirdly, international environmental experts rarely consider nuclear power plants considerably greener than their fossil fuel operated counterparts as uranium extraction and enriching produces substantial amounts of polluting substances at their fuel producing facilities. Finally, spent nuclear fuel treatment still remains one of the issues without a sustainable technological solution. Belarus is likely to export its nuclear waste to either Russia or Ukraine that have spent nuclear fuel storage facilities.

Therefore, from an environmental perspective, while Belarus will enjoy most of the benefits of the cleaner power generation, it is likely to create substantial trans-boundary environmental risks mostly for Lithuania, Russia and Ukraine.

New suppliers of hydrocarbons

Belarus currently attempts to diversify its oil supply by shipping Venezuelan crude to Black Sea and Baltic Sea ports. In addition, there exists a sound potential of diversifying Belarusian natural gas imports by gaining access to Ukrainian and Polish natural shale gas deposits as well as through constructing an LNG terminal at the Baltic Sea.

While the perspectives of these recent international advancements are not certain, in the case of sustainable progress they are likely to have important implications for the energy security of Belarus, which are closely interrelated to the implications of the shale gas and LNG revolution.

Emergence of new suppliers of hydrocarbons will have a positive impact on diversifying away from Russian fuel imports, but will also reduce incentives for the energy intensity and pollution intensity reduction as well as the modernization of the heat and power generating sector as economic stimuli for technological modernization fade away.

Diversification of hydrocarbon suppliers presents risks for the usage of Belarusian gas and oil pipeline systems. If oil would be transported from either Black Sea or Baltic Sea ports, this oil would compete with the Russian oil transport routes headed into the opposite direction to either Ukrainian Odesa seaport or Baltic refineries (see Figure 1). Pipeline transportation of shale gas from Poland would compete with Russian natural gas going in the opposite direction. At the same time, reduced revenues from transit of Russian hydrocarbons may be overweighed by benefits incurred from lower prices for hydrocarbons from the alternative sources.

Table 1 provides a summary of the reviewed trends and their impact on the energy security challenges faced by Belarus.

Table 1. Summary of the existing trends and their impact on energy security of Belarus

Policy recommendations

Table 1 suggests that the most of the vital energy security components will experience both positive and negative shocks in the nearest future. Nevertheless, it is possible to undertake a number of policy measures to enhance positive effects and secure against risks.

Reducing energy intensity of economy

All possible negative effects on the energy intensity reduction will be a result of either lowering incentives to modernize the existing technologies due to lower hydrocarbons prices or a reduced capacity to modernize due to drop in budget revenues. Yet, as discussed above, improving energy efficiency may become an important driver of economic growth in the foreseeable future.

Besides already existing Energy Efficiency Department of the Committee for Standardization and construction of the Astravets power plant having a positive impact on the energy intensity of the economy, the Belarusian government may also consider the following options:

Establishing a Research and Development (R&D) program on energy efficiency;
Creating a special energy efficiency fund to be used for the modernization and energy intensity reduction measures;
Imposing standards of energy use, especially in energy intensive sectors;
Introducing taxation schemes on energy use with industry-specific energy intensity reference values in order to provide additional incentives for businesses to undertake modernization and reduce energy intensity;
Issuing a mandate requiring gradual replacement and rehabilitation of obsolete equipment, especially in heat and power generating and energy intensive industrial sectors.

Heat and power generating sector diversification away from gas

Similarly, to the energy intensity challenge, the HPG sector diversification away from gas will be negatively affected by the reduced incentives to modernize and the lack of budget funds to impose these modernizations. Hence, the following measures may be considered:

Ensuring adequate progress of the Astravets power plant construction;
Imposing standards and taxation schemes of energy use by the sector;
Study options for electricity imports, especially in off-peak hours;
Gradually replace and rehabilitate obsolete equipment.

A number of steps to encourage use of specific fuel sources can be undertaken:

Study possibilities of expanding production and/or imports of coal;
Transfer some smaller-scale heat plants to coal and/or wood as environmental conditions permit;
Integrate production of fuel wood into conventional forestry and industrial timber procurement;
Assure quality standards and efficient use for forest chips.

While not being directly related to the sector’s diversification away from natural gas, the following measures will allow improving financial performance of the sector and, thus, providing additional resources to undertake modernizations in the sector:

Separate commercial operation of the sector’s state-owned companies from the government’s conflicting position as an owner, policy setter and regulator;
Imposing reporting standards, such as IFRS standards, in the sector in order to improve financial management of the companies and attract possible financiers;
Adopt and implement OECD 2005 Guidelines on corporate governance of state-owned enterprises. While a number of the guidelines are not applicable to the Belarusian noncorporatized companies such as Belenergo and Beltopgas, general principle allow for more effective management of the companies.

