Tag: Devaluation

Inflation Expectations and Probable Trap for Macro Stabilization

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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.


  • 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

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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:

  1. A growing deficit of trade and payment balances;
  2. The National Bank’s continuing Belarusian ruble emission partly because of pre-elective directive wages’ raise;
  3. 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:

  1. 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.
  2. 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.


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”.