Lessons (if any…) for Latvia from Belarus’ 2011 devaluations 26

Belarus saw a massive devaluation of its currency in 2011. Now that the macroeconomic impact is starting to be recorded (and not least felt...) it might be time for some stock-taking - what can we learn from this devaluation?
Baltkrievu rubeļi. Foto: Raitis Plauks, F64
Morten Hansen 5.aprīlis 2012 14:08

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

Source: IMF

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


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Plus_opinionrudolfs_bems Morten, given the fall in GDP and employment (incl. migration), I just do not see how one can cast LV crisis policies in a positive light, when making cross-country comparisons. Internal devaluation does sound nice, but did it actually take place? Is there any evidence of a sizable expenditure switching towards domestic goods at home and towards exports from LV abroad? Or was it just a brutal cut in income without letting relative prices do their bit? Yes, wages fell, but that's just the initial trigger in a long chain... what about relative P of final goods (not much evidence there) and what about relative Q? 2 years after the crisis LV global export share has fallen rather than increased (exports do look strong when normalized with GDP, but for wrong reasons). I doubt there is a lot of action in the relative Q in domestic demand either.
 +2  Radius_box_plus Radius_box_minus 3 ATBILDES  ATBILDĒT  5.aprīlis 2012 22:04
Belarus_2011 In the end of the day, Belarus only has 'conserved' the risk of massive inflation on bank accounts, fueled by extremely high interest rates for private deposits. In order to prevent social tensions, the Belarusian authorities choose to compensate deposit holders with skyrocketing interest rates for losses caused by the devaluation of the Belarusian Ruble. Therefore the volume of national currency has been growing virtually on bank accounts at a speed much higher than the National Bank of Belarus would have managed with the money printing machine.

In the end of day the devaluation risk conserved now on bank accounts of Belarusian banks will cause either gradual inflation for years to come (if nobody is panicking) or it will result in massive inflation, if mass panic starts like it happened last year in May and in October 2011. The explosives are growing on bank accounts day by day - and the longer this happens, the bigger the explosion will be.
 +1  Radius_box_plus Radius_box_minus  ATBILDĒT  9.aprīlis 2012 22:25
Fikseris Belarus is pretty much bankrupt. Central planning is a disaster. USSR already showed that but Russia, Belarus have not learned the lesson.
 +4  Radius_box_plus Radius_box_minus 1 ATBILDE  ATBILDĒT  5.aprīlis 2012 14:42

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