I purposefully omit an option of the ownership change of the heat and power generating sector’s companies in our policy recommendations, since this option is not consistent with the existing economic and political environment in Belarus.

Diversification away from Russian fuel imports

While all of the trends analyzed will have positive effect on diversification away from Russian fuel imports, this seeming progress is largely due to the fact that up until recently Belarus has been totally dependent on Russia’s fuel imports. Yet, a number of steps can be undertaken to further augment the diversification progress:

Ensuring adequate progress of the projects enhancing the diversification away from Russian fuel supply, namely LNG terminal in Kaunas, Astravets power plant and search of alternative suppliers of hydrocarbons;
Exploring possibility to access and explore Polish and Ukrainian shale gas fields with a possibility to operate some of the extraction facilities;
Studying an option to create a coal-bed methane extracting consortium with Ukraine to develop technology and extract coal-bed methane in coal-rich Eastern Donbas region;
Researching and developing biomass as a source of energy to replace a share of oil and gas usage.

Usage of pipeline system up to full capacity

It is next to certain that the configuration of the hydrocarbon routes in Eastern Europe is about to go through fundamental changes in the nearest future due to both reduced demand for Russian hydrocarbons from Europe and the launch of the Nord Stream pipeline system. Still, there exist a number of steps to ensure that Belarusian pipeline system is in operation and is enhancing the country’s energy security:

Creating a gas-transporting consortium with Ukraine to gain an additional market power to ensure adequate transit tariffs and share of volumes of the residual Russian gas exports to Europe after Nord Stream is launched;
If Russian hydrocarbons transit volumes fall below critical level, transfer to the reverse direction to make the best use of the Polish shale gas and Baltic seaports’ ability to receive oil for Belarus. By doing so, Belarus will ensure both hydrocarbons imports diversification and adequate operation of its pipeline systems;
Continuing search for alternative suppliers of oil and natural gas (including LNG) in order to assure adequate usage of the pipeline systems in the reverse direction.

Environmental effect

Similarly to energy intensity considerations, most of the negative effects of the current trends on the environment are related to either reduced incentives to modernize or reduced funds available for modernization projects. The following measures are intended to reduce pollution intensity of energy use:

Establishing a Research and Development (R&D) program on environmental effects of energy use;
Imposing environmental standards and taxes on energy use, especially in energy intensive sectors and bringing these policies closer to international standards;
Issuing a mandate requiring gradual replacement and rehabilitation of obsolete equipment, especially in heat and power generating and pollution intensive industrial sectors;
Establishing emission trade relations with the Kyoto Protocol Annex B countries to collect funds for the environmental modernization of equipment.

The following steps should be undertaken to minimize both actual and perceived environmental risks of the Astravets nuclear power station:

Working with the general public to educate them about modern technologies that guarantee nuclear power safety as well as inform them of virtually accident-free record of civil nuclear power besides Chernobyl disaster;
Establishing relations with the stakeholders that might be affected by the environmental impact of the projected power station, especially, local communities along Neris river;
On early stages, study the possibilities for the spent nuclear fuel treatment and reach the preliminary international agreements over the potential nuclear waste storage if needed;
Ensure compliance with the international standards of the power plant construction and operation and advertise this compliance strategy to the stakeholders.

Concluding remarks

Currently Belarus enters a completely new stage of its development as the old economic growth factors vanish, the political situation both within and outside the country transforms, and the geopolitical context changes. This new stage of the country’s development presents new challenges and new opportunities for Belarusian energy security, the key for any country’s independence. Careful consideration of the most critical energy security challenges coupled with professional and effective policy measures to tackle them is a vital task for securing Belarus’ economic growth, political sovereignty and quality of life improvement.

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Energy Security in Belarus: Economic, Geopolitical, and Environmental Dimensions

Posted on September 5, 2011 | Policy Brief

20110905 Policy Brief Energy Security in Belarus Image 01

Energy security is a complex issue that integrates economic, social, and environmental aspects. This brief outlines the fundamental dimensions of energy security in Belarus, highlighting key challenges and opportunities for decision-makers, policy analysts, and the general public. It examines how domestic policies, international relations, and environmental factors interact to shape the country’s long-term energy stability.

