Lessons (if any…) for Latvia from Belarus’ 2011 devaluations 26
During 2011 the Belarusian currency devalued twice: On 26 May the price of 1000 BYR dropped from 0.158 LVL to 0.102 LVL, a fall (i.e. a devaluation) of 35.4% and on 4 October BYR fell from 0.0929 LVL/1000 BYR to 0.0692 LVL/1000 BYR, a devaluation of 25.5%. Altogether, the Belarusian ruble has devalued some 63% since the beginning of 2011, or, in slightly different words it has lost two-thirds of its value while in terms of Belarusian money the Latvian currency has increased in price from 5618 BYR to 15198 BYR, a total increase of 170%, see also Figure 1.
Figure 1: LVL per 1000 BYR, 2011 - 2012, monthly data
Source: Bank of Latvia
According to standard textbooks this raises Belarus' competitiveness and should lead to increased exports while imports will decrease or, more realistically, not grow as fast as exports and this is exactly what happened, see Figure 2 - exports grew in terms of volume some 30% in 2011, much faster than imports and much faster than exports did the year before. Belarusian goods become cheaper, not in BYR, but in terms of LVL - on the other hand Latvian goods would, all other things held constant, become 170% more expensive in terms of BYR, which should reduce demand for them substantially, at least where local substitutes exist. Why did imports go up at all in 2011? As in Latvia, many exports require imported intermediate goods or raw materials - to increase exports, imports must rise, too. But we should believe that imports of many consumer goods have decreased.
Figure 2: Annual growth of exports and imports (%)
Source: IMF (as for all following graphs)
Note: 2011 data and in particular 2012 data are estimates.
More exports are good for economic activity - we should expect an increase in GDP. This also happened albeit at a slower rate than in 2010, see Figure 3. I am not sure of the details - 2010 was a year with particularly high growth following a dismal 2009, most likely private demand was subdued in 2011 due to dramatically higher prices for imported goods etc.
Figure 3: GDP growth (%) in Belarus
What caused this devaluation? Allegedly, the Belarusian authorities, in an attempt to secure votes (aren't votes secured by default in Belarus?) ahead of the December 2010 election, increased public sector wages dramatically. This leads to a big increase in consumption, certainly also for imports (see again Figure 2), which will show up in a worsening of the country's current account - which it duly did, see Figure 4. This deficit, if not financed by international borrowing, drains the country's central bank of reserves - and again that is what happened - until reserves were seen as too low to maintain the (semi-) fixed exchange rate and the Belarusian central bank chose to let the exchange rate go.
Figure 4: Current account balance, % of GDP
Not really many lessons for Latvia since what played out in Belarus was so predictable but let me offer two anyway:
It shows in its own brutal way that with a fixed exchange rate fiscal policy must adapt so as to avoid possibly unsustainable current account problems - this was ignored in Belarus and, quite frankly, so it was in Latvia where a far too loose fiscal policy exacerbated the country's massive current account problems of 2005-07.
Belarus' devaluation also provides ammo for those, myself included, who thought a devaluation in Latvia would not be the right choice. The comparison is imperfect as Belarus is a rather different economy and since the devaluation was handled very poorly there (a central bank that tries to impose restrictions on the purchase of foreign currency does not create currency stability...) but their devaluation did exactly what would have been so dangerous here: It overshot by a long way. Whatever competitiveness problem Belarus might have had I cannot believe that it would need a 63% devaluation to solve it, rather, as people panicked into foreign currency (which I could easily imagine that they would have done here - it has been seen before; March 2007 and the alleged text messages warning of a devaluation, June 2009 and the former Swedish central bank governor Bengt Dennis saying on Swedish TV that "it is not a question of if but when and by how much the lat will devalue" or, for that matter, December 2011 and the out-of-the-blue rumour of Swedbank's imminent bankruptcy) the Belarusian rouble devalued more than needed. Had that happened here virtually anyone with a foreign currency loan would have defaulted, possibly sending the banking system in the same direction.
I think it is a quite strong argument against external devaluation: Internal devaluation, as practiced in Latvia, is slow and brutal but it certainly does not overshoot!
As a further argument of this overshooting one may look at inflation in Belarus. Devaluation creates imported inflation as imported goods rise in local prices but Figure 5 seems to suggest that prices continue to rise so as to reduce some of the competitiveness gain of the devaluation or, as we would say, the nominal devaluation (change of the currency) ends up much bigger than the real devaluation (change of competitiveness).
Figure 5: Inflation in Belarus
And at the end of the day Belarus and its citizens hava a sharply devalued currency with most likely very little credibility, wages that have deteriorated massively in foreign currency terms - don't expect to see swathes of Belarusian tourists for some time to come - and high inflation eroding whatever competitiveness gain was made.
Morten Hansen is Head of Economics Department, Stockholm School of Economics in Riga