Understanding Energy Security in Belarus

Energy security is a growing concern for policymakers worldwide. In many post-Soviet countries, heavy dependence on Russian energy imports remains a critical vulnerability. This dependence is compounded by the high energy intensity inherited from Soviet-era industrial systems and decades of limited technological modernization.

Belarus, a landlocked country of around 10 million people, faces one of the toughest energy security challenges in Eastern Europe. It must balance its reliance on Russian resources with a need for diversification and modernization in an evolving geopolitical landscape.

Economic Growth and Dependence on Russia

During the early 2000s, Belarus experienced strong economic growth — averaging 7.7% GDP annually, outperforming Ukraine and Russia. However, the 2010 global economic crisis exposed a major structural weakness: Belarus’s dependence on Russia for both trade and energy.

Although Belarus’s economy weathered the 2010 downturn better than its neighbors, it became clear that the country needed to diversify its economic base. Russia continues to exert influence through energy pricing, gas pipelines, and political leverage, complicating Belarus’s efforts to achieve full economic independence.

Drivers of Belarusian Economic Growth

Belarus’s early economic success relied on three main factors:

Privileged access to Russian markets for exports and energy imports.
Preferential support for large, state-owned industries producing for export.
Government wage and price controls, which temporarily improved export competitiveness.

However, productivity growth — once the main driver of industrial performance — is slowing. Much of Belarus’s earlier progress came from “low-hanging fruit” investments in existing capacity, which are now nearly exhausted. Future growth will depend on innovation and energy efficiency.

Energy Efficiency Progress and Challenges

Between 1996 and 2008, Belarus improved its energy efficiency by almost 50%, supported by national energy-saving programs and major investments in modernization. Despite this success, Belarus remains more energy-intensive than its Western neighbors.

In 2008, the country required 1.17 tons of oil equivalent (toe) to produce USD 1,000 of GDP — far higher than Poland (0.41) or Lithuania (0.46). Closing this gap could raise annual GDP growth by up to 7%, underscoring the economic importance of improving energy efficiency and diversification.

Primary Energy Sources: Heavy Dependence on Natural Gas

Belarus’s energy system depends heavily on natural gas, which provides about 63% of the total energy supply. Over 80% of heating plants and 95% of electricity generation rely on gas as a primary fuel. Crude oil and petroleum products contribute another 29%, while renewables remain marginal.

This heavy dependence makes Belarus vulnerable to Russian supply disruptions. Strengthening renewable energy development and alternative fuel sources is essential for long-term security.

International Trade and Geopolitical Risks

Belarus produces only 14% of its primary energy and imports nearly all its oil and gas from Russia. While discounted energy prices once acted as implicit subsidies, Russia is now reducing these advantages.

To diversify, Belarus has sought alternative oil suppliers, including Venezuela, through agreements involving seaports in Odessa, Klaipeda, and Muuga. However, transport costs and geopolitical tensions with Moscow continue to pose challenges.

Meanwhile, Russia’s construction of the Nord Stream pipeline bypassing Belarus and Ukraine reduces their leverage as transit countries, threatening long-term energy and political stability in the region.

Environmental Impacts of Energy Use

Belarus ranks near the European average in pollution intensity, but energy-related emissions remain a concern. Improving energy efficiency and investing in modern technology could significantly reduce pollution.

The country still carries the legacy of the Chernobyl nuclear disaster, which affected nearly 20% of its territory and caused long-term economic, health, and environmental damage. Public concern remains high regarding the new Astravets Nuclear Power Plant, reflecting ongoing fears about nuclear safety.

Key Takeaways and Future Trends

Belarus’s energy security depends on three main pillars:

Diversification of energy sources and suppliers.
Improvement in energy efficiency and technological modernization.
Balanced environmental management and renewable development.

Future trends likely to reshape Belarus’s energy landscape include the shale gas and LNG revolution, Nord Stream operations, and the construction of the Astravets plant. How Belarus adapts to these changes will determine its economic sovereignty and energy independence over the next decade.

Achieving the Goal

Unintended Consequences

Conclusion

Bibliography

Conclusion

Main Energy Security Challenges for Belarus in 2011-2020

Policy recommendations

Concluding remarks

Understanding Energy Security in Belarus

Economic Growth and Dependence on Russia

Drivers of Belarusian Economic Growth

Energy Efficiency Progress and Challenges

Primary Energy Sources: Heavy Dependence on Natural Gas

International Trade and Geopolitical Risks

Environmental Impacts of Energy Use

Key Takeaways and Future Trends

Further Reading